11 minute read
access to capital
HOT BUTTON ISSUES
will be defining for many canadian biotech companieS in 2010
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When I was asked to write about a venture capitalists’ view on “hot button” issues facing the Canadian biotech industry, I initially considered many of the topics that typically drive the conversations amongst our partners, peers, and the CEOs in whom we invest: What will be the next big trend?; What will be the impact of healthcare reform in the US, particularly for new and emerging technologies?; Will big pharma continue to consolidate and/or broaden its scope beyond its traditional business model to cope with the challenges of the “patent cliff’ and lack of internal productivity?; How can we help our medtech companies more successfully cross the chasm from development to commercialization?; Is the current momentum in biotech M&A sustainable?; Are there better business models we need to consider in the financing of emerging companies?; Will there be a meaningful IPO window in 2010?; Will the pace of new biologic approvals at the FDA continue to grow and will biologics continue to emerge as an ever bigger proportion of those approvals?
Unfortunately, it didn’t take much evaluation to come to the realization that all of those issues are currently taking a very big back seat to one critical issue in this country. For emerging private health and life sciences companies in Canada the defining issue in 2009 was access to capital and this will continue in 2010. This issue is so prevalent that while speaking at a luncheon address to the New England-Canada Business Council in January 2010, Industry Minister Tony Clement, in following up on a discussion about a funding gap for U.S. biotech companies, stated “We don’t have a funding gap in Canada, we have a funding chasm.”
Having stated that access to capital is the hot button issue for 2010, I guess I should probably support that statement with some data. Let’s first take a look at where institutional money has historically been invested in Canada. From 2004 to 2008, private Canadian life science companies attracted close to $2 billion in new capital, with the vast majority of this capital flowing to early stage companies. In fact, during this period, funding levels for early stage companies pretty much followed the 10 per cent rule relative to levels in the U.S., with the real differential coming in terms of the
Funding gap in Canadian VC – HealtH and liFe SCienCeS 2004-2008
Total Invested
uSa(M)* Canada(M)* % of uSa Shortfall
$38,708 $1,870 4.83% $(2,001)
Early Stage Late Stage
$9,463 $1,025 10.83% 78 $28,958 $846 2.92% (2,050) Rat of Late to Early Stage 3.06 0.83 Predicted Late Stage Funding *** $28,958 $3,135 Short fall in Late Stage Funding $2,289
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Institutional Disbursements to Canadian Private Health and Life Sciences Companies Early vs. Late Stage HOT Deals
BUTTON ISSUES
Government Funding of Business R&D*
0.25
0.20
% of GDF 0.15
0.10
0.05 Cost of scal incentives (typically R&D tax creadits)
Direct government funding of Business R&D
0.00 U.S. Canada U.K. Netherlands Australia Japan *2005 date or last year available
Government funding of business R&D, whether through direct grants or tax credits, is a relatively small proportion of BERD in most DECD countries (e.g., about 20% in Canada). The use of tax-based incentives has been increasing in the OECD group, but Canada is unusual in its almost exclusive reliance on the SR&ED incentives. funding for later stage companies. We estimate that during this period, an approximately $2 billion deficit accumulated in terms of the amount of capital required to transition companies from the research and pre-clinical phase of development through to the clinical phase of development, where the average biotech will consume approximately 80 per cent of the total capital required to build and define the value of its products.
The accumulation of this financing deficit accelerated markedly through 2008 and 2009 as all forms of financing plummeted and investors began to focus their limited resources on maintaining and supporting their existing portfolio companies. The approximately $100 million invested in later-stage opportunities in 2009 addressed only a trivial proportion of the accumulated capital deficit. Still worse, the majority of these financings represented “survival capital,” in that while it allowed these companies to exist, it did not allow them to prosper and actually build value by advancing their development programs. The problem in Canada has been further exacerbated by the fact that during this same period, U.S.-based VC funds, one component of the funding ecosystem in Canada, fled the Canadian market, focusing instead on existing portfolios and new opportunities that were closer to home (it appears that 2009 was the first year since 2000 that no private Canadian life science company received a material first-time investment from a U.S.-based VC). Unfortunately we see little reason to believe that this will change in the near term. While U.S.-based life science and medtech focused VCs closed 46 new funds in 2008 and 2009 combined, in Canada for the comparable period the number is zero.
