Biotech & Med Device M&A Trends for Private Companies

Five years of startup exit data can tell an investor, entrepreneur, or technology transfer professional an awful lot about current trends in the life science market.  But where does one get such data?

Thankfully, Jonathan Norris and the folks at Silicon Valley Bank (SVB) publish a quarterly missive that aggregates and analyzes M&A numbers for biotech and med device companies.  In this blog entry I will focus on two graphs, one directly from Jon’s analysis and one that I made based upon Jon’s raw data, from SVB Capital’s recent article “Private Life Science M&A Analysis”. 

The Growing Divide: Upfront Payments vs. Milestones

This graph by SVB does a really great job of quantifying the growing disparity between upfront and milestone payments (also referred to as contingent payments, earn-outs, or biobucks).  While there is a clear trend toward milestone-laden deals for both medical devices and biotech companies, the divide between upfront and milestone payments is significantly larger for biotech companies.  While I think this graph is effective at getting the point across that milestone payments are currently trendy, it does not really sum up the entirety of the situation.

Some other points to consider:

• The decrease in overall deal size (upfront + milestone) for biotech M&A exits for private companies has been significantly impacted by pharma company consolidation.  Thanks to consolidation, Pfizer, Abbott, Merck, Sanofi, and Eli Lilly have literally become HUGE companies.  Purchasing a private company for a couple of hundred million dollars does little for the bottom line of such large entities, which is why many of their BD groups have been spending the bulk of their time on the lookout for small and mid-cap companies.  With pharma companies largely out of the game, valuations have come back down to earth creating an opportunity for mid-cap biopharma companies to become much more acquisitive as evidenced by the recent purchases of venture-backed companies by Gilead and Cephalon.
• Biotech companies typically have larger milestone components because they are purchased earlier on in their life cycles and acquirers want downside protection to protect against the possibility of clinical failure or unanticipated regulatory challenges.  While milestone-driven deals are currently wrecking havoc on VCs, it is actually somewhat surprising that such deals took so long to come into vogue.
• Med device companies now take longer to get to exit than biotech companies due to a combination of increased FDA pressure and the fact that a lot of the low hanging fruit has been picked (stents, aortic valves, access devices, etc.).  Devices are becoming increasingly complex leading to longer development times and increased regulatory scrutiny (PMA versus 510K).  A rash of post-market device failures and weak long-term results in outcomes-based studies has also not helped things.  Taken together, acquirers are much more willing to wait until med device technologies mature before they purchase them.  Because the companies are older and more de-risked, there is less of a need for milestone payments.
• While the stock market did crash in 2008, it probably had little effect on the considerable decrease in both biotech and med device M&A activity.  The underlying reason most likely had more to do with the considerable amount of M&A between large publicly traded companies (Pfizer / Wyeth, etc.) and the resulting stagnant activity of their BD groups.

Developing A Winning Biotech Investment Strategy

Whenever I get a core dump of great information like that from the SVB report, I always try to see if I can reduce the data to a series of bullet points that will enable me to make better investment decisions and provide pointers to my portfolio companies.  Jon’s analysis, by therapeutic indication, contains a bunch of great data that a VC would value, such as average years to exit by lead product, number of exits, capital invested per exit, and average multiple on invested capital.  While Jon provided a feast of data, I wanted to see if I could apply additional metrics to tease out which therapeutic indications would have been the best investment bets for VCs over the last five years.

My scoring system is pretty simple, 1 being the best and 11 being the worst (as there were 11 therapeutic indications in the study). 

As you can tell, my analysis confirmed a few common investor beliefs held among VCs but also produced some results that made me scratch my head. 

