Tech VCs are barging into the life sciences, and writing big checks

Key Points
  • Start-ups at the intersection of biology and tech are in hot demand, both from life sciences investors and Silicon Valley. 
  • There are some concerns that the newcomers to health care are not cognizant of the complexities. 
  • Start-ups in this space are receiving different valuations and checks. 
DuPont research scientists at work in a biobutanol molecular biology lab
Source: Dupont

Freenome CEO Gabriel Otte received two very different term sheets when fundraising for his diagnostics start-up earlier this year.

Freenome is one of half a dozen companies in the red hot "liquid biopsy" space, which is aiming to develop a blood test to detect cancer at the earliest stages. 

One of the term sheets came from a traditional health and life sciences fund, which Otte said offered him a modest valuation in exchange for about 40 percent of the company.

Another came from a Silicon Valley tech investor with a far higher valuation and check size than he expected. He turned it down, but eventually ended up taking some money from other tech investors with new-found interests in biotech.

"Tech investors will offer higher valuations if they believe you're going to grow like a tech company," said Otte. 

In recent years, technology venture capitalists are starting to embrace the health sector in a new way. Rather than investing in fitness gadgets and other tools for wellness, Sand Hill Road's VC firms and tech accelerators are now stepping into the life sciences. 

Some venture firms staffed up with medical experts and built out a scientific network, like Alphabet's GV (formerly Google Ventures). Others are driven by a thesis that software will "eat bio," as in the case of Andreessen Horowitz. All of these firms see huge dollar signs, given that the health sector is valued at billions of dollars.

"Just think of the marketing budget that Google can go after (with ads and such) — $200 billion," wrote Vijay Pande, general partner at Andreessen Horowitz's new bio fund in a blog post. "But compared to that, the U.S. healthcare budget is $2 trillion."

A tweet from VC Bill Gurley states the tech investor's point of view succinctly:

1) Over 3 years ago, sent tweet below. Having invested in OpenTable, Zillow, Grubhub, Uber, we felt same opportunity existed in healthcare. 

Life sciences investors told CNBC that the new competition will be good for the space overall. Some will collaborate with tech companies on deals.

But they also expressed concerns that some Silicon Valley tech investors are chasing the hype around health tech and might not be willing to stick by their portfolio companies as they grapple with the complexities of bringing promising science to the clinical market, and ultimately to patients. 

A biotech company is a science experiment at its core that has never been run before.
Ambar Bhattacharyya
managing director, Maverick Capital Ventures

"I hope that (new) backers understand that patients' lives are at stake," said Alexis Borisy, a partner with Third Rock Ventures, a traditional biotech-focused firm, and a co-founder of Foundation Medicine. Borisy said funds like Third Rock will offer a wide variety of support to companies beyond financing, including its extensive network of scientists and researchers. 

"It takes 10 to 15 years to bring a product to broad commercial acceptance, and companies need to have backers that understand that," he added. 

Chasing deals 

Otte ended up settling somewhere in the middle, taking a combination of biotech and tech financing. Andreessen Horowitz led the $65 million round, and GV, Charles River Ventures, Polaris Partners are among those that participated.

"It was nowhere near the highest valuation," said Otte. "A high valuation at this stage doesn't help us, because it means we need to justify it in the next round."

Like other venture-backed liquid biopsy companies, including Grail and Guardant Health, Freenome will need to front the cash for multiple rounds of clinical trials in order to satisfy regulatory requirements. Despite early data, which it showed investors, the company could still fail.

"A biotech company is a science experiment at its core that has never been run before," said Ambar Bhattacharyya, a managing director at Maverick Capital Ventures, a fund focused on health and technology. 

Life sciences investors warn health-technology entrepreneurs to be cautious. A high valuation typically means high expectations, which can be extremely challenging for companies in regulated industries to meet. And that might mean these companies struggle in later rounds to secure further financing. 

"The velocity in the tech world has created this dynamic of chasing deals with big check books," said Wende Hutton, a health investor with Canaan Partners. "That's a lot more difficult when rooted in the reality of clinical trials." 

Great day for Foundation Medicine: CEO