Yesterday’s announcement by Scale Venture Partners that it will make no new investments in healthcare companies may not have come as a huge surprise to some insiders. Kate Mitchell, a founder and managing director at the firm, says ScaleVP has been pondering the shift for two or three years, and that it effectively stopped investing in the life sciences a while ago. “It was known to people who know us,” Mitchell says. But now that the shift is public, she says, the firm and its life sciences partners Lou Bock and Mark Brooks will have an easier time taking part in discussions about what ails the biotech industry.
The ailments are many, but if they had a single name, it would be the Food and Drug Administration, in Mitchell’s view. When I reached her by phone yesterday and asked her to elaborate on yesterday’s announcement, Mitchell returned over and over to what she called the FDA’s “capriciousness” when it comes to reviewing clinical trial results. In the post-Vioxx years, she says, the FDA’s approval process for new drugs has grown so drawn-out and unpredictable that ScaleVP can no longer, in good conscience, ask its limited partners to risk new money on drug development deals. (She says the company will fully back the healthcare firms already in its portfolio, however.)
ScaleVP’s announcement did not go unnoticed in Washington. Mitchell (an Xconomist) says several members of Congress called her for more information yesterday after the announcement appeared—and she was happy to share a piece of her mind with them. “I hate to have ScaleVP be the sacrificial lamb, because I believe in this sector,” she says. “But if we can use this, we are going to.”
An edited version of our phone chat follows.
Xconomy: This must have been a difficult decision. Can you tell me how it came about?
Kate Mitchell: We have a very open and close-knit group. We think of venture as a team sport, not an individual sport here. We talk about these things as a group over time, and sometimes we go off-site and think about the sectors we want to focus on and the challenges and opportunities of each. So we have been talking about this, really, since the 2008 or 2009 time frame.
Our strategy in technology is that we like to invest after the pure science experiment is over and a company has a product that’s complete, and they are usually hiring sales and building out their commercial capability. In healthcare, our strategy had been to look for drugs that had some preliminary data in humans. One of our companies, Prestwick Pharmaceuticals, was going after a drug for Huntington’s disease. It was already approved and selling in Europe and Canada. Therefore it should have been a six- to 10-month process with the FDA. Well, it took us three years to get it approved.
There is such turn over at the FDA that there are a lot of people who are former insiders, so we have had some of these folks come in and talk to us about [the regulatory process]. As a result, we evolved our emphasis further to look at repurposed drugs. Orexigen is in our portfolio now; they make a version of wellbutrin, which is available generically and is one of the most widely available antidepressants. Early this year, the FDA said, ‘We can’t approve it and we aren’t even going to tell you what we need…We are going to wait for a year to even tell you what you need to go forward.’ They got some pressure from Congress, and now they have agreed that there should be another trial—after we had already done a successful Phase III trial. So, starting in 2008 through this year, we have had a continual series of problems with the FDA.
Our very first investment after we founded the fund was Seattle Genetics, which was a very successful investment for us. So our question to ourselves was, ‘Is this cyclical?’ If it is, that’s part of what we deal with as investors—thinking through how and when to invest. Unfortunately, we don’t think it is. Or if it is cyclical, it’s cyclical beyond the time horizon of our fund. It’s not the place to put our LPs’ money, despite our belief in the opportunity. As the time increases, your multiple goes down, your internal rate of return goes down.
We spent a lot of time talking about this over the course of the summer. We eventually said this is the right thing to do for the fund. Our job is to optimize the return of the fund by finding the right companies to invest in.
We have great entrepreneurs on the healthcare side, and they too are extremely frustrated. You might have seen the ‘Vital Signs’ report that the NVCA [National Venture Capital Association] put out. They founded this group called the Medical Innovation and Competitiveness Coalition, or MedIC, and I was the chair last year, and the thesis we have is that the FDA is making it uneconomical to invest in this sector. We are not saying that the FDA should willy-nilly give free passes to companies. But there are ways you can improve the process so that they feel comfortable they are not walking into another Vioxx or Celebrex.
X: What will Lou Bock and Mark Brooks do, now that they won’t be out fundraising or looking for deals?
KM: They will manage the portfolio. There aren’t any deals where you can just take your hands off the wheel. They are both going to stay actively involved. Lou is an active member in MedIC and we are going to stay active in that, probably more active. Lou worked at the bench at Genentech and went on to Gilead and he is? the perfect entrepreneur-investor; to have him not be able to invest is a good example of why the FDA needs to find some balance in their approach.
X: Stepping way back, I think it’s fair to say that biotech has not led to the discovery of as many revolutionary, life-changing drugs over the last 30 years as many observers hoped it would. So manufacturers fall back on making knockoffs and variations on older, approved drugs. I’m wondering whether part of what’s going on here is that this is just a lot harder than we thought, and biotech is simply a risky business—maybe too risky even for the venture industry.
KM: I think there certainly has been a lot of focus on me-too drugs. We should be focusing our dollars on things that are revolutionary, not evolutionary. But I think the bigger issue is the regulatory pathway. Look at how quickly countries in Asia and Europe are picking up the new technologies. You could get a stent in Europe long before you get could a stent here. There is something wrong with our approval process. That is the kind of risk we can’t underwrite.
X: You said in your blog post announcing the shift yesterday that this shouldn’t be seen as a signal that life sciences investing is over in the venture world, and that there may still be early- or late-stage funds that figure out how to make it work for them. How so? How do the issues at the FDA affect them differently?
KM: Talk to Ed Hurwitz at Alta Partners. He’s an early-stage biotech investor who has had a series of successful M&A outcomes, where before they get into expensive trials, they sell the company. Large pharmaceutical companies want to control the studies themselves, and they have more resources. That is certainly one strategy. Sofinnova does the same thing, and just successfully raised a fund. We do think there are some opportunities out there. But it’s difficult, when you are looking at the Phase 2 or Phase 3 stages, where there is some human data, and you are still subject to the capriciousness of the FDA’s approval process. When you look at the ‘Vital Signs’ survey, 61 percent of VCs said that regulatory challenges are the biggest single impact on venture investing, and over the next three years 40 percent said they were reducing their investment in biotech, pharma, and devices. That is the real message.
X: What about the life sciences firms that are still in your portfolio—Alimera, Ascenta, Oraya, Sonexa. How does this shift reflect on them?
KM: We think there is a lot of upside there. These are big markets with a great stable of CEOs—as strong a group of CEOs as you could find anywhere. We have them in regularly; a few weeks ago they were meeting with our LPs alongside our tech CEOs, and our LPs love them. They are good leaders. One of the reasons Marke and Lou are going to be busy is that we want to guide them to an optimal outcome. We have more than adequate reserves to take them through that. For whatever rounds they need, we are fully reserved, and our LPs understand that and approve that. So there is a lot to do here.
X: You’re the past president of the NVCA, the former chair of MedIC, the chair of the IPO Task Force. What do you think it says to the industry, and to government, when your own firm decides to walk away from life sciences investing?
KM: I have had some Congressmen reach out to me already today, and I’m glad that we can have those conversations, frankly. I am obviously not doing it for effect—it really came down to us sitting back and saying what is the right thing to do. But healthcare investing has moved outside our scope, and unfortunately, that does say a lot, and we are going to use it to further the dialog.