My Accidental Oncology Thesis

Generally speaking, there are two types of venture capitalists: those that are thesis-driven; and those that are opportunistic.  Thesis-driven investors believe that through identification of market inefficiencies or seeing trends before they happen, they can exploit those inefficiencies and decipher market developments better and faster than their peers.  While on the other end of the spectrum, opportunistic investors seek the best deal at any given point in time.

I have always considered myself to be an opportunistic investor.  This is partly due to the fact that the Osage University Partners model is predicated on tracking a robust pool of university start-ups and waiting for the optimal time to invest.  Every so often we do attempt to execute a particular thesis, but there is always a risk that by focusing too much on the thesis of the moment we will miss out on evaluating other quality opportunities.

A major portion of the active investments in the Osage life science portfolio is oncology-focused start-ups.  My colleagues and I certainly did not set out to create a portfolio of oncology assets, but in many senses, we have created the prototypical thesis-driven market index that touches on many of the in vogue oncology areas (immunotherapy, autophagy, tyrosine kinases, orphan disease, microRNA).  

But, if we weren’t trying to abide by an oncology thesis, how did my colleagues and I arrive at this point?  Oncology, as an area of drug development, has a number of attractive attributes:

As our Fund looks toward the future, oncology will likely continue to play a major role in our investment portfolio.  That being said, it is hard to imagine that oncology products will be able to maintain premium pricing in perpetuity, meaning that newer products will have to go further in defining product differentiation and the lengthening of patients’ lives.  Therefore, new products, like many of those in our portfolio, will have to push the edge of our understanding of cancer and drive drug development into whitespace – an area that pharmaceutical companies have historically rewarded investors.


Target Selection: How Do VCs Balance Risk?

Target selection is a topic that dominates boardroom discussions for many early stage venture-backed companies.  The central question regarding target selection revolves around whether a company should go after a precedented target that is theoretically de-risked, or tackle a novel target that comes with inherently more risk but a potentially greater return.  More times than not, management and investors have divergent opinions about what path – precedented or novel – a company should follow. 

There is a common assumption out there that VCs are inherently more risk-averse than company managers.  In my experience, I have found there to be no link between investors being risk-averse and management being risk-takers - yet, it is rare that both sides agree on what level of risk a company should take.  Moreover, target selection/risk management appears to be more of a visceral reaction by individual boardroom participants than groupthink by either side.

Recent data compiled by McKinsey and published in Nature Reviews Drug Discovery highlights the fact that biopharma pipelines (start-up and established) appear to be dominated by novel products.  Additionally, the modest number of drugs being developed per novel target would indicate that there is great breadth in the number of novel targets that biopharma companies are working on. 

To be frank, I think this chart is a bit misleading.  As Bruce Booth of Atlas Venture recently noted, there is a lot of lemming activity going on and while targets are “novel”, development activity is isolated to a select few as many of the “novel” compounds are just “me-betters”.  For instance, should drugs (e.g., PI3K, PI3K/Akt, PI3K/mTOR) that generally inhibit the same target be considered “novel”?

I strongly believe that life science venture fund portfolio construction must reflect the interest of the end buyer (biopharma M&A over IPO), which currently places a premium on innovative products, in order to generate the outsized returns that LPs look for in the VC asset class.  The challenge for venture funds is that biopharma buyers want to see clinical validation (ie, Phase II data) of those innovative products, which takes significant amounts of capital and time – more than the standard 10-year fund could support if a portfolio was built of only early stage innovative products.  Therefore, funds must selectively invest in a handful of precedented targets/me-betters in order to create portfolio balance.   Striking the right balance between novel and precedented targets will likely play a key role in what drives fund returns over the coming years.

Like most venture funds, Osage tries to balance risk across our portfolio by investing in companies at different development stages, therapeutic areas, and individual targets.  For instance, Osage recently invested in a Phase II-ready S1P agonist that is being developed by Receptos for multiple sclerosis.  The asset is a me-better that potentially has a more favorable PK and tox profile than Novartis’ Gilenya.  Our investment in a precedented target, is balanced with an early stage investment in Cleave Biosciences, a company that is developing a series of novel compounds around the theme of autophagy for cancer indications. Receptos and Cleave are not only great companies, but they also provide broad target, therapeutic area, and stage diversification for Osage. 


Where Has All of the Early Stage Capital Gone?

Early stage capital for life science companies is tight at the moment.  I believe there are two root causes for the lack of capital: risk aversion among VCs; and the need for VCs to support their portfolio companies longer than expected.

In a number of blog posts over the last year, I noted that while early stage capital hasn’t been exactly abundant, it has also has not dried up.  According to OnBioVC, the aggregate amount of capital raised by life science start-ups in Series A rounds actually increased by 33% from 2010 to 2011.  While 2010 was a low year for Series A rounds, the data from 2011 compared to 2009 was about equal.  

