Waiting for Godot: Will Venture Funding Return?

Published on: 
BioPharm International, BioPharm International-08-01-2009, Volume 22, Issue 8

Contract research, development, and manufacturing organizations betting on a comeback in venture capital financing will have a long wait.

Start-up bio/pharma companies backed by venture capital (VC) have been important drivers for the growth of the contract services industry in the past decade. The number of new drug candidates in early development (preclinical and Phase 1) has nearly doubled in the past 10 years, and small bio/pharma companies account for 75% of those candidates. That big run-up in early development candidates has fed demand for a wide range of services including process development, formulation development, animal toxicology, analytical testing, and manufacturing of clinical trial materials.

Jim Miller

The tremendous growth in the pipeline has been made possible by the steady flow of VC money into the biopharmaceutical sector. VC investment in bio/pharma grew rapidly in the second half of the 1990s, from $800 million in 1995 to $4 billion in 2000, a fivefold increase. That rapid growth was part of a VC explosion driven by the advent of the Internet, which created opportunities for new investment in software, telecommunications, and media and entertainment.

After the dotcom bubble burst in 2001, overall VC investment dropped like a stone, from $104 billion in 2000 to $40 billion in 2001 to $22 billion in 2002. However, venture financing going to bio/pharma remained remarkably robust through the decade and the number of deals per year actually grew from about 350 in 2000 to almost 500 in 2008. By 2005, bio/pharma had become 20% of all VC investment in the US, averaging over $4.1 billion annually.



Venture capital's largess toward the bio/pharma industry came to a screeching halt in the last quarter of 2008 and first half of 2009. VC investment in bio/pharma dropped 18% in the fourth quarter of 2008 from the third quarter, and it tumbled a further 46% in the first quarter of 2009 to just $500 million.

The funding cutbacks have forced bio/pharma companies to either shut down altogether or cutback on the number of candidates they can work on simultaneously. PharmSource analyzed 27 publicly reported restructuring events at small bio/pharma companies (public and private) in the first half of 2009 and found that those companies stopped development work on 46% of the candidates in their pipelines. At least another 10 companies went out of business altogether.

To understand the implications of such a steep decline consider the following: according to venture capitalists and entrepreneurs we talked to, about 70% of each dollar invested in an early-stage bio/pharma company goes into research and development (R&D) spending, with the remaining 30% going to corporate overhead expenses. A round of VC investment is meant to last, on average, about 18 months. That means the $500-million drop in first quarter VC investment will be felt as a $350-million decline in revenues for service providers and R&D product companies over the next 18 months. If that rate of spending were to be sustained throughout the year, it would mean a loss of $1.4 billion in spending on R&D services and products over the next three years.

Figure 1. VC investments in bio/pharma quarterly 2004–2009

In addition to reducing the overall funds available, the decline in financing has altered the pace of decision making at the early-stage companies. It appears that companies need approval from their board of directors on every major spending decision, including work being done by contract research, development, and manufacturing organizations (CROs and CDMOs). The spending process now appears to involve collecting request for proposals from vendors, selecting a vendor, negotiating final terms, and then seeking board approval for release of funds. This has lengthened the commitment process considerably from the days when companies received tranches of funds from investors and could proceed to spend it as necessary.


Many contract service providers are anxiously waiting for venture funding to make a comeback, in expectation that the rising tide of increased spending will lift all of their ships. However, many VC industry observers hope and expect that the volume of investment will not return to recent levels, and may actually remain at 50% of historical levels for some time to come.

The rationale for the sustained decline is straightforward; as massive amounts of capital have flowed into venture investing, returns on venture investing have fallen rapidly. VC investments are no longer paying the exceptional returns with which they have been associated, and which are expected to offset their higher risk.

Returns on VC investments exceeded 20% during the dotcom boom, when companies were able to float initial public offerings at very high valuations. However, since the dotcom bust, returns have dropped sharply, to single-digit and negative levels. Recent returns have not been significantly better than those offered by the major equity indexes.

The flow of funds into VC funds is already declining, and is already less than half of what it was just two years ago. New VC funds are having trouble attracting new investors, and investors are reneging on commitments made in the last two years to established funds. Further, venture capitalists are reluctant to accept new investors into their portfolio companies because the new investors are insisting on onerous terms.


The VC picture is bad news for the many CROs and CDMOs that have built their businesses strategies around the needs of on the venture-backed companies. This includes the so-called "one-stop-shops" that offer the complete menu of preclinical and early development services geared to getting early-stage companies to proof-of-concept as quickly as possible. It also includes the more traditional process development and formulation development CDMOs that have expanded their facilities and capabilities in recent years in response to the growth in the early development pipeline. As that pipeline shrinks, those companies are going to find themselves with a lot of idle capacity, which is likely to trigger a price war and a rash of closures.

The picture suggests that the period of entrepreneurial growth for the CRO and CDMO industry may be over. That doesn't mean there isn't opportunity and growth ahead for contract service providers, but that the future is likely to belong to larger, well-capitalized companies with a solid core of mid-size and major bio/pharmaceutical clients. It is no longer enough to depend on small venture-backed bio/pharma companies.

Jim Miller is president of PharmSource Information Services, Inc. , Springfield, VA, 703.383.4903, jim.miller@pharmsource.com