Venture capital investment picks up the pace

Australian venture capitalists invested more than $1 million per week in Australian biotechnology in the past financial year, an increase on the previous year and a recovery to the historic level of two years ago. As in the past, a large portion of the investment was made by a small number of investors, and was received by a small number of investees.

And although the absolute amount of venture capital has improved, the amount relative to other countries remains very small -- according to Burrill & Co, US biotechs received US$1.4 billion in venture capital investment in the first quarter of this calendar year, and US$815 million in the second quarter. Clearly, Australian biotechs must continue to develop financial and operational strategies appropriate to the level of funding available in this country, and the sector as a whole must continue to seek sources of funding beyond venture capital.

The 2003/04 biotechnology investor parade was led by GBS Ventures, which put in almost 15 per cent of the $ 53.5 million total, followed by Titan Bioventures and the Queensland BioCapital Fund. Together these three firms accounted for one-third of the total venture capital invested in 2003/04. Investments in biotechnology were made by thirty Australian venture capitalists during the year; the top 40 per cent of the firms put in more than 80 per cent of the funds.

GBS Ventures also led the way in terms of the number of investments, making 13 of the total of 82 biotechnology investments for the year. Uniseed, owned by the University of Queensland and the University of Melbourne, was next with 12 investments, followed by Start-up Australia with 10. Including UNSW's Unisearch, which made four investments during the year, the top four of the 30 firms made almost half of the investments for the year.

As in previous years, most venture capital firms that invested in biotechnology at all made a small number of small investments. A few firms made a larger number of investments, at a relatively small average size, while others made a smaller number of investments at a relatively larger average size. There are no Australian players in the 'Cambridge corner' -- the upper right hand side -- of a chart of investment frequency and average investment amount (the size of the bubble is proportional to the overall amount invested during the year).

Forty-seven Australian biotechnology companies received venture capital investments during 2003/04. Pharmaxis, which listed during the year, received $4.4 million, followed by Cytopia at $3.75 million and AtCor Medical at $3.25 million. Ten companies got between $2 and $3 million each, and another six received between $1 and $2 million. The bulk of the investments, of course, were small -- half of the companies received less than $750,000 during the year, often in multiple tranches.

With regard to investment stage, about 60 per cent of the total ($29.5 million) was classified as 'seed' investment, with $11.8 million start-up, $7.9 million early expansion, and $ 4.3 expansion. New investments accounted for $15.7 million and follow-on investments for $37.7 million of the total. The great majority of investee companies (35 of 47) received funds from just one venture capitalist, regardless of how much was invested or in how many tranches. Ten companies had two VC investors during the year, and only two companies had three investors. The venture capitalists also preferred to focus -- 17 of the 30 VCs who invested in biotechnology put their money into just one company, although occasionally in the form of multiple investments. Nine venture capital firms backed only two companies, and one each invested in four, five, eight and nine companies. Clearly, biotechnology remains a very part-time focus for the majority of Australian venture capital firms.

Moreover, nearly half of the firms that invested in only one company, and all of the firms that invested in only two, did so without co-investors -- they were the only VCs to put money into those companies during the year, and thus were presumably not relying on due diligence carried out by other firms as background for their own investments. Firms that invested in one, two, five and eight companies put very similar amounts into each investee company -- around $ 1 million -- while the two firms, both university-owned, that invested in four and nine companies respectively put substantially less into each of their investees. The challenge in all this, of course, is that substantial expertise is required to analyse a biotechnology investment properly. It would seem unlikely that such expertise can be afforded by firms that are making only one or two biotech investments per year, remembering that the average investment is around $650,000 and the average investment per company about $875,000. Perhaps venture capital firms are employing consultants or other advisors to evaluate potential investments for them, or perhaps the firms are less risk-averse than is generally believed.

In terms of geography, Victorian companies received both the most money ($20.1 million) and the largest number of investments (34). Queensland was in second place with a total of $17.9 million, but had the highest average per investment, slightly over $1 million. NSW biotechs received 27 investments totalling $13.9 million, and ACT companies $1.4 million across four investments. No venture capital investments were made in Western Australia, South Australia, Tasmania, or the Northern Territory during the year.

Whether by coincidence or not, Victoria was also the source of most of the VC investment into biotech -- a total of $ 19.3 million came from investors in Victoria during the financial year. NSW investors were next at $18.9 million, while Queensland VCs put in only $8.9 million, about half of what biotechs in that state received. WA VCs contributed $5.9 million, and ACT investors just $500,000. Ironically, however, Victorian investors put most of their money into companies located in New South Wales, while NSW VCs sent most of their funds south to Victoria.

Queenslanders split their investments almost equally across the three eastern states, while WA firms ignored NSW entirely in favour of Victoria and Queensland. Obviously the American pattern of investing only within driving distance does not apply in Australia.

Although the total amount of venture capital investment did rise compared with last year, a potentially worrying note is the fall-off in investment levels during the financial year.

One third of the total investment was made in each of the first two quarters of the year, and only one-sixth in each of the final two quarters. Is this a sign that enthusiasm for biotechnology is waning? Probably not -- this general pattern turns up across the past seven years. Between 1996 and 2003, 38 per cent of biotech VC investments (by dollar amount) were made in the first quarter of the financial year, 28 per cent in the second quarter, 21 per cent in the third quarter, and 12 per cent in the final quarter. Thus the 2003/04 data is not unusual; perhaps the moral for biotechnology companies seeking venture capital is to start early, before the money runs out towards the end of the financial year.

The overall picture for Australian biotechs seeking venture capital is thus moderately positive. The overall amount of VC spending has increased, the new pre-seed funds are starting to invest; and the money is being spread out somewhat more broadly that in the past. Still, given the general volatility of the venture capital market, as exhibited by the VC drought in Australia in 2002/2003, biotechs would do well to follow the Law of Appetisers, coined by legendary venture capitalist Eugene Kleiner: "When the hors d'oeuvres are being passed," Kleiner said, "take two."

Data regarding venture capital investments was provided by Private Equity Media and is used by permission

Michael R Vitale is a professor at the Australian Graduate School of Management, in Sydney. michaelv@agsm.edu.au