E666 | Charles Dunn & Ruth McKernan, SV Health Investors: Exit of the Year Winners and Biotech Company Builders

0:28Welcome back to the European VC podcast. iBio for a whopping$1.3 billion upfront to Merck and up to$3 billion in subject to hitting exact milestones. Am I correct in putting it like that? Yeah. And of course, also the recent launch of Drake Therapeutics with$140 million to tackle neuropsychiatry. Before we start the show, a quick note. If you're building or running a fund, you know it takes the right partners. At EVC, we only work with sponsors we truly believe should be part of your tech stack. Please do take a moment to hear about them. And if you do, reach out, mention your VC. It's the best way you can support what we do.

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2:34Tear down this wall. It's more than just an ally. This is a union of values. Let's start acting. This show is not investment advice, and the hosts of this episode may be invested in the funds and companies featured. Welcome to the podcast, both of you. And, Grace, I don't want to be pedantic, but it's pronounced drag. It's Welsh the dragon, and it's drag. And at drag, if anybody says drag, we make them lots of money in the pot. I'll bring some money next time because I'm sure I'll continue doing it throughout the podcast. Drag, I'll remember that one. And welcome to the podcast, both of you. Congrats on your massive success.

3:18Thank you. Yeah, thank you. So the majority of our podcasts are for what we might call traditional VC. So most people will be very knowledgeable of everything normal tech, like B2B SaaS models, maybe even deep tech. But biotech is one of the harder things to grab as someone just in the normal tech ecosystem. Could you talk a little bit about maybe how to fully understand and prepare for today's conversation if you're someone a little less used to the biotech scene? So what we do at HESPY is invest in therapeutics. And by that, we really mean drugs. And so these are things that can also be medicines.

4:01They're either first in class, so very novel medicines, as opposed to the next generation of paracetamol or something like that. These are drugs that really can move the needle on patient outcomes in areas of very high medical need. and what we do is take this very early science so a long time before these drugs are sold and help these drugs go through different clinical milestones which they have to go through phase one phase two phase three um in order to ultimately become approved and as investors what we do is provide the funding to do that and help the companies navigate their path through development to ultimately get these drugs to the patients that mean the most yeah and i've spent 27 in the pharma industry.

4:43And that really is a grounding to help SV and the companies that we invest in do the right sorts of experiments, do the right type of clinical trials so that ultimately pharma companies will see them as quality. They'll want to acquire them as they did with iBio, for example, or create a company that has such a, you know, such a sustainable set of molecules that we can actually IPA. All right. So then tell me, why is it that you've chosen to keep company creation venture in the later stage under one roof? So there's two different, I think, ways of thinking about that. One of those is from the perspective of the people who invest in us.

5:24Some of the new company creation opportunities are potentially very high return, but they're higher risk because they're generally earlier in development. And generally things that are earlier in development have more reasons why they can fail as they go through the subsequent stages of development. them, whereas things that are in later development may have a lower upside from a returns perspective, but also they have less risk attached to them. And so what we're trying to do is really diversify risk across the portfolio at the fund level. And that's one of the reasons why, from our investors' perspectives, we want to offer a diversified risk profile across the fund.

5:58And that's also why we have a number of investments in each fund, normally sort of 12 to 15 investments in every fund. I think the other side of it is from being a really high quality late stage investor, I think you can apply some of those learnings to early stage investing and vice versa. And so I think actually there is a real advantage, a competitive advantage in having a team whose skill set is very broad from that perspective, rather than having one that's very focused on early stage, but then maybe less experienced as their companies evolve into later stage opportunities. but you've done lots of company creation but also you know on the board of the company that's been acquired in phase three so yeah so you know i think when you say company creation people might think well company creation is right at the very beginning where you're trying to identify a target you don't really even have a lead molecule far less a development candidate but actually we we've created companies at different stages so drawing we created that company when it already had phase one data you know thanks to some fantastic work done by its founders work that was funded by the Wellcome Trust, the MRC they actually had phase one data so you know in most instances you wouldn't think of a company creation at that stage so if you really like portion things up in a very structured way you miss the opportunities for learning across as you said but you also might end up with companies that don't fit into one of those three categories and therefore it's really hard to invest in it.

