Avalon’s Kinsella Calls Out Big Pharma for “Bad Behavior” That’s Pushing Biotech Ventures “Almost to Point of Extinction”

Xconomy San Diego — 

San Diego’s Avalon Ventures has had some noteworthy success in the past couple of months. The 28-year-old firm raised $200 million for its ninth fund, which was oversubscribed by 33 percent. Avalon, which invests in both life sciences and Web technologies, also took some winnings off the table with the recent sale of a portfolio company, Boston, MA-based BioVex Group, for $425 million (with another $575 million in potential milestone payments). In addition, two other Avalon portfolio companies were acquired in December (reportedly at significant multiples of invested capital): San Francisco-based Cloudkick went to Rackspace and AOL acquired New York’s Pictela.

And then there is Avalon’s Series A and B round bets on the Zynga Game Network, which was recently valued at $7 to $10 billion and is expected to be the firm’s best investment ever.

With Avalon riding high, there may be no better time for Avalon founder Kevin Kinsella to raise a matter that he finds deeply troubling.

“There have been numerous instances of what I refer to as bad behavior—combined with short-sighted, brass-knuckle negotiating tactics—by some pharma companies that really go to the heart of whether this partnership between Big Pharma and biotech can really continue,” Kinsella says. He maintains that the pharmaceutical industry is doing enormous damage to the life sciences venture capital ecosystem. “Their predatory business practices,” he says, “are pushing the sector almost to the point of extinction.”

Kinsella concedes that Big Pharma CEOs might not even realize how their companies have been undermining the well-being of the biotech startups that Kinsella says are their chief source of new drug candidates. Talk to a Big Pharma CEO, Kinsella says, and he or she will glibly tell you that the next generation of products is coming from biotech, “while two floors below in business development, they are wreaking havoc on biotech startups.”

How is this happening?

In a series of interviews over the past three months, Kinsella has talked with me in detail about some of the egregious business practices in the pharmaceutical industry that he’s encountered, which he likens to overfishing by commercial fisheries. As a respected biotech investor with a 30-year record, Kinsella says he’s seen industry cycles come and go. But he contends the pendulum has gone too far this time, and it may be too late to set it back on its bearings. He’s calling out Big Pharma, and arguing for a more sustainable ecosystem for drug development. It’s not the whole story, but rather the opening fusillade in a debate that’s long overdue. Here at Xconomy, we welcome your response.

Kinsella lumps Big Pharma’s bad behavior into several piles:

Structuring Completely Back-Ended Deals: During one buyout negotiation, Kinsella says, “The acquiring … Next Page »

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28 responses to “Avalon’s Kinsella Calls Out Big Pharma for “Bad Behavior” That’s Pushing Biotech Ventures “Almost to Point of Extinction””

  1. Jens EcksteinJens Eckstein says:

    Kudos to Kinsella for telling the ugly and naked truth!

  2. Mike Krupp says:

    I think those of us who “grew up” in big pharma BD shops can understand the situation the Kevin has described all to well. Most of us used to believe that we were forming long term relationships with licensing/alliance partners. In that scenario we tried to create deals where both partners came out ahead. The “Wall Street” bottom line, winner/loser model is short-sighted, and doesn’t value the intangibles that make deals work. I hope this will change before we wreck the biotech industry.

  3. Cindy says:

    Insightful and direct. The trickle down effect of less Biotech in San Diego can already be seen – fewer opportunities, higher unemployment, talent leaving and more available commercial space… A once vital and important sector of the economy continues to be kicked while its down.

  4. Pasteur says:

    he makes very good points, but the irony of a VC complaining about being bullied by someone with cash (pharma) should not be lost on many entrepreneurs.

  5. Brian says:

    Insightful but he forgets to mention that as a result of such tactics, the VCs are feeding on their own with later stage rounds crafted with terms that are predatory on those in earlier rounds. Fewer funds are doing early stage bio investing and those doing later stage are crafting deals to try and get them early stage returns to offset the issues Kevin talks about. It isn’t just big pharma who is playing hardball.

  6. Joe Entrepreneur says:

    Is Mr. Kinsella really whining about how poorly he is being treated by big pharma? Let him go out and try raising money from members of his own ilk – the VC community. Talk about being treated poorly. Do I hear 5x liquidation preferences anyone? I have seen biotechnology VCs crush entrepreneurs with their board seats, control provisions, cram downs and other tools of the trade and I can tell you that whining when the shoe is on the other foot is quite hypocritical.

    Having just raised another $200MM I doubt that Team Avalon is crying about that lovely 2% management fee they receive every year. Boo-hoo because they can’t collect on their 20% carried interest until their “partners” make money. I find it quite interesting that this tear-filled appeal comes at a time when there is a nearly non-existent IPO market for biotechnology offerings and big pharma appears to be the only option for follow-on financing for VC-backed companies. What should biotech entrepreneurs say as VCs turn them away in droves? Unfortunately the sad fact is that in a good market for IPOs and M&A, the VCs are the princes and the entrepreneurs are the loyal subjects but in a bad market the VCs cry “pauper” and the entrepreneurs still remain the loyal subjects.

