What Biotech Can Teach Us About Long Duration Investing

In this episode of our Market Builders series, we’re sharing a conversation from our annual Summit with Keith and S2G’s Aaron Rudberg that explores how ARCH had to invent an entire capital market architecture because the asset class they believed in didn’t fit the venture model that existed.

They get into how ARCH survived biotech’s nuclear winter, how to bring in strategic capital and build a strong syndicate, how government and nonprofit funding can play a critical role, and even Keith’s take on GLP-1s.

It’s another fascinating look at how investors in other sectors have approached market building. We hope you enjoy. And please stay tuned for important disclosures at the end of this episode.

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Aaron Rudberg: Keith, it’s great to have you here. I’m gonna build on a little bit of what Sanjeev said. So Keith Crandell, based here in Chicago, co-founded ARCH Venture Partners in 1986. Probably many people in this audience, food, energy, ag, aren’t familiar with ARCH Ventures, so I’m gonna give a little bit of details then you can follow up.

Invested in over 400 companies in your history. Your tagline is, ​“Disruptive companies from great science.” Companies like Illumina, Grail, Juno, et cetera. Your latest fund, little over $3 billion that you raised two years ago, roughly. They’ve had dozens of M&A events in life sciences, IPOs, et cetera, including the recent sale of…and this is all public information- Yeah … so you can, you can deny it if you want to…Metsera, an obesity drug that you sold for a little over $10 billion to Pfizer. And my understanding, again, publicly reported, was that your firm made more than $2 billion on that deal alone. So there’s a lot we wanna learn from you today.

Keith has really been one of the leaders in the biotech life sciences place and has really redefined. Today’s conversation is not about biotech and life sciences, but it’s really about fit-for-purpose capital, ​’cause you’ve really had to build kind of a capital market solution for what is a very difficult long duration category.

So thank you for being here.

Keith Crandell: Oh, no problem. Thank you, and of course, great work by you and Chuck and Sanjeev, and others, of course, to get your fund up and running. It’s super impressive in this environment. So the work that we started at the University of Chicago, and again, ARCH stands for Argonne National Laboratory, University of Chicago.

We kind of took the AR and the CH and put that together so that we could actually get it out during a phone call without having people hang up on us. But there was some legislation that passed the US Congress that enabled operators of the National Lab System in the US, which was funded at about $20 billion a year, to take title to the intellectual property that was developed there.

So before that, all the inventions from that research went to a central office in Washington and were licensed to all comers on a non-exclusive basis. So this was, I think, viewed as a watershed set of legislation that sort of created the opportunity for groups to try and do exclusive licenses, which would enable capital to form to support the efforts.

And the University of Chicago, a great place for doing experiments, decided to set up a wholly owned subsidiary at that time to commercialize. So there was a licensing function which was more or less an arm’s length kind of traditional contract which is done around many universities

Aaron: Still today. I mean, tech commercialization’s very much a part of the engine of these universities.

Keith: Yep, I think that’s right. I think if you look at the data on that, the number of licenses that actually perform in terms of repaying the cost of the patents is actually quite small. So the notion at ARCH, and this was something that Walter Massey and others architected off the board of trustees and so forth at the university, was that small, focused entrepreneurial groups that were at risk would have a much better potential for actually seeing the inventions through.

Fortunately the board of Arch was able to recruit a great gray hair individual who was our leader and initial partner. I was actually a student in the business school at the time, and I volunteered…

Aaron: Lazarus, is it?

Keith: Yes. Yeah. So Steve Lazarus.

Aaron: I met him once.

Keith: He has a lot of patience. I would say it was one of his virtues. And basically we set out to try and find things in the lab by walking the halls, meeting with the scientists, and trying to validate basically that an innovation would lead to some improvement in a market or in society, and then we look to form companies.

I would say at that time we did not know what we were doing. But no one else did either, so that allowed us to continue onward. I think we realized pretty quickly that if we didn’t have capital, there was really no leverage in the model because if you only had a couple of volunteers and a gray hair, you know, how many projects could you pursue?

