No doubt you’ve heard that the IPO market for biotech companies has been especially weak the last two years. Few companies went public in 2008 and 2009, and those that did raised less money than expected, at lower prices, and with significant insider participation or other sweeteners. But the IPO environment seems to be thawing, with more companies expected to go public in the coming months, which leads to the question: Is this really such a good thing?

Holding aside the numerous macroeconomic reasons in support of a favorable IPO environment, IPOs in the biotech industry have particularly important place in the financing “cycle of life”. Drug development is long and very expensive, and IPOs (the theory goes) provide significant growth capital to maturing companies in an amount in excess of what venture capitalists (VCs) provide. IPOs also provide an exit point for early investors, granting them liquidity and a reward for the risk they took in funding a nascent private company. Fewer robust IPOs, however, mean VCs see fewer profitable exits, resulting in portfolio companies maintained in portfolios longer , which means less capital for new companies. This generally results in lower returns for VC funds and less money allocated to new VC funds during the next fundraising cycle. So, just like in the wild, take away an important prey (the IPO exit), and the predators (VCs) either starve or adapt to a new niche. This seems to have occurred the last few years, as many investors have favored late stage deals, and done more in medical devices and molecular diagnostics. So, for the biotech industry to thrive, we need a favorable IPO environment, right? Well, yes and no.

Certainly, removing a potential source of capital for companies is bad. But the problem is that the public markets are not well designed for pre-revenue, pure R&D companies, which describes the vast majority of biotech companies. What the public markets do well is value companies with revenues and earnings, because earnings and the present value of future earnings, along with other quantitative metrics, provide a sound basis for assessing company performance and forward prospects. Without earnings, R&D companies are VERY difficult for public markets to price, and all the value must be based on the hope of future earnings, which may never materialize. Thus, the soft bases on which public biotechs are valued results in tremendous pricing discrepancies between competitors with similar profiles and significant volatility in stock prices since perceived value fluctuates with news flow instead of quantitative data on corporate performance.

Maybe the difficult IPO market for biotech companies isn’t broken at all. Maybe it was broken in the past; it wasn’t long ago, 2004-2007, when 20+ biotech companies went public per year. Is that rational market behavior? The Silicon Valley timelines of tech companies, just a few years from inception to IPOs, are possible because those companies are capable of rapid go-to-market strategies to prove their technologies and generate real revenues. But this is incompatible with the long, expensive product development paths in drug development. Today, institutional investors are applying stringent criteria to IPO candidates, by and large backing only very late-stage companies with commercial launches on the horizon or products already on the market. This seems completely rational, and my hope is that it reflects a new chapter in the biotech industry.

Adam Bristol

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While vacationing in the US during the Chinese New Year

early February, I attended a Bay Area event organized for VCs (venture

capitalists) and medical device entrepreneurs. I was a bit surprised by the

sentiment voiced by the panelists and the audience that “there is plenty of

venture money available in China”

and “given the tough funding environment in the US,

companies should look to China

for alternative sources of venture money”. “Aren’t the roads there paved with

gold?” a Chief Medical Officer for a Bay Area biotech startup jokingly asked

me. As an active healthcare VC in China in the past few years, I know

this view is far from accurate.

It is not hard to understand why investors and entrepreneurs

might view China

as a bountiful source of financing. At the end of 2010, China held over

$2.8 trillion of forex reserves. The Chinese government has played white knight

in an effort to help stabilize the Euro zone economy, by buying

euro-denominated Portuguese and Spanish debt. These facts have been widely

reported in the US press,

and I’m sure that US biotech entrepreneurs have also heard about the

hyper-active PE (private equity) and VC industries in China.

There is no comprehensive list of all the PE and VC funds with

a focus on China

who are actively investing. However, there are probably over a thousand of

these funds, and it is quite possible that more than half of them probably

raised fresh money over just the past two years. Statistics from ChinaVenture

suggest that such funds raised more than $12.3 billion in 2009, and over $30

billion in 2010 alone.

Moreover, the Chinese government’s 11^th and 12^th

five-year development plan spanning from 2006-2015 places a high priority on

biotech. As a result, dedicated central government funds have been allotted to

incentivize new drug development, and dozens of biotech parks have sprouted

around major cities to support biotech companies.

So is China

a good place for your biotech startup to look for money? Think again!

Over the past two years, I have come across a fair number of

entrepreneurs from North America and Europe,

with deals ranging from pre-clinical or phase I/II therapeutics to

prototype-stage medical devices. Many of these entrepreneurs had included some

sort of China-related story in their business plan. But most of them have

ultimately not been able to implement the Chinese dimension of their plan, even

after half a dozen trips to China

and many meetings with local investors and bio-parks. As a consequence, they

have left the country empty-handed — though after a series of eye-opening

experiences, and probably a sense of repletion after several elaborate banquets.

So the people I met at the Bay Area event are not so very

different from many bio-entrepreneurs who came to China with high hopes but major

misconceptions. Many of them appear to believe that: 1) there is plenty of VC

money available around China

for biotech startups; and 2) startups can get free funding from the government

and local bio-parks.

Unfortunately, I can tell you that if you are a starving

early stage biotech startup, chances are slim for you to get funded in China.

In next blog post, I’ll be explaining why.

(Karen Liu is a healthcare investor at a leading China based PE

not represent those of her firm.)

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Karen Liu