December 15, 2016

The Unexpected Winner of the Distribution Derby

Life Science funds can be an important source of returns and liquidity for a venture portfolio @CRMcCrea @WeathergageTeam

IT-focused VC funds seem to attract all the attention, and most of the capital, of investors. Yet, if one is keeping score, one would be well served to check in on recent returns and distributions from Life Science funds. 

Many limited partners wrote off Life Science several years ago. At the time, it seemed to be a reasonable decision – massive capital requirements, long time to exit, lack of liquidity and an obstructive FDA are but a few of the hurdles that resulted in poor returns for life sciences investors. But that was then and this is now.  The underlying science and the exit markets appear to have finally caught up, making Life Science funds a source of good returns and liquidity for for a venture portfolio.

Since 2006, healthcare focused venture funds have been producing notably higher DPI’s (Distributions to Paid In Capital) as compared to the venture industry as a whole. As you can see in the following image, during these nine years (2006-2014), healthcare focused venture funds have produced superior distributions in every year and outperformed the larger VC industry by an average of 35.3%.  If we could take the healthcare-only funds out of the all venture capital bars, the difference would be even more pronounced. 

During this same timeframe, Life Science funds also have produced impressive IRRs. Over the last five years, the IRRs have been meaningfully higher than those produced by the VC industry as a whole. The vintage years from 2006 to 2009 also produced attractive returns for Biotech, however IT funds did better.   

So, why have IRRs and distributions been so strong for funds in the Life Science sector? There has been a confluence of factors. 

Over the last decade, we have seen tremendous innovation in Life Science. Today’s innovations are in areas such as immuno-oncology (teaching personal immune systems to fight cancer), personalized medicine (using drugs only on patients with specific DNA traits), orphan drugs, gene mapping, gene therapies and the use of big data in healthcare. 

These innovations are now combined with a more receptive FDA and with cash-rich pharma companies desperate to fill their product pipeline via the acquisition of more innovative companies.  In the chart below you can see the meaningful increase in acquisition value, especially in 2015. 

Not surprisingly, the IPO markets were receptive to these waves of innovation and the more reasonable FDA process. The image below shows the surge in Biotech and Medical Device IPOs beginning in 2013. This surge has since dissipated somewhat but it is important to note that Biotech and Medical Device IPOs still comprised the majority of VC-backed IPO’s in 2015 and thus far in 2016. 

So, what should an investor conclude? 

Life Science funds have long played second fiddle to IT in the minds of many venture capital investors. Looking at the data, Life Science funds can be an important source of returns and liquidity for a venture portfolio and therefore worthy of reconsideration. We at Weathergage think it deserves more respect.  

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A nautical term that indicates a favorable position relative to the wind. A ship that "has the weathergage" has the initiative and hence a significant advantage over its rivals.