7:26We wouldn't want that. Tell me, just because you also have the transit landing angle, tell me, where does Europe and the UK have a true edge right now? Is it in talent, translational science? Is it some advantaged assets that we have here in Europe more than other places? I think it's a combination. Yeah, I'd say, well, I'd look at it from a scientific perspective and then you'd probably look at it from more of a financial perspective. But when I think of how we've invested, you know, some of those companies we've created and some of them are opportunities that have come to us. The ones that we've created, I'd say it's a network of really high quality science, often with people who've come from the farmer industry, that have moved from industry either into an academic setting or, you know, just working in a network.

8:16So I think we've got real strength in science. so really real strength in company creation and i think that kind of entrepreneurial spirit is growing in the uk it's always been strong in the us i don't think we would deny that and i see a lot more of it in the uk now too yeah i mean i think the key statistic about the uk is that four of the top 10 global research universities are in the uk so the uk sort of punches a long way about this way from a scientific perspective i think from a sort of foundational research perspective and And where we see the real opportunity there is that there hasn't that hasn't translated necessarily yet into a biotech ecosystem that reflects that.

9:00So before I attend of the top universities. And so I think that's what I think what funds like us can help do is fund that academic science into companies ultimately and ultimately help those companies develop drugs. Yeah, I mean, we could talk specifically about the creation of drug if you think that would be a useful thing to do. I was actually going there in just a second. I just wanted to ask one question because we should get much more into company creation. But I'd love to ask you just a question on where we are in this cycle right now for biotech. Because of course, everyone knows that tech tends to go up and down and we have ebbs and flows of where it's nicer, better to be in the sector than others.

9:41Where are we right now in biotech? Is this the top of a cycle or are we in the bottom of it somewhere in the middle so i think it's been a challenging period in biotech i mean the public markets have been closed until very recently yeah although we're seeing really positive things actually in psychiatry i mean there's one company that's just ipo'd lb and then there's another that is in the works too and both of those are psychiatry companies so actually i think that there are some green shoots but i would say it's been a challenging market environment equally we were really at the top of the cycle through kovates and that was probably overvaluing the section so there was some natural correction and um that that's also a particular cultural political um environment in the us that i think is has been um slightly challenging for the biotech sector and from the regulatory perspective but i would say things now feel like they are yeah i think i i feel things are improving and and also we talk about biotech as if it's one thing and actually I'd say neuroscience is in the ascendancy you know ophthalmology has had a really good run with iBio particularly there's been some great exits in neuroscience so I think that's a strong area maybe doing a bit less oncology than we have done in the past so you know across the different therapeutic areas we see you know balancing up and down for investment yeah i think it's been hard i mean i know we raised 140 million but generally it has been hard to the companies in the last year to raise really significant amounts of money and i see that it's moving yeah and i think there's been a shift in the market from during covid the sorts of things that were able to raise lots of money were generally very broad platforms which was sort of very high science but we're a long way away from drugs and the things now that have found it much easier to raise money are companies which have very clear programs that look like they could ultimately become drugs that are commercially extremely valuable and that's that's one of the reasons why drag was so successful in raising that money because the program there looks like it could be really transformative in the space that it's being developed in yeah we keep teasing drag but i'm going to keep you from it one second because ruth you just mentioned a very yes ruth you just mentioned a very interesting breakdown of the different sciences or parts within biotech what is it that drives oncology to be less important right now or less investable right now and another yeah don't get me wrong I mean it's still investable I think it's a matter of there are a lot of opportunities in oncology and pharma companies have made quite a lot of acquisitions and build their own portfolios and so there's there's a lot of choice whereas actually in neuroscience there's less choice and a lot more interest yeah so i think that's that's the difference you know and then cycles so everything was out of neuroscience 10 years ago and now now it's coming back and what drives this what drives if we take neuroscience as as an example what drove everyone to be out 10 years ago and then never want to be very much in today?

