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Meet the ‘biotech mafia’: how specialized biotech VC firms are dominating industry funding once again

Between 2020 and 2022 – largely due to the biotech innovations that came about by the COVID-19 pandemic – there was an influx of generalist investors in the biotech industry, betting big on new technologies like mRNA vaccines. But, now, these investors appear to have backed off, leaving room for specialized biotech venture capital (VC) firms to lead innovation in the industry once more.

So, why exactly was it that generalist investors entered the biotech industry a few years ago, before recently deciding to leave again? 

COVID-19 led to rise in generalist investors 

The year 2020 saw the biotech industry experience incredible growth, with capital deployment levels far greater than ever before, and dealmaking occurring in both public and private markets. It was also at this time that generalist investors shifted their attention to biotech, funding both private and public companies through venture capital funds and stock indexes, respectively. 

A large part of this was down to the COVID-19 pandemic. There was significant ‘hype’ around emerging technologies, such as mRNA vaccines, that promised to transform health, which was attractive to generalist investors. Ultimately, the pandemic heightened the visibility of the biotech sector, and investors saw a lot of potential here. 

David Schilansky, co-founder and chief executive officer (CEO) of Home Biosciences, said: “2020-2022 saw the outlook for many sectors become pessimistic and uncertain, whereas the search to understand and find treatment or preventive solutions to COVID-19 caused a lot of capital to flow into life science. As the XBI outperformed the S&P, generalist investors shifted their attention to biotech. There is also a real convergence between technology, computational science, and biology that attracted a new class of investors that were traditionally more focused on pure technology projects.”

Sergey Jakimov, co-founder and managing partner of LongeVC, agreed that the COVID-19 pandemic brought in a broader range of investors. He said that the pandemic underscored the importance of rapid innovation in healthcare, and that the ensuing surge created an impression of lowered entry barriers and potential strong short-term benefits. He also pointed to the fact that he does not believe biotech was unique in this phenomenon, as similar inflations and generalist investments happened in other areas, such as AI.

But, as the hype around COVID-19 advances eventually came to a natural halt, it was not long before many of these generalist investors started to exit the biotech scene as quickly as they came onto it, coinciding with the economic downturn.

The ‘biotech mafia’: how specialized VCs are dominating the biotech sector once more

But why did generalist investors exit the biotech scene? 

According to Jakimov, the biotech industry is complex, and requires a deep understanding of scientific and regulatory aspects, which may not align with the expertise of generalist investors. He said that, while large funds (a16z, Sequoia, etc.) can still assemble dedicated life sciences teams, smaller generalist funds often cannot withstand the scientific due diligence biotech investing requires. Generalist investors faced a much higher risk profile that they could not mitigate with in-house expertise, which often resulted in halted investments. 

“Understanding that the nature of biotech investments has not changed is essential,” continued Jakimov. “They were – and still are – somewhat intricate, niche investment cases requiring a deep understanding of the field. This includes an ability to predict (with a certain degree of confidence) the translatability of data from animals to humans, understanding regulatory risks, and more.

“What changed was the ‘heat level’ of the market. When a market is overheated, even mediocre tech can survive. When the market cools off, everything becomes data and merit-driven. This is where an investor’s limited scientific due diligence expertise becomes detrimental.”

And, as Schilansky noted, a good VC firm should bring more to the table than just capital. This is where specialized biotech VC firms come into play – the likes of Sofinnova and Medixci – as they have more expertise in the industry. 

“Biotech is complex, and an entrepreneurial journey should not be a path to learn while moving forward,” said Schilansky. “Specialist life science VCs also have a better understanding of what can be a long process, particularly if the venture in question is pre-clinical. A generalist’s lack of knowledge can lead to basic mistakes like underfunding operational excellence, inaccurate benchmarking, skipping steps, not thinking about the exit strategy, the end product and market.”

Schilansky also pointed out that this is actually not the first time that generalist investors rushed into, and then exited biotech. “The early 2000s saw the biotech market hit by an exodus of generalists. However, the major medical breakthroughs reaching patients in the last few years demonstrate that investment in R&D did not stop because generalists reduced their holdings. Moreover, there has been growth in biotech specialty investing that makes generalist investors less necessary for long-term funding. Good science with solid evidence led by good teams will still get funding, though not likely at the kind of valuations we saw in 2020.”

Therefore, since generalist investors have begun to exit the biotech industry, specialized biotech VC firms are now simply continuing to do what they were doing before, bringing critical expertise in understanding the nuances of biotech ventures. 

Jakimov said that the benefits of this are identical to the specialist versus generalist debate in any other sector: “What matters is the ability to dissect core tech (and data) into components and evaluate their feasibility. Understanding the current industry demands, including regulatory perspectives on specific tech, is a must. In other words, any generalist looks at tech holistically, while specialists dissect the value proposition to identify weak spots.”

Still room for generalist investors in biotech

However, Jakimov said that there is still room for generalist investors in the biotech industry, as often their most viable strategy is co-investing with a specialized biotech VC firm in order to leverage their established due diligence processes.

Jakimov said: “Having specific knowledge comes with responsibility, and one should not restrict this expertise to only fellow team members. Specialized VCs should share their findings, inviting more generalist investors in the rounds, spearheading the scientific due diligence process, and creating joint success stories. Only then will the industry flourish.”

Schilansky also agreed that generalist investors will likely return to the industry eventually. “It is a difficult industry to invest in, but living older in good health is a major concern, and every person in the world requires healthcare. It’s too large an opportunity to stay away from forever. When you think about it, healthcare is probably the only industry today where demand is infinite.”

However, if generalist investors do re-enter the biotech industry, it is likely they will take a more cautious approach due to the previous challenges they experienced when trying to navigate the sector.