Impact Investing, are you doing it wrong?

Life-Science — The Forgotten Impact Investment

What is impact investing? A quick google search yields the following results:

“Investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.” — GIIN
“Impact investing is investing that aims to generate specific beneficial social or environmental effects in addition to financial gain.” — Investopedia
“Impact investing is the placement of capital into businesses, organizations and funds with the intent to create measurable social or environmental benefits alongside a financial return.” — Mission Throtle

Traditional Impact Investing

Although impact investing is still an emerging sector, I have seen a consolidation in the mindset of impact investors. Investments directly tied to developing countries or low-income communities in developed countries have become the de-facto target segments. Impact investors can easily quantify and empathize with the impact potential of these investments. This naturally has led to the development and consolidation of some major impact investing sub-sectors:

Clean Drinking Water

Example Investment Profile: Water purification plants in rural villages.

Fair Trade / Job Creation

Example Investment Profile: Fair Trade and organic-certified coffee cooperatives.

Clean Energy Access

Example Investment Profile: Solar energy for lighting and refrigeration in rural households.

Housing

Example Investment Profile: Affordable homes designed for low-income and/or rural families.

Analyzing Your Impact Investment Criteria

The aforementioned sectors clearly provide impact potential and good financial returns if executed correctly. However, in this post I want to point out that there is a trap inherent in the consolidation of the traditional impact investing mindset.

As an impact investor one must necessarily think along a dual axis of Impact & Financial Returns:

If we analyze what kind of companies will rank higher on these two axis, a large portion of the traditional impact investing sectors do rather well on both metrics. However, there is one asset class that stands out above the rest and it’s precisely one that impact investors don’t often mention when discussing impact investing.

Life-Sciences

Life-sciences is a sector very rarely discussed among those in the mainstream impact investing circuit. Perhaps, it’s not as sexy or alluring. Despite this, the impact and financial potential of the asset class is undeniable.

It appears that in this new age of modern technology and interconnectedness we have forgotten what kind of ventures and innovation have most fundamentally impacted society. From a typical for-profit retail investor we have seen a shift to consumer software, digital, social media and SaaS asset classes. I wrote about this phenomena a few weeks ago: Invest in Things That Matter: Please Stop Funding Social Media Apps.

Meanwhile from a more social conscious investor or the emerging “impact investor” we have seen a shift to BOP solutions, Job Creation, Financial/Education/Housing/Services Access, etc. Meanwhile the life-science sector has been largely ignored in these broader market investor trends.

Why are Impact Investors Missing out on Life-Sciences?

While it’s hard to draw a broad stroke and generalize all impact investors there are a few key characteristics that we can focus on.

Delayed Impact

Many impact investors partake in impact investing at least partly because of the immediate feel good feedback that investing in underserved communities provides. Their dollars can very quickly translate to better access to a product or service for some underserved communities.

This is valid, and understandable. Life-Science is tricky in that it requires a lengthy period of time to see the impact return on the investment. For a therapeutic it can mean 10+years of development and regulatory oversight before it can begin impacting everyday patients lives.

For this reason it is important for investors to ask themselves what their ultimate goal is with regards to the impact of their investment. If it’s to cause impact as soon as possible or if it’s to maximize impact in general? This is a personal question that every investor can only answer themselves but can be important in crafting their overall investment thesis.

Mainstream Acceptance

There is little conversation within the impact investing mainstream about life-science investing. New and existing impact investors have little exposure to the sector and there are few outspoken voices on the topic. Without more people bringing life-science impact investing to the fore-front it’s unlikely we get significant amounts of impact investors to contemplate life-science as a viable impact asset class/sector.

Difficulty

Investing in science can be difficult. Impact investors often lack the scientific expertise to undertake diligence on startups in the sector. It’s difficult to understand molecular structures or to navigate the drug development process if one does not have a background in it. Stronger diligence and supporting frameworks need to be created around life-science investing that make these investments more accessible to individuals interested in the sector.

Can Life-Sciences Really Deliver on Financial Returns?

The current funding landscape in life-sciences and biotech is in a bit of flux. The funding conditions have cooled off significantly in the past ~2–3 months. However, this may not be indicative of anything sector specific since this trend has also been prevalent in the broader startup and public financial markets. We have seen investors be more cautious in the early going of 2016.

Over the past few years we have seen very strong upside potential for life-science / biotechnology startups. There have been just over 140 biotech IPOs since the spring of 2013, the most prolific IPO window in history for the sector.

The NASDAQ Biotech Index was at 3500 heading into a new year, something never previously seen.

