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Bioinformatics Startups Hit with Cash Crunch as VCs Tighten the Purse Strings

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  Anyone could tell you that this isn’t the ideal economic climate to go looking for venture capital funding, no matter what kind of business you run. But for early-stage bioinformatics companies, it seems that the going is especially rough, as the general economic slowdown has only served to drive home a situation that some say was a long time in coming: Until bioinformatics companies prove they can make money, funding will remain hard to find.

Unfortunately, both public and private bioinformatics companies have exhibited a poor track record recently. Disappointing revenues at Genomica and NetGenics led to their recent acquisitions, while a number of other companies have reported layoffs in the face of lackluster sales. Even InforMax and Lion — successful firms by bioinformatics standards — have yet to turn a profit.

This atmosphere of doubt has affected some smaller companies who have barely had time to get a product on the market. X-Mine, a Hayward, Calif.-based startup that just launched its first product in August, was recently forced to lay off an undisclosed number of employees when an expected round of VC funding fell through.

Jeffrey Johnsen, business development manager at X-Mine, noted that his company is not alone. “The general malaise in the VC funding cycle is contributing to funding difficulties for many bioinformatics firms right now,” he said. Indeed, Entigen’s recent round of layoffs reportedly occurred in response to a similar situation.

Another company with heavy interests in the bioinformatics sector, Parabon Computation, has also had its share of funding woes. Several sources close to the company told BioInform that the company was expecting a cash infusion in the early fall, but the economic uncertainty that followed the events of September 11 caused the potential investor to balk and the company is running dangerously low on cash.

Parabon CEO Steve Armentrout declined to comment on the company’s current funding situation, though he confirmed that the company is “in discussions with the VC community.”

 

What’s the Problem?

 

While macroeconomic conditions are certainly to blame for a large portion of the funding slowdown, the spotty history of the bioinformatics sector shoulders its share of the blame. “Nobody in all of bioinformatics is making any money,” said Michael Martorelli, who covers bioinformatics as a research analyst at investment firm Investec PMG. VCs simply have “little or no appetite” for anything pre-profit in the healthcare sector right now, he added.

David Stone, a partner at AGTC Funds, agreed: “It''''s hard to point to models of bioinformatics companies that have been successful in generating revenues and earnings.”

The primary difficulty, according to Stone, is “there are not enough life scientists doing any particular thing that one can easily make a simple shrink-wrapped software product.” This leaves a very limited market for players selling enterprise solutions, and an even smaller one for firms selling niche products. “Even companies selling software for which there''''s an intense need have a hard time getting enough seats,” he said.

Investors are also finding that many bioinformatics startups are entering the game with unrealistic expectations. “Entrepreneurs come up to us and say, ‘We have this great software module. How can we go public?’” said Martorelli. “We say, ‘Wait a minute, you’re asking the wrong question here. Do some other things first and we’ll talk to you in a few years.’”

Martorelli added that we’re heading back to the “good old days” when investors wanted to see earnings rather than “products masquerading as companies.” The capital markets aren’t at fault, he said. “It’s the idea of how to get funding that’s off-kilter.”

Stone agreed. “What we’re seeing is not a trend from normal conditions to really bad ones, but from abnormally good conditions to something more normal.”

 

The Big Disconnect

 

If recent market estimates are any indication, new bioinformatics firms are on the cusp of a gold rush. Market research firms have predicted the market for bioinformatics tools and services could reach as high as $7 billion by 2006 [BioInform 01-28-02]. So why are new companies finding it so difficult to prove they can sustain themselves?

In-house development within pharmaceutical and biotech customers is partly to blame, according to Stone. “Up to twenty percent of a startup’s budget represents internal spending on bioinformatics for a modern life sciences company,” he said. “As a supplier, you’re not going to be able to capture a large part of that from selling software and outsourced services because some part of the infrastructure needs to be in house.”

Another difficulty is the low barrier to entry in the field, especially in the wake of the dot-com crash, which left a community of out-of-work information scientists fishing for investors in “the next big thing” from the same, very limited, pool.

Finally, according to Stone, the lack of usable standards in bioinformatics has prevented many software products from gaining widespread acceptance.

Despite the challenges, there’s still a market out there for standalone bioinformatics software vendors, Martorelli said, “but you have to prove you can earn money doing it. … It’s not just about having a different business model. It’s results, execution, and performance.”

“Good companies can always get funded,” agreed Stone. “The best venture capitalists are always open for business.”

Martorelli noted that bioinformatics firms should seek funding only from specialty biotech investors who are familiar with the ups and downs of the market. “Others out there, when the Internet is hot, they fund the Internet. You have to know who you’re looking for,” he said.

As for Johnsen, he remains confident that even without additional funding, X-Mine will pull through. “We’ve got more customer interest than we know what to do with right now,” he said. “The business isn’t going to go away. It’s just a matter of whether you can scale and work on competitive issues or whether you have to bootstrap your efforts.”

— BT

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