Confirmed Investor Beliefs…

• Anti-infectives: Performed better than all other therapeutic indications.  It was not too long ago that anti-infectives were on the “Do not fly list” for VCs.  As recently as the early 2000s anti-infectives were a generic market that had no real need for innovation – that is, until the so-called “superbugs” started sprouting up in hospitals.  With hospitals being paid a flat procedure rate by Medicare, there was all of a sudden a real need for good anti-infectives to reduce complication rates and people were willing to pay for new drugs.  Pharma companies had all but abandoned this area of drug development, leaving the door wide-open for startups.  On top of all those considerations, VCs generally like anti-infectives because animal models correlate pretty well with human trials, making pharma companies much more willing to purchase young companies.
• Target Generating Platforms:  This really speaks to how hot biologic drug discovery technologies were from 2005-2010.  Established biologic companies, as well as traditional pharma companies that were looking to get into biologics, were willing to pay steep multiples in order to get their hands on great platforms.   Small companies like Facet, GlycoFi, and Adnexis were purchased as well as large publicly-traded companies (not listed in the SVB report) like Cougar and Medarex.  The go-go days of antibody platform plays are probably over, but there is a chance that the dance party will continue for those companies developing antibody-drug conjugates (see February 23 blog entry).  Newer startups will have to find novel ways to differentiate themselves in order to entice acquirers to scoop them up early.
• Oncology:  I expected oncology to be the winner instead of anti-infectives, which is a relatively new investment area for a lot of VCs.  Oncology is a logical investment area because there is a huge unmet need, lots of validated targets, and a growing patient population due to people living longer.  Also, oncology products are typically reimbursed at a pretty high rate thanks to guaranteed Medicare coverage for approved FDA products.  However, with 900 oncology products currently in development, product differentiation will become increasingly challenging.  On top of that, the FDA continues to raise the bar for oncology, and will make overall survival data versus progression free survival the primary endpoint for most clinical studies, making success both harder and more expensive for drug developers.  While challenges abound, I for one, am quite excited about the prospects for great new oncology products getting to market.  There is so much exciting drug development going on right now in episomal regulation, DNA repair, antibody-drug conjugates, etc. – all of which could contribute to improved outcomes for patients struggling with cancer.

…And a Few Surprises

• Ophthalmology:  I would have pegged ophthalmology as a top performer, yet it performed the worst!  From an investment standpoint, ophthalmology has some very attractive characteristics: reasonable reimbursement and regulatory hurdles, low side effect risk (drugs applied topically or via direct injection into the eye), huge markets such as glaucoma and acute macular degeneration (AMD), and patients require chronic care.  So why did ophthalmology perform so poorly?  First, Xalatan (glaucoma) and Lucentis / Avastin (wet AMD) are really good drugs that are challenging to best in head-to-head trials.  A lot of drug programs have been shelved after lackluster clinical data, meaning that they were not counted in the SVB study.  Second, there are relatively few acquirers for ophthalmology products, giving such companies moderate incentive to “jump” on high-rising startups.  This means that VCs hold onto ophthalmology investments comparatively longer than other therapeutic areas.  This is not a huge issue for VCs though, since ophthalmology products typically move through clinical development rather quickly.  This means the companies are bought at later stages and therefore typically at higher valuations.  A final point is that 2005-2010 was relatively quiet with regards to M&A events for ophthalmology companies, so one should not read to much into this data set.
• Metabolic:  Despite the fact that I recently wrote a blog piece that said VCs are hesitant to invest in metabolic companies right now, the metabolic indication performed 2^nd best.  Diabetes, among other metabolic disorders, is such a huge market that any pharma company would be willing to pay a huge multiple for a phase III asset that produces positive results.   And according to the SVB data, they did just that – but that doesn’t really tell the whole story.  Remember, the SVB data only focuses on positive outcomes – the M&A events of private companies.  What it does not mention is how many companies failed, had partnerships terminated, or got through Phase III with positive results only to have the FDA ask for more data to quantify the risk of cardiovascular side effects.  The reward for metabolic disorders will always be there for VCs, the question is which VCS are willing to stomach the risk?

I enjoyed studying Jon’s data and pulling together this blog post.  It confirmed, as usual, that I know far less than I think I know.  More importantly, it also provided data to say that the life science investment community is doing better than the current negative sentiment would suggest.  While life science investing is not experiencing the current explosive growth that consumer internet is having, it is moving along at a solid pace – enough to provide reasonable returns to investors and to get products into the hands of patients who deserve the best care possible. 

I should also take a second to provide a quick shout-out to those who are working hard to ramp up excitement for life science startups.  First, to Bruce Booth who continues to tell the world about how great the biotech IPO class of 2010 is performing.  That is not an easy task given the amount of hype and press coverage currently being directed toward LinkedIn, Facebook, Twitter, and Zygna.  And second, to Canaan Partners and Safeguard Scientifics for finding an asset (see FierceBiotech press release) that no one believed in and turning it into one of the best investments ever made by a life science fund.

Early stage platform startups, a smart investment?

