The current global financial crisis is having an enormous impact on almost every sector of the economy. Biotechnology and other life sciences companies are no exception to the consequences of the credit market carnage. It is very difficult to make any predictions about the near and medium term outlook for life sciences companies' ability to raise needed funding. However, one can be fairly certain that the environment will remain very difficult for some time. Since the short term picture may remain somewhat gloomy, companies need to appreciate the challenges and adopt strategies which are realistic and enable them to avoid potential disasters.
The recent financial debacle has definitely opened everyone's eyes to the horrible mess in today's global credit markets. However, the credit "crunch" (as opposed to "crisis") has been a feature of financial markets for over a year. The Canadian venture capital market has been relatively lethargic for a significantly longer time period. Consequently, Canadian life sciences companies have faced a difficult funding environment for some time now. Nonetheless, things are clearly getting worse. Venture capital investment in Canada in the first half of 2008 was down 39% compared to the first 6 months of 2007. In the life sciences sector, the drop in investment compared to 2007 was less severe, but still significant. Just as concerning, new emerging companies looking to the venture capital market for the first time continued to have a particularly difficult time raising funds; over 80% of venture capital investment went to follow-on financings of companies in which venture capital funds have already made an investment. Venture capital investment by U.S. funds accounted for 35% of the total invested in Canada during the first half of the year, a slightly lower percentage than in 2007. However, investment by U.S. funds remains significantly higher than its historical average and it is likely that any growth in Canadian venture capital financing will come from U.S. venture capital funds.
In the U.S., venture capital investment remained relatively flat in the first half of 2008 compared to 2007, although the life sciences sector witnessed a significant drop in activity. More ominously, the National Venture Capital Association ("NVCA") noted that for the first time since 1978, there were no venture-backed initial public offerings in the second quarter of 2008. This followed an exceptionally slow first quarter when only five venture-backed companies went public. The NVCA has characterized the situation as a "capital markets crisis for the start-up community". (In Canada, there was one venture-backed initial public offering during the first half of 2008.)
The dramatic slow-down in exit activity for venture-backed companies has serious implications. First, exits, especially those that generate high returns for investors, correlate strongly to funds being reinvested in new companies. Secondly, if venture capital funds realize that their exits will be postponed, they are likely to reserve funds for their existing portfolio investments that would otherwise be available for investment in new companies; the venture capital funds need to maintain cash which may be required to meet cash flow needs of existing companies which cannot go public or be sold.
In the public markets, life sciences companies have suffered severe losses in market capitalization along with almost everybody else. After an almost 30% drop for Toronto Stock Exchange listed life sciences companies in 2007, recent stock market plunges have taken a huge toll. In the U.S., there has been a meltdown in biotechnology and pharmaceutical public company stocks in the past few weeks, after they had held up fairly well for most of the year. According to Burrill & Associates, U.S. biotechnology financing, both for private and public firms, is on pace to generate about U.S.$10 billion, the lowest amount since 1998.
As bad as some of these statistics are, they reflect activity only through the first half of 2008. Information for the third quarter is not yet available. It is reasonable to assume that the overall situation in the venture capital community has already or will worsen over the next few months. In addition, there are now fears that limited partners who provide the capital to venture capital funds will begin to renege on their commitments and simply refuse to honour capital calls.
What does all this mean for life sciences companies? According to the BIOTECanada/PricewaterhouseCoopers surveys, access to financing has been consistently the number one issue for Canadian biotechnology companies. It is likely to become even more difficult for life sciences companies to raise new or follow-on funds in the months to come. Companies need to carefully assess whether they can delay or reduce the cost of their development programs to conserve as much cash as they can. Companies that do attract venture capital interest will discover that the terms offered to them will be much more onerous than they would like. Many companies will not be able to reduce their cash burn rate sufficiently or raise new funding. For these companies it is important that they evaluate their situation soberly and realistically. The one silver lining in all of this mayhem is that the M&A trend in life sciences, especially for biotechnology companies, will likely continue its upward trajectory. Big pharmaceutical companies are still looking to fill their product pipelines by acquiring or otherwise locking-up biotechnology assets. Licensing arrangements, strategic alliances or partnerships and outright sales to pharmaceutical and other strategic investors may be the most effect way for many life sciences companies to keep their products alive. If these companies wait too long to consider and pursue such opportunities, they may run out of both cash and time. The best advice for such companies may be that, until the funding environment improves, careful evaluation and assessment of possible M&A transactions should become an integral part of their ongoing strategic planning.
These very difficult times may provide an opportunity for the life sciences sector, governments, the investment community and other stakeholders to take a close look at the fundamental issues with the funding of emerging companies. There are those who argue that the model currently in place is flawed and needs to be re-thought and significantly adjusted. Perhaps the current financial crisis will motivate discussion and consideration of meaningful improvements to this model with long term sustainable benefits.
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