How many companies could you really start up? So I think Steve decided that we were gonna raise a small venture fund, which was nine million. We started with about half of that capital committed by the university pension system, or endowment really, and then we went out and basically fundraised for fourteen or fifteen months, pitched about a hundred groups and came up with nine million total.

And we actually had a commitment for the last million, but it took us so long to raise the capital that the four people at Allstate that had committed the million all left Allstate during that period, and the last person there wanted to give us a debt instrument on top of a venture partnership somehow, and that wasn’t something we were prepared to suffer through.

So we did do a dozen companies initially out of Argonne. Got some great managers to help push that along. Syndicated, which was an important aspect I think of venture, which is maybe under-appreciated in some ways, is just the strength of having to have a contest of ideas to kind of check the plans that you have, and also to use the network.

So we were big fans of syndicating, which we did. Ultimately, we got four of those public, sold four, wrote off four, and then had a friendly separation from the University of Chicago, raised our own sort of private independent venture group, which we called Arch Venture Partners. And then we’re kind of doing a second fund and the rest is history.

Yeah, the rest we kind of moved up in the sweepstakes, I guess, a little bit.

Aaron: As we think about, you know, again, staying sort of at the origin a little bit, today, IPOs in some respects kind of finance the clinical trials. Back then, was that also the case? Or I guess, ​’cause this was a new ground that you were covering in many ways.

Keith: Yeah, I think it was a mix. I mean biotech has historically had a whole series of booms and busts. And, you know, it’s an entirely different industry when the capital dries up than it is when the capital is sort of flowing. And there’s relatively short periods of time when you have either the boom or the bust that’s not occurring.

So there were some limited partners that were set up around single assets, and some capital was raised that way, and then there was the IPO side. I think historically, people thought of IPOs as sort of the exit because you, in theory, after the lockup, you would have liquidity.

But in biotech it’s really an intermediate funding event. Because the amount of capital is enormous that it takes to get through trials, especially when you’re trying to do the gold standard trials that make it easy for a new or for a bigger company to acquire. So we were fortunate to be able to tap into that.

And again, when there’s a boom, you’re trying to do more with more. When it’s a bust, you’re trying to do more with less. So we were kind of coming into the jaws what they used to call the nuclear winter of biotech, which was from March of ​’93 to about December of 1999, where we only had one IPO during a six-year Period, which was Aviron, the company that did the cold-adaptive flu vaccine.

But during that period, there was not much there that you could really push on. So you have to develop other strategies. And the good news is if you’re kind of swinging on the chandelier with the top scientific talent, they usually have essentially a platform that’s been developed, and you could take pieces of that and then partner that off with larger entities.

And that enabled strategic capital to come in without giving away the core identity of the company or maybe the value driver and that allowed you to kind of get critical mass, continue to make progress, and stay in the game basically until maybe the situation would evolve.

Aaron: I’m assuming, though, there were debates internally at your partnership of, let’s shut the company down, or this isn’t working. I mean, you’re talking about sort of dividing up the assets, you know, again, buying time.

Keith: Yeah.

Aaron: Many of us probably have those debates in our own boardrooms and in IC meetings.

Keith: Yeah. I mostly wanted to shut down my partner’s companies, not my own. But we work on a principle of a unanimous vote. So nobody was gonna shoot down, you know, shut down anybody else’s companies…because of course… So then we were stuck with having to-

Aaron: Engineer the outcomes.

Keith: Yeah. Try and make them work, which it’s a good feedback loop because it helps you think harder about what Christmas future looks like before you actually put the capital in and makes it a little more rigorous, which is a good thing. And in terms of the partnerships, I think we used to think of it as basically slicing salami.

So you would give away a field of use in a particular platform, and you wanted to make a thin slice of salami because you might have to cut some more off of that salami, and you wanted to have some left, and you didn’t wanna goof up your chances of having your main application work.