I recently had a call with an entrepreneur who wanted to spin out a platform technology from a university and during the course of the conversation the entrepreneur paused to say “why are we even having this chat, its not like you are going invest in an early stage platform anyway”.  I thought the entrepreneur had to be joking and took the comment in stride.

After the call I dialed up a few VC friends to ask them if they too had heard a similar refrain from entrepreneurs.  They confirmed that my conversation with the entrepreneur was not an isolated incident.  It would appear that quite a few entrepreneurs, or possibly one very vocal entrepreneur, seem to think that VCs hate platform companies.  Sure there are challenges with platform investments (finding the killer app, development timelines, capital required, etc.), but that does not imply that platform deals are dead on arrival when they hit a VC’s inbox. 

VCs do invest in platforms and will continue to do so for the foreseeable future.

I thought it might be helpful to walk through how I analyze platform investments, how that analysis can be applied to a well known university startup, and finish up with a short list of some up-and-coming platform plays.

My platform investment checklist:

First, it is always a good habit to start a diligence process by looking at an investment through the eyes of the ultimate acquirer, which is almost always a pharmaceutical company.  After I put on my best pharma exec face, I begin to analyze the following:

Scientific founder: The most valuable platforms are those that solve unmet needs and provide significant technical hurdles that prevent (or at least delay) other groups from being able to reengineer the discovery.  There in lies the rub for investors.   Bleeding edge discoveries are risky because the work is so new and sophisticated that few, if any, outside groups can replicate it.  Therefore, trusting the quality of the work is essential, which is why many VCs turn to founders that they have worked with before.  Also, choosing the right founder to invest behind can have significant advantages when it comes time to build partnerships and ultimately sell the company as many top researchers have deep industries ties that they can leverage.

Managerial talent: Developing a platform requires a lot of skill and know-how, therefore building a team that can nurture the development of the technology is essential to the ultimate success of the startup.  On top of that, choosing the right lead indication and backup programs requires significant skill.  The challenge is formidable, which is why many VCs turn to entrepreneurs they have worked with before.  That is also the same reason that CEOs tend to choose teams they have worked with before.  Experienced CEOs know that platforms are always more challenging than investors predict, which is why they want battle-tested people around them when the going gets tough.

Ability to generate value quickly:  Platforms have to be able to reach a significant inflection point after two rounds of venture investment.  “Significant inflection point” can have many meanings, but I would describe it as a stage where there is enough data in hand for a pharma company to hang their hat on and give significant thought to acquiring the platform. 

Acquirer integration:  Run tests and assays as if you were a pharma company, which helps make the startup “integration ready”.  However, there is always a tug of war between penny-pinching and going overboard with development costs.  VCs certainly do not want their portfolio companies spending their money profligately, but they also do not want to risk skipping an assay or clinical end point that an acquirer values. I always encourage companies to ask pharma companies what they think.  You would be surprised how open pharma can be when it comes to giving out advice.  While you do run the risk that the pharma could change their stance over time, you do at least get some input as to what should be done to be acquirered.  

Lead program: Pharma companies typically buy startup companies because the lead molecule is too good to pass up / provides a strategic benefit for the company (ex: Daiichi acquiring Plexxikon), or because the platform has shown early promise for its ability to spawn numerous products (ex: Gilead acquiring Arresto Biosciences).  It is rare that pharma companies buy startups because they value both the platform and the lead molecule, as pure platform acquisition typically occur before the lead is in late stage development while lead product acquisitions are the reverse.  Therefore, platform companies must nail down the platform to entice an early platform takeout by an acquirer, but also have a strong lead molecule in development to provide a safety net should the company not be acquired early.    

Breadth of platform: This typically does not matter a whole lot, as VCs typically prefer to see 2-3 possible indications that a small startup can support, rather than a litany of indications that only a large cap pharma could handle. 

Tranching the investment: This is becoming more common in early stage platform investments as VCs look to better collaborate with startups on goals and expectations for the company.  I like tranching as it bakes in an inflection point where all stakeholders must provide an honest assessment of how the company is progressing.

Syndicate partners:  The average length of a holding period for life science VCs is a little more than 7 years.  Given that time frame, it is essential to surround yourself with people you can work with, who have capital, and are willing to support the company with you should it hit a rough patch. 

Case Study: Promedior – Rice University

Scientific founder: Promedior is based upon the research of Dr. Richard Gomer and his associate, Dr. Darrell Pilling.  Dr. Gomer is an expert in cell counting and enumeration, and he is an HHMI alumnus (2000-2005). 

