Reviving Europe's IPO Market: What VCs Need to Do

Professor Christopher Evans, DSc, chairman of venture firm Merlin Biosciences, identified European public market investors' continued reluctance to support biotech IPOs as a significant threat to the sector's viability during a keynote presentation at the Financial Times Global Biotech conference in London in November. Yet there's a lot more VCs themselves can do to get the sector back on its feet, acknowledges Merlin's CEO Mark Clement, including putting more money into creating stronger companies from the outset, and simplifying approaches to, and support for, M&A.

Q: What can the VC community do to help increase European public market investors' support for IPOs?

If we—VCs—can put our money to work effectively creating stronger, more sustainable companies, there should then be support for them to IPO. There are some of our companies that are pretty close [to satisfying public market investors' demands], such as Ardana, Ark and Microscience, but we're not quite there yet. It takes a lot of money to make these businesses deliver.

Institutional investors bought into a vision in 1999/2000, expecting the sector to deliver stunning returns fairly quickly—but that obviously hasn't been the case. Some blame VCs, saying that the companies that listed during the boom years were too young or immature. Some of them were young, but that doesn't mean they were no good. I think that both public and private investors failed to fully appreciate the time it takes to deliver in the bioscience business.

But both kinds of investors are now more selective about what they are prepared to back. And the public ones aren't yet convinced that the companies ready to IPO are good enough to support. Investors are now looking for mature companies, with products that are on or near to market and that can demonstrate they can create sustainable value and ultimately become profitable: this industry, just like any other, will be driven by revenue, profits and prospects.

Q: M&A is one obvious route to building more sustainable—and floatable—companies, yet transactions remain rare in Europe. Management ego is an oft-cited hurdle, yet aren't VCs themselves to blame in some cases?

Yes. The problem is, when you support the development of a biotech company you can end up having three, four or even five rounds of investments, each with different kinds of participating shareholders, with different underlying shareholder agreements, and granted different rights and priorities. When it comes to agreeing on an M&A proposal, the different shareholder groups' interests can be misaligned and the squabbles that result have frustrated a number of potential M&A transactions.

The often large numbers of investors involved in such transactions also makes the whole process very difficult and time-consuming for CEOs to manage. Negotiating a deal with a counterparty is difficult enough, without having to also be negotiating with several shareholder groups at the same time.

Q: How can VCs attempt to improve this situation?

VCs must simplify their approach, for example by giving very clear and concerted support to the M&A process early on. And there is a duty on the part of the lead investors to ensure that potential conflict points are resolved up front.

Q: If VCs pour all their cash into building quality late-stage companies ready for IPO, doesn't that leave seed and early stage companies out in the cold?

Yes. It's true the bulk of VCs out there at the moment don't want the challenge of supporting early-stage firms; they would rather be feeding off the back of specialist early-stage investor groups. But there are certainly still VCs with an appetite specifically for early-stage investments.

It's nevertheless always a challenging question: where is the money available put to best use? Do you put it to work in early-stage companies, creating more diversity, more innovation, or do you put it behind the established companies and make them more developed and more sustainable? We already have more than 1800 bioscience companies across Europe—far more than is sustainable long term, so many will inevitably fall by the wayside or be bought. I think the money's better spent in those companies already showing the most promise.

Q: If the VC community cannot or will not plug the early-stage funding gap, do you think government should step in, as the UK's recently-published Bioscience Innovation and Growth Team report* recommends?

If there is a funding gap in this area then there's probably a place for government funding. Governments want to support innovation, but the problem is that governments aren't necessarily the best judges of what should and what shouldn't be backed. You need an arbiter of quality, to ration the capital to where it can be best employed. Indiscriminately allocating funds on a purely scientific (and/or political) basis rather than on a commercial basis will mean you run the risk of ending up with a large number of sub-optimal investments. These might overall lead to a few winners, but you'll have a lot more losers too, which is not good for the industry. The German situation, whereby the government BioRegio program provided support for myriad young companies, many of which shouldn't have been backed, proves that.

If you believe in the free market approach, then the venture community is best placed to provide the commercial test. The European Investment Fund (set up by the European Union), for example, has over €4 billion ($4.75 billion) of funds but invests through VCs and institutional investors.

Q: Would a single pan-European stock exchange—as suggested in the BIGT report—help concentrate support for the sector and facilitate IPOs?

Anything that makes doing business more efficient has got to be good news. Concentrating liquidity could be helpful too; having just a few companies listed on a range of exchanges is inefficient, and works against liquidity.

But these structural issues aren't what's causing the lack of support in the European public market. The primary driver for such an exchange may be to tap broader participation from US funds, but big bioscience investors like Fidelity in Boston already happily trade across European exchanges wherever the opportunities lie. A single European exchange won't kick-start the sector or kick-start the primary [IPO] market. The stock markets in Europe are not closed [to IPOs] because we have a mosaic of micro-exchanges; they're closed because investors remain to be convinced that the companies that are going to access the markets are good enough to support. It's going take building quality companies to attract investors back to the sector: there are no short cuts.

*The UK BioIndustry Association's Bioscience Innovation and Growth Team in November 2003 published a series of policy recommendations for keeping the UK biotech industry in the top position in Europe. The full report can be found at www.bioindustry.org/bigtreport.