Third Rock Ventures, one of the premiere healthcare venture capital firms, is loaded for bear again.
The Boston-based VC group recently closed its 3rd fund, a $516 million tranche that will go towards launching some 15 to16 new life science companies in the coming months. In the past 6 years Third Rock Ventures has raised more than $1.3 billion and launched some 31 companies across the life sciences spectrum.
Third Rock, which counts Taris Biomedical, Cibiem, DC Devices and Seventh Sense among its current medical device portfolio, has a unique process for how it invests its money, according to partner Neil Exter.
"We prefer to invest in fewer companies, get heavily involved in those companies, make bigger bets," he told MassDevice.com. "We believe that we can increase the ability of success by working that way. If we ended up taking smaller pieces, we would end up having many more companies, which would dilute our efforts and, we think, limit our return on investment."
Exter, who has been with the fund since its inception in 2007, took some time to talk to us about the firm’s investment philosophy, how it incubates companies, the state of venture investing and his recipe for a successful venture in the life sciences space.
MassDevice: How does Third Rock determine when to make an investment?
Neil Exter: We run Third Rock like an operating company. Every week I fill out a time sheet and so do all the partners. That’s tracked and we review where we spend our time on a quarterly basis because we want to make sure we’re spending our time in the appropriate place. We want to make sure we have a philosophy that we will invest in 1 or maybe 2 external deals that are brought to us over the year. We get a lot of things but we don’t want to be so focused on things being brought to us. The majority of the companies we end up funding are companies that we incubate, 1 way or the other, inside of Third Rock.
In the device space we have an incubator called Coridia, where we’ve split it with SV Life Sciences to incubate ideas and spinning out companies. We see lots of things on the device side but we like the model where we find great people that we want to work with and we build those companies together with another venture group or do it ourselves.
MassDevice: Is Third Rock’s latest fund a sign of the health of the VC world or is it simply validation of Third Rock’s strategy?
NE: I think it’s hard to say. We clearly have a differentiated model and our [limited partners] have responded really well to that. I can’t really comment on how that may be affecting the entirety of the VC marketplace. However, we’re pleased with the results. We’re pleased with the partners and the syndicate members we get involved with in the device space.
MassDevice: Tell me about the goal of launching 15 or 16 new life science companies with this fund.
NE: A lot of what we do at Third Rock Ventures is to create a very tightly integrated model. We prefer to invest in fewer companies, get heavily involved in those companies, make bigger bets. We believe that we can increase the ability of success by working that way. If we ended up taking smaller pieces, we would end up having many more companies, which would dilute our efforts and, we think, limit our return on investment.
MassDevice: Do you plan to make investments across all sectors of the life sciences industry as you have done in the past, or are there 1 or 2 areas that you may concentrate on with this fund?
NE: We are stronger in the therapeutic and drug space then we are in the medical device and diagnostics space. However, in each of our first 2 funds we’ve done some diagnostics and done some devices. I think you’ll see that split be about the same in this 3rd fund.
Generally, we like to stick to our knitting and what we’re really good at. There always needs to be some rationale as to why we have a unique insider perspective on the types of companies we invest in, or how we can bring the Third Rock model into play in a way that can help change the answer. We’re highly selective, so in each of our funds we have a couple of device companies and I think we’ll continue to do that in fund 3.
We focus on investments that have significant unmet medical needs that, we think, can have a huge impact on patients. We think some of the trends in the medical device space, when you look at the device companies, they would like the same level of innovation that you see on the therapeutic side… We’re less focused on devices as a device. We’re more focused on ‘what’s the large unmet medical need? Are devices a modality that can affect that? Can we have a profound impact on that and change the answer? Also, is it an area where we have some level of competency?’
MassDevice: So, you’re not looking for any of the so-called "me too" products?
NE: No. It’s much harder with pressure on reimbursement to be successful in a ‘me too’ endeavor.
