A certain song has been running through my head the past few days. Lately, it strikes me as an anthem of sorts for biotech venture capital in 2013.
It’s Fleetwood Mac’s classic break-up song, “Go Your Own Way.”
Allow me to explain. Biotech venture capital has been going through a shakeout now for a couple years, which I’ve written about quite a bit. If you want to be charitable, there are maybe half as many venture firms investing in life sciences companies today as there were five to 10 years ago. There are maybe only a dozen firms left in the U.S. who can say with a straight face that they still are active investors in early-stage biotech startups. It may be harder now than it’s ever been to raise money for a new biotech idea.
That’s a problem. What fewer people seem to have noticed, though, is just how the shakeout has fundamentally changed the venture capital business model, and how the firms who are left standing relate to each other. Venture capital firms have traditionally formed tight little cliques known in the business as syndicates. The idea here was to find a great entrepreneur to back, call up 3-4 of your buddies at other VC firms, and get them to co-invest for the next decade. The conventional wisdom said that it was a good way to make sure a startup drug- or device-maker would have enough capital to reach the desired “liquidity event” of an acquisition or IPO. Along the bumpy journey, each VC firm knew it had between 12 and 20 percent ownership in the startup, and could take solace knowing the network limited their risk. A couple bad bets on startups, in other words, wouldn’t wreck an entire fund.
Critics have long scoffed at the groupthink that emerges in these syndicates. VCs often get criticized for behaving like lemmings who blindly run together off of cliffs.
But VCs are behaving less like lemmings today, and more like lone rangers. There are a number of reasons. So many venture firms have been slowly going out of business that there aren’t many players left to syndicate with. The few healthy firms remaining have been freaking out about what they call “syndicate risk.” That’s a fancy way to describe the fear VC firms have that their peers will run out of cash in the next few years, leaving their portfolio companies high and dry when they need more money. Increasingly, the surviving venture firms are figuring out ways to start companies on their own, hold onto a bigger piece of the equity ownership, and hold their breath until this especially high risk/high reward proposition pays off.
Recently, we’ve seen a string of stories in which VC firms are proving they can place winning bets on their own, without the support of a syndicate. Take a look at some recent examples:
Third Rock Ventures—The Boston and San Francisco-based venture firm is not opposed to joining syndicates, as it has welcomed some big-name friends (Bill Gates, Yuri Milner, et al) to co-invest in one of its gems, Cambridge, MA-based Foundation Medicine. But Third Rock often prefers to have its partners involved in incubating companies it starts in-house, enabling it to retain operational and financial control for young company’s formative years. Once its hatchlings emerge from the incubator, Third Rock has shown a tendency to commit $30 million to $40 million of its own money in Series A financings, without any syndication.
The go-it-alone strategy paid off in a big way with its bet on Lotus Tissue Repair. That company was acquired in January for about $49 million upfront, plus $275 million in milestone payments. The deal represented a three-fold return on Third Rock’s investment on the upfront payment alone, and could end up being a 20-fold return over the long haul. Why was it such a big winner? Third Rock, the lone VC in the deal, retained a whopping 73 percent ownership stake in Lotus Tissue Repair.
Flagship Ventures—the Cambridge, MA-based firm takes a lot of pride in its history of active investing, not just passively putting money into companies and sitting on the board. This week, one of the alumni from Flagship VentureLabs came out of nowhere to create huge value. Cambridge, MA-based Moderna Therapeutics, which Flagship
