Author Archives: Justin Chakma

China’s Biotech Future

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chakma globeContinuing our interview series with life sciences venture capitalists to accompany a study on venture capital in emerging markets published in the March 7th, 2013, issue of Nature Biotechnology, we return to China. Our third interview is with a venture capitalist, who wishes to remain anonymous, from the one of the most prolific early-stage life sciences investors in China (14 innovation-focused investments to date). Previous posts are here and here.

 

 

How much early-stage life sciences activity is there in China, and who is driving it?

China always goes by the five-year policy plan set by the Central Government. We are in our 12th five-year plan, and one of the clear initiatives is investing in innovative science, and one area specifically relates to life sciences, medical devices and new drug discovery. A year or two ago, many cities started moving toward establishing biotech parks, life sciences parks – initiatives similar to efforts in the internet sector early on. The government is pushing scientific research in universities, but the quality of the research – whether it is innovative enough compared to the United States or Europe is another question. I think there is some catching up.

Most of the brightest researchers in China want to go abroad. That was the trend 10 years and 15 years ago. There is a reversal with a small group of talented life sciences researchers coming back due to the economy in the United States and Europe not doing well. These people are becoming involved in copy-cats, improvement of old drugs, and some purely proprietary discovery work.

The local government is incentivizing these returnees or sea turtles by providing them with facilities. Not much of this research has originated from China’s universities or research institutions. Most of the work is sourced from the proprietary knowledge of returnees who have been educating in leading foreign universities. The researchers see the opportunity of being backed by the government, so they come back and start their own companies. There are some licensing deals, but these are mostly occurring in Hong Kong and Taiwan. But the knowledge that they’ve come back with is dated by 5 to 10 years, and is probably already behind the United States and Europe, where science and technology advance much faster.

There is a clear critical mass of leading scientists who want to build up the capabilities of Chinese universities similar to what we see in the United States. I’m not sure that is happening yet. People move because of money. Singapore has tried to attract a lot of talent by buying them to build its BioPolis hub, and they have been doing it for over 10+ years. The results have been so-so. People come and go, and they never really got good results. In 5 years, I predict nothing much will change.

 

If innovative science is still emerging, what are venture capitalists investing in?

Most healthcare venture capital funds typically have a 10-year life, and are allowed to invest in the first 5 years, with the last 5 years for harvesting. They have to identify opportunities in China that fit into their own timeframe. This means being revenue and profit-driven. There’s nothing wrong with that, investors look for returns, and for companies like WuXi PharmaTech. Their model is clear – US-dollar revenue and RMB costs, that’s an easy mode, so a lot of investments have been made into CROs. However, the CRO space is saturated, and typically the first three leaders pick up the most market share.

The hottest thing is in pharmaceutical and medical device distribution. It’s valued more than technology because even if you have a so-so product, you can still push your product and sell, and make a lot of revenue. If you have a world-class product, but you don’t have a channel to the doctors, then you are just going to sit there until the copy-cats come, in a few years.

In our own portfolio, most of the entrepreneurs went abroad and then returned. Very little IP is sourced from China. Virtually all of it is in-licensed from abroad. Certain studies are still being done in the United States and Europe, and part of the development is being done in China to take advantage of the lower costs. The cost advantage of development in China is still very apparent even though it is narrowing due to currency depreciation, as well as the rising cost of the people.

 

What advice do you have for potential life science investors in China?

My advice would vary depending on the fund mandate. If your fund’s mandate is really growth and returns, then you need to identify such models in China, which are not difficult to find. Right now, whoever captures the distribution channel basically captures the bulk of the value. In fact, if you look across all industries, whoever controls the distribution channels has the dominance in that sector. The key thing is how to negotiate with management. You have to really identify a management team that can deliver, and sometimes the scientist isn’t the right person.

Don’t invest in early-stage technologies unless you really think that you are a very, very long-term investor. If you’re not a long-term investor, go with the China-distribution model with a very good management team. Firms such as TPG and Carlyle initially wanted to do more early-stage investments, but came to the realization of where most of the returns were and started participating in IPOs.

Justin Chakma

Insights from India

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chakma globeContinuing our interview series with life sciences venture capitalists (here for previous post) to accompany a study on venture capital in emerging markets published in the March 7th, 2013, issue of Nature Biotechnology, we turn our eye to India. Our second interview is with Aditya Kapil, who was a principal at VentureEast at the time of our interview in 2012.

VentureEast is one of the pioneering life sciences investors in India, having made 15 life sciences investments from a $40 million fund raised in 2004. A second life sciences focused fund targeted at $200 million closed in 2012; it has made 3 new investments.

What is your fund’s investment strategy?

Aditya Kapil: There have been some changes in terms of strategy with our second fund. Broadly, we looked at three life sciences-driven sectors – healthcare, food & agriculture, and cleantech – but what will change is that the amount of money  we will invest in pure innovation deals or pre-revenue deals will be much less this time around, due to the size of the fund. We did drug discovery, typically biotechnology-type deals in our first fund (6 out of 16 were early-stage drug discovery companies). It is unlikely we’ll have such a high exposure to things like that, with maybe 10-15% of the fund going to things like this. Another change is that our focus will be on India. Last time we had companies, which were outside India, and those companies had to have an Indian angle. Meridian has a drug for head & neck cancers, and only the clinical trials were done here. This time, all of our companies will be based out of India, because the life sciences space has changed significantly.

