Life Sciences Investments on the Rise

They’re back. Like survivors of a natural disaster revisiting the scene of destruction, investors slowly are returning to the floundering life sciences industry, a sector they virtually abandoned after Wall Street’s near implosion of 2008.

They’re not back en masse or even at a consistent pace just yet, but investors indeed are returning, as evidenced by the escalation in cash flowing into the segment. Venture capital funding in the life sciences industry, which includes the medical device and biotechnology sectors, jumped 21 percent last year, according to a recent report from PricewaterhouseCoopers LLP (PwC). Venture capitalists invested a total of $7.5 billion in 785 life sciences deals in 2011, topping the previous year’s performance despite a decline in both deal volume and funding in the fourth quarter.

Image courtesy of PricewaterhouseCoopers report “Zigzagging Upward,” with data from the PricewaterhouseCoopers LLP/National Venture Capital Association MoneyTree Report, based on data from Thomson Reuters.

Other industries experienced increases as well, including the clean technology, media/entertainment and Internet-specific sectors. Such gains potentially could signify the start of a comeback of sorts for capital investments, though analysts are skeptical that funding levels will everreturn to their 1999-2000 peaks.

There’s good reason for that skepticism, too: Over the last decade or so, venturecapital investments for all industries plummeted 71.3 percent, falling from a high of $99.1 billion in 2000 to $28.4 billion in

2011, according to historical records fromthe PricewaterhouseCoopers LLP/National Venture Capital Association MoneyTreeReport based on data from Thomson Reuters. Venture capital funding nearly doubled from 1999 to 2000, increasing an astounding 91.2 percent. Since then, however, investments have fallen steadily, peaking again slightly in the second quarter of 2008 (that apex was nowhere near the levels of the first three quarters of 2000, when funding averaged $26.2 billion) before slipping again and bottoming out in Q1 2009.

Over the last three years, investments have seesawed between gains and losses, prompting an overall slowdown in investments and shaking the confidence of previously generous financiers. The venture capital industry was so troubled in 2009, in fact, that investors adopted a “things have to get better” mentality for 2010.

And remarkably, the market did get better that year. Investments jumped 16.2 percent to $25.2 billion, according to data from the MoneyTree report. Buoyed by that increase, venture capitalists were quite optimistic in late 2010—more than half of investors who participated in a survey conducted by the National Venture CapitalAssociation (NVCA) and Dow JonesVentureSource expected capital funding to rise again in 2011.

And sure enough, investments rose last year, climbing 22 percent in dollars and 4 percent in deal volume. “As previously projected, venture capital investing in 2011 exceeded 2010 levels and ranks in the top three years for VC investing in the past decade,” noted Tracy T. Lefteroff, global managing partner of the venture capital practice at PwC.

Financiers had forecast significantincreases in capital funding for severalsectors last year, including information technology, consumer Internet anddigital media, cloud computing andmobile/telecommunications. Their predictions were fairly accurate, too—the media/entertainment sector experienced one of the largest infusions of cash in 2011, with investment dollars jumping 53 percent. IT services received a 39 percentincrease in VC funding while the software sector overcame a fourth-quarter setback ($1.8 billion was spread among 238 deals) to attract $6.7 billion worth of investments, a 38 percent increase compared with 2010. The money went into 1,004 deals, a 7 percent rise in volume compared with the previous year, the PwC/NVCA MoneyTree report states.
Internet-specific companies also experienced a significant increase in VC investments in 2011, reaching the highest levels of funding in 10 years. The $6.9 billion that was funneled into 997 deals represented a 68 percent jump in funding and a 24 percent rise in deals compared with the $4.1 billion that went into 807 deals in 2010. (Internet-specific is a discrete classification assigned to a company whose business model is fundamentally dependent on the Internet, regardless of the firm’s primary industry category). These companies accounted for 24 percent of all venture capital dollars in 2011, up from 18 percent in 2010.

The clean technology and life sciences sectors stunned investors by attracting significant funding in 2011. The VC prognosticators who correctly predicted funding increases for IT, Internet-related and telecommunications firms believed that clean technology and life sciences companies stood little chance of attracting interest from venture capitalists.

Imagine their surprise, then, wheninvestments in clean technology firms swelled 12 percent to a record high of $4.3 billion. Investments in this sector remained on par with 2010, accounting for 15 percent of all VC dollars that changed hands last year. Interest in the industry appears to be picking up again following a crushing blow from a confluence of factors, including fluctuating silicon prices, newly cheap natural gas, the Great Recession and China’s ascendant solar industry.As a matter of fact, three of the top 10 VC deals last year involved clean technology firms—those companies that work with alternative energy sources, pollution and recycling, power supplies or conservation, according to the MoneyTree report.

