Biotech market winter gradually recedes, venture capital shows early signs of recovery

Although the COVID-19 pandemic has passed, its impact on the biotech industry has lasted for years. Now, after five years of pressure on small pharma companies, some venture capitalists see new signs of optimism.

During the pandemic, a large amount of capital flooded into the biotech market, benefiting both public and private companies, creating a "bubbly" environment in which biotech companies once thrived. However, when many clinical programs failed to deliver and development costs rose, the bubble burst, and many companies lacking data support faced a difficult road ahead.

Just last year,the funding environment for private biotech companieswas still at a low point, with weak investor confidence and an uncertain economic climate. Manycompanies were forced toshut down, lay off staff, or cut programs.

At the same time, pharmaceutical companies began to open their wallets, leading to a series of deals, including acquisitions ofover $10 billionby companies such as Johnson & Johnson, Novartis, Pfizer, and Merck. Despite a slow start, biotech IPOs alsoreopened。

Biotech companies are looking up because investors are more focused and disciplined in their attention to early-stage projects, says Omar Khalil, managing director of Santé Ventures. The venture fund recently completed a$330 million fundraise(its fifth fund).

Here, Khalil discusses how the biotech industry has changed since the company's founding in the early 2000s, the challenging funding environment of the past few years, and what is driving the potential start of a biotech recovery.

This interview has been edited for length and style.

PHARMAVOICE: The biotech landscape has changed dramatically since Santé Ventures was founded two decades ago. How would you describe those changes, and how have they shaped your focus along the way?

OMAR KHALIL:Looking back 20 years, the amount of capital flowing into biotech was very different from today. Biotech venture funding in 2005 was just a fraction of what it is today, and pharma R&D outsourcing was not as thorough as it is now. Companies were less willing to acquire or partner on early-stage projects, whereas today the ecosystem has matured to the point where biotech is expected to feed the pipeline, with pharma handling late-stage development and commercialization.

The types of assets people invest in have also changed a lot, especially as our understanding of biology has expanded dramatically, opening doors that were unimaginable 20 years ago. Back then, an exciting deal might have been drug repurposing or accelerated pathways to minimize technical risk. Over time, there has been greater interest in programs with the opportunity to change the status quo from the patient's perspective. Of course, investing in new modalities involves more risk. But there are always waves, and in the past few years, risk-taking has decreased, especially among later-stage investors in new targets and novel biology.

What has been most difficult in the past few years? How did you strategize to get through such a tough funding environment?

One change is inflation—not necessarily the consumer price index, but the significant rise in clinical trial costs for biotech companies. The complexity of clinical development has increased, requiring more capital to move from one milestone to the next. Many trade-offs had to be made, and every company in the ecosystem had to prioritize and cut resources.

We tend to make focused capital plans, so we typically don't invest in large teams with hundreds of millions of dollars. The teams we invest in are already efficient and focused, so no portfolio company was forced to shut down due to capital running dry. From a funding perspective, we were able to see all our companies through. Sometimes clinical data might cause us to change direction, but funding was never the driver.

Biotech valuations shifted at the start of this decade. How do you view the current state of valuations after the post-COVID downturn?

Valuations in both public and private markets were very bubbly. During the COVID bubble, we saw preclinical companies go public at billion-dollar valuations, and that translated to private companies. It was easier for the math to work when raising more money at higher valuations. Conversely, when public valuations crashed—starting in 2022 and in the following years—it had a dual impact on private companies. Investors would look at private valuations and say, "Why should I invest in a private company when I could invest in a public company that might be more mature and cheaper?" So not only were valuations eventually corrected downward, but capital inflows on the private side also dried up.

Now, over the past six to eight months, if you look at biotech indices and the IPO window, public valuations have started to rise. It's not crazy, but we are seeing sustained improvement, and it is beginning to translate to the private market. For pharma companies filling their pipelines, it was harder to justify deals at aggressive valuations. Now that valuations are starting to correct, I hear more pharma companies expressing interest in earlier stages. Valuations are aligning with them moving upstream again.

What are the main drivers of this nascent biotech recovery?

One unsatisfying answer is that markets are cyclical. These things happen. But the COVID bubble had a lot to do with it—the market was too aggressive, and too many companies that shouldn't have gone public did. We needed time to squeeze out those bubbles. At the same time, inflation and interest rate shocks shifted capital from higher-risk asset classes to lower-risk ones, and that all pulled valuations down. The companies that survived are also of higher quality than three or four years ago, with more time to advance better data and compelling stories.

Apart from geopolitical uncertainty, the macroeconomic outlook has improved for capital inflows. Investors are no longer sitting on cash—they need to deploy capital. People have learned to live with uncertainty, and we are seeing some optimism return to the industry.

How have these changes transformed the industry?

Right now, the focus is on clinical data. You can see this in the rise of China in the biotech space. The key drivers of the industry have been reset toward impact on patients and healthcare systems. This may manifest as more licensing of Phase 1 or Phase 2 assets, often fast followers. This wave could lead to a glut of clinical-stage programs with comparable data but lacking differentiation.

As the biotech recovery matures, what do you anticipate for the future?

As an early-stage investor, we look for innovative technologies that could be best-in-class. In a world where there might be six or seven Chinese competitors in a single category, it's harder for us to build conviction. Validated targets have become crowded, so there needs to be a release valve elsewhere.

The timing is good because the pendulum is swinging back. Timing is harder to predict, but hopefully those investors who look at their portfolios and find them weighted toward validated targets will want to diversify and also invest in some more novel approaches.