Venture Capitalists Closely Following Health Care Debate

Posted December 11, 2009 at 1:59pm

In the venture capital world, investments are made in our shared future. Using all available information about start-up companies as well as intelligence about the business and economic environment, a calculus is done assessing which will be successful and which will not. Part of the calculus formula is an assessment of the government environment. What is the political and regulatory atmosphere? Will it allow them to be successful and flourish? What and where are the regulatory hurdles likely to be? We do this assessment because investment opportunities are many, and as fiduciaries for our investors we must make investments worth the risk.[IMGCAP(1)] One of the most exciting areas for investment, both in potential returns, but more importantly because of the great benefit it holds for patients, is biologics, which is why the venture capital industry is carefully watching the current debate over health care reform.While the future looks bright based on where the debate stands today, there is reason to be concerned that the industry may face barriers to success erected by the government. Decisions made in the next few weeks matter because venture capitalists can invest their funds in any number of businesses.For those of us who care about our health care future, we hope Congress makes the right decision to spur and increase, not decrease, funding in the biologics industry.Everyone agrees that we need to establish a regulatory approval pathway for bringing biosimilars to market. The creation of such a path in the traditional pharmaceutical industry has been a boon to lower costs and greater access for patients, while still allowing innovation and discovery to flourish.The question is how to create a pathway that avoids undercutting the incentives to investment in the research necessary to produce the new medical marvels that give so many patients and families hope for a better, healthier life, while allowing competition from biosimilar companies.While there are many similarities between the biotech and pharmaceutical industry, there is one major difference that we overlook at our peril.Unlike the pharmaceutical industry, most biotech companies are small, privately held enterprises funded primarily by venture capital. This is important because current analyses of the industry are based on publicly traded companies ‹ which, in addition to being larger and more mature than the vast majority of companies in the biotech industry, have lower investment costs. In other words, most venture-backed biotech companies face a higher threshold for “breaking even—; if the value of the earnings from a biologic becomes less than the cost of “inventing— it, no one will bother investing to invent it. It’s a delicate balance.A recent study commissioned by the National Venture Capital Association provided two entrepreneurial finance experts with access to proprietary venture capital databases. They concluded that the cost of capital for small, venture-backed biotech firms is at least 20 percent, likely higher ‹ at least twice the cost for publicly traded biotech companies ‹ and that 44 percent of venture capital investments in biotech result in either partial or total loss of capital. The risk could not be clearer.This finding is critical to the current debate and points out what is at stake. The current debate around biosimilars hinges, in part, on the amount of time necessary for an investor to recoup costs and make a positive return on an investment in developing new biologics. A commonly cited analysis sponsored by the generic industry found it would only take seven years ‹ on the assumption that the cost of capital would be 10 percent, based on publicly traded biotech companies. Reliance on flawed assumptions clearly invalidates this conclusion about the “break even— time for biological drugs.The issue is complicated, of course, by the unique nature of biologics. These drugs derive from living matter; as a result, unlike traditional generic pharmaceuticals, biosimilars can only be held to a standard of “similar— rather than “identical.— This distinction means that patents are an imperfect tool for protecting intellectual property and spurring innovation, as it would be possible for competitors to “work around— a patent while still meeting standards of similarity under a biosimilars approval process. Additionally, this means that compounds “similar— in structure but not “identical could also result in untoward side-effects or lack of desired primary effect.The good news is that there is a solution called data exclusivity ‹ the period of time between when a drug is approved and when competitors can begin to use its data for studying its similar compound and gaining approval. Currently, language in the Senate and House reform bills provide for 12 years of data exclusivity for biological drugs. This is the right approach and shouldn’t be tampered with in developing a final reform bill.Twelve years of data exclusivity accounts for the higher cost of capital faced by venture-backed biotech firms by enabling them enough time to recoup their investments, and it also helps ensure parity between biologics and small molecule drugs: Under a bill sponsored by Sen. Orrin Hatch (R-Utah) and Rep. Henry Waxman (D-Calif.), small-molecule drugs effectively have 12 years of market exclusivity before facing generic competition. This is the standard that must remain if we want a vibrant, cutting-edge biologics industry well into our future.James Blair is a partner at Domain Associates, a leading venture capital firm based in Princeton, N.J. Dr. Blair was involved in the successful creation of Amgen, Amylin Pharmaceuticals, Applied Biosystems and NuVasive, to name a few.