Funding issues for Canadian life science and medtech companies have not been confined to just the private companies or institutional sources of capital. While angel investors fought the brave fight and increased their commitments to the sector through 2007, the past two years broke that trend and today we are seeing angel funding levels back to those at the beginning of the decade. At the same time, the angel deals that were done in 2009 were very concentrated with only a few companies garnering the bulk of the angel capital; a trend we expect to see continue in 2010. On the public side of the equation the story has been more or less the same. While biotech and medtech companies enjoyed steady, albeit not spectacular levels of funding prior to 2007, in 2008 public market financings plummeted to the lowest levels in a decade. The latter half of 2009 showed signs of life, but even so funding activity was still at less than 50 per cent of the levels seen in prior years.
One would of course be remiss in discussing the access to capital issue if one did not look at other “non-dilutive” sources of capital. While the recession in 2009 prompted the Obama administration to announce $5 billion in new research grants for the U.S. National Institutes of Health (which already spends more than $30 billion a year on medical research) a similar response has not been forthcoming in Canada. In fact, in Canada the problem was even more insidious, as amongst OECD countries Canada is the highest in terms
of providing financial support for R&D in emerging companies via tax credits as opposed to direct cash contributions. The problem is that this results in a negative double whammy in times when investment capital is tight. In 2009, the recession, coupled with the lack of fresh capital, caused virtually all emerging companies to markedly reduce business expenditures in general and discretionary R&D spending in particular. So just when active engagement and participation by the federal government was needed the most the response, albeit a passive one, was to reduce its financial support for the sector, thereby further compounding the problem. In fairness, while the lack of additional direct R&D support remains outstanding, virtually all the provinces and to some degree the federal government (via new initiatives at EDC and BDC) have acknowledged the dearth of domestic venture capital and responded by launching a variety of new programs and initiatives (Teralys Capital in Quebec, the Ontario Venture Capital Fund, the Alberta Enterprise Corp. and the Renaissance Capital Fund in BC to name a few). Unfortunately, what is preventing these initiatives from quickly providing capital relief is to some degree the lack of engagement and participation of co-investors such as Canadian banks, pension funds and endowments who were historically the key sources of institutional capital in Canada for the venture sector and whose U.S. peers remain the backbone of the U.S. venture ecosystem. During the past four years dozens of these players in Canada have dropped venture as a supported alternative asset class. This, despite the many positive changes the Canadian VC industry has gone through, and despite the growing success stories of new managers and managers like ourselves who have made a substantial commitment to change and are delivering substantial value to our limited partner investors (to learn more I invite you to attend the CVCAs annual conference in May 2010 which this year is focused on “Driving Innovation”). Hopefully the recent $400 million venture fund of funds commitment by CPPIB to Northleaf Capital is a sign of better things to come.
Finally the lack of capital also appears to reflect a growing lack of engagement from some (though admittedly not all) of the established biotech and pharma players in the Canadian market who collectively generated $16 billion in Canadian-based revenues in 2008 (a 52 per cent growth since 2001). During the past seven years this group has steadily reduced its R&D commitment in Canada below the 10 per cent threshold level that was the basis of the “hand shake” agreement that accompanied the passage of bill C-22 in 1988. In fact at eight per cent, the reported level R&D spending in 2008, the “deficit” was $364 million, or more than twice the amount of VC capital deployed in 2009. Interestingly we are now seeing some of these same players committing substantial resources to the venture ecosystem in other countries such as France, where nine big pharma players (only two of whom are headquartered in France) have committed 63 per cent of the capital for a new fund to be managed by CDC Entreprises and focused on later-stage biotech and life science opportunities in that country.
So that’s the “hot botton issue.” Where will emerging Canadian biotech companies find the capital to continue to successfully build their businesses? The key thing to consider is not just the issue per se, but rather the opportunity that this issue underpins. During the past decade Canada has poured billions of dollars into building a viable biotech industry, and as a result today the Quebec/Ontario corridor is defined as the 3rd or 4th largest biotech cluster in North America, BC has produced handfuls of world class companies, and provinces like Alberta, Manitoba, PEI and Nova Scotia, not generally considered biotech hubs, have produced their share of significant success stories. Today, we are at a tipping point and it has come time for governments, HOT BUTTON established and emerging pharma and biotech companies alike, pension funds, ISSUES academics, investment bankers, venture capitalists, and all others in the life sciences ecosystem to make a choice: engage and work to implement solutions that benefit all these stakeholders (and in doing so grow the pie for everyone) or squander it all and watch Canada lose its foothold in a key knowledge-based industry that accounts for $45 billion of annual spending and that constitutes the backbone of many of the academic institutions across this country.
Peter van der Velden is the President and CEO of Lumira Capital, a leading North American life sciences venture capital firm with its head office in Toronto, and offices in Montreal, Boston , MA and Mountain View, CA
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