Life sciences has overtaken software as the primary recipient of early-stage funding

For as long as I can remember, and I’ve been in the startup world since the 1990’s, venture capital has been nearly synonymous with software.

From the dotcom daze where money was thrown at even the stupidest ecommerce concepts to the pre-covid days where funding flowed to SaaS, virtual reality, crypto, fintech, and AI for anything and everything, if you wanted venture capitalists to fund your startup, you needed to be pitching some sort of software.

But in the past few years, the dominance of software has waned. Life sciences has become the new king of the sand hill.

In 2022, 54% of the startups that Tech Coast Angels, one of the most active angel groups in the country, invested in were life sciences, including pharmaceuticals, medical diagnostics, medical devices, and digital health. Software accounted for only 22% of deals, consumer products for 7%, and everything else was in the noise.

Last year wasn’t a one-time fluke. Life science funding has continued to grow since 2000, grabbing a larger and larger slice of the pie away from software and applications.

Life Science vs Software Business Model & Funding

The standard venture capital funding model runs in well-trod stages from friends and family to angel seed funding. As revenues grow, validating the size of the market, venture capital funds write increasingly larger checks to expand the marketing and help the company expand until it eventually reaches critical mass and is acquired by an industry giant to goes public in an IPO.

This standard model of venture capital works best for software, but it’s the same model applied to hardware, consumer products, and everything else. Everything, that is, except life sciences.

The Advantage of Life Sciences

Life sciences flips the standard venture model on its head. Especially when it comes to pharmaceuticals and medical devices, market size and revenue growth are irrelevant. Success is 100% about the product.

Unlike software, there’s no need to consider market size. If the product solves a common problem like heart disease or a common form of cancer, there’s a market of tens of billions waiting for the winner. That’s no different from software, though, where a better AI platform would also be worth billions.

The difference is in the niche opportunities of which there are an infinite number. For software, a SaaS platform to support a specialized industry might struggle to generate $10M in revenue, making it unfundable.

But niche medical products are different. A new gene therapy that treats only a few thousand sufferers of an obscure condition is able to charge $3 million per patient. With the patients themselves paying little of that cost, everyone who could benefit will demand access to the treatment.

Thus even the most obscure new product has a guaranteed market size in the billions. The medical giants therefore swoop in and acquire anything that has been proven safe and efficacious. Depending on how far along they are in the testing and approval process, acquisitions are usually in the billions.

Unlike software, there’s never any need to build a sales team or spend millions on advertising. The startup will never have to master manufacturing, distribution, and supply chain challenges themselves. There is no competition except for the inadequate status quo. The life sciences team won’t struggle to hire and manage a team of thousands, and in some cases, can reach a billion dollar exit with a team of under 10 people.

And while the drug testing process can be incredibly long and expensive, unlike any other startup, life science startups are often acquired at stratospheric valuations even before the product has completed testing. If the company can even go public in an IPO years before the product has received approval to begin sales or even proven it works. Try doing that with software, or a new protein bar!

This makes life science startups surprisingly easy to finance by angel investors and small VCs. The checks for hundreds of millions for AI and fintech apps that dominate the VC funding charts are rarely needed with life sciences. Even so, the 3 largest VC funding rounds announced last week were Neuralink ($280M), ADARx Pharma ($200M), and AlltRNA ($109M).

That makes the life science startup pitch very simple: what’s the product, what’s the science, what’s the FDA approval process?

The Problem With Life Sciences

As much as I admire startups developing cures for cancer or eliminating the misery of the common cold, they present a problem for me as an investor.

Software is easy to understand. Because their success hinges far more on the market than the underlying technology, I don’t need to understand the details of their tech stack or AI algorithms to determine if I think they have a good chance to reach that elusive exit. Consumer goods are even easier to evaluate because we’re all consumers. At most, I’d have to talk to customers and industry insiders to validate the details.

Life sciences, though, is all about the technology. It requires highly specialized knowledge to evaluate. Can a new molecule, gene therapy, or mRNA treatment eliminate colon cancer? The pitch sounds convincing, but I don’t have the background to evaluate the claims. In fact, I don’t even understand half the pitch. And investing in a pitch I don’t understand seems a recipe for losing money.

Fortunately, my investment group includes doctor, biologists, and medical industry experts. If they approve the investment, I’m happy to join in. Unfortunately, I have little to contribute to the diligence process myself.

So while I appreciate the innovation that is going into solving our most pressing health and medical problems, I kind of feel left out. I enjoy working with early stage startups as mentor, advisor, and investor, but life science startups exist in a different world where my experience as a startup founder and investor is of little help.

So while I’m sad to see so much of our investment focus move from software to life sciences, I am thrilled to see so much investment money going into innovations to improve lives and health.

If you enjoy my articles, please read my novel, To Kill a Unicorn. The founder of a hot startup is hiding the fact that their chief scientist is missing, and perhaps their product has a few bugs that might be killing their customers.

Get your copy today! 
https://amzn.to/3RQnLuc