What types of innovation and deal flow do you see?

AK: There is a lot of deal flow in the early-stage life sciences, and we basically showed that there are a huge number of early-stage companies that are being funded by government. Several of those companies are coming to us for investment, which comes straight out of India. We have become known as life sciences investors, so we see a disproportionate number of deals. It’s a mix of CSIR-funded labs, and in-licensed technologies, as well as technologies within larger companies. The generics companies are realizing with competition from China that generics are not a long-term strategy, but listed Indian companies are averse to having a high R&D spend because the stock market punishes you for that. There are schemes where a larger company with an innovative project can get capital with four-year moratorium loans.

It’s slowly gaining traction – technology transfer processes are maturing and beginning to mimic the kinds of terms that you would find in the United States. Before, the university would have a one-time payment and those payments were paltry compared to the return to the company, but now you have milestone payments based on development as well as royalties.

What are some challenges in the Indian biotech landscape?

AK: Exits are challenging. In one instance, we were trying to sell one of our drug assets to a listed company in India via a share swap to avoid dilution. It took 14 months to execute on this deal and educate the company, so the M&A market is not very mature. The IPO market in India is very simple. You need revenue to IPO.

The Indian FDA is not the greatest in terms of quality and negotiating with them can take a very long time, and they don’t really understand the science behind a novel chemical entity. Even if you can get the drug past them, it’s very difficult to persuade physicians to prescribe, as they are happy with the drugs they currently use, and they rely heavily on big branded names. I don’t think India has made enough strides in normal drug discovery for it to be credible with local physicians. The marketing costs are very high. You could have a partnering strategy, but Indian generic companies are risk averse, so even in a partnership you would need to put in several million dollars.

What sorts of therapeutic areas are you interested in?

AK: Reformulation has becoming extremely easy, so we’re interested in modified generics in cardiovascular disease and diabetes, where India has some of the highest prevalence rates in the world. If I was looking at a new chemical entity, I would focus on the global market, and particularly oncology, where the need is much greater, and even a marginal increase in therapeutic value will result in a huge increase in the valuation of the company.

Are CROs becoming increasingly involved in innovation?

AK: As the competition for the CRO market has grown from China, and ‘big pharma’ has decided that it does not want to pay by the full time employee (FTE), CROs have begun to take on work that look like biotech/pharma deals. The pharmaceutical company provides an upfront payment and milestone-based payments, where the Indian company takes on risk, starting with targets and going all the way to pre-IND. This allows them to increase their fee from $90,000 per FTE to $250,000 per FTE, and allows the CRO to get paid in 18 months despite the risk being far lower.

What can government do to help replicate APIDC-VE’s success?

AK: Replicating what we did might be a good start, where the provincial government (Andra-Pradesh) was a 49% stakeholder in the original fund. What’s funny is that APIDC-VE was successful because something went wrong – the World Bank institute liberalization in 1992 or 1993, which led to the privatization of APIDC-VE, allowing it to have an entrepreneurial dynamic. But can you replicate this model?

I’m not sure you can replicate this model in a hurry. VC funds sponsored by the government have sprung up, but there is much lower team motivation. I don’t think the government understands exactly what they have to do. It takes a lot more work than throwing some money together with a group of people. We have the advantage of team longevity, and excellent performance. Our first fund had a 42% internal rate of return.

The reason why we are changing our investment style is that while $200 million is a small fund in the United States, it is a medium-sized fund in India, which is causing our deal size to increase to $8-10 million per company, and reducing our ability to do seed-stage investments. We’re still looking at innovation – we’re thinking of investing in a Phase 3 oncology asset out of Philadelphia.

How do you source your investments?

AK: Historically, deal sourcing couldn’t be through a network because there was no network in those days. In 2005, I went to the Biotechnology Industry Organization (BIO) conference in the US, and I literally went through more than 1,000 abstracts from the booklet they send you once you registered, and I shortlisted 100 projects that were not too academic, and not too large-company like – projects that I thought were in the sweet spot of venture capitalists.  I did cold emails and then got 12 of them to take appointments with me. Out of those 12, we made one investment. It was an important investment because that company had two different US venture capitalists (VCs), and that opened up US VC networks.

Today, we participate on the boards of India’s research institute incubators, and one partner has participated in a sub-body of the Department of Biotechnology. This is a full-fledged proprietary network that other VCs cannot access. Our deal flow today is unbelievable. Our total deal flow over the first fund was 320 deals, and we received over 320 deal proposals upon announcing this new fund, with about 85% of them direct contacts without an intermediary. So our effort from the first time has paid-off.

How does due diligence differ in India?

