Venture capital evolved to venture creation. Will it stay that way?
By Risa Stack
Risa Stack is a venture partner at RA Capital. She has played a significant role in the early operations, financing, and development of over 25 companies.
Michelangelo, Public domain, via Wikimedia Commons
June 24, 2021
When I joined the venture firm Kleiner Perkins (KPCB) in 2003, we were like many other VCs in that we invested in discovery- and development-stage life sciences companies. But we were one of the few firms that also started companies from scratch. Sometimes we leveraged venture partners or entrepreneurs-in-residence, but many times we just dug in and dived in. It was a fun but challenging rite of passage.
Fast forward to today. The so-called venture creation model has fully taken root, underpinned and enabled by biotech's longest-ever boom cycle and unprecedented sums of available capital. To understand whether VCs' build-it-yourself approach to starting biotechs can withstand an interruption in the boom - a familiar return to the capital scarcity that has followed biotech booms since the industry started - it's important to understand what's so appealing about the strategy in the first place.
In 2008, I started Veracyte, alongside an amazing CEO, Bonnie Anderson. KPCB, Versant, and TPG rolled up our sleeves to identify clinical questions that could benefit from a diagnostic to improve patient care. Finding the “right” people for a company was hard, as we didn’t have a bevy of venture partners to bring into the mix. This often led us to collaborate with one or two other firms from the very beginning to pool resources. It also took a lot of time of the partner leading the project, limiting the number of Series A or later-stage deals he or she could work on.
We started our own companies when we saw a problem that needed to be solved; we would go hunting for technology and the people to build the business. We had to own a lot of the company; as time is the most precious resource, we needed to make sure it was worth our time. While other firms may have debated as to whether this was efficient, at KPCB, we had a history of company building and taking CEO roles, so there was general support in the partnership.
Bonnie has since built the company into a diagnostic powerhouse focused on very challenging clinical questions including reducing unnecessary surgeries and informing treatment for thyroid cancer diagnosis and increasing confidence in IPF diagnosis. Most recently Veracyte has ventured into the more popular world of cancer diagnostics with Percepta, a nasal swab test designed to identify early lung cancer. Veracyte continues to evolve its business through the recent acquisitions of Prosigna from Nanostring and Decipher Biosciences.
Meanwhile, the venture creation model has evolved. Most notably, it’s become more efficient. You might even say a handful of biotech VCs have industrialized the process, building or retrofitting their entire organizations around company building, to the near exclusion of traditional VC investments. Traditionally, venture firms identify “companies”; these are often a few individuals with a business plan, some previous financing, and key proof-of-concept data. In other words, the idea has been fleshed out and the foundation already built. However, the venture firm does not get as large an equity stake as if they created it themselves.
So why the shift to company creation at prominent biotech venture firms? For one thing, starting companies is hard and it is important to get all the right people around the table to mitigate risk and execute efficiently.
A few of the more well-known firms doing venture creation include Third Rock, Atlas, Versant, Flagship Pioneering, and RA Ventures. In addition to experienced biotech executives in the form of EiRs and Venture Partners, another key resource is internal recruiters with strong biotech networks to speed the hiring process. Processes that are often brought in-house include internal HR, legal, and accounting. Some firms even have CFOs with financing experience to help drive the fundraising process.
Recently, Flagship Pioneering has garnered a lot of press through the success of Moderna, which has become synonymous with their mRNA Covid-19 vaccine that has helped so many of us get back to normal life in 2021.
So why the shift to company creation at prominent biotech venture firms? For one thing, starting companies is hard and it is important to get all the right people around the table to mitigate risk and execute efficiently.
The newer incubation models allow for this. Many of the key people needed are already employed or affiliated with the fund, making the processes of vetting new ideas more robust. Firms review many ideas yearly; according to Noubar Afeyan, Flagship Pioneering explores 50 to 100 ideas per year, of which a half dozen or so move forward in the process. A team of six or seven people works on the “Protoco”, some then become internally staffed, ultimately spinning out into what Flagship Pioneering calls Newcos.
Firms like Flagship and like RA, where I am a venture partner, conduct detailed vetting and early staffing with experts to allow ideas to fail more quickly than they otherwise might. It’s not clear, however, if there is any data on a direct comparison of companies from company creation firms versus the traditional financing path.
Having many people around the table is expensive, and not every firm can afford to pull together this kind of expertise in-house. But as biotech venture funds got bigger and the number of funds in general has expanded, the competitive pressure mounted to secure ownership and influence over future allocations in the best companies. Some investors in publicly traded biotechs recognized that the solution to being excluded from an IPO was to invest a round prior, creating the crossover model of investing, while a subset of those then took this thinking to its logical conclusion that you can’t get any earlier than just creating the companies from scratch.
Some have specialized. For example, in 2019, Foresite Capital started its own incubator, Foresite Labs, to focus on building companies at the bridge between healthcare and information technology. In 2013, I created a team inside of GE Ventures to focus on company building inside a large company. While there were a lot of barriers, cultural and procedural (being in a big company comes with a lot of structural barriers!), we spun out some great technologies into companies (Menlo Microsystems and NuVera Medical, for example). These were opportunities we could not have accessed if we were outside investors. We also got great business ideas from GE customers, some of which led to first-in-class companies like Vineti - the first company to develop supply chain software for cell therapy.
RA Capital started as a hedge fund roughly 20 years ago, began doing crossover investing in 2012, and then leveraged its experience with private companies to create its own companies. RA manages a single, integrated portfolio in the main fund, as opposed to being a fund complex with different teams managing mostly private or mostly public portfolios.
The advantage of being part of a multi-stage fund with public market experience is that RA views the world from the eyes of public market investors. We survey the whole landscape of companies when we are looking to build a newco. From the outset we are thinking about how we will build and position the new businesses to be public companies. That’s not because being public is the goal but because there are more investors in the public markets from whom to raise money, so it’s always good for newcos to have a sense for when going public may be an option.
The assembled networks that underpin the model, whether informal or sponsored by large investment institutions, are presenting opportunities for their members to cycle into companies when their expertise is most valuable, and onto new opportunities after that.
Biotech is a cyclical business, and we are in the longest boom in the history of biotech. The rise of the venture creation model has both helped drive and benefitted from this boom. What will happen when the music stops (if it stops)? Will venture capitalists retreat back to the traditional model that allows a broader, more varied portfolio and requires less capital, if capital becomes scarce?
The company creation model biases to opportunities with large exits, as so many resources are necessary to do the builds and the goal of the larger fund is to deploy more capital. Thus, those firms that build internally are often focused on therapeutics which tend to have larger exit multiples.
Whether or not the venture creation models we see today would survive a (so-far hypothetical!) downturn in the capital markets might depend on firms’ willingness to entertain lower valuations, at least temporarily, for the companies they create. But it’s unlikely the firms embracing the model today completely pull up stakes.
That’s in part because the model is resulting in better companies that are tackling harder problems and moving faster than used to be thought possible. And the assembled networks that underpin the model, whether informal or sponsored by large investment institutions, are presenting opportunities for their members to cycle into companies when their expertise is most valuable, and onto new opportunities after that.
I believe the venture creation model is sustainable, and here to stay, because unmet needs remain and the networks of experts and builders are simply too valuable in and of themselves to disband.