Why do VC’s not cut losses in time?
A clinical trial is a very expensive experiment for testing a hypothesis, while hoping for a positive outcome. However, if well designed, a negative outcome could increase the potential for a positive outcome in a subsequent trial.
Carry on – or close it down. This is the dilemma life science VC’s face when experiencing a “failed experiment” in a portfolio company and the decision-complexity can sometimes be increased by commitments and investments already made but yet unspent by the company.
In our analysis of VC Losses, described in our previous two posts, we did not include companies with accumulated losses to VC’s below EUR 2M. The rationale being that they can be absorbed by most VC’s without significant impact to overall portfolio performance. About 75% of all losses in therapeutics have accumulated investments below EUR 2M, indicating that many seed funded companies do not have the quality to get substantial VC funding – or simply fail early.
For the remaining 154 companies in our dataset, with >EUR 2M losses to investors, we wanted to understand whether the time we hold on before cutting our losses correlates with the phase of development. One would expect a longer time in pre-clinical development while trying to resolve difficult biology and a shorter additional time to a loss after a relatively addressable phase I that may fail. We were thinking 3-4 years to fail in preclinic and an additional 1-2 years if failing in phase I and having to take the loss.
Below we have plotted the “time to loss” after first investment, relative to the clinical stage, when taking the loss. To our surprise, the time to loss is close to 10 years regardless of stage!
As you may know, most venture funds have a 10 year outlook with commitment to close the funds after 10 years. Is the overlap a coincidence? – or are life science VCs not sufficiently disciplined in closing down failing investments before they have to? Or do VC’s believe that the “second shot on goal” has a higher likelihood of success and justifies the additional investment?