Key Discovery: Scientific founders discovered a naturally occurring blood protein that prevents dangerous scar tissue from forming.  Depletion of serum amyloid P (SAP) causes bone marrow derived cells to migrate to the site of injury and produce collagen, the main component of scarring. SAP orchestrates the type of microphage that shows up at the wound, is also dominant over the traditionally accepted cytokines in the fibrotic process.  By pumping up the levels of SAP, Drs. Gomer and Pilling showed that fibrosis could be inhibited in mouse models.

Managerial talent: The CEO, Nick Colangelo, has an ideal mix of industry, entrepreneurial, and domain experience.  While not a scientist by training, Mr. Colangelo has significant drug development experience and was a founding Managing Director of Lilly Ventures.

Ability to generate value quickly: While fibrosis is a very difficult disease to treat, there are several in vivo models that can tease out possible efficacy early on in a program’s development.  For instance, a methacholine challenge model for asthma is widely accepted, cheap, fast, and easy to perform. 

Acquirer integration: A key step for Promedior is showing pharma that the company can successfully produce their protein at scale.  Once the protein is produced at scale, the acquisition would be rather turn-key.  The challenge for the acquirer would be to figure out how to choose what markets / programs to go after.

Lead program: Promedior’s lead product, PRM-151, is in clinical trials to analyze if it can prevent scarring that typically occurs after glaucoma filtration surgery, a niche condition that could afford the company orphan drug status.  VCs like ophthalmology because you can get a pretty good idea of a drug’s efficacy early on its development, studies require relatively few patients and can be performed quickly, and typically the diseases being addressed are chronic in nature.  Promedior’s lead program will build out the efficacy and safety profile of their protein in a relatively cheap and efficient manner.

Breadth of platform: There are dozens of fibrotic diseases, including atherosclerosis, asthma, cirrhosis, scleroderma and pulmonary fibrosis.  There are also numerous fibrotic diseases a small company can tackle such as asthma, NASH, idiopathic pulmonary fibrosis, and diabetic retinopathy.  The challenge is less to develop platform itself, but more to choose the right first indication and to nail it.

Tranching the investment: While tranching milestones were undisclosed, it appears that the Series A extension was timed with the filing of the company’s first IND.

Syndicate partners: Forbion, Polaris, Morganthaler, HealthCare Ventures have invested about $40 million to date.

Intangibles: Could be first treatment that prevents the build-up of deadly scar tissue in a broad class of diseases that account for an estimated 45 percent of U.S. deaths each year.  Since there are no FDA-approved treatments to prevent fibrotic tissue from forming, doctors typically consider fibrosis to be an irreversible process, and they try to slow it as much as possible with anti-inflammatory and immunosuppressive drugs that have serious side effect risks. 

Up-and-coming platform companies

• Anosos Biotherapeutics (UPenn)
• Envoy Therapeutics (Rockefeller)
• Helix Therapeutics (Yale)
• Origen Therapeutics (UC Berkeley)
• Redwood Biosciences (UC Berkeley)
• Synbody Biotechnology (Arizona State)

University Startup Roundup > Recent Exits

The last quarter has been a pretty exciting for university startups.  This is important to note, as the overall market for acquisitions and new alliances has been way down during the start of 2011.  I thought I would highlight a couple of interesting startups that were recently in the news, with an emphasis on the scientific founders and universities that spawned them.    

University of Colorado: Founding scientists Woodruff Emlen and V. Michael Holers spun Taligen Therapeutics out of the University of Colorado at Denver in March 2004.  The ability to modulate the body’s pro-inflammatory system while still preserving the natural immune response provided an interesting investment opportunity, and Sanderling Ventures ended up leading the Series A.  While other complement focused companies were eyeing complement 3 (C3) or C5, Taligen sought to inhibit Factor H, which is unique to the alternative pathway (other complement pathways are lectin and classical) and exists upstream of complement proteins C3 and C5.  Over time, Taligen raised additional capital from Alta Partners and Clarus Ventures, bringing the total venture haul to $65 million.  Building upon the core alternative pathway discovery, Taligen went on to create a series of dual inhibitory molecules that had combined inhibitory activity against autoantibody formation (via CR2 inhibition) and alternative pathway (via inhibiting Factor H). In February, Alexion Therapeutics acquired Taligen for $111 million upfront (Taligen had only pulled down $36.5 million of the $65 million).

