SVB’s Norris Discusses New Investors in Start-Ups

Jonathan Norris, a managing director for SVB’s Healthcare practice, says fund-raising numbers for biotech start-ups is strong while Medtech is seeing a decline. While VCs still will make bets in biotech, traditional Medtech VCs are pulling back, But medtech start-ups are drawing more capital from other players including corporates, family offices, limited partners and others.

Participant:

Transcript

TS: This is Tom Salemi at OIS TV. We are here at OIS@ASRS, and I’m here with Jon Norris, Managing Director of Silicon Valley Bank. We’ve let you hydrate after your presentation. I know you always put a lot of energy into the –

Jon Norris: It’s quite a workout, yes.

TS: Yes, yes, I know.

JN: Feeling better now.

TS: A new aerobic regimen. So give us the good news/bad news. Where are we in the life sciences venture world?

JN: So when I look at what’s going on in the world, I focus very much on venture healthcare. So that’s biopharma, medical device, and tools and diagnostics. And when I look at the first half of the year, a couple things that are pretty interesting and on the good news side: one, you continue to see a lot of investment in the companies. That’s good news. Venture firms went out and fund raised over the last few years. They all have plenty of capital to put into new companies. So we see lots of investment, and specifically on series A, both device and tools and diagnostics have funded more series A companies the first half of this year than they did all of last year.

TS: Wow.

JN: And on the biotech side, there was a huge amount of investment into companies last year for biotech. There were about 75 companies that raised $1.8 billion in series A financing. And you look at the numbers halfway through this year: we’re on track to get over 100 companies and close to $2 billion invested in those companies. And so it’s kind of shocking when you think about it because last year you saw this, crossover investors really sort of start to come into these series A financings with the idea that OK, we’re going to get a toehold in, we’ll invest a little bit of money in, and we’ll push them out as an IPO. And this in Q4 and then into early this year, we’ve seen the crossovers really retract from the market. So they’re doing a lot less investment than they did last year. Yet, series A is garnering more dollars than ever.

TS: So where is – I keep hearing how much the venture industry is suffering and how the model is broken, particularly on the medtech side. I’m a medtech guy, so it’s kind of like being an old-time Red Sox fan and you just got – you’ve got your brain looking in one way. But are things that rosy in the venture world? Or are there other investors coming in and kind of filling that gap that we weren’t anticipating would come in and fill that gap?

JN: You know, I think it probably makes sense to look at each of those sectors individually. On the biotech side, you’re seeing lots of exit activity last year, lots of IPOs, lots of M&A activity, lots of crossover investments. So that sector is feeling really robust. And maybe last year a little frothy in terms of the amount of investment into the sector. But I still think that that sector is feeling really good. On the device side, we were seeing a real decrease in series A activity over the last few years, which made me very nervous because actually, on the M&A side, the numbers of deals for acquisitions were actually fairly stable. So you’re seeing stable M&A, and then series A sort of falling off a cliff. And you’re like, well, how is this all going to work? Because you need to have new series A companies for folks to buy –

TS: Right.

JN: – or else at some point there’s going to be no gifts under the Christmas tree. And so seeing this in 2016 with more series A investment, I think that’s good. What we’ve also seen in device is, you know, going back like a decade, you could name like 5 or 6 VCs that did almost the vast majority of series A investing in device. But now the list is so diverse. It’s not just your typical venture folks. You’re seeing some corporate, but you’re also seeing a lot of family offices. You’re seeing LPs that used to invest into venture funds still doing that, but also do targeted investment directly into companies. And then you’re seeing some PE focused folks coming in and start to invest in in the series A side. Much more diverse.

TS: That’s amazing. You’re right. If you look at the roster of venture firms, and say you want to come out here and set up a meeting with VC firms investing in medtech in the Valley, which I was going to do, it’s not a huge list. And but you’re right, the money is still coming in there. Why have we sort of – I don’t know if your data would tell you this, but why have we sort of moved beyond the venture model into early stage medtech and allowed or enabled these other entities to kind of come in and invest. What sort of happened there?

