Why do software venture capitalists also invest in biotechnologies?
I’ve always wondered why software VCs often also have a biotechnology start-ups investment arm (let’s not give out the VC names));. Frankly, I find it hardly understandable, for a number of sound reasons:
- No external synergies: software start-ups are founded by software developers; biotech companies are ran by medical doctors, healthcare engineers or biochemistry PhDs. By external synergies, I mean moving a good manager from a bad investee to a good investee with a bad manager.
- Distribution strategies are clearly different. Biotechnologies focus on R&D and go through big pharma corps for manufacturing and marketing. Software start-ups tend to try to master the whole value-chain, prepare to go international fast, and may sell directly to the end-customer via the Internet.
- Geographical clusters aren’t necessarily common. The following picture is very broad: in Europe, biotech players regroup in Cambridge (UK), Denmark & Switzerland. In the US, in Boston, Austin & Cincinnati. Software players in Europe are located in Paris, Munich & London, and in the US, in Palo Alto, San José, Seattle, Boston & New York. But since technology makes remote work very easy, it’s everyday harder to locate software clusters.
- Both markets have nothing in common, that’s a no brainer. So one VC has to chose in which industry (s)he’s going to specialize in.
Looking for explanations, I found two major ways to look at VCs doing both software and biotech players:
- There is too much money available for investing vs. too few entrepreneurs (at least in Europe). So, VC funds manage to raise a lot of money, too much money. And since there might not be enough deals in one industry (and the bigger, the more money they make), they start a new fund in another industry to diversify their portfolio. The way they may justify such a move is crystal clear: in case the software industry enters economic doldrums, biotechnologies play a defensive role and vice versa.
- This is the very best reason, although I still don’t find it quite satisfying, why VCs could invest both in software and biotechnologies: investment cycles are similar. Time periods may differ (obviously much longer in biotech), but in the end, in both industries, the time-to-market may get pretty long. In other words, between the idea and the product, between the invention and the innovation, you need a relatively long time to launch a market-ready device. And development time costs money: you need to pay software developers or researchers, you need to invest in computers and testing hardware, you need to pay for business development expenses, lawyers, accountants, etc. Bootstrapping in software is feasible (although very ambitious people will tend to raise early-stage money), but impossible in biotechs. In both cases, before you breakeven, you need to have enough cash to breath – and the lower the cash burn rate, the better. That’s what I call investment cycles, and they’re often similar in the businesses of software and biotech.
When all’s said and done, I’ve thought about it – as you can see, but I still don’t understand why VCs in one industry don’t start another VC brand to invest in another industry. And when I’ll become an entrepreneur, I will for sure not select an investor that doesn’t specialize in my industry, and my industry only.
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Could be that the global risk profile is the same!
High profit margins and expected exit returns…
Alex: maybe, but I’m not sure. These industries are far too broad. For instance, PLM software aren’t a good pick during downturns since R&D budgets are often cut very early. This argument wouldn’t go for finance software for instance. On the other hand, whether a biotech discovers a new illness remedy isn’t linked to economic cycles, so I guess biotech are defensive picks rather.
And had our intention been to analyze risk profiles, we would’ve had to take a deep look at the debt burden, company by company.
Maybe I didn’t understand well your remark though.
Olivier> That’s for sure, on the condition that the VCs are good and understand well the market growth potential as much as the executive abilities of the management team. For instance, although theoretically a niche software may sell high, bad execution (eg never-ending implementation projects, etc.) may damage the company’s reputation and lower mid-run margins. The same would go if market growth was badly assessed initially: the company couldn’t reach breakeven fast and treasury management would be too imbalanced.
What if the biotech firm doesn’t actually find anything? I see biotech as a much riskier business than software (although expected exits are huge, IF something big is found in the R&D dept.).
The VCs who invest in IT and Biotech usally have two very different teams, because, as you mentioned, there are no synergies.
Hello Daya,
You’re totally right. But I still don’t understand why these guys trade under the same name. To lower support costs? (fax, secretary, etc.) I bet not. Any idea anybody?
Hi Jeremy.
There are different kinds of biotech companies. I will only focus on Biotech developing medicines.
I think that the main reason why VC invest in both biotech and soft firms is a way to balance the risk of their investment.
Investing in a successful biotech company can probably provide a higher ROI than software firms. However, Biotech is a very risky activity maybe riskier than software firms. I would say that issue of a biotech company is binary: success or failure, only depending on the properties of the molecule. I don’t really think that a Biotech-specialised VC firm would be viable!
I would add that many current R&D biotech companies have developed an original technology allowing them to provide a service activity in addition to R&D activity. As you will see here (http://www.quilliet.net/index.php/2006/09/comparaison-entre-une-ssii-et-une-srsc-societe-de-recherche-sous-contrat/), soft and biotech-service business are not so different.
Hello Laurent,
Alex cannot stop talking about you these days (saying only great things, I can assure you). Welcome on Tech IT Easy!
My opinion is that your argument is not valid. Say you’re an institutional investor. Rather than investing in a diversified fund (software and biotech), I’d rather select the best software VC on the one hand, and the best biotech VC on the other hand – instead of selecting venture capitalists not certain enough of their capability and flair to make good returns on their picks.
The link you provide us with is great. I didn’t know this blogger Xavier Quillet before, but he looks learnt on biotech issues (a field I don’t know well, as you would have understood by yourself Laurent
). A shame he blogs in French. Anyway, a very interesting comparison and idea.
Considering that I’m an institutional investor, I will give my euros to the funds giving me the best return (healthcare investment) while minimizing the risk (diversification of investments).
As said Daya, most of VC have two teams specialised in both sector. In conclusion, I would be confident in that kind of fund.
In fact, I realised that pure biotech VC are not very common. I actually know only two pure-player funds.
Why biotech-software synergies? I’m sure asking a VC, of finding one of the many blogging VCs that syndicate these investments, will be able to answer that question.
But ok, here are some of my theories.
The software market is getting more competitive/less attractive and the biotech-market more. Why the latter, because struggling pharmaceuticals, with patents running out are buying start-ups like candy. So a. I think it is just a very attractive industry to invest in for software-people with excess money.
b. The VC business is largely a people-business. Sure, you have to know how to do valuations and such, but you are investing money into ventures that are still in the vapourware-phase.
And people-wise, I don’t think the software and biotech-industries are that different. They are both filled with scientist who lack money—ok, less for software—but they also lack the other values a VC typically provides: business-knowhow and -contacts. So there is a people-match also.
Just some thoughts..
I actually got the confirmation today. Investing both in biotech and IT is a way to balance the risk for most of funds.
Another information:
I recently heard a VC on the radio saying that VC funds does have plenty of money. The problem is the low number of good quality projects. Thus, they can’t focus on a single field.
Okay, many thanks for the follow up Laurent. I agree with the theory that although there is some money, we lack entrepreneurs (not necessarily with good projects; if the VC are good, they help the entrepreneurs shape their business plan).
You’re right Jeremy, he also said that we lack good entrepreneurs (I check if there is a podcast of the radio show).
> if the VC are good, they help the entrepreneurs shape their business plan).
They could do it if they had time. I think that’s the business of the fund raiser team and not the job of VC.