LANSING — Nothing sells like success.
Investors say once Michigan’s maturing life sciences industry can regularly generate success stories, the chances are that more venture capital will follow. Until then, the industry will have trouble attracting venture capital. Likewise, funds that focus on life sciences will have a hard time luring investors.
One of the hurdles life sciences faces in attracting capital is the decade it generally takes to generate a return on investment, even for a successful company. Investors tend to want a much shorter ROI period of perhaps three to five years, which creates problems for funds that focus on life sciences to attract investors and their money.
“Until we get those returns, it makes it very difficult because investors have a very short memory and are very impatient,” said Dale Grogan, co-managing director of the Michigan Accelerator Fund I in Grand Rapids who moderated a panel discussion at the recent MichBio Expo in Lansing. “That is not the nature of life sciences investing because you’re building innovation along the way.”
MAF-I — which focuses on life sciences, alternative energy, homeland security and advanced manufacturing — may have been the exception to what’s occurring. The fund closed this summer on a first fundraising round that netted $15.1 million from investors.
The fund easily surpassed its initial goal of $10 million as venture capital fundraising nationally continues to recover, although it’s yet to return to pre-recession levels.
Tracy Lefterhoff, vice president of the biotech practice at PricewaterhouseCoopers, called the present period “one of the most challenging environments” nationally he’s ever seen for venture capital fundraising to support life sciences.
“It is really a very, very tough environment for companies in this space right now,” Lefterhoff said.
Life sciences, in fact, is a down sector within a down venture capital industry.
Through the third quarter, overall VC fundraising across the country totalled $17.42 billion for 190 funds, according to the National Venture Capital Association. That compares with $12.38 billion for 160 funds nationally through the same period of 2011.
VC fundraising peaked in 2008 at $24.9 billion for 212 funds, then fell off sharply during the recession to $13.5 billion for 173 funds in 2010. It recovered to $18.6 billion for 182 funds in 2011 and is on pace to beat that in 2012.
Speakers at a MichBio Expo panel discussion said that although activity is picking up nationally, they expect fundraising to remain difficult for the next few years for funds with a life sciences focus. They pointed to a need for the industry to generate returns on a regular basis before investors in larger numbers begin putting more money into VC funds that support life sciences.
“As a whole, the industry needs to generate better returns, and that will whet the appetite,” Sam Hogg, partner in Open Prairie Ventures, said during the MichBio Expo panel discussion.
The Effingham, Ill.-based Open Prairie opened an office in Kalamazoo this year after partnering with the $65 million Southwest Michigan Life Science Venture Fund and plans to begin raising capital for a new fund in 2013.
Despite the difficulty in attracting investors for life sciences, speakers agreed that Michigan’s industry is on the right track and continues to mature after a decade of major public and private investments.
“I’m very, very bullish on Michigan,” Hogg said. “There is no place in the world that I’d rather be than right here.”
Hogg and others said the state needs to have the patience to breed more success stories that can lure additional investors and attract more attention from large funds on each coast. In recent years, those funds have begun to look more often to the Midwest for deals. Michigan, with its strong research universities, is generating a strong pipeline of innovations and startup companies to fund, they said.
“We have a long way to go, but we’ve come a long way,” said John Hoesley, managing director of the Chicago office of Silicon Valley Bank that invests in life sciences, information technology and agricultural technology.
Life sciences investing is a “marathon” that takes a long-term commitment to generate a return, Hoesley said. “And you never know when you’re going to hit the sweet spot.”
“Stay the course. The commitments made over a period of time, you’re starting to see the early success of it,” he said. “You really have to keep plugging along at it.”
Until those efforts start to pay off over the next three or four years through successful exits that generate returns for investors, Hoesley sees a “very tough scenario” for VC fundraising.
“The overriding thing I hear (from investors) is ‘we’re not getting any money back’” from life sciences, he said.
If VC fundraising does not pick up, corporations in the sector and family offices may take up some of the slack, Hogg believes.
“You’ll see a tremendous stepping up” from corporations and high-net worth individuals who already have a connection to the industry, Hogg said.
Hoesley added that the number of VC funds formed by corporations has doubled in four years.
NVCA data shows investing by venture funds in life sciences companies falling off in recent years.
Through the third quarter, the amount of venture capital invested in life sciences companies was down from the same period in 2011 by 19 percent to $1.7 billion and the number of deals funded declined 12 percent to 181.
Investing in the medical-device sector alone declined 37 percent in value and 27 percent in volume to $434 million going into 65 companies through the third quarter, according to the NVCA.
The device sector — an area that has been growing in Michigan — has some strong headwinds against it that are steering away investors. They include a 2.3 percent excise tax on sales that begins Jan. 1, an inconsistent regulatory environment and lengthy review time for new products, Lefterhoff told MiBiz in a recent interview.
“If they don’t know what it’s going to take to get a product to market, the appetite for investors is commensurate,” he said.
In Michigan last year, venture investors put $100 million into 30 deals, 22 of which involved follow-on investments. Nearly half of the money went into firms involved in life sciences, an indication that funds based in the state are still investing “very aggressively” in the industry, Grogan said.