Since yesterday I’ve been poring over the quarterly report from CB Insights (http://www.cbinsights.com/blog/venture-capital/q2-2012-quarterly-report) and thanks for providing an advance copy! I’ll be going into some of the overall detail but mostly focusing on healthcare dealflow and dollars.
One of their headlines from the Exec Summary did make me cringe and proved to be a rather apt synopsis: “Healthcare VC on Life Support: Bad healthcare puns aside, the trend for healthcare VC is not a great one. Deals hit a five quarter low while funding rebounded modestly from the Q1’12 lows.” This is not good. I am clearly passionate about healthcare and biotech and if you’re reading this, chances are you are, too. Let’s look a little at the gory details and dissect this past quarter (yes more healthcare puns are on the way – brace yourself!).
Let’s dive in. A shift in the VC industry investing trend has been towards early stages, i.e. seed and A round. This trend is solidifying which makes good investing sense in sectors that essentially deal with data in all it’s forms. To wit, seed and A make up 50% of all deals and seed is nearly half of that so almost parity with A at 22 and 28% respectively. That’s a five quarter high counting from Q2 2011. The data-heavy sectors led by internet expanded to top a five quarter high in deal share and which matches the funding share distribution.
Let’s now shift gears and focus on healthcare. This sector definitely continues its trend and falls to a 5 quarter low both in dealflow and dollars. It’s worth recounting that this sector includes everything from medical devices, through drug development, diagnostics, to medical IT. This new low is reached after what was then an encouraging uptick of percentage gains in dealflow. Q4 2011 showed 23% total dealflow but since then Q1 (19%) and now Q2 at 17% are a discouraging trend in investor sentiment who are rethinking their capital allocation and diversification strategies.
The Breakdown of Healthcare Investing
Cali and Mass Lead Healthcare Sector but this section should be more appropriately called the breakdown of MA healthcare! California and Massachusetts combine for 50% of deal share and 60% of funding dollars. However, the story starts to look much worse for the Bay State when you compare and contrast it to the Golden State. Massachusetts got a comparatively tiny 13% of all deals done, a five quarter low (high was 24%) and has given up all that share to California, which is at a five quarter high at 37% dealflow. The dollars look even worse though, when mentioned that MA and CA account for 60% of funding, it’s only 15% that MA brings the table. The other whopping 45% are contributed by California, near but not quite at the five quarter high of 46% in Q2 2011.
What does the deal structure look like though? Seed deals have always been low at our around 10% and that’s where we find ourselves this quarter. A rounds typically make up a quarter or slightly more and this time it’s 29%, very much in line with the general 5 quarter trend of horizontal movement. In fact it’s only ¾% off from the 4 quarter simple moving average (4QSMA). Now Both C and E rounds show modest gains at 16% and 10% total, respectively, but the D round picks up substantially more over the SMA and also over the standard deviation. The 3% increase brings it to 16%. Now who’s left to supply that deal volume and give it up? That’s right, it’s the B round. Five and a quarter drop here in volume, which leads one to speculate that investors have sharply curtailed the funding of A round companies that are not performing exceptionally. Maybe we’re seeing a new valley of death here with regards to funding. The dollar figures paint an even starker picture, all early and even mid-stage rounds lost ground, only D and E gained. Here the D round stands out due to an increase of almost 5% over the 4QSMA, while the E round increases by 2.8% over the 4QSMA.
Lastly on a sub-sector basis, medical devices make up the majority of funding, followed by biotech in general. Interestingly and highly concerning, both biological and small molecules together make up only 19% of the dealflow. This could be a lasting trend, and not to sound alarmist, but where is innovation going to come from on the therapeutics side? It’s not coming from big pharma that much is clear.
Diversifying a VC funds portfolio might have a different meaning in the future than it does now. It might mean investing in five different flavors of web / mobile / social plays rather than hard science plays or even consumer products. I sure hope that’s not the case, the US’s crown jewel is it’s vibrant entrepreneurial ecosystem with access to capital for all ideas, including those that have longer time horizons and require more development time. There’s another blog post there on the need to change the VC fund model (is the traditional 10-year, 20% carry, 2% fee structure not tenable?).