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The Experiment Begins: Y Combinator Admits First Biotech Startups

Xconomy San Francisco — 

Mark your calendars: the high-profile tech incubator Y Combinator holds its Demo Day in August. Even though its alumni include runaway tech successes AirBnB and Dropbox, much of the scrutiny will land on the handful of biotechnology companies that, for the first time, Y Combinator is admitting to its program for the upcoming summer session.

The hacker enclave is starting an experiment to see whether biotech innovators can become more like Web entrepreneurs—quickly launching lean, agile startups that get a first-stage product out as soon as possible to reap some revenue and tap into feedback from potential users and investors. Y Combinator chose its first few biotechs in private meetings this week but declined to release the names. The incubator’s new part-time partner Elizabeth Iorns, a Y Combinator alumna and former cancer researcher, was recently hired to help evaluate biotech applicants. Iorns is also a spokesperson for Y Combinator’s expansion into life sciences.

Iorns told Xconomy that Y Combinator will consider startups from any life sciences sector, including medical devices and diagnostic imaging systems. “At this stage, we’re really wide open,” she says. “This is really very much an experiment.”

The only detail Iorns divulged about the first several biotech participants is that they’re working on “research tools that have longer term medical applications.” The door is still open; candidates can apply for the summer program until the end of May.

Y Combinator’s decision to expand into life sciences has changed its overall investment structure. Because biotechs need more cash, the incubator will increase its own commitment to all startups, not just biotechs, to $120,000 per company. The higher funding level was also intended to support other capital-intensive projects, such as computer hardware startups.

The move into biotech has also sparked online debate, including skepticism that after launching more than 600 Web startups since 2005, Y Combinator has the know-how to shepherd life science companies. Other criticism seems rooted in anxiety about cultural divides breaking down; that the influence of Web technology will have a pernicious effect on the next generation of biologists.

In a sense, though, that cat is already out of the bag, let loose in part by Y Combinator itself. One of its alumni is Experiment.com (formerly named Microryza), a crowdfunding platform that allows biomedical entrepreneurs to raise seed money for research when they lack access to established financing sources such as government grants.

Another was started by Iorns herself. She used her summer 2011 residence at Y Combinator to co-found the Palo Alto, CA-based Science Exchange, an online marketplace that helps scientists outsource some of their experiments to research centers whose expensive equipment would otherwise remain idle part of the time. This reduces capital outlays for biotech startups, because they don’t have to raise huge amounts to buy all the equipment themselves.

One young scientist (and Science Exchange user) says Y Combinator’s program, with Iorns involved, should work well for life sciences companies. “I think it is very transferable,” says Ethan Perlstein, who in 2013 bootstrapped his own rare-disease drug discovery lab and now rents space in a corporate-sponsored incubator in San Francisco. “I’ll be really interested to see what the first batch of biotech companies looks like.”

On-demand services like Science Exchange could spark an expansion of biotech entrepreneurship in the same way that Amazon lowered barriers to entry in the hi-tech world by hosting other companies’ apps and other products on its servers, Iorns contends: “Amazon Web Services transformed Web development.”

Another factor is the emergence of incubators where small companies can rent laboratory bench space for as little as $1,000 a month. “Fundamentally the economics and timelines for biotechs have really changed,” Iorns says.

Traditional VCs already know that biotech structures can be made more virtual or “modular,” to use a software term. But Iorns extends a more radical idea to the conservative biomedical world: “Anybody can do this if you have a great idea. You don’t necessarily need to have a tenure track position (in a university) to do research.”

The tech world has long celebrated its upstart heroes who began in dorm rooms or garages. But the prospect of a similar opening of biomedical entrepreneurship has set off some cultural tremors.

Should a former post-doctoral student, stymied by a lack of faculty positions, use a crowdfunding site to ask ordinary folks to finance a therapeutics startup? What about undergraduates? How will the resulting research be validated if that student isn’t working under a university professor toward publication in a peer-reviewed journal? These worries have surfaced most noticeably in a news story from Nature, the elite publisher of peer-reviewed scientific journals, that questioned Y Combinator’s financial support of the Immunity Project. At the time of the backing, the independent initiative to develop an HIV vaccine had not yet published its research.

