The significant pace of scientific and medical breakthroughs, combined with the merger and acquisition (M&A) interest from large biotechnology and pharmaceutical companies and growing optimism for successful public listings, has drawn institutional investors to life sciences-focused venture capital (VC) funds for decades.
Many investors seek to capitalize on the secular tailwinds and innovative technologies propelling the life sciences industry forward, such as aging populations, the need to identify cures for various illnesses, and the potential for artificial intelligence (AI) to transform drug development and optimize clinical trials. In recent years, biotechnology has seen a surge in investment due to breakthroughs in genomics, personalized medicine, and gene editing technologies that many know as CRISPR, the acronym for clustered, regularly interspaced short palindromic repeats.
LIFE SCIENCES VENTURE CAPITALISTS: INVESTING IN MEDICAL BREAKTHROUGHS
Life sciences VC managers typically target investments in human therapeutics that solve unmet medical needs. Managers investing in the industry must have the scientific rigor to properly diligence technology opportunities. Moreover, life sciences managers often work collaboratively with management to drive value creation by aiding drug development, negotiating corporate licenses, setting clinical and regulatory strategies, recruiting talent, and preparing companies for exit. Managers aim to produce strong returns by investing in companies with assets from pre-clinical, or not yet in human trials, to Phase I, or beginning human trials, stages.
Early-stage life sciences firms seek to invest in pre-clinical programs, which often includes identifying or incubating teams that are developing or have developed technologies with the potential for commercial market opportunities. Once a technology is developed, teams work to take the drug(s) through clinical and regulatory approval processes. Investments in this area are often tranched and milestone-dependent, allowing managers the opportunity to preserve capital if early milestones are not met.
Other life sciences managers target investments focused on later-stage clinical therapeutics. These firms pursue companies with mature products in development or seek licensing opportunities with established biotechnology and pharmaceutical companies.
When drug efficacy is demonstrated, and risk is lowered, managers seek to sell the company to a strategic acquirer—such as a large biotechnology or pharmaceutical company—or the public market via an initial public offering (IPO). Large biotechnology and pharmaceutical companies typically acquire assets around the Phase II trial. Since 2020, the median years to exit larger assets—greater than $75 million—to strategic buyers has ranged from four to five years, and historically, these exits have provided investors with attractive relative and absolute returns.
LIFE SCIENCES MARKET REGAINING SUSTAINABLE MOMENTUM
The abnormally active venture capital market in 2021 transcended the life sciences industry. The monumental year was distinguished by record-breaking fundraising dollars, unprecedented deal volume, rich exits to strategic buyers, and inimitable IPO activity. Much of the industry's high-octane period was attributed to pandemic-accelerated Food and Drug Administration (FDA) approvals.
Biotech IPO activity peaked in 2021 when more than 100 biotech companies entered the public markets and raised nearly $15 billion. Many drugmakers that priced offerings did so uncharacteristically, bringing companies that were in pre-clinical or early-stage clinical testing to market. This is significant because capital invested in earlier-stage assets is more exposed to the capital-intensive nature, prolonged timelines, and higher drug development and approval process failure rate.
The life sciences industry was adversely affected as interest rates increased, causing recently publicly listed companies to experience a higher-than-average failure rate. The hyperactivity of the life sciences market meaningfully decelerated after the first quarter of 2022. Investor capital, which had previously flowed freely into life sciences VC, pulled back, deal volumes fell precipitously, and distributions from exits were minimal. Compared to the 100+ biotech IPOs in 2021, the sector saw just 22 IPOs in 2022 and 19 in 2023.
In the first six months of 2024, the life sciences market has begun to show signs of reinvigoration. Fundraising dollars have exceeded the pre-pandemic pace, deal flow has increased, and 13 companies have already been publicly listed this year. Unlike in 2021, most biotech companies with priced IPOs this year have already begun testing their products in humans, to some extent reflecting an investor shift toward safer bets. As advancements in innovation and AI continue to propel drug development, life sciences activity is expected to maintain momentum.
THE RISE OF LIFE SCIENCE VENTURE CAPITAL FUNDS
After a few years of growth about a decade ago, life sciences VC fundraising essentially doubled before skyrocketing during the pandemic. That short-lived peak has since subsided to more sustainable levels, reflecting a strong but reasonable growth level above pre-pandemic years.
