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Venture capital flocks to the public markets

23 August 2009 No Comment

By Helen Kaiao Chang

See original story on SDNN

Wednesday, July 22nd, 2009

You wonder where all those venture capitalists have gone? Most biotech industry experts know they’re not staying in San Diego.

Like migratory birds that flock to where the money is, VC funds have largely deserted the city in search of greater profits.

So where have they flown to?

One popular place is the public markets – individual stocks, exchange traded funds and index funds.

“We have seen a whole bunch of money going into that market,” said Robert More, a partner at Frazier Healthcare venture capital group.

“One of the problems facing the early stage science right now is that late stage science is really cheap.”

More was speaking at an event on “The Future of Successful Investment in Biotech,” organized by the San Diego Venture Group. The breakfast panel took place Wednesday at the Hyatt in La Jolla.

Other professionals attending the event concurred that VC funds have fled to public markets in the last year, but they said that it was only a temporary move. As the market has risen in recent months, VCs are starting to look at private biotech investments again, promising fresh rounds of funding for primarily late-stage companies, they said.

In the last year, venture capital investment in San Diego has dropped by nearly half, according to industry reports. Many venture capitalists have hunkered down with existing investments, unable to raise fresh rounds of capital. Others have simply gone out of business.

Many VCs have turned to the public markets to earn higher returns on existing cash, rather than tie it up in risky biotech firms.

Frazier’s More invested in one public pharmaceuticals company in January when the stock traded at $2 per share. The company was far along in its research and development, with Phase 2 data available and about to release Phase 3 data. Now, the stock has risen to $10 a share.

“I’ll take a five-‘X’ (return on investment) in six months,” said More. “It’s a public investment and you don’t have the risk of liquidity, because you can sell.”

In addition, publicly-traded companies have longer track records for the management team and financing, further lowering risk, said More.

That makes it harder to justify investing in early-stage, private companies, which have flat valuations. “If you’re putting $100 million into something that’s going public at a $100 million valuation, the risk reward is just not making sense,” said More. “We can go trolling in the public markets for things that are about to reveal Phase 3 data and they’re trading at cash value.”

Such thinking is typical during down markets, but is only temporary, said J. Somvel Armstrong, vice president of investments at Wells Fargo Advisors, who attended the event. During the late 1990s, when the market was rough, VCs also invested in public stocks, but only for a short time, he said.

Instead, biotech companies need to focus on developing their products. Armstrong noted that companies that can secure federal approval for a $1 billion drug will attract investors regardless of the economy.

VCs are already reaching the tail end of the market run, said Jake Schiable, president of Toscana Ventures, a San Diego-based investment group specializing in start-ups. This is because market prices have been rising lately, making the public markets more expensive.

“A lot of the dumb money has already been made” in the public markets, said Schiable. “So a lot of VCs are starting to come back” to private biotech investments.

Because many biotech companies have also closed their doors in the last year, the ones left standing are stronger. This makes them more attractive to VCs, said Toscana’s Schiable.

This will also makes it easier for Toscana to attract VCs. Toscana investments average between $500,000 and $2 million, and their series A and B shares typically require about $20 million, he said.

But VCs such as More are still sticking to late-stage companies for now. “Money tries to find the place of best adjusted rate of return,” he said.

Follow Helen on Twitter @HelenChang.

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