European venture funding for the life science sector

For the third year in a row, European venture funding into life sciences looks likely to top $2bn, reinforcing the health of the early stage ecosystem. And while M&A in 2017 have been a little slower so far, the continued fashion of big pharma partnering with smaller biotech companies, and the recently installed CEOs at GSK, Eli Lilly, Novartis and Alexion, should ensure a healthy M&A appetite going forward.

Venture funding remains strong

The UK continues to take the largest share of venture funding - $1.2bn since the beginning of 2016 to H1 2017 and larger than the next three combined - Germany, France and Switzerland. New funds such as Oxford Sciences Innovation, Syncona (which listed at the start of the year and consequently increased its deployment capital) are likely to reinforce this trend going forward. In stark contrast to the post-crisis situation, there is an abundance of capital and some investors report greater competition for the right deals, with associated higher valuations.

The greater risk - given the inelasticity of the supply of R&D to the sudden increase in capital - is a lowering of the quality bar as marginal companies obtain investment. If this happens it could adversely impact the exit environment that continues to be more fragile for European companies, and thus negatively affect the recycling of capital back to limited partners and investors and thereby threaten future funds for the sector.

Keeping the bar high

To guard against this risk, it is essential that investment groups maintain a high bar for making investments and, perhaps paradoxically, deploy the ‘right’ amount of capital to ensure success. This has meant in fact putting greater capital to work in companies. Our research shows that in Europe, the average deal size, especially for deals with biopharmaceutical companies, increased from just under $6m in 2014 to $16m in 2016.

While it is important to maintain capital efficiency, especially at the very early stage, it is equally important for companies in highly innovative areas with programmes entering the clinic to provide runway and capital so companies can conduct the right trials, give themselves various exit options and ensure management is not distracted by fundraising every year.

An interesting merger?

At the time of writing, two major UK venture groups are engaged in a potential merger. IP Group and Touchstone Innovations (formerly Imperial Innovations) are both publicly listed investment vehicles. They are focused on university spin-outs, supporting them to a relatively late stage of development. Their listed status means these groups, theoretically, need not worry about returning capital to limited partners in a fixed time frame like a traditional venture fund. The idea being that the underlying net asset value would reflect the value of the investments, giving investors in IP Group liquidity options.

In reality, both groups have a narrow shareholder base meaning poor liquidity and thus undermining the model. The proposed merger is designed to create a larger group, able to access capital from a wider base of investors and thus solve this issue. A likely fallout from this process will be a new or refined investment strategy. The combined group would have approximately 130 companies between them in sectors as diverse as healthcare, technology, cleantech and materials. It is of course too early to speculate on the life science component, but with Oxford Nanopore and Cellmedica being two jewels in their respective crowns, capital for the sector from this important group should be maintained, albeit with a modified focus.

Focus on immuno-oncology

Oncology and especially immuno-oncology continues to take the majority of the funding within biopharma and while this is an exciting field - the first CAR-T approval is likely to accelerate interest - the sheer number of combination therapies and PD-1/PD-L1 inhibitors could result in a commoditisation of this area that could threaten returns for venture groups that are heavily invested in this area.

Capital markets infrastructure is a barrier

European biotech companies continue to find it hard to raise public money in Europe. Pockets of success on Euronext mask the fact that leading European venture groups primarily look to the Nasdaq, at least for their top companies.

The recent flotation of Syncona’s Nightstar Therapeutics demonstrates that it’s not the perception of European companies per se, but fragility in the capital markets’ infrastructure that is impeding access to later stage capital.

Digital health investment accelerates

The most interesting trend in the sector is the acceleration in digital health investment. This broad category covering everything from clinical grade wearables, smart diagnostics to AI-enabled chat-bots and drug discovery companies, is attracting investment from technology as well as healthcare investors.

Babylon and Doctolib raised $90m between them with major investors being Kinnevik and Accel respectively - two groups known predominantly for tech investments. BenevolentAI, rumoured to enjoy a ‘unicorn’ valuation, has Woodford and Landsdowne as major investors. Equally interesting is the lack of traditional healthcare investors in this field - predominantly biopharma groups have stayed away, usually citing a lack of knowledge of how these types of businesses scale, and scepticism over commercialisation.

Digital health companies, especially in Europe, will find it challenging to monetise their propositions and face continued challenges handling privacy concerns and inserting themselves in a relevant way into the workflow. And within the specific field of AI/ML there is certainly a degree of hype that has not been matched by evidence to date - IBM’s Watson for Oncology was recently revealed to have been a failure thus far.

These entirely new fields of investment also represent challenges to the healthcare system; multiple skills in technology and healthcare are required to do due diligence within a sector, further complicated by the fact that the companies themselves are creating the environment in which they aim to be successful. As in the early days of the dotcom boom, hype will not match reality and money will be lost. However there were survivors and if, as some contend, the internet doesn’t seem to have changed life so much, that’s only because the technology has become so pervasive that we can’t remember a past without it.

Digital health will go the same way and we expect to see the emergence of investment groups and specialist teams who understand the combination of technology and health environment. With venture fundraising in the US at a high, and the Nasdaq demonstrating a continued appetite for late stage funding, capital flows into the sector look strong for the years ahead as the world wrestles with its healthcare challenges.