After the 2021 public biotech market shakeup, life science investment dollars may be shifting. The past few years have seen a crowded investment market, with both veteran life science investors and new opportunistic investors getting in on the groundswell, especially in the case of IPOs.

In 2021, many of these transient investors cleared out when the bottom finally dropped out. While this investor exodus has been tough for pre-clinical and Phase I startups hoping to go public, steadfast VCs and other biotech investors have the flexibility and wherewithal to weather the froth coming of the IPO market . Comparing 1Q22 to a year earlier is revealing: only nine came in the first three months of 2022 versus 33 IPOs in 1Q21.

So, how will investors wield this new-found freedom? Some signs point to early-stage opportunities as a good destination for their dollars.

Demand for biotech IPOs still weak

One factor pushing investors away from later stage biotech is compressed exit opportunity – either through acquisition or IPO. The fervor for biotech investment carried over from 2020 drove the overvaluation of biotechs going public at all technology stages, leading to a poor post-IPO performance from 2021’s public crop. This trend has shaken confidence in the ability of biotech IPOs to yield returns and has caused all except dyed-in-the wool biotech VC investors and strategics to hang back. While there

is a continued supply of biotechs at the age and stage to go public (approximately 75 companies have SEC registrations ready), there is simply not enough demand for those IPOs currently.

While companies considering an IPO do not all necessarily boast technologies in advanced clinical trials, there is certainly a correlation between technology maturity and propensity for IPO. As a result, those in late-stage clinical work with technologies closer to market may feel the pressure of a slumped IPO market more acutely than less mature firms, primarily because of their cost structure.

With the XBI still leveling out at about half its highwater mark of a year ago, investor confidence in the biotech market will take time to recover. So, it may be a while before capital flows back into public biotech markets to enable the consistent exit environment of last year.

Though the valuations won’t be as lofty as in 3Q21 without the “crossover” or pre-IPO investors, late-stage biotechs can nonetheless seek financing from seasoned VCs, eager to put their money into more reasonably priced deals, and fund the significant

C-rounds needed to support these larger, more mature biotech firms.

Late-stage acquisitions few and far between

The other exit path for late stage biotechs, acquisition by big biopharma, is showing very little activity currently. At the J.P. Morgan Healthcare Conference in January 2022, big pharma such as BMS, Novartis, Pfizer, and Roche indicated their preference for smaller, ‘bolt-on’ deals with small- to mid-size companies rather than large, capital-intensive M&A deals. Smaller deals allow big biopharma to leverage the target’s unique expertise, whereas value added from large, late-stage biotech acquisitions may be not as substantial because of acquirer overlap with the target’s skills.

Moreover, the hawkish tone of the FTC since 2021 has indicated that the coming years could see increased scrutiny on large deals. While the Pfizer completed the acquisition of Arena Pharmaceuticals,  the waters of large-scale acquisitions remain untested. These factors may make the ‘exit via merger’ route harder to come by for a large share of later stage companies..

Could VCs and strategic investors shift focus upstream to earlier-stage biotech?

Given biopharma’s currently small appetite for late-stage acquisitions, the focus on earlier-stage biotech is coming from both strategic investors and life science VCs. And that’s not a bad thing, as it will avoid putting more pressure on the large number of biotechs that went public in 2021 whose shares trade below their IPO price. An investor shift toward earlier-stage, private-market opportunities where those companies remain private longer will give public biotech markets time to recover. Meanwhile, companies spending time to create real, milestone-based value, will be in a position for an exit either via industry acquisition or through a solid, facts-based IPO story.

Moreover, looking backwards to early-stage companies could help investors find more potent contenders to face the now-crowded startup scene. The IPO enthusiasm of 2021 weakened the winnowing process for biotechs and led to an environment with too many companies, with similar, poorly differentiated technologies. Backtracking to earlier stage opportunities could help investors find technologies with the potential to leapfrog the current generation rather than ones providing only incremental improvements.

Rising interest rates could interfere

While a new focus on earlier stage companies seems to be a natural shift, factors like current events and high inflation, which add uncertainty to the market, may intercede. Investors expect the Fed to push interest up rates several times over the coming months to fight inflation, projecting interest rates six more times over the year. These higher interest rates work against longer term, riskier investments while pushing investors into safer markets. However, the magnitude of this effect on current markets is unclear as of yet.

Takeaways: Early stage biotechs could be the winners of 2022

Despite the difficulties of 2021, life science investors are fueled up and ready for

another round. Already in the first quarter of 2022, VC funding reached almost $8 billion, which is higher than all of the last three quarters of 2021. Many of these funds are explicitly set for new venture creation or early stage technologies, such as Atlas Venture’s recent $450 fund geared toward generating new biotechs from existing and new creators. Other players are also making their plays in the early-stage biotech market – including corporate VC such as Fujifilm, which has set up a small new fund of $60 million explicitly for early-stage companies and in modalities like cell therapy.