Given the OnBioVC data, there appears to be sufficient Series A capital in play, but it is not necessarily going to early stage start-ups.

Historically, Series A rounds were associated with start-ups that were developing risky, bleeding edge technologies.  Instead of investing in those “early” technologies, VCs are increasingly funding corporate spinouts of later stage assets, which are perceived to be less risky.  Because those corporate spinouts are raising their first institutional capital, they are also defined as “Series A” companies.  Series A capital might be relatively abundant, but it is not necessarily being deployed to traditional early stage start-ups.

Adam Rubenstein of OnBioVC pointed out to me that “for 4Q11 the ~$500M in “first-time” institutional financings was approximately split 1:1 between early-stage “innovative” products and “reconstituted” advanced clinical-stage products.”

That is troubling news for innovative development stage start-ups.

The second challenge hindering VCs from deploying capital into early stage opportunities is that legacy portfolio companies are requiring significant capital infusions.  As the chart below from OnBioVC shows, there has been an explosion in the number of Series E, F, and G rounds over the last year.

Supporting companies for 8-12 years creates significant issues for VCs.  First, most funds do not typically reserve capital beyond 5 to 7 years after an initial investment.  Supporting a company 7+ years after of an investment diverts capital that would otherwise be used to support less mature portfolio companies. Additionally, funds generally have a 10-year term and investors (LPs) expect to receive a return on their investment by that time.  While most funds are allowed to extend the length of their funds by 1-3 years, that is often not a palatable outcome for both VCs and investors. 

Given the fact that LPs currently see a lot of old deals on VCs’ books, there is pressure on VCs to show their investors that they can participate in deals that are likely to return capital in a reasonable amount of time. That pressure results in VCs steering away from early stage companies in favor of corporate spinouts or expansion capital rounds of more mature start-ups. 

Uptick in Late Stage Medtech Financings

Over a billion dollars of capital was deployed in Series E, F, and G rounds last year.  While Medtech accounted for 32% of the aggregate capital raised by the life science sector, it represented 42% of the capital raised in Series E, F, and G rounds.  The uptick in late stage medtech financing activity is not entirely a surprise given regulatory challenges imposed by the FDA and a consolidation of potential acquirers. 

Silver Lining

Osage invests in both early and late stage opportunities from our affiliated universities.  While we are seeing an increase in the number of attractive later stage opportunities, we are also tracking a number of great early stage opportunities.  For a contrarian investor, there has never been a greater time to invest in early stage opportunities.


University Equity Structures in Start-ups

When universities license their technologies to start-ups they often take equity in those start-ups, typically in the form of common stock.  The reason why universities take equity can range from the philosophical – “the work was done in our labs” – to arbitrage by forgoing an upfront licensing fee in exchange for equity in a start-up (saves the start-up $). 

Because universities take equity for different reasons, the way in which they structure how they receive their equity varies by institution.  This presents a challenge for investors looking to license university technologies because most investors wrongly assume that university equity arrangements are standardized. 

Given the lack of clarity around how universities acquire equity in their start-ups, I thought it might be helpful to explain the 3 primary types of equity structures – Upfront, Milestone, Phantom - that universities employ.


The Upfront equity structure is the most common type, but also the one that varies the most between academic institutions.  In the Upfront structure, the university takes their equity in the start-up at the time of the company’s founding and the equity is typically baked into the pre-money value of the company.  I have seen pre-money values (note: includes management ownership and options) range from $2.3M to $7M for start-ups.  Those pre-money values directionally represent fully-diluted ownership of 2-40% for the university start-up at the time of its founding.    

The massive variation in the amount of equity a university receives Upfront is primarily dependent upon the value of “sweat equity” the university has put in, the stage of the product, the breadth of the patent portfolio licensed, and the amount of dilution the university foresees itself being subject to.  Sweat equity is typically the most controversial point when negotiating university equity because it is often hard to quantify and the quality of work in some cases is questionable.


The Milestone equity structure is typically the most welcomed by investors, but can be quite risky for a university.  In this structure, the university takes no equity upfront, but takes equity at significant milestones such as entering human trials or submitting an NDA.   The equity given at the milestone is based upon the fully-diluted share count at the time of the milestone achievement.   For example, a university might receive 0.375% equity in the company at the time of IND filing and an additional 0.75% upon finishing Phase 2 studies. 

The challenge with the Milestone model for universities is that they only receive equity at 2-4 predetermined milestones.  If a company is sold before a milestone is achieved, then the university does not fully capture their potential equity in the company.  Some universities insert clauses to hedge their risk of an early sale, but that is not always the case. 


