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Bullish on biotech: In-house creation vs traditional VC investment

A new model for investors

Venture capital (VC) companies are taking the proverbial bull by the horns and creating biotech companies themselves. This trend provides VCs with something more than their traditional investment models—namely, increased control and the ability to shape the company from the very beginning.

Like traditional entrepreneurs, these VC-formed companies can take the company in the direction that want. But unlike their traditional counterparts, VC-formed, rather than merely VC-funded, companies have the funding and support they need to meet their milestones early on. Those two factors, coupled with the heavy vetting of the science and likely markets before the company is even formed, sets them ahead of the pack and can bode well for their eventual success.

[Learn more about what the experts have to say at BioPharm America]

A different value proposition

From a VC’s perspective, “The people you’re working with are as important as the underlying scientific substrate,” Michael Gladstone, principal, Atlas Venture, says. “Therefore it’s natural for us, as an early stage investor, to spend as much time ensuring we have the right people as that we have the right science. Incubating a company in-house, therefore, helps us assess interesting ideas with experienced drug hunters and executives. It gives us a running start in company-building, because those entrepreneurs-in-residence who helped perform due diligence and shape the effort often step in to lead the new companies.”

While VCs do have complete ownership of the companies they form, “Company-creation is a team sport,” Gladstone emphasizes. “We like being able to help shape early efforts, but it’s equally important that the entrepreneurs are central drivers of this process, and that they have both the influence and economic ownership that reflect and incentivize this.”

In a VC-formed company, the leadership may be employed by the founding VC or, in Atlas’ case, by the seed company. This new business creation model provides a safety net for entrepreneurs that encourages them to rigorously, objectively evaluate opportunities. If the endeavor fails, Gladstone says, “We’ve been very successful in finding entrepreneurs another opportunity within our portfolio. This provides a safety net.”

Innovators who choose that path are trading autonomy for security and early access to expertise and funding. They often have more than 15 years of work experience and know how challenging it can be to build a successful company.

For some scientific founders and entrepreneurs, however, the value is in autonomy. “They may want to form a company on their own, particularly if they perceive they wouldn’t get enough ownership or reward from being part of an in-house creation,” Anna Turetsky, PhD, VP, Lightstone Ventures, says. “Working independently, entrepreneurs typically have more ownership in their company, but give up the safety net of venture fund affiliation, and may need to invest their own money initially. “It’s a higher risk/higher reward endeavor,” she says.

“For investors, creating a company in-house gives them more say in very early hiring and strategic decisions that shape the company,” Turetsky continues. This helps them to avoid some of the common, early missteps that many scientific founders tend to make.

What’s a VC-formed company?

There’s no definitive definition of what exactly constitutes a VC-created biotech company. “What does it mean to build a company? To build a team? To build a product?” she asks rhetorically. “Is it building a business plan and strategy, or does it also include running experiments?” Traditional VC models are involved in most of those steps, so what constitutes in-house company formation?

“I don’t think we are thought of as company creators, per se, but we are certainly company builders. We are involved so early, we may as well be considered creators,” Turetsky says. Lightstone Ventures invests in seed, Series A, and Series B rounds. “For seed investments, we typically work with one or two additional firms to provide funding and divide the workload.

“We’ll work with a single, independent entrepreneur, but are unlikely to start a company completely from scratch,” she says. “Lightstone does, however, form medical device companies through a close relationship with The Foundry, a medical device incubator in California.”

Trending: Entrepreneurs-in-residence

To create a company in-house, “You need somebody dedicated to the new company,” Turetsky says. Within VC companies, entrepreneurs-in-residence often spearhead company formation. Once a strategic vision or platform is identified, these scientific or business experts typically scout for technologies around which to start a company, pull together the scientific assets from academia and pharma, develop the business strategy for the nascent company, and put a management and scientific team in place.

They also are responsible for obtaining lab space or outsourcing biology or chemistry work. “One of the most important early tasks is to repeat experiments to ensure the discoveries that form the foundation of the new company are replicable,” Turetsky says.

Having the early backing of a VC can make that easier, by providing the funding to access labs and equipment and by guiding the entrepreneur-in-residence to researchers who have expertise in specific areas. “Drug development is hard, so if a company is likely to fail, it’s better to learn this early,” Gladstone says. In contrast, an independent researcher risks his or her own capital to do that.

At Atlas, entrepreneurs-in-residence have had long, successful careers in drug design and development, or in senior management at pharma or biotech companies. “Typically, they come to us saying they are interested in building a company from the ground up and want to identify an interesting idea to build a company around, or are interested in entering a company early in its life cycle,” Gladstone says. “They may investigate several ideas before focusing on a particular opportunity.”

As a startup of one to five people, these VC-founded companies typically are housed in the VC’s offices, leveraging its resources and personnel, and contributing to additional projects, he says. There’s a synergy that comes from being together with other creative, well-connected people that jumpstarts a company.

The new normal?

While in-house company formation by VCs is a definite trend, it’s unlikely to become the new normal anytime soon. But, for many early-stage VCs, creating companies from scratch is the next logical step. This lets them leverage their acquired knowledge, but requires a significant commitment to formalizing their infrastructure and integrating their capabilities so it can be repeated and scaled up.

There’s room in the VC ecosystem for many different models. “There are still a number of investors out there who back young, independent companies,” Turetsky notes. In-house company formation may be a good option for entrepreneurs with proven track records, but scientists and managers still building their reputations are well-advised to thoroughly understand the landscape.

“The investment landscape is cyclical,” she points out. “In 2018, we’ve seen the lowest number of acquisitions—6—and the highest number of IPOs—30—that we’ve seen in years. There’s a lot of capital out there right now for new investment.” This available capital (and the need to invest it) is one of the factors driving the trend for VC to form companies in-house. “It will be interesting to see whether the trend reverses,” Turetsky says.

Anna Turetsky, PhD, VP, Lightstone Ventures, and Michael Gladstone, Principal, Atlas Venture, are participating in the BioPharm America™ panel discussing the trend of VCs to form biotechs in-house. Join them Thursday, September 6 at 9:30 am.

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