University of Kansas: Founding scientist Valentino Stella spun out CyDex Pharmaceuticals from the University of Kansas in 1993. Dr. Stella is best known for its development of Captisol, a compound that binds with pharmaceutical products to improve their stability and solubility. Captisol attaches a modified cyclodextrin (a ring of sugar molecules) derivative to IV and topical medications to enhance their solubility, bioavailability, and stability.  In January, Ligand Pharmaceuticals acquired CyDex for $32 million upfront.

Stanford University:  Founding scientist Amato Giaccia spun Arresto Biosciences out of Stanford in 2007 with $16 million in backing from DAG and Kleiner Perkins (along with Abbott Ventures and NorthGate).  Tumors love to divide and grow, but that requires lots of food (sugar) and oxygen.  When tumors don’t get enough oxygen they become hypoxic, and well, rather angry and disobedient.  It turns out that hypoxic tumors tend to express a lot of an enzyme called lysyl odixase (LOX), and hypoxic tumors expressing LOX tended to metastasize more often than non-hypoxic tumors. Studies by Giaccia, Technion in Israel, and Arresto indicated that LOX expression correlated with extracellular membrane modulation and subsequent cell motility and invasion (hallmarks of metastasis).  LOX is expressed in both solid tumors (liver, lung, kidney) and fibrotic disorders (pulmonary fibrosis, cardiac tissue post-MI), and Arresto has developed a series of LOX inhibitors to address these cancer and inflammatory indications.  Gilead acquired Arresto for $225 million in cash. 

Stanford University: Founding scientist Bradley Hill spun Vasonova out of Stanford in 2005.  Visualizing correct catheter placement remains a challenge and there is a need for a noninvasive, cheap, and easy to use system.  Dr. Hill and Vasonova developed a vascular positioning system that provides real-time intra-vascular catheter navigation without the need for outside metal detectors or viewing screens, or an X-ray. Vasonova raised $14 million from CMEA and Arboretum Ventures and was acquired by Teleflex for $25M upfront with $15-30M in earn outs.

What does this data all mean? 

While the summaries I provided are interesting, they are not overly informative if you are an entrepreneur or scientist that is working on his or her next startup.  Below is an analysis / postulations of why I think these companies were valued initially by VCs and later by acquirers: 

Taligen 

• VC: Complement factor has attracted VC interest for some time as it provides a number of druggable targets and is implicated in a broad array of disorders such as auto-inflammatory disease and acute macular degeneration (AMD).  Previous VC investments in complement factor companies included Archemix (Atlas, Highland, Rho, SV Life Sciences), Optherion (Quaker, Domain, JJDC, Pappas), and Potentia Pharmaceuticals (HealthCare Ventures).  While an attractive target, early drug development efforts have shown that complement factor inhibition carries significant toxicity risks, even in the context of local administration.  However, the side effects appear to show up rather quickly in early trials, and if avoided, can lead to an early acquisition, as was the case with Potentia Pharmaceuticals (a University of Pennsylvania spinout). 
• Acquirer:  Founded in 2004, it is unclear if Taligen had entered human trials at the time of its acquisition.  My guess is that investors saw the1.5-3X (hard to exactly know how much money was actually pulled down of the $65 million) offer and said ‘thanks, see ya later’.  For Alexion, Taligen was a logical acquisition as the company is sitting on plenty of cash and needs to diversify its product offering (Soliris is its only marketed product).  Soliris is a humanized monoclonal antibody complement inhibitor approved for treating patients suffering from paroxysmal nocturnal hemoglobinuria (PNH), and Taligen’s complement expertise and pipeline is a natural extension of the Soliris product line.  

CyDex Pharmaceuticals

• VC: Reformulations are a toss-up in the venture world.  Some people like the fact that reformulations are far less risky than novel therapeutics, while others dislike reformulations because they typically attract lower valuations and IP issues can be tricky to overcome.
• Acquirer:  CyDex leveraged the Captisol discovery into numerous collaborative partnerships with drug developers that results in the creation of five FDA-approved medications.  The pipeline of partnerships generates over $16 million per year in royalty and milestone payments for the small Kansas-based drug developer.  By paying 2x the 2010 year-end sales, Ligand gets access to a steady flow of cash to support its own drug development activities and a novel reformulation technology that the company can use on its own products.

