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Hurdles Remain in VC Funding Environment for MDx Firms

By Tony Fong

NEW YORK (GenomeWeb News) – A rapidly changing regulatory environment, slow adoption by clinicians, and the soft economy continue to be barriers to venture capital investments into the molecular diagnostics space, according to some VC investors and officials at MDx firms, with one venture capitalist calling the current environment one of the worst he's seen.

Attracting VC funding may never have been simple, but in interviews with investors and MDx company executives, they paint a picture of an environment that remains a challenge made tougher not only by historical obstacles but new ones, as well.

For the purposes of this article, GWDN considered the private financings of firms whose primary business is making instruments or assays for molecular diagnostics.

There have been some success stories in 2010 so far, of course, and among the firms who have tapped the investment pool are Biocartis, which in April said it had raised more than $41 million in a Series B round. And a couple of weeks ago, Veracyte, which is working on molecular cytology tests, raised $28 million in a Series B financing.

In all, through June 16, 18 companies in the MDx space attracted at least $235.4 million in investments in the form of private investments, venture capital, angel investments, and other forms of financing, according to a review by GenomeWeb Daily News.

The investment total may be as high as $282.4 million: two companies, Epigenomics, which announced that it had raised more than $44 million in April, and Cyntellect, which said it had raised $3 million a month earlier, did so through combinations of private and public placements. It is unclear how much of each company's total investments were private placements and/or VC funded.

Still, even with the successes, 2010 is shaping out to be an especially bad year for VC funding, in general, said Joshua Phillips, managing general partner for Catalyst Health Ventures, a VC firm based in Braintree, Mass., which specializes in early-stage investments in healthcare firms.

And for early-stage MDx companies, "we're actually probably seeing the worst environment there is in venture capital," he said, adding his company has made no investments into the MDx space this year.

Traditional barriers to VC funding into the space, such as a paucity of exit opportunities, a meager IPO market, and high risk-aversion among potential investors, remain, he and others said.

So too has inadequate research-and-development work. "It continues to be that many of the tests are just not validated on enough patients to have confidence that they're going to make the grade," said Steve Gullans managing director of Boston-based Excel Venture Management.

What has changed for MDx developers is an increasingly aggressive stance from regulatory agencies. In the past month, the US Food and Drug Administration has cracked the whip on several DTC genetics tests that it believes to be in violation of regulations, which in turn prompted an investigation by a Congressional committee into DTC genomics providers.

"The direct-to-consumer space dynamic has changed completely in the last six months," Gullans said, adding that his company recently passed on some opportunities to invest in businesses in that space.

With the DTC genomics space in a state of flux, "uncertainty means more time and more money" that will need to be spent to get a product to market, he said. "It's that simple."

"We don't doubt that it will be solved because there is the compelling need in the marketplace for many of these tests," he added. "We're just concerned about the timeline while this is resolved."

The FDA is also considering what steps it may need to take to improve oversight of laboratory-developed tests and last week announced it would be holding public hearings in July on the issue. In the meantime, the agency last week said that it would put off issuing guidance on in vitro diagnostic multivariate index assays, as it shifts its focus to LDTs, according to GWDN sister publication Pharmacogenomics Reporter.

Whether it's IVDMIAs or LDTs, as long as there is no clear guidance from regulatory agencies, it "presents a significant amount of risk," especially for early-stage investors, Phillips said. "Will we have to go through the FDA [to get clearance]? Will we have to fund a clinical trial? Does the FDA even understand this space?" Phillips said, ticking off some of the questions potential investors are likely asking.

Another area of concern is healthcare costs. Efforts to control healthcare spending are not new, but the recent Patient Protection and Affordable Care Act passed in Washington has raised the stakes for some, and MDx developers can no longer expect that if their tests improve healthcare, they will automatically be adopted and reimbursed.

"We find that entrepreneurs, in general, have not done enough homework to specifically define the cost savings that their tests will provide," Gullans said. "If a test is going to be priced at several thousand dollars over the course of a disease, you need to know the healthcare system is going to save that, and specifically which part of the healthcare system will save that."

Startup Foundation Medicine, which is developing pharmacogenomic testing services directed at cancer, has tried to address this and anticipate changes and challenges that are inevitable for a new company by creating a team of management and advisors from across all aspects of the molecular diagnostics pipeline — including the clinical side, the regulatory side, and the technology side — in order to get necessary input, its CEO said.

In April, the Cambridge, Mass.-based firm announced that it had raised $25 million in a Series A round. "We all understand the uncertainty of how to get [to market], but we figure if we recognize what we know, and just as importantly what we don't know, and we assemble the right team, then we'll be able to navigate those waters," said Alexis Borisy, who is also Foundation's president and co-founder.

For VC firms, the emphasis now is on a quick turnaround from investment to returns.

"The key to us is to spend as small amount of investment dollar as possible in getting through to the marketplace," Phillips said.

The CEO of South San Francisco, Calif.-based molecular cytology firm Veracyte saw that first hand while the firm was raising its $28 million Series B round. Bonnie Anderson, who is also Veracyte's co-founder, said that even as the company was completing its Series A financing two years ago, the management team knew that the next financing round would be challenging.

"We really honed our plans and our spending, and tried to be as capital efficient as we could be. And I think that certainly served us well," she said. The fact that the company is poised to launch its testing service in thyroid cancer by the end of the year also indicated to investors that they would not have to wait indefinitely for a return on their investment.

"There's no question the investors are just looking for much lower risk deals," she added, "so they're expecting people to be much more advanced on Series A money … and really looking for companies [that are] mapped out around commercialization strategies [and] reimbursements, now that they've learned that the science isn't the only difficult part of developing these advanced products, and that commercializing them is also a big hurdle."

The vetting process for later-stage financing is no easier. T2 Biosystems, based in Cambridge, Mass., raised $15 million in a Series C round in May. According to CEO John Donough, investors spent "an extraordinary amount of time" talking to clinicians, brought in several experts in magnetic resonance — the basis of one of T2's systems — and experts in engineering, among other things.

During the past year to 18 months, the VC environment has slowly improved, he said, but the bar remains very high for getting financing.

"I think there's a lot more effort and due diligence being done by investors. …The level of depth [that] they went into anything was deeper than I've seen in the past," he said.

Ultimately, the firms that will attract funding in the current environment are those that not only have proven that their products can improve patient care, but that they will be adopted by clinicians — always an iffy proposition. In an article published last week in The New England Journal of Medicine, FDA Commissioner Margaret Hamburg and National Institutes of Health Director Francis Collins noted that despite all the new discoveries that have been made during the 'omics era, clinicians have largely ignored them.

"These newly discovered genes, proteins, and pathways can represent powerful new drug targets, but currently there is insufficient evidence of a downstream market to entice the private sector to explore most of them," they wrote.

While the days when investors flung money at any firm that sought to commercialize on the potential 'omics bonanza are in the past, Foundation Medicine's Borisy said that may not be such a bad thing.

Borisy is entrepreneur-in-residence at Boston VC firm Third Rock Ventures and was the CEO and co-founder of pharma firm CombinatoRx. He led that firm through a Series A round in 2001. In the early days of the 'omics space, he said, "Too many companies were being funded and probably too much money was going into too many companies … venture capital has gone through significant pressure points in the last couple of years."

There are fewer venture capital firms now, but those who have remained are stronger and looking to invest in "very high-quality companies," with a better chance of taking their product to market and becoming viable businesses, he said. "For the strong companies with the strong ideas, and the strong VCs, that actually is a healthy and robust environment."

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