Iorns, on the other hand, has been challenging the status of peer-reviewed publications as a guarantee of scientific validity. Studies published by established academic scientists often can’t be reproduced by other labs, she says. Through Science Exchange, pharmaceutical companies are now arranging to have key experiments repeated before they pour money into drug development projects based on the original papers, she says.

Iorns says entrepreneurs can now bypass the standard academic cycle of discovery, whose slow pace she calls “ridiculous.” Researchers write grant proposals, wait for the funding, do the experiments, write up the results, then submit the paper to a journal for a long review process. “The whole iterative cycle is about five years,” she says.

Meanwhile, Perlstein is an example of how that cycle can be circumvented. The former Princeton post-doc is developing a screening platform for drugs to treat extremely rare orphan diseases. Through social media, he recruited a network of advisors to evaluate the business plan for his company, Perlstein Lab. One of his Twitter contacts became an investor. Perlstein told Xconomy he recently signed part of a deal for an early financing round that is substantially larger than the $120,000 Y Combinator will invest in each of its startups beginning this summer.

Y Combinator doesn’t usually announce the names of the 60-odd startups it chooses for each of its two annual sessions in summer and winter. During the three-month program, company founders may ditch their original idea and pivot in a whole new direction.

Outsiders will be eager to see whether Y Combinator can help biotech companies enough to make them attractive to the next round of investors, in time for the incubator’s big Demo Day at the end of the summer session.

Some of Y Combinator’s core benefits transfer easily to biotech companies, Iorns says. For example, the incubator makes sure each startup’s incorporation paperwork is in good shape, a requirement to attract new investors. It also mediates disputes that can arise between co-founders.

But it has to adapt, as well. Y Combinator will recruit outside biomedical experts as advisers, and it will arrange for private meetings with life sciences venture firms if necessary, Iorns says.

Y Combinator will not build its own lab facilities (it doesn’t provide office space for tech participants, either), but it will keep a file of resources on hand so its biotech participants can line up lab space, Iorns says.

To help meet the higher capital needs of biotechnology startups, Y Combinator has changed the standard terms of its investments. Most participants will now receive $120,000 in exchange for a 7 percent stake. Under the former terms, the startups got $17,000 for the same 7 percent stake, and a later investment of $80,000 from affiliated venture firms and angel investors.

Y Combinator will advise its biotech flock to get an early product to market if possible while pursuing longer-term goals. As an example of this strategy, Iorns points to Menlo Park, CA-based Stem Cell Theranostics, which was founded in 2013 to commercialize stem cell research from the labs of two professors at the Stanford University School of Medicine. Its co-founders include a former Stanford undergraduate, Divya Nag, and a Stanford post-doctoral student, Andrew Lee, who also co-founded StartX Med, the student-run campus incubator for biomedical entrepreneurs. Stem Cell Theranostics now supplies a research tool, stem cell-derived heart cells, to drug companies. Drug developers use the living cells to evaluate the safety and possible effectiveness of treatments for cardiovascular disease.

Whether Y Combinator will be able to scale up its biotech development model remains to be seen. Lab space rental facilities may not expand to meet the demand. Even if starting up is easy, further growth may be hard. Less than a few dozen early stage investors are active in biotech, compared to the crowd of angels, venture firms, and established tech companies that compete to invest in Y Combinator’s hot Web startups, Atlas Venture partner Bruce Booth said in an extensive analysis of the incubator’s new initiative on his blog, Life Sci VC.

Nonetheless Booth applauded the Y Combinator experiment and defended the group against criticisms that biotech would be too hard: “The risk of failure for a tech startup is way higher than biotech.”

Y Combinator also got a vote of confidence from Breakout Labs, a hybrid philanthropic and investment initiative funded by PayPal co-founder Peter Thiel. The organization, a unit of the non-profit Thiel Foundation in San Francisco, is helping to fill the funding gap for life sciences companies with grants of up to $350,000.

“At Breakout Labs, we’re focused on taking ideas from the lab into the economy,” says executive director Lindy Fishburne. “The companies making that move would certainly benefit from the strategic rigor that Y Combinator is known for providing its companies.”