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Key Insights from Healthcare Venture Capital Firms

 I recently attended a biotech/medtech entrepreneurial conference and gained some valuable insight from a panel of prominent national (and even one international) healthcare venture capital firms discussing their current investment strategies.  Whether you are an active healthcare investor or avoiding the sector since the end of the “double digit pharma returns for anyone with a pulse” – era, some interesting points were addressed that reflect how capital is flowing and not flowing within the sector as a whole in this current stage of immense regulatory and financial uncertainty.

In the seemingly distant past, healthcare venture capital banks heavily funded young drug companies and successfully pushed many to exponential returns and strategic exits to Big Pharma. But now, the FDA is hammering even the best of companies, VC funds are shrinking, high potential companies are failing, and early stage and disruptive innovations are becoming too risky to fund (even one VC proclaimed that sequencing the genome would never be funded in today’s climate).  Contrary to popular opinion, there actually is much hope in investing in this sector if you understand where it looks to be heading. Even though the nature of VC firms may differ from investing in the stock market, there are some key trends which stood out to me that the VC partners in the panel alluded to that can serve as an indicator for how to invest in companies that have promise in the new healthcare era:

1.  New Definition of “Early Stage”

VC firms as a whole are avoiding companies with pipelines that are in the early stages of clinical trials.  However, one of the panelists stated that his fund’s strategy is to invest primarily in the early stage companies.  When further probed, his definition of “early” showed that they were not investing in companies in the middle of Phase I drug trials or anything that early, but those positioning itself for Phase III.  Most of his venture capital brethren are investing in companies even later in the to-market cycle, and it is important to be updated on these developments if investing in the sector.

Investment Takeaway:  Look for companies that have pipelines with strong promise in Phase III trials and are much closer to market.  Companies with very lean operations and a cash-holding management team are the only targets.  The largest investors and Big Pharma are minimizing their risk as much as possible and they have determined this is the best way to do so.

2.  Big Pharma’s Portfolio Strategy

As many may know, Big Pharma’s M&A activity is intense right now and only expected to continue as they move away from the blockbuster drug model and move to diversify their portfolios in niche markets.  VC firms are increasingly interested in firms that offer key capabilities for differentiated, under-tapped populations and will ultimately be very attractive to the diversification strategy of the multinational companies.

Investment Takeaway:  Keep an eye on what individual Big Pharma companies are buying and look at other smaller firms with similar or better capabilities as potential acquisition targets in the near future.

3.  More Device and Diagnostic Firms

VC firms are diversifying as well from traditionally funding only biopharmaceutical firms, and now to expanding their portfolios with growing medical device, diagnostic, and IT companies.   Yes, the FDA is becoming more difficult as a whole, but it is RELATIVELY less stringent on devices and may facilitate quicker devices to the market.  The large payers are fully backing this movement as they see tremendous value and savings from technological innovation.  VC firms recognize this and their money is acting accordingly.

Investment Takeaway:  Diversify your healthcare portfolio and seriously consider device and IT companies for short-term and long-term growth.  Not all these companies will succeed but identify those that reflect the key characteristics of (you may have heard this before, but it really is true): cheaper, more effective , aids in maintaining chronic disease, less invasive, and interoperable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.