Arresto 

• VC: Novel enzyme target, well regarded scientific founder, and large underserved markets (fibrosis and cancer) make for an ideal venture investment.
• Acquirer:  Paying $225 million for a company with only Phase I data is a pretty good sign that Gilead liked what it saw in Arresto.  Arresto’s lead product, a mAb against hLOX2 for idiopathic pulmonary fibrosis (IPF), compliments Gilead’s own IPF molecule, Letairis, which is Phase 3.  The Arresto molecule is either a nice second shot on goal for Gilead and/or a reasonable complimentary molecule to build out an IPF franchise.

VasoNova

• VC: Catheters continue to be an attractive investment area for venture capitalists due to the sheer volume of catheterizations that are done per year (estimated at 5 million).  The challenge for this investment area is that catheters are cheap, so the technology has to be a must have to provide the scale needed to generate returns that are acceptable for VCs.  Simplifying catheter placement is something that hospitals and doctors would both value, although product adoption carries a significant risk.
• Acquirer: Teleflex paid $25 million upfront for VasoNova (equals about 2x invested capital), with some near-term milestones on the back end.  Vasonova initially hired two well-known ex-Bard folks to move the product in 2009, but then inked a distribution deal later in 2010.  Maybe the company had a two-pronged sales strategy, but more likely sales were not as strong as planned and investors looked for the exit sign.  Either way, VasoNova’s catheter placement technology fits in nicely Teleflex’s own PICC product line.  Selling the PICC products and VasoNova unit together could provide significant strategic advantages for Teleflex.

Taken together, my analysis indicates that there is a robust funding system for university startups and those startups have consistently generated solid returns for venture investors.  

While my analysis is completely subjective, I do hope readers find it helpful and informative as they try to map out their own path for startup success.  

Q1 2011 Life Science VC Investment Report

It is no secret that early stage (Series A & B) life science investing was way down this past quarter, 50% year-over-year to be exact.  The question is, why? 

Some possible reasons include: 

• VCs are short on money / number of new funds is way down
• Hostile regulatory environment making VCs sit on the sidelines
• Too much capital pumped into companies over last 5 years, VCs waiting for valuations to be adjusted
• Partners sitting on too many boards, need to sell existing companies before making new investments
• Lack of early stage deal flow

Despite the challenging investment environment, a bunch of great therapeutic, device, and diagnostic startups were funded during the last quarter and I compiled those financings into two lists (therapeutics and device / diagnostics) below.   

I should note that the inclusion criteria for my lists were somewhat subjective, as I compiled them from FierceBiotech press releases.  I also did not include Seed rounds because they are not often picked up by major news outlets and can therefore be quite hard to track. 

While my therapeutic financing list is somewhat short (reflective of the overall activity in Q1), some trends can be pulled from the data: 

• The most active VCs (Clarus, SV, Third Rock, etc.) are the funds that most recently raised capital.  Not a shocker, but it is important for startups to know which funds have money before they go out and fundraise.
• Cancer, cancer, cancer.  It is, and will continue to be, a sure thing for investors.
• Omega-3s are hot.  Lots of companies are working on novel Omega-3 formulations or creating agonists that bind to putative Omega-3 receptors.  Also, inflammation is a growing and poorly served market, and pharma is actively looking for inflammation modulators that have improved side effect profiles.
• Cosmetics.  VCs are branching out into consumer, IT, service, and generic plays in an effort to find products that get to market faster, with less risk, than traditional therapeutic plays.  Don’t be surprised if you see a lot more consumer plays over the next year.
• Immunotherapies continue to be hot.  Many startups are leveraging Dendreon’s success to raise capital in a tough financing environment.  Genocea, Gliknik, and Kite Pharma all raised rounds to finance the development of immunostimulatory programs.  Cancer vaccines and infectious disease therapies continue to be the main thrust of immunotherapeutic drug development.  I should also mention that Dendreon did something of incredible value (I actually covered this in my last blog post) to investors, which is to show the investment community that CMS will cover immunotherapies that are used to treat cancer.

Investors hate uncertainty, and by sending mixed signals regarding how it intends to tweak the 510K approval process, the FDA is causing VCs to think hard before making a new medtech investment.  The rumor is that the FDA will provide new guidelines for 510K approvals sometime this summer.