AK: Most companies are family-run, and there are cultural issues. Family-run businesses don’t like drag-along clauses or selling their shares, so we spend a lot of time talking to teams, and ensuring their interests are aligned with ours in terms of control and exit. The classic US term sheet is not executable in India as the family will not play ball with liquidation preferences from preferred shares, or pay to play clauses. Due diligence is also very difficult because documentation of data is not good. It’s more difficult to check the robustness of the science. It’s not because the quality of thought is poor. It’s that the rigor is not that great. What challenges do you face legally and culturally in negotiating term sheets? What are the major aspects in which the term sheets differ in emerging markets (information rights, liquidation rights, anti-dilution protection)?

Who are the entrepreneurs that are starting companies?

AK: It’s typically vice president or project-level people that have been in Indian companies for a long time, and are now willing to start their own thing. One of our entrepreneurs was the head of marketing at BioCon. They are the people who understand, but they are still a rare commodity in India. It’s slowly changing.

Justin Chakma

 

Life Science Venture Capital in Emerging Markets: a View on China

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chakma globeAs part of a study on venture capital in emerging markets published in the March 7th, 2013, issue of Nature Biotechnology, my colleagues and I interviewed several life sciences venture capitalists operating in emerging markets. In the coming weeks, we will be sharing some of the insights from these investors here on Trade Secrets.

Our first interview is with Dr. Jonathan Wang, senior managing director at Orbimed Asia Advisory, the Asian off-shoot of OrbiMed, the world’s largest dedicated healthcare investment fund. OrbiMed Asia Advisory raised its first $185 million fund in 2008. It announced plans to launch a second healthcare-focused of $300 million in October 2012. In this interview, Dr. Wang describes OrbiMed Asia’s investment strategy and the state of early stage life sciences innovation in China.

What sorts of investments are you looking for?

I have been looking for early stage and innovation-focused biotechnology companies in China, but we have not invested in any [as of early 2012]. It’s not because of any lack of interest, because innovation-focused companies will be a very important portion of what people will invest into in the future. For now, they are still nascent, with very few companies doing high-quality innovation, and fewer still, receiving investment from venture capitalists.

Why are there so few early stage innovation deals?

If you ask me why there are such few deals focused on innovation and drug discovery, it is because of the comparative attractiveness of low-risk deals that already have products or revenues, and in some cases, are even profitable. Early stage development involves very long-term investment, high financing requirements, and talented people who can execute. It also involves development capabilities in China, and global standards such as GLP facilities, which are very young. There are many reasons why innovation deals are so few today.

Still, some early deals are happening today. Hua Medicine is one example. The scale comparatively is a lot smaller than more mundane types of revenue-stage investments. The key question is whether innovation and early stage deals are going to become mainstream investing. That’s anybody guess, as you can imagine that it is a very dynamic process. Both the question and the answer are quite fuzzy, but some of the major factors include:

  1. Talent. We need the right people who can develop drugs – somebody who has developed drugs for 10 years at Merck and can take advantage of local resources. We need more talented peoples especially at the managerial level.
  2. Standards. We are still learning about drug development and implementation of standards such as GLP and GCT are early, and need to become more robust.
  3. Time. We need time to take a compound from the library to drug lead to drug candidate to preclinical studies. It takes years.
  4. Cross-Border Licensing. We need partners to develop these compounds.

What is the role of government in the life sciences industry?

Government is playing a very positive role for supporting the life sciences industry. It’s doing a very good job. Essentially, for a deal to be invested in, we must have government support in most cases. I might still do the deal if the company by itself looks good, but typically in China, government provides support. This support comes in the form of cheap or free facilities, local tax benefits, and many grants (county-level, city-level, province-level and national-level).

Do you have interest from foreign venture capital funds?

We have huge interest from foreign funds, but there are some hurdles. Currency is the biggest hurdle. When you have a foreign currency, it is difficult to invest in local companies. Government is trying to establish policies to make it easier for foreign funds to exchange their currency into RMB, but that process has not happened in a robust way. To exchange local currency, the company might become a joint venture, but lose its status of being a purely domestic company and the accompanying government support, although that’s less the case now.

What do the limited partners in China look like?

For Western funds such as OrbiMed and KPCB, the limited partners look very similar to other funds in North America. They are endowment funds, pension funds, fund of funds and banks. Inside of China, the situation is quite different. There are many small mom and pop RMB funds, managing $50 million or less, with backing from high-net-worth individuals, local companies and governments. These LPs lack experience in understanding how a LP should support a fund. For example, in the West, you draw down money from limited partners over time as you need it, and don’t store it in your entire fund. Sometimes, LPs in China will not follow through, and answer draw-downs creating trouble for funds, so some funds will draw 100% of their fund down at the outset. The LPs also sometimes want to be the general partnership of the fund as well and play an active role in investing. In the West, the general partnership has investing autonomy.

What advice do you have for prospective investors in Chinese life sciences?

First, you need to have the right people who understand the local environment. Second, you need to understand that the decision-making process is different. In the United States or Canada, deals are clean, and you don’t have to worry about the government, assets or hand hold the company as much. In China, a lot of deals are dirtier, requiring more involved decision making, because they focus more on the local market needs and low cost, as opposed to being innovation focused. Third, developing a strong brand is key in order to attract the right deal flow.

Justin Chakma