With the intensity of the current market downturn, factors pushing investors towards earlier stage companies are also strong. Namely, the lack of exit opportunities for later stage companies, either by IPO or acquisition, could cause capital to shuttle rapidly up pipeline. The recently churned market may yield exciting opportunities to a fresh generation of early-stage tech in 2022.

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If the atmosphere of the pandemic is feeling somewhat optimistic after years of tumultuous ups and downs, the tenor of Biotech financing is feeling rather the opposite. While 2021 broke records in biotech IPO and private investment markets, it left many disappointed by the aggressive cool-down following the February peak. With a steady downward trajectory for the XBI, the S&P index for Biotech, leaders at emerging biotechs, established pharmas, and life science VCs have had to change strategies to face the challenge. Now, with some distance from the bubble of 2021 and the first quarter of 2022 over and done with, it’s time to evaluate how the biotech markets have been faring.

Recap of 2021 biotech capital markets

2021 started out strong with a record-breaking total of IPOs and an unprecedented number of early-stage biotechs going public, with many not yet able to provide clinical data. This frenzy was fueled by high demand for IPOs and rewarded crossover investors with high returns over short turnover times. This steady string of successes compelled even investors traditionally interested in less risky ventures to turn their attention to biotech.

Large early-stage crowd at the IPO door 

A dearth of M&A deals by large pharma companies accompanied this IPO craze, despite pharma giants purportedly holding ample cash. The lucrative IPO market and inflated valuations pushed smaller biotechs and large pharmas away from more traditional M&A partnerships and collaborations.

This rush to list brought a crowd of insufficiently de-risked companies to the public markets, causing a disappointing run for XBI. In total, 80% of 2021’s biotech IPOs ended the year below their initial offering price, signalling investor flight and sapping demand for IPOs. With the bubble of investor enthusiasm for biotech financing burst, startups and fund managers moved to reevaluate their strategies for the coming months.

Little clinical data, similar indications

The early IPO plan pursued by many biotechs in 2021 needs revision for those looking to go public in 2022. The poor performance of 2021’s batch and the tightening availability of capital has made IPOs a much more difficult process. Only five biotechs have had IPOs in Q1 of 2022, and of those only two are currently trading above their listing price.

The aftermath of 2021’s frenzied IPO market are cut-down valuations for biotechs and increased pressure to show value through concrete milestones. Moreover, the 2021 biotech IPO surge brought with it a glut of similar technologies for similar indications, frustrating investors who were seeking differentiated offerings for their money.

Tourists flee, layoffs, but VC & industry at the ready

Investor hesitation in biotech markets is now reflected in a recent rise of layoffs in biotechs, such as at Zymeworks and Passage Bio. The CEO of life sciences executive search firm Slone Partners recently told Fierce Pharma that layoffs seem more prevalent at public biotech companies, underscoring the direct impact of the market-wide decrease in investor confidence in the real strategies of public biotechs.

Despite the flight of investors from last year’s poorly performing market, life science-focused VCs have maintained a deep purse to invest in new biotech startups and technologies. Atlas Ventures recently announced a new $450 million fund, targeting new venture formation. Frazier Healthcare also announced a fund of $987 million to invest in novel biopharmaceuticals in a range of maturities.

Slow down the race to the IPO gate, get concrete milestones in order

According to some biotech leadership and VC managers, emerging biotechs are likely to stay private longer in lieu of the abridged IPO timeline of the last few years. While the enthusiasm of crossover investors has waned with the demand for IPOs, the reshuffling of VC and startup strategy may be a beneficial correction in the long run.  

Perhaps most interestingly, large pharma companies are in a strong position for transactions for the remainder of 2022. The lofty valuations for emerging biotechs in 2021 proved difficult for pharma, evidenced by low M&A activity which consisting primarily of small acquisitions rather than large deals.

Slight uptick in M&A 

In 2022, M&A deals have seen a small uptick. So far, major deals include UCB taking over rare disease biotech Zogenix and AbbVie acquiring neuroscience-focused Syndesi Therapeutics. Furthermore, giants like Pfizer have ample cash on their books and have stated their willingness to spend it on deals. Though yet to play out, such prospects are no doubt on the minds of many.

In addition to the IPO hangover, the slow return of M&A activity may also stem from uncertainty in the regulatory environmentsince March of 2021. At that time, the FTC announced a ‘working group’ to the include European, Canadian and UK competition authorities to create a framework for analyzing pharma mergers, triggered by a spate of deals and high drug prices. However, the FTC recently allowance of  Pfizer’s acquisition of Arena Pharmaceuticals may resolve some lingering concerns holding up similar transactions.

Seasoned investors have plenty of dry powder for clear milestones

Despite a tough couple of quarters since the 2021 cool-down, biotech stakeholders are changing strategies to weather the current market. Many committed investors see the increased scrutiny and focus on milestone-realism as a healthy voice for the true value of biotechs, rather than the overexuberance that led the overbought market of 2021.

Though unclear how long the climb from the 2021 sell-off will take, seasoned life science investors and leaders see this as a temporary blight.

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