12:54Okay, well, extensive failure is never a good look. So when a lot of drugs did not do well in late stage clinical trials, you know, and I worked in pharma at the time, you know, so people want to invest in biotech and in pharma companies in areas where there's a big unmet need, and you know how to make the drugs. So in oncology, we had a fantastic increase in the scientific understanding of which patient should get which drug based on the genetics of their tumour. And that really opened up the area and brought forward lots more oncology drugs. In psychiatry and neurodegeneration, in fact, neuroscience generally, that degree of stratification, as we call it, really hasn't existed until recently.

13:44So in In Alzheimer's disease, for example, we now have blood-based biomarkers. So we have tools to begin to understand who should get the drugs that are being developed. And in psychiatry, we now have sort of the emergence of a lot of digital and tracking tools that allow us to understand who is unwell and what type of drug is likely to be useful for them. So I think it's the emergence of the best assessments, the best tools to match patients with the appropriate drugs in clinical trials and beyond. That's what's changed. You're like a lexicon. I'm really enjoying this, Ruth. Then tell me, AI, we don't have it anywhere else in the script.

14:30We'll only touch on it now. How does the current AI boom that we're all talking about in tech, how does that kind of come through to you? Well, let's take that. Yeah, also, I love this stuff. So there's a lot of hype about AI, but I'll give you a few specific examples of where we've used it. And it's been fantastic. So one of the areas that's really emerging is speech analytics and being able to break down speech into different features. So, for example, people who suffer from depression are very slow to respond to a question. And when you're interviewing somebody with depression, which is what you need to do, there's a set of questionnaires that are used for assessing depression.

15:18if you use speech analytics while doing that you can now begin to get an understanding of is this person truly depressed how depressed are they what sort of depression do they have that sort of analytics is really making a difference in terms of understanding patients and their needs and I'll give you a very specific example of how we used large language models it's a trivial example but it just made a huge difference for us when we were fundraising we have some very very technical evaluation of our lead molecule using MEG which is magneto encephalography incredibly complicated stuff analyzing the brain waves in multiple dimensions in a patient so we interviewed the incredibly clever guy and Chris Singh who did the experiments we interviewed him for an hour and then we got a large language model system to turn it into a question and answer, which we checked with him on how it worked and what we'd found.

16:22And that took eight minutes. And we were able to use that in our fundraising to explain to people what our drug did and how we'd done something really novel, really different in a way that anyone could understand. And I thought I was going to have to actually do that piece of work. And I put aside two days because this is not simple stuff. But, you know, thank you. Eight minutes and we were there. And here, of course, you mentioned it is our fundraising. In this case, it's for DRIG, am I right? Yes, yes, it is. Now, now should I tell you my exciting story? Yes, please tell us your exciting story.

16:55I couldn't wait, could I? So Charles and I have actually been working on the formation of DRIG for 18 months, and for six months at least before we got the seed investment. And so DRIG is formed by two founders from Cardiff University, from the Medicines Discovery Institute there. So both professors, John Atack and Simon Ward, and they came from pharma. So I worked with John at Merck. Simon had been at GSK. They'd worked at other companies, biotech, since then. And then they moved into a university setting and they set up their own Medicines Discovery Institute. They got funding from the Wellcome Trust, from the MRC, actually from the Welsh government.