JN: You know; I think part of it is just related to a function of how long it takes these investments to get to exit.

TS: Sure.

JN: When you look at biopharma, biopharma from the moment that you have an asset and you start to do preclinical testing and get into the clinic, the time to get a commercial product is pretty long. I mean you’re talking 10 to 12 years. You’re talking a lot of investment. On the device side it’s shorter time and shorter investment, but what the interesting point is, you started to see exits change around 2009. And you saw what used to be late stage biopharma M&A start to become early stage biopharma M&A. And so the time to exit for biopharma started to come down significantly. And there were a few years in the last 3 or 4 years where an average 4 to 5 years from the close of series A getting to either an IPO or M&A. So these companies obviously don’t have phase 3 data in hand. They’re early stage companies with really compelling data and an interesting technology that’s yielded exit. So I think what happened is the venture folks saw this and said, you know, would I rather put more money into a company that’s going to exit quicker? That sounds pretty good. And when you look at M&A on the device world, the vast majority of M&A happens for companies that have CE Mark, and then get FDA approval. They raise a commercialization round, and they start to ramp revenue. And that point is when the acquisitions start to happen. And so because of that, the time to exit in device is actually longer than the time to exit in biopharma, which is counter to what you would think based on the development life cycle of those two sectors, but that’s sort of what happened. And so investors are saying, OK, I have this capital to deploy in a finite amount of time. Where am I going to put those dollars? And a lot of folks were doing both biopharma and device, and you just started to see the scales tip to more dollars going into biopharma because those were exiting faster.

TS: Well, it’s a story we’ve heard before. And you’re right. If you’re going to get out of a company in 4 or 5 years, you’ll do that deal all day long. But the family funds, the corporate funds, they’re not giving their money away. They obviously expect to make money back from their – are they just more patient and they’re willing to wait for that deal? Or do they see something that the VCs are missing? Or perhaps they have other personal motives to invest in those medtech startups?

JN: Yeah, I think a little bit of it is philanthropic and personal motives of they see an area that is close to the benefactors of that fund’s hearts, and they’re like OK, I’m very interested in that sector. I think it’s also combined with not necessarily being as IRR driven as your typical venture fund. And then thirdly, I think the fact is that they have probably seen that there’s less investment in the sector, so if they are trying to strategically make bets, then you have M&A being constant and investment going down, you know, there’s a better probability of those device deals getting acquired. I think you’re starting to see some of the venture folks get more back interested in that sector. There are a few firms that in the past fund, their percentage allocation to device was fairly small, and now they’re ramping that up quite a bit because when you do think about it, what’s the story for wanting to invest in device? One, less companies, so you have your pick of the technology. You have pretty much your pick of the founding team. You have your pick of valuation, or at least it’s very investor friendly, and you have constant M&A. So when you put all those things together, it sounds like a pretty good time to start investing in early stage and M&A for device. But what people worry about is how long do we have to wait for those companies to get to exit. Will there finally be a flurry of early stage acquisitions? And we sort of saw that last year in 2015. We saw a bunch of mitral valve with one ophthalmology deal thrown in that were all development state, that happened in a quick succession. And so it’s great to see that because that starts to get people excited again to see very quick exits with compelling early stage technologies in device. But coming back to 2016, it’s sort of come back to the later stage exits so far this year. So I think we’re going to continue to see those flurries. The more that we see them, the more interest there’s going to be in investing in early stage device. But as you say, it’s sort of a mixed bag. You’re starting to see more investment in series A, which is good to see, and you continue to see M&A to be a fairly good, constant number. Which again goes back to device is a really interesting sector to invest in.

TS: And that makes me happy to hear that the good times are still ahead. We had our Medtech Conference in May – in June, actually, June first. It was a very positive feeling. It feels like people have sort of adjusted to the new reality and they’re moving forward and finding ways to invest in companies. But within ophthalmology, you mentioned some of the M&A. I mean we saw some great deals just this past quarter. The InFocus acquisition, pretty impressive if all those earnouts come to be. MIGS has been obviously a hot space overall. Is ophthalmology, is it representative of medtech? Is it an exception of medtech in that it is getting M&A activity? And yeah, the companies are older than 4 or 5 years in some cases. But again, the payouts are pretty robust.