Accounting for an impressive 17% of all VC fundraising dollars, the life sciences sector made up a record-breaking share of the overall venture dollars raised in 2023. This signals a piqued investor interest in the space. Although the annual total raised for life sciences-focused funds in 2023 did not match 2021, it was still robust, with over $15 billion raised, coming close to the totals from 2020 and 2022. Fundraising activity was notably more concentrated within larger funds than in previous years, with 13 funds closing on at least $500 million. These 13 funds accounted for 75% of the total life sciences VC raised in 2023. The ongoing interest in AI for drug development is expected to continue driving the trend toward larger life sciences venture capital funds.
CAPITAL FLOWING INTO LIFE SCIENCES DEALS
Life sciences deal value in the second quarter of 2024 reached the highest quarterly total since the first quarter of 2022. Of the $10.3 billion invested in life sciences deals during the second quarter, 44% was invested in late-stage venture deals. This reflects life sciences VC managers’ bias toward lower-risk, more mature companies compared to higher-risk, pre-clinical, and early-stage clinical assets. The capital committed to late-stage biotech deals peaked in the first quarter of 2021 and has remained the dominant financing type.
With $19.3 billion invested in the sector year to date, 2024 is on track to match 2020 and 2022 deal levels. Apart from 2021, these annual totals eclipse all prior years and serve as evidence of investors’ ongoing appetite in this segment.
Given the recent influx of capital dedicated to investing in the industry, life sciences deal activity is expected to continue. As of December 31, 2023, Pitchbook estimated that $39.7 billion of dry powder was available for life sciences VC deals.
LIFE SCIENCES VC EXIT PATHWAYS
On average, life sciences investments returned more capital per deal when compared to exits in the broader venture capital asset class. In 2023 and through the first half of 2024, life sciences exits accounted for only 8% of the total venture capital exit count. Still, the exit value for these companies comprised 25% of all dollars generated by venture capital managers. This indicates that, on average, exits in the life sciences VC market are less frequent than those in other VC sectors. Yet, when life sciences liquidity events occur, they are often of considerable value. As such, life sciences VC funds typically have lumpy distribution cadences.
The average life sciences exit value in 2023 was $175.6 million. As several sizeable exits were completed in the first half of 2024, the average exit value increased to $347.4 million, demonstrating that just a few exits within a life sciences VC fund can significantly impact overall fund performance.
In addition to M&A events, stock listings give life sciences companies the funding they need to develop their drugs and provide venture capital managers and their investors an opportunity to earn a return. While the IPO market remains muted, the public market activity—though comparatively minimal from 2021 highs—hints at opportunities for good companies. Biotech IPOs raised over $1.9 billion in the first half of 2024, with 13 life sciences companies listing on the public market. Only 4 of the 13 biotech companies listed this year are trading above their IPO price as of July 30, 2024. This indicates skepticism about life sciences companies from public market investors while showing strong investor backing exists for quality assets.
Risky assets like life sciences with longer-dated cash flows bode well in rate-cut environments, as their future cash flows are discounted at a lower rate, making them more attractive to investors due to the higher current valuation. There was early enthusiasm in the life sciences ecosystem regarding 2024’s biotech IPO prospects on expectations of early rate cuts from the Federal Reserve (Fed). However, some of the enthusiasm has worn off as the Fed has continued to push rate cuts until later in the year. The hope of impending rate cuts is sending a glimmer of optimism through the industry for a strong IPO biotech market in the back half of the year.
EVALUATING FUND PERFORMANCE
Life sciences VC managers have a wider dispersion of investment returns than private equity (PE) funds, indicating the effect of life sciences’ higher-risk, higher-reward strategy. Life sciences VC specialists generally perform similarly to the broader VC asset class by pooled internal rate of return (IRR) but underperform across vintages when measuring total value to paid-in (TVPI). This may be due to the capital-intensive nature of drug development. Many managers and investors are bullish on the performance improvement of life sciences venture capital in the coming years due to the potential for AI to increase the efficiency and effectiveness of the drug development and approval process, thus reducing the time needed and capital expenditure.
