In these times I like to reference one of my favorite books — The Hitchhiker’s Guide to the Galaxy by Douglas Adams — because the phrase “Don’t Panic” is emblazoned on the cover of the Guide in large calming font.
After the heady ride up in 2020 and 2021, the current downturn in public biotech indices, which are down between 30-40% (BTK or XBI) since their peak, has had a knock-on effect for private biotech companies trying to fundraise. With valuations decreasing and companies struggling to raise their next round of financing, it’s a good to heed those words and not panic.
Stretching the Budget
It took roughly 2 to 2.5 years to see bear markets turn positive following previous biotech public equity downturns. However, given that biotech initial public offerings in 2020 and 2021 broke records with 149 companies raising at least $50 million vs. 83 companies in the prior two years, it’s likely markets won’t bounce back up to the 2020-time frame and instead we’ll see recovery with valuations similar to the 2018-time frame. Venture capital firms have all taken a hit to their returns, some worse than others depending on the number of public biotech companies in their portfolio. Given this hit, investors reserved more capital than originally planned for their companies, which has meant fewer new investments. Private biotech companies should expect the next few years to be tough for raising new capital from venture investors.
Companies need to think about being capital efficient and stretching their current budget during these lean years. For first-time CEOs who haven’t experienced a downturn, it’s important that the board provides support. This generally means taking a hard look at budgets and potentially cutting back to two or three key programs and sometimes cutting staff to conserve cash to get programs further in development than originally anticipated. In fact, 29 companies in Q3 2023 announced layoffs with median reductions in workforce of ~ 33% to extend cash runways for about two quarters.
Over the past two years, there was an influx of cash available from typical private venture capital investors but also crossover and generalist investors who, for the first time, were investing in early-stage Series A private biotech financings. The first half of 2022 saw a 12% decrease in number of biotech startups in the US and EU raising financing with a >20% decrease in total capital raised — $11.2 billion in 422 financings vs. $14.5 billion in 480 financings in 2021. Many companies in 2020-2021 raised significant Series A rounds — $75 million to $100 million — to fund the company through development candidates or investigational new drug filings. To attract new investors today, funding needs to have at least line of sight to clinical proof-of-concept. This typically means turning to business development to supplement with non-dilutive funding to extend runways. On the bright side, pharmaceutical companies are still dependent on biotech for new products with ~50% of their products in-licensed.
Companies should also temper their expectations on valuation. Generally, the current mantra from investors is a flat valuation is the new up-round and a down-round is the new flat valuation. There has also been an increase in insider-led terms-sheets with one in five financings announced in Q3 2022 led by an existing investor, about double the average from the last two years.
Longer Path to Exits
With the IPO window essentially closed, at least to preclinical stage biotech companies, we should see an increase in M&A from pharma companies, especially those sitting on a lot of cash from COVID treatments. Additional motivating factors are the looming patent cliffs, with industry leading big pharma companies expected to lose more than $200 billion in revenue by 2030 from loss of patent exclusivity.
We have seen M&A activity pick back up from the five-year low in the second half of 2021. The first half of 2022 saw a substantial amount of dealmaking with ~$92 billion worth of deals announced, including Pfizer’s highest-value deal in more than 5 years, the $11.6 billion acquisition of Biohaven.
Future is Still Bright
Remember nothing is permanent and this too shall pass, or whichever cliché you like best. But it is true, these moments can be tough, the company may have to make hard choices about its pipeline and/or take a lower valuation in the next financing but if the team and science demonstrates clinical impact, everyone will win – company, investors and especially patients.