JN: Yeah. And I think they’re getting their fair share is what the feedback would be. It’s not – you’re not seeing 6 to 8 ophthalmology deals getting acquired on a yearly basis. It’s maybe half of that. But I still think when you look at since 2013 by indication for biopharma and device together, which indication has the most exits? Ophthalmology comes in at number 4, which is good, when you think about I’m looking at probably 15 different indications. So number 4 looks pretty good. And when you look at series A and you’re seeing about 18 or so series A companies that I came up with since 2013 that have a primary focus on ophthalmology. So for example, a biopharma that has oncology as their first asset and they have something for ophthalmology behind that, I’ll classify that as an oncology company. So missing out on a few, but 18 of those since 2013, and you have about that same number of IPOs and M&A during that same period of time, makes you feel like this is a pretty attractive sector in terms of getting these companies to exit.

TS: Going forward, looking ahead, do you anticipate your report next year to be – will the first 6 months continue the second 6 months? Do you think we’re definitely in a cycle? Or was it just a particularly weird first 6 months, I don’t know, for the election or whatever reason? Is there some sort of anomaly that drove the activity this year?

JN: Yeah. I think overall, the venture healthcare sector, 2014 and 15 were really just amazing years from the types of exits that were happening, the number of IPOs that went out, M&A was very solid. But what I’m thinking about for the year 2016 is in biopharma, M&A I think is going to be at least the same level as 2015. You’re just going to see IPOs dip down. There’s going to be less IPOs. I’m thinking maybe 7 to 8 IPOs per quarter in the biopharma side. In medtech, I think M&A should be similar to what we saw in 2015. But IPOs have really sort of fallen off.

TS: Yeah.

JN: It really takes a very, very strong commercial story, big ramp to think about accessing the public market. And there’s probably a few that might do that this year. We haven’t seen many. We’re seeing some reverse merger activity, and then financing on top of that. But not your classic IPO. But I do think the M&A will continue to be solid. It would be my hope there’d be another flurry of early stage acquisitions in device in the second half of the year, but really it’s hard to know that. What typically happens, these flurries happen with one acquirer acquiring an early stage technology, and you sort of have that follower mentality of the 3 or 4 folks that have an interest in that particular area saying, Oh, boy, I’d better grab my next best technology out there to make sure I’m not missing out. And so you saw that in the mitral valve area last year. And so it’s my hope that you see that again this year, but it’s kind of hard to do that, try and make an estimate based on time for sort of a flurry of acquisitions. It just depends on when that first acquisition happens. But overall, I’m feeling pretty good about the sector, pretty good about venture healthcare. I think fundraising is going to be down a little bit this year, and that’s really just a function of so many firms just raised in the last couple of years. And you had a firm like OrbiMed that raised within 2 years of their last fund, which would have normally put them in maybe a 2016 cycle, but they raised in December of 2015, that throws things off. And then you have big firms like NEA that has a huge percentage of their – maybe let’s say close to a billion-dollars sort of focused in making investments in healthcare. And that was a fundraise that was 2015. So 2016 might not reach those numbers, but I still think that, when I think about the LP community, there’s interest in the healthcare sector, so those firms that are out look like they’re going to be able to close. And I think overall, I’m feeling very bullish.

TS: Great. And that’s a great way to end, but I refuse to end it because I want to ask this question. Looking at the numbers, do you see a sector that maybe has a lot of startups that maybe are prime to be that hot sector where one goes and then the dominoes just kind of fall?

JN: You know, I think afib and neurotech on the device side are probably really interesting on the flurry side. I’m not as close enough to ophthalmology to pick a subsector within ophthalmology that’s hot, but I know that there continues to be interest in that sector.

TS: Sure.

JN: Yeah. But if I had to guess, I’d say probably afib or somewhere in the neuromodulation area is where you’re going to see your next flurry of early stage acquisitions.

TS: Terrific. Well, we’ll hold you to that. Thanks for taking the time today, Jon.

JN: Thank you.