NAVIGATING REGULATORY AND ECONOMIC CHALLENGES
Life science companies operate in a challenging landscape of regulatory complexities and economic pressures. Regulatory affairs ensure the safety and efficacy of products, with agencies like the FDA requiring extensive data over lengthy periods. However, the timetable is sometimes accelerated during public health emergencies like COVID-19. Economic uncertainties and financing costs, alongside policy issues such as the Federal Trade Commission’s (FTC) anti-competition policies, the Inflation Reduction Act, and the National Institutes of Health’s (NIH) framework for march-in rights, further complicate the industry’s environment.
Life science companies must employ proactive compliance strategies to navigate the ever-evolving regulatory landscape. Engaging with regulatory bodies, managing risks, and maintaining agility are essential for adapting to policy changes. Collaborative efforts with stakeholders support reimbursement strategies and policy advocacy, helping to secure market access and commercial viability in a rapidly evolving sector.
AN ADDITION FOR A DIVERSIFIED PRIVATE EQUITY PORTFOLIO
Life sciences managers pursue a narrow strategy because they focus on the therapeutics sector, which is regulated and subject to reimbursement rates from insurance companies and other third-party payors such as Medicare. Increased regulation on drug approval or pressure on reimbursement rates can, therefore, adversely affect returns. Life sciences VC funds are higher-risk investment strategies that should be considered part of a diversified PE portfolio.
HIGH-RISK, HIGH-REWARD: THE ALLURE OF LIFE SCIENCES VC
Despite regulatory hurdles and economic uncertainties, life sciences investments' high-risk, high-reward nature continues to appeal to institutional investors. Constant scientific advancements, an aging global population, and the transformative potential of technologies like AI and gene editing catalyze the need and capability for disruptive medical breakthroughs. While the industry faces regulatory and economic challenges, ongoing interest and substantial capital inflows underscore investors’ confidence in its growth prospects. Given the upward trajectory of life sciences deal activity and exits and the sector's capacity to address critical global health issues, life sciences VC funds remain an attractive proposition for institutional investors seeking both financial returns and societal impact. Recent robust fundraising and deal activity highlights the enduring appeal and promise of this dynamic and innovative field.
INVESTOR IMPLICATIONS
Fundraising, deal activity, and exit activity are expected to stay below recent historical averages. If the current macroeconomic conditions continue, investors may experience down rounds and reduced carrying values in upcoming quarters. FEG advises clients to exercise caution when making new commitments.
1–8 Pitchbook; NVCA Venture Monitor Q2 2024;
June 30, 2024
9 Refinitiv; December 31, 2023 (most recent available)
INVESTOR IMPLICATIONS
Despite deal and exit activity showing signs of improving, private equity continues to face near-term challenges due to high interest rates, earnings volatility, and geopolitical tensions. FEG advises clients to exercise prudence when making new commitments.
1–8 Pitchbook; June 30, 2024
9 Refinitiv; December 31, 2023 (most recent
available)
INVESTOR IMPLICATIONS
The economy remains resilient amid a normalization of interest rates in the U.S. and inflation remains sticky/lower. Looking into the third quarter, the Fed appears poised to make a policy adjustment lower, but potentially not as much as the market anticipates, as has been the case all year.
1 Golub Capital Middle Market Report 2Q2024
2 Insights – Private Debt Q2 2024: Preqin Quarterly Update
INVESTOR IMPLICATIONS
Since the downturn in real estate that began in early 2022, property values have declined approximately 20%, although some, such as office, have fared worse. Significant debt maturities of nearly $1 trillion remain in the coming two years and will need to be resolved by borrowers and lenders. With interest rate cuts now on the horizon, the market may see an increase in transaction volume, which in turn would provide greater price discovery and clarity on valuations. These signs point to a possible bottoming in the market. As a leading indicator, recent gains in REITs suggest that this may be the case. Managers with a flexible mandate and the ability to invest across the capital stack should be well-positioned to take advantage of shifting market dynamics in the current market environment. Additionally, smaller deals likely offer more attractive risk/return profiles due in part to a lack of competition and greater inefficiencies.
