In 2016, the U.S. spent 17.9 percent of GDP on healthcare. While other countries’ healthcare spend is lower, healthcare clearly is one of the largest sectors worldwide and a market with huge potential. It is no surprise, therefore, that start-ups and VC investors target innovative products and services for new medical applications.

One of the most profitable and but also very risky venture is the development of a new drug that ultimately need to be approved by the FDA before they can be marketed to US patients. Other sectors targeted by start-ups and VCs are medical technology, diagnostics including genomics, and most recently “Digital Health” applications.

Biopharma Start-Ups

Biopharma drug development, i.e. the development of new medications, has become a fruitful field for entrepreneurs and investors alike. As the development of a new drug to approval usually requires a few hundred million dollars spent over 10 or more years, any such start-up sooner or later turns to venture funds or other large investors for financing. Funding rounds with $50 million to $100 million are not uncommon. Once a new drug is approved by US FDA, the market potential usually is significant. The revenue potential of the 45 novel drugs approved by FDA in 2017 was estimated at close to $50 billion.

During the first half of 2018, 203 young biopharmaceutical companies in the U.S. received $7.6 billion of venture funding (out of $52 billion total venture capital invested). Thus, 2018 looks to be a record year for biopharma venture funding (and venture capital in general). In 2017, VCs invested $10.6 billion in biopharma companies up from $7.5 billion the year before. Similar amounts went to young companies in other healthcare sectors.

Large Pharma and Biopharma Start-Ups

The pharma industry today is still dominated by traditional large companies such as Pfizer, Novartis, Roche, Merck, J&J and the like. However, former start-up companies Gilead and Amgen have made it into the top 10 and were in 2017 ranked #7 and #10, respectively, in terms of worldwide pharma revenues.

Amgen, founded in 1980, was one of the first venture-funded biotechnology company. And, Gilead, founded a few years later in 1987, focused on anti-viral therapeutics.

These examples and many others show that breakthrough innovations in medical research often happen outside of the larger pharma companies even though the largest companies spend billions in R&D. Biotechnology drugs (proteins and antibodies as therapeutic medicines), cell therapies, therapeutic vaccines to combat cancer, so-called “orphan” drugs, immuno-oncology and other novel therapeutic approaches have all initially been pioneered by small companies.

Today, young and former start-up companies play a major role as developers of new drugs. Of the 45 new drugs approved by FDA in 2017, 27 or 60 percent were initially developed by young/ small companies! Many such start-ups then get bought by larger companies before they even reached revenue-stage. Others list on NASDAQ, which recently has been very receptive for biopharma companies with promising products in development.

Larger pharma companies today heavily rely on innovations from start-ups to “refreshen” their product range. They not only buy private and public biopharma companies on a regular basis, but also license drugs at all stages in development. Most large pharma companies also actively invest in young companies, usually through a corporate venture fund and have set-up incubators or university collaborations to get closer to the source of medical innovation.

Drug Development a Risky Business?

Overall, there are about 15’000 (!) of new drugs, i.e. new chemical molecules and new biologics, in development. Over 50 percent such potential new compounds are still in the discovery phase, i.e. have not been tested in humans.

These numbers show that only a very small fraction of drug projects succeed, making new drug development and related investments a highly risky proposition. Chances for success and good investor returns, however, can be improved if start-ups follow some of the recommendations below (see box). And two last pieces of advice: (1) Raise as much or more money than you need when conditions (internal and external) are favourable even if it means significant dilution for founders. Raise money at least one to two year before the next significant milestone. (2) If you receive a decent offer from a strategic partner to acquire your company, think twice before rejecting it, even though you believe that your product might be a “blockbuster” drug.