Here is a list of other trends I am seeing:

• VCs are looking for niche products that can be taken to market with less than $20 million of invested capital. 
• Most device startups are now choosing to run their clinical trials in Europe, which has a far more defined regulatory path than in the US.  The new paradigm seems to be, hit CE Mark then come back to the US to go for IDE.
• VCs are looking at a wide array of medtech opportunities, not just orthopedic plays.  Orthopedics used to be the bread-and-butter investment for VCs, due to a simple approval process, high reimbursement rate, and the fact that orthopedic surgeons were likely to buy/try a new product.  All of the reasons why VCs used to love orthopedics are now under regulatory and reimbursement pressure.   Advanced Animal Diagnostics, a diagnostic to rapidly identify disease in farm animals, is a good example of the lengths that VCs are going to find medtech opportunities that have appropriate risk / return profiles.
• European VCs are getting in the game.  While many US-based funds have closed their Europe offices, it would seem to me that now is a prime time for US venture firms to open small European outposts to leverage European medtech talent and clinical trial access. 

There Will be No New Diabetes Drugs in the Future

Last Friday, I had the pleasure of attending the Wharton Healthcare Conference and sat in on an interesting venture capital panel. The moderator, Steven Sammut, a venture partner at Burrill, asked the panel to list some of the challenges they see in vc. Stephen Sullivan, a Partner at Skyline Ventures, paused for a second and then looked straight out into the crowd and said, “there will be no new diabetes drugs going forward.”

A rather bold statement and one that I thought had quite a few holes in it considering the amount of activity in the space. There are variety of new agents are in development for the treatment of type 1 or type 2 diabetes, including dipeptidyl peptidase-4 inhibitors, glucagon-like peptide 1 analogs, thiazolidinediones, glinides, and new insulin formulations. There are also a bunch of recently formed startups in the diabetes space including PhaseBio (Duke University), Catabasis Pharmaceuticals (Harvard University), and the Metabolic Development Solutions Co. (ex-Pfizer scientists).

Clearly, there are diabetes drugs in the pipeline, so why say that there will be no new diabetes drugs?

In 2007, Steven Nissen of the Cleveland Clinic published a paper in the New England Journal of Medicine linking GSK s Avandia to increased risk of congestive heart failure and heart attacks and accused GSK of hiding the heart risk from patients. The paper sent shockwaves through the industry as litigators lined up to sue GSK, Avandia would receive a blackbox warning, and Nissen rose to prominence as the protector of all patients. The reality is that Avandia probably did carry a higher risk of heart complications compared to alternatives, but it also was more efficacious and the pool of at risk patients was rather tiny compared to the entire treated pool.

The result of the Avandia fiasco is that the FDA has raised the approval bar for diabetes drugs so high that it is now prohibitively expensive to run a Phase III clinical trial for a new diabetes drug. Phase III diabtes studies are now outcomes-based studies with 10,000-30,000 patients. No startup company can fund such a trial, which means large pharma is left to foot the bill. Now even large pharma is saying they can t stomach the cost of the trial because even a good outcome no longer ensures FDA approval, as the approval bar keeps sliding.

In October 2010, Amylin believed that their long-acting GLP-1 analogue, Bydureon, would be approved as their Phase III study hit all of its endpoints with no safety concerns. Instead of approving the drug, the FDA came back and asked for a QTc study to evaluate the risk of higher-than-therapeutic doses of Bydureon on the cardiovascular safety profile. Amylin s management was at a loss to explain the FDA s seemingly newfound concern over the drug s possible cardiovascular risks at higher-than-therapeutic doses, since previous trials of Bydureon hadn t raised any red flags.

By most accounts, Bydureon is a good drug that should already be approved. The FDA s actions have had a profound effect on pharmaceuticals companies, many of which are simply walking away from late stage diabetes assets. Roche walked away from their late stage taspoglutide program, leaving its partner Ipsen to find $500 million to get the drug over the goal line.

While I think that Stephen s comments were provocative, I am not sure they are entirely true. Surely one of the new compounds bring developed by big pharma or one of the startups will get approved. What I do agree with is the fact that it will be prohibitively expensive for a startup company to develop a diabetes drug on their own. Partnering with pharma, especially for a lead product, limits the terminal value of a company and potential returns for a venture investor. While PhaseBio and Catabasis both have diabetes programs, they are also developing assets for different indications. This enables them to partner their diabetes program and focus on internally developing assets that are more manageable for a startup to pursue.

Even if what Stephen said was tongue in cheek, it is important to worry about the relative lack of drug development activity for a disease that afflicts 8% of the US population.