Life sciences companies and venture investors suffering a tough 18 months have been turning to US drugs com- pany Eli Lilly.
Founded in 1876 by Eli Lilly, a Union Army colonel and trained pharmaceutical chemist, his company has developed one of the most innovative and sophisticated corporate venturing divisions in the industry.
Its Lilly Ventures and Lilly Asian Ventures teams have been syndicate members in investment rounds worth more than $200m in its past 10 investments since January last year, according to Dow Jones VentureWire news reports.
Its investment pace has parallelled an increase in cor- porate venturing investments, such as the $40m series D round for Aileron Therapeutics last June that included four such in-house divisions – Lilly Ventures, Glaxo- SmithKline’s SR One, Roche Venture Fund and Novartis Venture Funds.
The Lilly corporate venturing teams, which manage a combined $200m, are headed by Darren Carroll, who, as well as signing off on the Aileron investment, has also pushed through a number of significant changes to the way his group operates. In August, Lilly Ventures tranformed into an effective $200m venture capital fund with one investor, Eli Lilly, called a limited partner (LP).
As well as creating the potential for other companies to join future funds as LPs, this change allows the Lilly Ventures investment team to earn performance fees – called carried interest – on its deals.
Carroll said: “I restructured Lilly Ventures I into a pure VC fund with a single LP and where management gets a carry. But I, as chairman of the investment committee and president of the management company, do not benefit from carry in order to avoid conflicts of interest. The fund structure allows the possibility in funds II and III for multiple LPs.”
This is a significant change for a group that in the 1980s, under Ron Henriksen as director of business development, started making equity investments in start-up companies as part of a licensing deal with them but which subsequently evolved to acting as a financial investor first.
Carroll said: “We have been a VC proactively since 2003. Venture-backed innovation is a critical part of our front-end product, but this is not the case for every indus- try. Our view is we have to engage fully with VCs on their terms. This means being an active participant with active board seats, running valuations and a lead time of five years and where financial returns are first.
“We assume strategic benefits will come over time. We do not take a shotgun approach to investing – a large number of small and passive bets – but a rifle. This means we look for opportunities where our sci- entists can interact with third parties, such as Avid Radiopharmaceuticals, which has a novel approach to Alzheimer’s.”
The change in compensation is partly a reflection of the team’s success over the years in backing companies, such as biotech veteran Amgen, but also because once people become more senior the remuneration package is relatively lower than in other equivalent jobs.
Carroll’s two predecessors, Dominick Colangelo and Chuck Schalliol, both left in 2005 to join Oscient Pharmaceuticals and an Indiana state initiative, respectively, while managing director Ron Laufer went to Visium Asset Management in late 2007 and principal Michael Gutch headed to HIG Ventures in 2008.
Carroll said Lilly Ventures hired and retained “tremendous people”. He said his recruitment policy was “to hire people who will be my boss one day, such as Yi Shi, who I hired at Lilly Accelerators [formed in 2000 to incubate the ideas of Lilly employees] 10 years ago as the first employee”.
Now Yi is managing director of Lilly Asian Ventures, which was formed in 2007. Carroll remains the overall boss of Lilly Asian Ventures and said he worked a month in China each year “as it is the most capitalist region in the world today and really entrepreneurial”.
Carroll’s boss, Eli Lilly chief executive John Lechleiter, told newswire Reuters that the US drug maker planned to launch 15 products in China in the next five years and had established positions in its fastest-growing therapeutic areas, including oncology and diabetes. Lechleiter told Reuters Eli Lilly’s $100m Asian venture capital fund, focused on life sciences and healthcare in China, was one of the most active venture capital investors in the country’s biopharmaceutical industry. He added: “In the two and a half years since it started, Lilly’s Asian venture has made six investments and deployed more than $40m.”
The decision to expand outside of the US and to Asia, however, was not an easy one. In October 2005, in only his second month in charge of the venturing team, Carroll had to decide whether to make a series A round investment in Australia-based Protagonist Therapeutics, according to a Harvard Business School case study published in July 2007.
The concern was the distance between Australia and the US and whether American VCs would also support an investment. Carroll, in the Harvard case study, which was co-written by one of his former colleagues at Lilly Ventures, Laufer, said: “One of the great advantages of being a corporate venture capital fund is that we are able to make invest- ments that are earlier stage than regular VCs.
“Protagonist is an exciting opportunity for us, and in many ways exactly what we should be doing at Lilly Ventures. In fact, what is interesting is how Protagonist mirrors some of the larger issues we face as to what the role of corporate venturing should be here at Lilly [in 2005].”
Lilly concluded the key to making money on early- stage deals was to find companies with lower labour and overhead costs, such as those in Asia, and with lower valuations. The answer to whether to invest in Protagonist for Lilly Ventures, therefore, was yes, despite the absence of US VCs in the syndicate, and it led initially to a $9m investment round in September 2006, of which the second tranche was drawn down only in January last year.
More recently, supporting Protagonist helped pave the way for Lilly to set up the Asian ventures team that has been active in China and to back a potential $250m Australian state biotech fundraising. Announced last month, Eli Lilly will invest 20% of the biotech fund, which is based in the same city as Protagonist, in Brisbane, Queensland.
Lilly, however, has generally avoided acting as an LP. Carroll said: “We are also an LP as part of the VC plat- form [in Australia] and BioVeda, a China fund, through our Lilly Asian Ventures. But this is only where we can cornerstone to access dealflow, including deals not done by the VC,and where we get co-investment rights. The VC becomes a partner, with us sitting on their investment committee.
“This approach follows the lessons we learned 15 years ago, when our being an LP was a complete waste of time. We were promised access to dealflow but in reality were treated like every other LP and just sent capital calls. We will never do another of those again. Period.”
But the role of a corporate venturing team has only increased in importance in those intervening years, according to Carroll. He said: “The value to Lilly of Lilly Ventures is a real partnership. With an in-house GP [general partner to a venture capital fund] you sit in on marketplace decisions and gain a reservoir of information.
“The industry is changing from a Fipco (fully integrated pharmaceutical company) model with total vertical integration to Fipnet, or fully integrated pharmaceutical network. This means Eli Lilly becomes very active where we have world-class competence, and where others do things better we use them.
“Lilly Ventures, therefore, is the investment node on a network. As a network architect, being a VC helps identify gaps and companies that can fill them. It can pilot ideas through an intrinsic embrace of VCs.
“Healthcare is evolving this way – to Fipnet – as its lifecycle depends on new products, which are taking 13 years from the eureka moment to the point of the drug being registered and taken to market.
“This is very expensive, on average $1bn in develop- ment, including the cost of failures. And drug develop- ment is poorly behaved – science happens. But whereas 40 years ago the industry could rely on innovation to build value, now it is about examining how it is built – from universities and governments, VCs backing a volume of companies, to mergers and acquisitions and initial public offerings.”
Fact box –
Lilly Ventures Formed: late 1980s, 2007 for Lilly Asian Ventures
Funds: $200m evergreen Lilly Ventures, Lilly Asian Ventures
Key people: Darren Carroll, vice-president – new ventures; Edward Torres, managing director; Steven Hall, PhD, venture partner; Armen Shanafelt, PhD, venture partner; Yi Shi, PhD, managing director, Lilly Asian Ventures