David H. Crean, PhD, Managing Director for Objective Capital Partners, a leading investment banking advisory firm examines the healthcare market for 2018.
Following a decade high of VC invested in 2017, and on a record pace again in 2018, valuations continue to move higher across all stages within life sciences.
It has been a robust three quarters in 2018 within the life sciences sector for mergers and acquisition (M&A), investments and initial public offerings (IPO’s). A supportive fundraising environment is playing a part in the strong investment atmosphere, as 2018 is on track for a fifth consecutive year of $30B+ closed in all sectors by venture funds (VC’s). To round out the venture cycle, a healthier IPO market is providing much-needed returns to limited partners (LP’s) and capital for reinvestment by VC’s.
Following a decade high of VC invested in 2017, and on a record pace again in 2018, valuations continue to move higher across all stages within life sciences. Much of this valuation expansion has been caused by the buildup of “dry powder” and availability of capital to innovative, differentiated, high-growth prospects, which have given these companies pricing power in negotiations with investors. The result has been rising pre-money valuations, most notably for Series A financings, which have typically been less affected by frothy funding markets, but are now experiencing an unusually dramatic increase in valuations
Seed-stage financings are also witnessing a transformation since peaking in 2015. The number of seed-stage investments has moderated and been reduced. A cohort of those seed firms has raised larger follow-on funds and more institutional capital, while several firms died off or were not able to raise later funds. This shift has led to many seed deals being completed today at levels that would have amounted to a Series A round just a few years ago. Companies are now being more fully valued at the angel & seed stage, with investors tempering their expectations for unchecked valuation growth going forward. Is seed-stage the new Series A?
Valuation Step-Ups
Data from the beginning of 2018 suggests that the median valuation step-up between VC rounds increased to 1.6x. According to Pitchbook, this step-up is the greatest increase seen in recent years by a significant margin, as median step-up over each of the last three years settled into the 1.4x to 1.5x range. Median valuation step-up of early-stage rounds reached a decade high of 1.9x in the first quarter of 2018. Given that equity acquired in early-stage financings remained relatively unchanged, it appears that business owners and founders were able to negotiate significantly larger financings and valuations without having a haircut on dilution.
Rounds with corporate venture capital (CVC) participation have consistently carried higher valuations than those without. CVC-backed round valuations were 11% greater than those without CVC backing, a small but noticeable spread seen since 2009. The surplus of dry powder has provided non-CVC investors with ample resources to compete for higher valued companies at the early stage, providing larger checks that result in larger valuations.
Negotiated Deal Terms
Negotiated deal terms and investor rights continue to play a key role in the ultimate valuation figure. By increasing the number of investor rights or sweetening the payout, investors are more willing to accept a higher valuation. The challenge with and the economic reality of raising a down round remain strong constraints for VC-backed companies, and adding investor-friendly terms can sometimes prevent this outcome.
Sector Activity
In terms of activity by sector, pharma and biotech grew most in the number of deals and deal values relative to other industries. Venture inflation underpins life sciences’ surge. Proportionate activity from life sciences continues to climb. Life sciences is pacing for another strong year and VC’s are gravitating towards larger deals. Corporate investment has continued to skyrocket in the third quarter of 2018. CVC participation in venture deals has already surpassed 2017. This historically high investment activity and these larger deal sizes may relate to the greater capital availability from corporate tax cuts and capital repatriation, as well as strategic initiative to fund innovative technologies.
In terms of public offerings, healthcare is the most active industry for IPO’s YTD relative to other industries and has been for the trailing twelve months (TTM).
With the public and private markets at or near all-time highs, the number of venture-backed IPOs hasn’t kept pace, however. The availability of greater late-stage capital is certainly part of the reason for not hitting expectations, but there are also a number of policies and economic conditions that are restraining the IPO market for VC-backed companies. Nonetheless, the life sciences sector continues its momentum.
Disclosure
David H. Crean, Ph.D., is a Managing Director for Objective Capital Partners, a leading investment banking advisory firm whose Principals have collectively engaged in more than 500 successful transactions serving the transaction needs of growth stage and mid-size companies. Services include M&A sale transactions, partnering/ licensing, equity and debt capital raises, valuation and comprehensive advisory services. Additional information on Objective Capital Partners is available at www.objectivecp.com.
This article is provided for informational purposes only and does not constitute an offer, invitation or recommendation to buy, sell, subscribe for or issue any securities. Securities and investment banking services are offered through BA Securities, LLC Member FINRA, SIPC. David H. Crean is a Registered Representative for BA Securities. Objective Capital Partners and BA Securities are separate and unaffiliated entities. While the information provided herein is believed to be accurate and reliable, Objective Capital Partners and BA Securities, LLC makes no representations or warranties, expressed or implied, as to the accuracy or completeness of such information. All information contained herein is preliminary, limited and subject to completion, correction or amendment. It should not be construed as investment, legal, or tax advice and may not be reproduced or distributed to any person.