17:36And they developed their own portfolio of molecules. And, you know, they're in my network. I've known them for a while. But we saw what they had in the pipeline at the MDI. And, you know, we had this idea if we took three of the most advanced molecules, we could form this into a company. Up until that point, they'd been, you know, shopping them asset by asset to pharma or biotech. And there was a better opportunity to be built there. so we we spoke to them we we brought them in we did some what we would call prepared mine sessions to think about how we would develop those molecules which the best assets were put together a business case which i think they would have struggled to do on their own an investment business case and then sb agreed that they would be the first investors and then icg followed do you want to add to that i was going to add just drawing on some of the things we talked about already um sort of why did we think that this was the right thing to do and and the conversations that you and i had like you said it was six months before we actually had seeded these assets we had an idea that we wanted to do a company in psychiatry because that was an area that had been under invested in and therefore there was a long opportunity there and there was less competition um and your cerebellar experience was certainly um as a halo there given the market capital our company but also the the technologies that you just referred to to really understand the kinds different kinds of depressed patients and to characterize them in a way that meant that the challenges that you've the long history of failure as you referred to it may be able to be reduced and so it was a more ripe area for investment there was more sort of upside than had previously been the case and that was one of the reasons that i think we got very interested and we looked we looked at many other things absolutely there were pharma companies that were releasing assets for investment we looked at those and actually my judgment was that the assets that they had developed at the university of cardiff were quantifiably and and in evidence better than many of the things that we'd seen from karma and some of those have gone into companies and they might do fine but scientifically i thought this portfolio of assets was stronger and from an investment perspective they hadn't had the same level of investment as the car companies asset owners and that into them and so from thinking about that as an investor the sorts of the sort of deal that we could construct here has a lot more upside than if you were to take a farmer asset that had been heavily invested in and therefore came with that kind of a price tag into a new company can you um just contrast this to iBio and the journey with iBio well it has some similarities actually and i'd say the similarities were that iBio was formed by deep deep experts in ophthalmology that actually SV had worked with before and here we have some deep experts in psychiatry the assets were they're reasonably well thought through and advanced i would say and the company formed quite quickly because we had a network of for dry i'm saying we had a network of people that could literally jump in and get going so the founders came in obviously I came in as a chair as exact chair to start with um Dave Watson came in as COO and then Maxim Smith so we had a core of five people to just get the company up and running which we did really quickly and and Maxim really did a lot of work on putting together the investment deck and really working on getting a nice story a really well put together story so yeah five people five good men that's all you need or four and a woman is fine yeah i mean i completely agree i think actually i would say that the drug portfolio is more mature than the i-bio portfolio was to start with but the scientific promise of both of those lead programs was really top top top tier and that That is what really attracted us ultimately to those and made us think it's worth establishing a company around.

21:41They said we had the right domain expertise in our venture partner network to lead those companies, maybe Guy and I, Bio and you in drive. I mean, it does always come down to the quality of the assets. Are they really good? Does the team know how to develop them? And every time you raise funds, that's what the investors all want to know. When's the value inflection point? how long is it going to take you to get there? How much is it going to cost? I mean, that's sort of, that's what everybody wants to know. And going in with a well-thought-through narrative on that story is really important. Let me just get a second up into the helicopter here and look at, because now we spoke about two specific assets.

22:23One of them obviously out the gates with an incredible 150 million euro seat round or whatever we choose to call that. And the other one ending up with a$3 billion exit, if everything goes well. Could you just talk about the returns profile in this, both on the individual asset, what you can expect there, maybe contrast this type of investment versus the company creation type investment versus some of the later stage stuff you also do, and make people that listen in with an LP angle understand what is the opportunity in this space and what is it, Why is it that you're able to do this? Because if we look at iBuyer, we named it or awarded it the exit of the year.

23:07It was an incredible story. Four years since inception or so that you exited it at three billion. I can't remember how much money was invested in that period, but it was not too much. Yeah. So from a returns profile perspective, there's a couple of different points, I think, in there. But in general, company creation type investments, we would expect probably a higher risk associated with them because they're generally early in stage of development, although I think drag is a site normally there. And because of that, we can own more of those companies or investing in a lower valuation. Ultimately, the upside is far bigger and you could be getting exits north of 10x times your money as a return.

23:49we balance that in the portfolio with later stage investments which are potentially lower risk but have a lower upside and so that we have a really diversified portfolio from an lp perspective and that's that's sort of how i think about how do those two kinds of investments and that's obviously it's a spectrum right but how do those kind of different kinds of investments fit together specifically in company creation um one of the things that sve does when they create companies is we take also some founder shares because we are the people who provided the initial funding to actually bring all these people in the management team together.

