Returns in Venture Capital: Why we believe Biotech investments will outperform Tech

In today’s digitally driven world it is a common habit of the general public and media to dedicate significantly more attention to the classic tech and software space than to biotechnology.

Understandably so: Big success stories in the tech economy are loudly communicated and feel always present - seeing Amazon take over the retail space or sharing your daily avocado toast on Instagram makes it natural to consider them major investment opportunities. Products of biotech companies have a different kind of charm: The enthusiasm here is ambivalent as you hope you will not ever need them.

Investors often feel that the expertise going into research-heavy products of biotechnology and biopharma companies is beyond the grasp of a layperson. Surprisingly, they tend to put more blind trust into developers at tech startups engineering a tech-heavy product and easily hold the belief that they will lead to investor returns. Certainly, both kinds of products require sophisticated knowledge to make promising investments.

Consequently, the general public as well as the majority of players in the VC space hold their unjustified suspicion against biotechnology and automatically suppose tech companies to pose more attractive investment opportunities - but that is not entirely true.

Biotech has already outperformed tech investments in the past

It may come as a surprise, but VC-backed biotech companies actually perform better than the widely discussed tech companies. Looking at Cambridge Associates’ US Venture Capital Index and Selected Benchmark Statistics as of March 2020, over the past 20 years biotech startups’ IRR was around 7% higher than the return of classic VC cases software & services on average. Even in Europe returns are better in life sciences investments than in tech: The European Investment Fund (EIF) in its Annual Report 2019 declares life sciences as the top-performing sector in its European Venture Capital portfolio. Compared to tech, life sciences investments have a significantly higher chance for an IPO. Returns are also less binary and are not subject to higher risk than tech - as often assumed of companies working on innovative but R&D-heavy products - according to EIF Ugly Duck 2019. Within life sciences biopharmaceuticals are by far the hottest category for VC investments according to CB Insights’ analysis on the healthtech and biotech space.

Keeping these facts in mind, increased capital efficiency through achievements in lab automation technology, for instance decreasing costs in DNA sequencing and efficiency increases through artificial intelligence is likely to further accelerate science and fuel the translation of innovation as well as investor returns for biotechnology investors. Using 2017 as a base year with a market size of $399.4 billion for biotechnology the projections for the period of 2019 to 2025 are a CAGR of 9.9% resulting in a 2025 value projection of $ 775 billion with biopharmacy being the biggest chunk.

Although the best performing tech investments have led to higher multiples for investors, a more thorough look reveals the rest of the story. For example, in the case of Juno Therapeutics, ARCH Venture Partners made a 23x return on their money invested in the Seed round when the company was acquired by Celgene for $9 billion 3 years after its IPO. There are quite a few biotech companies that have delivered these sorts of returns after going public.

Due to the fact that most of the top performing biotech companies were acquired within only less than six years after Series A, we do not know how valuable theses companies would have been, if they had stayed independent for the same amount of time as the tech companies they want to be compared to.

But what are the underlying causes for the dynamics discussed above?

We at Apollo Health Ventures want to share our insights of why we believe the biotech space will continue to be favourable for investors:

1. Catching the Next Big Wave:
   Speaking of time and age of the space: Jared Friedman from Y Combinator said that investing in biotech and life sciences today looks a lot like investing in a tech company a decade ago. Costs of getting the company started have dropped significantly due to achievements in lab automation technology, in DNA sequencing and efficiency increases through artificial intelligence and the emergence of a sophisticated contract research industry enabling outsourcing of many specialized tasks such as chemical synthesis or animal model studies, just like open source software, modern web frameworks, SaaS developer tools and cloud hosting at the time in the tech space. This decreases the demand for large capital needs in early days and, at the same time, accelerates early proof-of-concept. If we look at the invention and commercialisation of the consumer internet space in 1990 as the most important and significant industry-enabling revolution for the tech market, we realize that the biggest winners in the market - be it Facebook, Paypal or Netflix - were founded and seed-funded within 10–15 years after “the revolution”. We see the breakthrough in human genome sequencing in 2003 as such a breakthrough for biotech which will (continue to) fuel an industry just like the internet did. Hence, the explosion in biotechnology investments has only just begun and investors should keep their eyes open no later than now.
2. Many more Blue Oceans
   In the market of developing innovative biopharmaceuticals science is continuing to race at an ever-accelerating pace producing new biology, targets and tools constantly creating opportunity space. While there are countless unsolved problems in biotech, due to the profound biologic and medical knowledge necessary to found a company in biotech, the space is far less crowded and far from exhausted. In numbers, over the past seven years only on average 5.25% of closed venture deals were in pharma and biotech compared to 38.12 % in the software space. The companies in the market commercialize game changing innovations and deals are more sophisticated.
3. Future Exit by Design of the Market
   One of the greatest perks of the biopharmaceutical space has a very healthy M&A culture as the acquisition of biopharma startups is the main strategy for driving innovation in big pharma. The share of revenues of pharma companies caused by acquired assets has grown from 25% in 2001 to whopping 50% in 2016 and this trend is continuing upwards. Needless to say, M&A scenarios are preferable compared to another upround where they deliver actual cash instead of further “paper money”.
4. Walled Gardens — in your favour
   One strikingly different and very interesting characteristic in the biotech industry is the very high market entry barriers for direct competitors: innovative therapeutics are protected by patents. Once you have successfully protected your asset you are in a very privileged position to harvest the market generating stable long-term returns - a no-brainer from a business perspective. In addition to this, in cases of failure to reach the ultimate goal of commercializing the research conducted, biotech startups can still monetize their intellectual property, while startups working on software are normally a complete write-off.

In summary, given the expertise and a good strategy to make the right bet in the market, you create outstanding business opportunities that can easily lead to more than desirable investor returns through acquisition or IPO scenarios.

We at Apollo Health Ventures have collected the experience and knowledge in one of the most promising areas of biotech investments to capture those great opportunities created in this rising market.

Please note that this article reflects the opinion of Apollo Health Ventures based on the data cited or mentioned herein. It neither constitutes the solicitation or offering of any investment product nor any type of investment advice, recommendation or endorsement and as such cannot be relied upon in any context.