Despite the strong IPO trends, going public may not be the most promising trend for biotech exit opportunities. Established Big Pharma is undergoing a transition phase for many of their market leading drugs. A large cliff of patents are nearing expiration and Big Pharma has looked to young, novel and more nimble biotech startups as a way to replenish their pipeline. For the year 2014, 60% of projected pipeline revenue comes from externally sourced products, an all-time high according to the Deloitte survey.

“University ventures are 144x more likely to IPO (8% vs 0.07%)” — National Council of Entrepreneurial Tech Transfer

Exit opportunities are there and the potential to make significant returns is very possible in the sciences.

Can Life-Sciences Really Deliver on Impact?

Lets begin with something that the majority of readers can relate to. If asked, what is the biggest killer of people world-wide? What would you say?

If you guessed heart-disease you are correct. 7.4Million deaths were associated to heart-disease in 2012 alone according to the World Health Organization. This number could have been higher if not for Akira Endo a Japanese researcher.

A number of years ago Akira was post-doc at the University of Rochester. While there he worked on cholesterol research and hypothesized that fungi repel bacterial infection via cholesterol inhibition. Soon thereafter he was able to develop the first version of statins. Statins are a class of pharmaceuticals that are the best selling drugs in the world and first-line treatment for cardiovascular/heart related diseases.

There were estimated sales of 18.7Billion USD of statins for the year 2005 in the US alone.

It is estimated that the development of Statins has saved over 5Million lives thus far. There is also an ongoing debate on wether more widespread use of Statins would be beneficial and could potentially save even more lives.

Akira Endo’s story is just one of many.

  • John Enders — The father of modern vaccines is estimated to have saved 114M lives through his work.
  • Howard Florey, Alexander Fleming and Ernst Chain collectively developed and ran clinical trials for penicillin. They are estimated to have saved over 82M lives.
  • Frederick Banting who developed the extraction and purification techniques for insulin and later partnered with Elly & Lilly to commercialize insulin. Estimated to have saved over 16M lives.

If Life-Science Is So Profitable / Big Why not Just leave It To Existing Investors or Venture Capital?

Many of the figures I noted above for life-science & biotech companies is money being poured into the later stages of the startup life-cycle. Venture capital typically comes in at later stages in the life-science company cycle. For pharmaceuticals the process typically looks something like this:

There is significant amount of capital available for basic research carried out in stage 1 of the graph above. This capital is provided by public institutions such as universities and research centers around the country. Similarly, there is a large pool of capital available from VC’s and Big Pharma for companies performing clinical trials I, II & III which is stage 3 for the graphs above.

There is a shortfall of funding available and a critical need for risk capital in stage 2 for the above chart. This funding gap in the pharmaceutical pipeline is known as the “Valley of Death” in industry circles. Life-science startups that are not working on a pharmaceutical product for example synthetic biology startups will face a less extreme / time-intensive / regulatory version of this. However, they will typically follow a somewhat similar development cycle and face similar funding gaps.

I would dive even deeper and argue that the most acute funding gap happens in the pre-clinical stage. The pre-clinical stage is the second half of stage 2 in the graph above. This is the step right before heading into clinical trials where there is much more available funding sources. At this stage start-ups are assessing safety, pharmacokinetics and biological activity. There will likely be some chemical optimization as more robust data is achieved through this stage.

It is at this stage where Impact Investors can produce a disproportionate amount of impact. Due to impact investors interest in leveraging capital to maximize impact while still pursuing market returns, this stage of investment in the life-sciences is tailor made for impact investors involvement. We are in an age with unprecedented scientific progress and our understanding of biological systems is evolving rapidly. On top of this the infrastructure of software, storage, genomic data, computational power and new approaches like network pharmacology are opening up new opportunities for life-science startups and investors.

“There’s a backlog of about 20 years of drugs that are waiting to be tested but can’t be funded.” — Roger Stein, Senior Lecturer in Finance at MIT’s Sloan School of Management

Conclusion:

I am not advocating impact investors focus only on life-science and entirely leave their more traditional impact investments. I am arguing for re-thinking of what it means to think about impact in impact investing. New therapeutics and biotechnology products impact everyone. From developed nations all the way to developing nations.

Even higher-priced drugs developed under patent protection in the US, Japan & Europe usually end up helping developing countries very quickly. This is due to more relaxed patent protection regulation that allows copycat drug companies in developing countries to reformulate successful compounds originally developed in developed nations. Without incurring the extreme costs of the original R&D process they are then able to sell it at an affordable price in the local market.

If you are an impact investor, I hope that after reading this you take some time to rethink your investment thesis and consider life-sciences as part of your strategy. If you have any questions feel free to reach out to me on Twitter and check out ScienceVest our attempt to help bridge this funding gap. Similarly, the folks over at Impact Science Angels (I am a member) are also happy to help with any questions.