1 NCREIF; June 30, 2024
2 NAREIT; June 30, 2024
3, 4 Preqin; June 2024
5 Trepp CBMS Research, June 2024
6 Grant, Peter, Surge in Commercial Property Foreclosures Suggests Bottom is Near,
The Wall Street Journal, July 29, 2024
INVESTOR IMPLICATIONS
The wave of merger and acquisition activity in public upstream energy is already leading to the sale of non-core assets, creating acquisition opportunities for private energy funds with available capital. Upstream deals are characterized by attractive cash flow distributions, resulting in faster paybacks. There is a growing consensus that the energy transition will take longer than initially expected and that traditional energy will continue to be a vital part of the energy mix for the foreseeable future. Finally, with the continued rollout of AI, the question of power availability for data centers has become a key issue. FEG continues to see robust opportunities in multiple areas of the evolving energy landscape.
1-4 Energy Information Administration www.eia.gov, June 30, 2024
5 Baker Hughes, June 30, 2024
INDICES
Bloomberg US Corporate High Yield Index represents the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets are excluded, but Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. The index includes the corporate sectors: Industrials, Utilities, and Finance, encompassing both U.S. and non-U.S. Corporations. See www.bloomberg.com for more information.
The Russell Indices are constructed by Russell Investment. There are a wide range of indices created by Russell covering companies with different market capitalizations, fundamental characteristics, and style tilts. See www.russellinvestments.com for more information.
The FTSE NAREIT Composite Index (NAREIT) includes only those companies that meet minimum size, liquidity and free float criteria as set forth by FTSE and is meant as a broad representation of publicly traded REIT securities in the U.S. Relevant real estate activities are defined as the ownership, disposure, and development of income-producing real estate. See https://www.londonstockexchange.com/indices?tab=ftse-indices for more information.
The S&P 500 Index is capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NCREIF Property Index is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.
HFRI ED: Distressed/Restructuring Index — Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings. Managers are typically actively involved with the management of these companies, frequently involved on creditors' committees in negotiating the exchange of securities for alternative obligations, either swaps of debt, equity or hybrid securities. Managers employ fundamental credit processes focused on valuation and asset coverage of securities of distressed firms; in most cases portfolio exposures are concentrated in instruments which are publicly traded, in some cases actively and in others under reduced liquidity but in general for which a reasonable public market exists. In contrast to Special Situations, Distressed Strategies employ primarily debt (greater than 60%) but also may maintain related equity exposure.
Information on any indices mentioned can be obtained either through your advisor or by written request to information@feg.com.
DISCLOSURES
This report was prepared by Fund Evaluation Group, LLC (FEG), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department.
The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. FEG, its affiliates, directors, officers, employees, employee benefit programs and client accounts may have a long position in any securities of issuers discussed in this report.
Index performance results do not represent any managed portfolio returns. An investor cannot invest directly in a presented index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
Bloomberg Data Disclosure: Source- Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy or completeness of any information herein, nor does Bloomberg make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, Bloomberg shall not have any liability or responsibility for injury or damages arising in connection therewith.
Neither the information nor any opinion expressed in this report constitutes an offer, or an invitation to make an offer, to buy or sell any securities.
Any return expectations provided are not intended as, and must not be regarded as, a representation, warranty or predication that the investment will achieve any particular rate of return over any particular time period or that investors will not incur losses.
Past performance is not indicative of future results.
Investments in private funds are speculative, involve a high degree of risk, and are designed for sophisticated investors.
An investor could lose all or a substantial amount of his or her investment. Private capital funds’ fees and expenses may offset private capital funds’ profits. Private capital funds are not required to provide periodic pricing or valuation information to investors except as defined in the fund documents. Private capital funds may involve complex tax structures and delays in distributing important tax information. Private capital funds are not subject to the same regulatory requirements as mutual funds. Private capital funds are not liquid and require investors to commit to funding capital calls over a period of several years; any default on a capital call may result in substantial penalties and/or legal action. Private capital fund managers have total authority over the private capital funds. The use of a single advisor applying similar strategies could mean lack of diversification and, consequently, higher risk.
All data is as of June 30, 2024 unless otherwise noted.