The life sciences industry attracted its fair share of funding in 2011 as biotechnology companies captured $4.7 billion in venture capital through 446 deals. Despite a 9 percent drop in deal volume (but perhaps saved by a corresponding 22 percent boost in funding), the biotechnology sector was the year’s second-largest investment class. Not far behind was the medical device arena, which attracted $2.8 billion in 339 deals for an overall fourth-placefinish in terms of dollars and deals.

Even with such gains, though, growth in the life sciences industry remained jagged in 2011, rising for the first two quarters and then falling for the final two (perhaps it is fitting then, that PwC titled its February report on life sciences industry funding for the fourth quarter and full-year 2011 “Zigzagging Upward”).

“Life sciences investments in the fourth quarter outperformed total venture investment when compared with the same quarter of 2010. We did see the IPO window crack slightly during the fourth quarter of 2011…life sciences companies claimed three of the 11 venture-backed IPOs,” Lefteroff said. “However, at this point, M&A deals continue to offer more exit opportunities for life sciences companies than IPOs.”

Investments in the life sciences sector were somewhat lopsided in Q4 2011, with biotechnology garnering 72 percent of the funding and medical devices capturing 28 percent. The allotment was more evenly split during the third quarter, when biotechnology firms received 60 percent of VC dollars and medical device companies collected 40 percent. For the entire year, biotechnology’s share of life sciences VC funding remained more or less at 2010 levels, climbing just 0.5 percent to reach 63 percent. Medical devices finished the year with 37 percent of all life sciences investments, PwC’s brief report states.

During the final quarter of 2011, biotechnology funding surged 46 percent to $1.3 billion. Deal volume fell slightly (1 percent) to 111 transactions. Medical device investments for that quarter were not as profuse, rising only 10 percent to $498 million. Two companies each raised $65 million in funding during the quarter—Redwood City, Calif.-based Heartflow Inc. and AcuFocus Inc. of Irvine, Calif., according to data from VentureDeal, an online database that provides the latest information about venture capital, venture-backed technology companies, venture capital firms and transactions in the United States. Hearflow is using its VC dollars to help fund the development of a system that would provide superior data about blood flow in coronary arteries, while AcuFocus will put its share toward its efforts to help treat near vision loss.

Other notable funding allocations of 2011 included a second-quarter allocation of $107 million to Cameron Health Inc., a San Clemente, Calif.-based company developingproducts it refers to as “the next generation of implantable electronicdevices utilizing state-of-the-art technologies” and the third-quarter awarding of $150 million to Bridgewater, N.J.-headquartered Valeritas Inc., which provides patch format drug delivery systems to the diabetes market. The funding for Valeritas came from a large syndicate of venture capital, private equity and strategicinvestors, according to VentureDeal data.

One of the most dramatic fundingincreases for the life sciences sector occurred during the fourth quarter in early stage investments. PwC’s report states that early stage funding skyrocketed 88 percent to $987 million; compared with Q3 2011, early stage funding jumped 47 percent.

“This increase in early stage funding is a positive sign for the industry,” Lefteroff noted. “It shows that venture capitalists have not lost confidence in the potential for companies to develop innovative products to meet critical needs in the market despite higher clinical and regulatory risk at this stage.”

During Q4 2011, early stage deal volume slid marginally by 1 percent to 105 deals. Compared with the previous quarter, the number of deals rose 12 percent; average deal size ballooned 90 percent year over year to $9.4 million, a 17-year record.

“It’s no surprise that average deal size is up at the early stage. Venture capitalists recognize that the path to market is longer and increasingly expensive,” Lefteroff said.

For the first time since the second quarter of 2010, early stage funding for lifesciences companies topped late-stage funding. Late-stage deal funding declined to $786 million, a 2 percent decline compared with the fourth quarter of 2010 and a 37 percent decrease compared with the third quarter of 2011.

Late-stage deal volume fell 10 percent when compared with the same quarter of 2010 and 19 percent compared with Q3 2011. Average late-stage deal size climbed 9 percent to $10 million.

“Part of the movement of investment dollars from late to early stage suggests that later-stage companies continue to find exits, which frees up investment dollars that would have been allocated to later-stage deals to be invested into early stage companies,” Lefteroff concluded.