24:20And that also gives us another kick on our returns, because as well as the equity that we get for the investments, we also attract some equity for bringing together the ideas and the people to establish actually these new companies. But that is the fun part of it. So Dryg is the fifth company that I've been involved in putting together with SV. And, you know, some of them I just did a bit at the beginning. And as soon as we got people that knew what they were doing, I wasn't really required anymore. But with Drag, this one I particularly like because, you know, I've been I've been intimately involved with the company for 18 months and I've been interim CEO.

25:00Our real CEO is arriving in a month's time. We've got a fantastic chair that we've hired. you know the series a investors have formed a really really good board and so this feels to me like i've lived with this company for longer so maybe i've just loved it a bit more but the others have been they've all been really exciting companies to start so you know astronautics is based on really fabulous new science which is the way that the brain removes toxic species at night so really using this new system not discovered that long ago called lymphatic clearance to take out amyloid tau in fact any accumulating an aggregatory element in the brain that you just don't need and don't want that was a fantastic one alchemab again another fantastic company and a platform company not a not a therapeutic company where um jane osborne and And Rachel Bashford Rogers came up with a way of finding protective antibodies in human blood.

26:08And if you can find a protective antibody, that in itself becomes the therapeutic. So that was a super idea. And that company is also doing very well. And then the others that I've been involved in, Lockers 23, which is a Huntington's company, and Cumulus Neuroscience, which is a company that actually builds some of those digital assessments that I spoke about earlier. that are used in clinical studies across neuroscience generally. So a variety there, which I think speaks to your portfolio piece. Yeah, it is the fun part. I might have said that already. This is a true masterclass. Okay, let me just then understand one thing because you spoke about it as well, the platform versus asset-centric therapeutics versus a platform and also the open-ended discovery approach that can also be taken in this space.

26:58Can you both expand a bit on the concepts that I described super poorly here and then say how you employ those? Platform companies are generally earlier. They take more investment. And from my perspective, I think they're more at risk of being superseded by another technology. And so when we invest in a platform company, we really have to understand what the value inflection is going to be for that platform. And so for Alcumab, for Jane's company, it was very easy to see that you could, as soon as you found the antibodies, you got the opportunity to make a therapeutic. So I would say on balance, we have more therapeutics companies, more biologics, drugs, even new modalities.

27:48We have more of those sort of platforms. Yeah, I agree. I think we're very sort of product centric. I think now our instances as Alcomab is a really good example, where we think that the platforms are producing things that are much closer to drugs. And I think platforms are very broad term, where you can have discovery biology platforms, which are really identifying just new targets. But that is a long way away from generating even a drug to preclinically start exploring that biology. Whereas you can have things like Alcomab, where actually what you're doing is identifying the antibody, which is going to be your therapeutic and you can much more quickly develop those.

28:22So I think that sort of captures quite a broad range. And we do look at quite a lot of platform companies. But the challenge that I see with them is how you're going to get your return in a reasonable time frame. So if it's a platform, as you say, to identify a target that you then got to identify a molecule and you then got to take that through clinical trials, that's a very long run. and it just doesn't quite have the speed, the return, the inflection points that you need to see for a very good investment. So sometimes you come across ones that are just fantastic, but it's not the majority of our portfolio, is it?

29:01Yeah, and I'd say ultimately the things that drive the returns are the programs. Actually, the programs are what validates that the platform has value in itself. The platform isn't valuable if it's not able to produce a truck. And so ultimately you generally are going to be judged, the platform will be judged against the first few programs it produces. Yeah, and pharma will acquire a company for its assets, much less likely for its platform. And that's certainly my experience when I was at Pfizer, when I was at Merck. You know, we're more interested, pharma's more interested in the next really well-validated drug with great clinical data rather than something that's an exploratory new technology, just does not command the same route.