MassDevice: Is that a result of reimbursement or regulatory environment alone, or is it because those products have limited exits?
NE: It’s all of that. There’s not that many acquirers in the medical device space and what people are looking for is something that’s novel, which can drive top-level growth. If you’re going to produce the 3rd version of whatever widget it is, that’s probably not going to create a huge amount of value for a potential acquirer. The exits in devices are more likely to be through M&A than an IPO.
MassDevice: You’ve been at Third Rock since 2007. How has the market changed since then?
NE: Coming from a macro prospective. We’re still very bullish on early stage investments. We’re as bullish as we were back in ’07. The fundamental views on large unmet medical needs, on being 1st-in-class with breakthrough products, on owning larger shares of individual companies are all still true. If anything, we’re eventuating those going forward so you’ll see us making larger investments in companies going forward.
We’re starting to hear some rumbling from device companies that they’re looking to do partnerships with us similar to the way therapeutic companies do. On the device side you’re seeing more companies that have a focus on financial engineering, which I think is a 1st step.
Ultimately though you need to be able to have innovation as a driver of value. The question then is ‘how do we drive innovation as a value and is there a way to create intriguing partnerships to do them earlier with device companies?’ We haven’t done anything in that space yet but I think there’s at least a possibility certainly exists.
MassDevice: What do you mean by financial engineering?
NE: Financial engineering is initiatives to drive earnings-per-share, such as buying back shares, restructuring, reducing costs in R&D, looking more at emerging markets as a driver of top-line growth. For the longer term you have to develop new products. It’s the life blood of pharmaceutical and medical technology companies.
MassDevice: When we an environment where companies are looking to reduce R&D costs, is that an opportunity for the venture model to thrive?
NE: It is, because we believe we can really focus on innovative ideas that some of the larger companies aren’t doing because they’re focusing on those cost control measures. We believe we can take advantage of that to bring an entrepreneurial culture.
On the device side the FDA has raised the bar and, in some respects, the way the agencies have raised the bar makes [device companies] feel almost like pharmaceutical companies because you’re required to do larger, more significant clinical trials that feel a little more like therapeutic plays. That’s a place where we would feel very comfortable with and understand.
MassDevice: When do you think is the toughest time for a start-up company? Is it raising that 1st round, or is afterwards, when you have to raise follow-on rounds?
NE: It’s none of those. In the large companies you have a lot of ballast and momentum. In small companies, the excitement is when you build the business plan, the challenge comes when you deviate from the beautiful plan you developed and it’s dealing with the incredible highs and some of the adversity. All companies experience both and it’s one of the challenges that we say is true of 99% of the companies we work with. The first 10-20 people define the success of a company because you’re looking to build that company culture for a sense of ‘how do you deal with things when they don’t go perfectly?’ That’s what we spend a lot of time and efforts on.
We try to inculcate in all our portfolio companies best practices about how you build and start great companies and how you make sure companies get off on the right foot. That’s one of the things we do really well.
MassDevice: What’s the required reading list for that?
NE: At Constellation, the first 3 employees were post-docs and so they had no experience of being in a company environment. There was a couple of us from Third Rock and the post-docs and we started off with book reviews. The books we liked were "From Good to Great" and those kinds of books, because we wanted to talk about how you build great culture at companies. I think initially some of the people thought it was crazy but how do you build that sense of culture, that sense of teamwork in a company when people don’t innately feel that because of their backgrounds?
MassDevice: Would you care to share any of those tips?
NE: We have a program called "Beyond Great," where we get together the CEOs of our portfolio companies so they can share best practices with each other. We like to do the same thing with business development as well.
There’s a partnership team at Third Rock and we have relationships with the key executives at pharmaceutical and medical device companies and we will periodically have very senior meetings with the top executives at those companies. We will then bring that information back to our portfolio companies.
MassDevice: Do those fundamental lessons pay off in the value of the exits they achieve?
NE: It is a core belief.