Big Pharma VCs and LPs Accelerate their Entry into Early Stage Venture Investment in the Life Science Sector

Major pharmaceutical and med-tech corporations are ramping up their participation as co-investors, or limited partners, in venture capital funds focused on early stage startups in the life science sector. Many also are establishing their own venture investment arms to compete with traditional VCs for early stakes in the most-promising new biotech ventures, said Clay Thorp, co-founder and general partner at Hatteras Venture Partners.

This growing trend is reshaping the future of the sector in ways that will impact both life-science venture investors and entrepreneurial companies, added Thorp, who delivered keynote remarks at the joint MGCS and Coulter Investment Forum on May 17.

Hatteras Venture Partners, formed in 2000, invests primarily in early stage companies with a focus on biopharmaceuticals, medical devices, diagnostics and health-care IT. With five funds and $450 million under management, the Durham-based firm has established a solid track record for building successful new biomedical companies in the research-driven regions of North Carolina and the southeastern United States. Thorp, an entrepreneur-turned-venture capitalist, has co-founded eight life science companies.

“There are lots of big corporations, such as GlaxoSmithKline, Merck, J&J and Novartis, that are developing externalization-type relationships,” Thorp explained. “They are taking their balance sheets and investing $10 million, $20 million, $40 million in a venture fund alongside other financial investors. They are not getting a right to buy the [portfolio] companies, but they certainly are getting a balcony seat. Their whole point is to expand the number of risk-exposure opportunities they have, and hopefully be able to jump on one or two of those opportunities when they come along.”

The number of pharmaceutical corporations with an active venture investment arm also has been on the rise, although at a slower rate than the increase in pharma LPs.

This phenomenon has been accelerating, according to recent data on the pharmaceutical industry. “The Volker Rule (part of the Dodd-Frank Act) may have pushed U.S. banks out of the sector, but large pharma and med-tech companies have come right back into it to fill that void,” Thorp remarked. “I think it’s fair to say that without this [financing], we would have a whole lot less innovation. This is a very important phenomenon.”

Recent data reveal that the percent of total corporate involvement in early stage venture capital deals has reached what Thorp termed a “staggering” level. Currently, deals that involve either a corporate VC or a venture fund with a corporate LP now account for nearly 40 percent of all deals struck in the pharmaceutical industry. “Almost two in five deals have some large company balance sheet component in them,” he said. “I find that either really exciting or really problematic.”

Thorp posed two questions for life-science investors and startups to consider:

“First, what happens if these guys change their minds and decide to flee out of the sector? I think we’re hosed.

“Second, how high can that number go? If pharma is trying to externalize, and if biotech is their innovation factory, might we see 50%, 60%, 70% of all early stage deals with some corporate involvement? We might. And maybe that’s going to be really healthy. Maybe it will be like the IT sector where the big companies buy the startups fairly soon after everything gets rolling, and it might just work out great.”

Thorp said he didn’t have a conclusion to the story ─ yet. “It is being written right now,” he added, “but it’s something for all of us to keep our eyes on.”