29:42From an investor perspective, I think one of the things that is attractive about platforms is that you can bring an additional capsule through business development deals with pharma that can actually help you, that you can leverage against your proprietary programs. And so there definitely is some advantage to that. And if you can have actually the investors not be the ones who play for the platform, it's people they're doing deals with who pay for the platform. So there's a licensing opportunity there, and you can license that form many times over, but it's still not going to give you your 3V.

30:13Yeah, it's not going to be driving your exit. It's just going to bring in additional capital to reduce the burden on investors. Yeah, take the risk out. My feeling is that when we look at the tech buyer investors that have come in that are interested, so to say, probably primarily on the back of AI and the opportunities that that is creating, that is primarily on the platform side that they're interested. Am I not correct? Yeah, so the interest, I think, is on the platform side with AI is in identifying a small molecular drug more quickly or being able to predict the properties of molecules. That's where the excitement is.

30:51And I think pharma companies are licensing those sorts of AI approaches directly from companies. But they're more likely to license than acquire. And my knowledge and experience of companies, you know, pharma companies that I've been in is they want to use the technology. They want to be able to use it for their own programs, particularly, rather than out-license their programs to a company that has some specific or some novel platform technology or AI ability. I'm a little worried, I'll be honest, that the use of AI has been somewhat overstated and we might see a bit of a contraction in that space.

31:37We'll see. Given what you say here, that the acquirers are not really interested in acquiring that type of company, the play is then to IPO and the assumption, so to say, by the VCs that back these types of companies is that the platform might be big enough and the team might be able to turn it into what we in defense would call a prime. so we might not be the people to talk about that since we don't have many of those sorts of companies in our portfolio we don't really we don't really have like anything like a digital tech company like that or a tech bio company yeah i mean alchemab is it's not that and but that is the closest and actually although i don't think pharma as interested in buying platforms as they are in buying products because they really want to try by revenue streams.

32:32It's much harder to predict what your revenue stream is for your platform than it is for my products. But actually I can see the outcome of that platform as one that Farmer would be interested in acquiring because of the unique features of that platform and how quickly it can discover drugs, which isn't necessarily true of some of the others. But I think the, you know, so there's some great AI companies, you know, I'm thinking about companies like Benevolent AI, companies that use data in a different way to identify repurposed drugs or to find a faster way through optimizing chemistry but that technology is always developing so if you buy it you kind of bought it at a stage when it is you know it's now locked in and there'll be another technology along in a while and yeah when I was in Pharma I really spoke to a lot of technology companies and we licensed some, but we didn't acquire any of them.

33:29Thank you for going down this route with me. I just wanted to hear the take from someone who's obviously knee-deep in biotech and then for whatever reason, or as you just described, have decided platforms and pure tech plays in this space is not exactly what we want to do. There are investors that do that and they are deep in it and very knowledgeable. It's just not quite the sweet spot. Yeah, so I'm hearing your perspective on why you've decided not to do it and why it's not a fit for you. So that was interesting to hear. Okay, then let me go back to company creation. I just want to hear one quick thing because company creation is something that historically most firms do not do very well.

34:10You do it very well because you're very specialist. But I'd love to ask you, how do you stand up the founding team? Because that's one of the things where it often goes wrong. Well, I would say for the companies that we have created, identifying the founders, and they usually come with the ideas and they're in our network. So finding the founders, finding somebody that can, you know, physically set a company up, the legal, the contracting, all of that, putting a team together is the fun part. And actually, SB has a really huge network for this. I mean, I think actually very often the way the founding teams have comes with the opportunity or part component of the founding team comes with the opportunity.

34:50In the case of Drag, we had John and Simon, obviously, and you pulling that company together. Of course, we had David and Caroline, Ben. You know, David Guy, we had Phil of I, I, belongs with Tony and Amos. So generally, I think that part of the investment pieces for us is a great opportunity, but also we've got the person to go and execute on that opportunity. And generally, you put both of those ingredients at the beginning. And very often it's the scientists that come. And then you need to put a support system around them to actually make it a company, to take it from an academic set of thinking to a business and milestone driven way of thinking.