Only a few institutions use Phantom equity, but it is a structure that has gathered quite a bit of attention over the last two years.  Phantom equity is an arrangement in which the school does not hold equity in a start-up until the time of the company’s sale.  For example, as part of their “Carolina Express License”, the University of North Carolina takes 0.75% of the start-up’s fair market value at the time of a liquidation event (M&A, IPO, asset sale).  Typical Phantom equity can range from 0.5-2% at the time of sale.

Most life science companies raise well in excess of $60M before they are sold.  Raising that kind of money results in massive dilution for early investors, making 2% Phantom equity for a university quite attractive.  The risk for the university is that the company is sold before it raises a lot of capital, resulting in the university leaving money on the table.

Equity & Start-ups

Negotiating university equity in a start-up is often a point of contention between investors and the tech transfer office.  To avoid misaligned expectations, both sides should be upfront in what they perceive to be fair market value and have data points in hand to defend their position.  Having a standardized term sheet outlining equity expectations may expedite license negotiations and align both the company and the university in the pursuit of creating shareholder value.    


Welcome Bill Harrington!

We are very excited to annouce that Bill Harrington has joined Osage University Partners to focus on life science investments.  Bill is a great addition to the Osage family and looks forward to working with all of the universities and start-ups affiliated with our fund.

Press Release:

BALA CYNWYD, PA—(Marketwire -01/05/12)- Osage University Partners today announced that William (Bill) Harrington has joined the firm as a Managing Partner. Bill previously spent twelve years as a Partner at Three Arch Partners investing in early stage healthcare companies. Osage University Partners is a novel venture capital fund that has partnered with over forty leading universities to make direct investments in their most promising startup companies. In January 2011, Osage held its final closing on its inaugural fund, achieving its $100 million fundraising target.

During Bill’s twelve years at Three Arch, he led investments in and served as a director of nearly twenty healthcare companies, a number of which had their origin as university spinouts. He most recently served on the boards of Cameron Health, Baxano, Voyage Medical, Nevro Corporation, APT Pharmaceuticals, and Centerre Healthcare. Prior to entering venture capital in 1999, Bill spent a decade as an interventional radiologist, working with promising new imaging technologies, medical devices, and minimally invasive surgical procedures. Bill holds an MD from Harvard Medical School, an MBA from UC Berkeley, and a BS in Biology and Chemistry from Tufts University. Bill is a CFA charterholder.

“We are excited to have someone of Bill’s caliber join Osage University Partners,” said Robert Adelson, Managing Partner. “Bill has over a decade of partner-level experience at a top-tier venture fund managing over $1 billion in healthcare investments. Bill combines his extensive investment experience with a strong clinical background, which will be critical in evaluating university life science opportunities. We anticipate that healthcare investments will represent half of Osage University Partners’ portfolio.”

Osage University Partners has created a unique model through which it manages the coinvestment rights held by its affiliated universities. These coinvestment rights provide Osage with contractual access to invest in the future financings of some of the most promising startup companies that have licensed technology from those universities. Affiliate universities then share in Osage’s profit and can use their proceeds to stimulate further education, research, and commercialization initiatives. Universities nationwide collectively create approximately 600 new startups each year based on their research discoveries and have created nearly 5,000 new startups over the last ten years.

“Osage University Partners provides a new approach to investing in the venture capital asset class that offers many advantages over historical models and affords our university partners a means of unlocking an otherwise untapped opportunity,” said Dr. Harrington. “The firm has very strong university partners and terrific deal access. It tracks the progress of a very large group of university start-ups and selects the strongest in which to invest. The firm has had great success in partnering with top universities and raising a first fund in what has been an exceptionally difficult fundraising environment, a testament to the excitement and interest in a truly novel investment strategy.”

Osage University Partners invests in both early and later stage companies with ties to its affiliated universities. The fund invests across a range of life science and technology sectors, including therapeutics, medical devices and diagnostics, energy, advanced materials, semiconductors, and information technology. The fund has invested in sixteen companies to date. Of those, Avid Radiopharmaceuticals, a diagnostic company focused on Alzheimer’s disease, was acquired by Eli Lilly and Gevo, a biofuels company producing isobutanol from biomass, completed a successful IPO in 2011.

Osage University Partners is a member of a family of investment funds developed by Osage Partners. Bill will be working out of Osage’s Bala Cynwyd headquarters.

About Osage Partners
Founded in 1990, Osage Partners is a family of investment funds located just outside of Philadelphia, PA. Osage Partners manages in excess of $200 million. Current fund strategies include Osage Venture Partners, an early stage enterprise technology fund focused on the Mid-Atlantic region, and Osage University Partners, a multi-stage fund that invests in university startups across a range of sectors. Under the Osage Partners umbrella, member funds cross-fertilize ideas, leverage internal expertise and share networks and resources.