    Specific complaints include: (a) Structuring Completely Back-Ended Deals – is this not what every VC does with the founding entrepreneurs, diluting their interest down to a mere few points only to tell them “wouldn’t you rather have a small piece of a big pie eventually rather than a large piece of nothing?”; (b) Bad Faith Negotiations – although I have never heard anything specifically about Avalon (to the contrary I have only heard good things) there are a number of firms that utilize the “bait-and-switch” tactic citing “new discoveries in due diligence that now lead to a lower valuation”; and (c) Partnerships Without Risk – OK, so this is an area where I have to concede and say “yes, VCs do take risks” (but with other people’s money while getting paid a 2% management fee).

    At the end of the day at least VCs are in the game and getting paid to be in the game. Entrepreneurs are the ones who should be crying foul. If VCs don’t like a pharma deal just do what my momma told me when I passed kids smoking on the street – “just walk away”. You may ask why VCs just don’t invest money more efficiently so they can generate returns without being forced to deal with big pharma? The answer lies in the VC model which is driven by putting large amounts of money to work regardless of capital efficiency. If a VC invests $5M to make a 30% IRR over 5 years he/she gets $100K/year management fee ($500K) plus a $2.1M payday upon exit (assumes 10% high water mark return for LPs) for a total of $2.6M. If the same VC invests $30M to make a 15% return (on average they should be so lucky given the stats over the past 10 years), he/she collects $600K/year management fee ($3M) plus a $2.4M payday for a total of $5.4M. My math might be off a little but I don’t think its off by close to $3M.

    I hope you can see why its hard to be sympathetic. Despite this I would still do the brotherly thing and take up a collection for the venture capital community (although it might come with a 3-year non-dilute).

    Joe Entrepreneur

  7. stockfodder says:

    Speaking of a current situation… Does anyone have any insight into the debacle over at Tengion yesterday? like who the partner was that walked away from the deal??? No one seems to have dug that one up yet.
    If you heard their leader Dr. Nichtberger speak on Monday at BioMed conference, giving a concise and very upbeat take on Tengion’s future in regenerative medicine and then got hit with the almost 50% drop in share price two days later, your neck is still stiff from going back and forth (or rotating).

  8. Pathfinder says:

    I wish KK would have named horse and rider instead of leaving the reader in the dark about the identities of the accused but that might have burned some bridges (smiley). Despite the frustrating and anger provoking behavior of some black sheep I do not believe that this is representative for “pharma” as evidenced by many lucrative deals that actually got done. Most understand the symbiosis with biotech very well. But then: Who is not aware of some pharmas affording themselves large but scattered BD resources with lack of direction, confusing org charts and reporting lines where the left hand does not know what the right hand is doing, where commitment to external R&D is more a lip service that anything else? Beware of those!
    Also, one must not forget the many cases of expensive phase III deals that blew up because of negative clinical results. Those who paid a lot of money probably faced a lot of questions in their respective organizations. The next deal will be different.
    Other factors that hamper the prosperity of VCs and their portfolio companies certainly include the unpredictable behavior of the FDA, the recent financial crisis, which shifted the risk-reward paradigm toward risk in red capital letters, the virtual disappearance of the IPO market and, last not least, a certain overindulgence of the VC industry itself, which is now experiencing a drought. And then there is Joe Entrepreneur. Take that.
    There is no one cause for the current calamity but rather many contributing factors (surprise).
    Time to rethink and regroup using a self critical and reflective approach towards self renewal.

  9. The situation... says:

    Let’s play Harvard Business School:

    So you are an entrepreneur with a Great Drug. A biologic (so the success rate on average is 15%, not 7% ); let’s say that it can be made “cheaply” in bacteria and doesn’t require mammalian cell culture; you have an initial go-to-clinic indication for an orphan disorder, with upside for much larger mainstream markets that can be partnered out; a good safety profile based on mechanism of action and highly specific targeting; limited competition, an established market and a proven drug target that you have greater potency against than the standard of care; issued broad patents with significant remaining term; licensing and research partnership with a marquee medical center where the innovator wants to continue to do grant-funded R&D to advance the program; you are not yet in the clinic, although you have bootstrapped and own almost all the equity – however, you have burned most of your savings, and now need a salary, plus the $3-4M needed to get into Phase I.
    This should be as bulletproof as it gets, right?

    But, given the current dysfunctional state of the food chain, what are you, Jane Entrepreneur to do? Do you: take VC money to go big and move rapidly through pivotal tox and early stage clinical, but keep only a few percent of the equity that is going to get crushed by preferences and a flat Pharma exit anyway? Go the Pharma partnership route early but try to keep the orphan indication off the table? Try to fund through IND with grants and Angel money (if such a thing exists without VC terms these days)? Throw up your hands because the system is so broken?

  10. Gil Arie says:

    Great article. All that we need now is an article (interviewing a startup CEO…?) that will tell us about the predatory economics offered to startups by the life sciences VCs.

  11. Chris says:

    Fascinating interview, and great comments from both sides of the fence. With regard to the short-sighted behavior of big pharma, it reminds me of the Idun-Pfizer-Conatus story from last year, which I wrote about on my blog: http://blog.absorption.com/absorb-this/dont-kill-the-goose-that-laid-the-golden-eggs/. Here’s to the little guys!

  12. A says:

    “Kinsella maintains that another consequence of Big Pharma’s mercenary mindset is a refusal to assume the risk that goes with early stage drug development.” There goes the argument that drug prices in the US need to be high to allow all that expensive research.