Merck Looks to Startups

With pharmaceutical industry research budgets shrinking, large drug companies are instead looking to support early-stage biotechnology startups. Merck, Eli Lilly, and GlaxoSmithKline have all announced investments in such companies in recent months.

The multinational drug giants are moving to partner with venture-capital firms and nascent biotechnology companies in hopes of feeding their drug development pipelines. “We are going toward external innovation. We’re dealing with more academics and biotechs than we ever have,” said James Schaeffer, Merck Research Laboratories’ director of West Coast licensing and external research, speaking at a BioVentures’s C21 conference in California last week.

In April, Merck announced it would invest as a limited partner in a new $270 million biotech fund raised by Flagship Ventures, a Cambridge, Massachusetts-based firm. Merck won’t choose the investments, but will advise newly formed companies. The money comes from Merck Research Ventures Fund, a $250 million strategic venture capital arm the company launched last September targeted at early-stage companies.  

In another recent move, Merck said this March it would spend up to $90 million creating a nonprofit institute in San Diego to translate basic research projects into conceptual proofs for a new drug or therapy. External researchers will be able to tap Merck’s expertise and laboratory resources. In return, they give the company the first option for an exclusive commercial license.

These sums aren’t much given that Merck spent $7.7 billion on research and development in 2011. But Schaeffer says that securing internal funding for early-stage projects is difficult today. The bulk of those billions go toward advancing therapies that are in clinical trials, closer to reaching regulatory approval.

The moves by Merck come at a time when early-stage biotech firms are struggling to survive. Many venture capital firms that used to nourish such startups are backing away from high-risk investments in the sector and focusing attention on later-state companies.

Today, only a handful of venture-capital firms invest in early-stage biotech companies at all, and the ones that do are now seeking out pharmaceutical company involvement as early as possible. The further upstream from the finish line, the harder it is for a startup to find capital today, says Flagship Ventures managing partner Noubar Afeyan.

Only 10 biotechnology companies received first-time financing in the first quarter of 2012. That is the lowest quarterly number since 1995, according to Thomson Reuters data from PricewaterhouseCoopers and the National Venture Capital Association.

Venture capital funds bankrolled by fewer than a dozen or so big pharma firms aren’t going to solve the problem. Says Schaeffer: “We can’t invest $250 million in 150 companies.” And Schaeffer says he doubts whether corporate venture funding efforts are enough to fill the innovation gap for drug companies with dwindling prospects in their clinical trial pipeline.

Partly, there is a vicious cycle at play. Most traditional venture firms are lining up to find and sell assets that have already advanced to clinical trials. Drug companies are also forced to look for short-term acquisitions to replace revenues from expiring patent drugs. Merck’s top-selling drug, for instance, loses patent protection this August. In the meantime, no one can afford to take the long-term view to fund high-risk early-stage startups that are years away from having a product. And yet without such startups, the long-tem pipeline is in danger of drying up.

And, for now, there is little sign that this will change. Developing drug leads for big-market diseases such as diabetes or Alzheimer’s is no longer a good bet for venture investors to make a profit. “What we need is a mechanism so the VC guys can make money funding early-stage companies,” Schaeffer says.