On the other hand, if you slice too thinly, the partners weren’t gonna participate ​’cause they, of course, get a vote in the whole thing. So I think there’s a bit of skill knowing how much you sort of slice off of the salami, you know, without losing your end.

Aaron: The Rahm Emanuel finger.

Keith: Yeah. That’s right. Yeah. The finger thing. Yes. So you have to be careful with that. And I would say, you know, another important factor was when we were starting out as a partnership, we were all working on the same companies, And we knew they had to work, basically. There wasn’t an opportunity to not have them work, which I think is a really good teacher and for longevity in the business.

Aaron: But I wanna make sure the audience really appreciates that ARCH was really leading the way in this, probably, I mean, due to the fact there weren’t many other groups doing this. These cycles tended to wash out a number of folks. You also had generalists coming in at times, few specialists that were coming up with these models, fields of use, sort of cutting the salami and figuring out new ways to raise capital really for survival reasons.

As you think about building the firm over time and the full capital stack, particularly with the duration of what you’re investing in, I mean, we’re all paid to generate exits ultimately. I’m just curious how you think about engaging with generalists, specialists, bankers, how that’s evolved over time.

Keith: Yeah. We think of it more or less as a ladder of capital. So in the good times, the folks from the public markets will start moving down that ladder and try and get earlier and earlier into the companies, which favors us because I would say over two-thirds of the companies we’ve done, we lead, co-lead or co-found the company.

So if you’re in early, more capital wants to come in, you do particularly well. I would say when the capital dries up, if you will, and again, in boom cycles, it’s almost always obvious that it went on too long, it never should’ve happened, and so forth. And I have a theory which I will share with you for the first time today in public, which is takes about four years for the people that went too far too fast and never should’ve done it to kind of get washed out of the industry and a new group of people to come in to be able to evaluate that.

So you can hold me to that.

Aaron: Four years from now?

Keith: Yeah. Okay. I mean, if the baby Jesus doesn’t call me before then… you’ll have to talk to someone else. So we spent, you know, I would say a lot of time trying to foster the relationships that we were able to develop on that ladder and then, you know, when you don’t have that ladder of public market generalists or even specialists, the question is, well, what to do then?

And, you know, first one is to cut your partner’s portfolio companies, which of course didn’t work in our case. So then it’s a question of how well can you partner and then there’s usually a government leverage part of it and we actually did a look at this over a 10-year period, and I think it started sometime in the mid-’90s and went to maybe ​’05 and our portfolio companies had actually raised almost a billion dollars, which is actually more than we invested as a venture fund.

So the non-equity funding from government sources, and it wasn’t all US government, I would say it was also some from not-for-profit sectors and so forth, but that’s like having an extra syndicate- member in your syndicate. And then as you work your way up the ladder, if you build a super strong syndicate, maybe the one that takes you all the way through to IPO and other sources of capital, you’re really putting your CEOs in the strongest possible position because they always have the inside option to fund the company from the insider syndicate.

So they’re not in a situation where there’s no more insider support, they have to raise capital, and the new investors kind of sit back and wait till the company runs out of capital.

Aaron: You’ve said to me at least, the syndicate you start with is the one you end with. I guess, what does that mean in practice? I guess these are through lessons learned of seeing that experience of syndicate members dropping out and that being a signal to the market that something’s wrong with the company even though maybe the science is good or whatever it may be.

Keith: Yeah. ​‘Cause I think the traditional model is, well, you have some milestones, you should hit those. If you hit them, then you get funded. If you don’t, you don’t. But I think when you’re dealing with entirely new areas of science, you know, at the forefront of gene therapy or siRNA, sometimes doing the experiment you actually learn more even though it didn’t happen the way you expected, and therefore the team may be proven out, the technology may be even better, but may be harder and takes longer in some way, which is an opportunity to file more intellectual property and strengthen your position because anybody who’s coming after you would have to crawl up that same slope.

So there’s opportunity there. And then we’re, you know, basically trying to make sure that we’re basically over syndicating, I guess would be the one sentence or… So normally, if you had two or three groups in it, you’d probably try and pick up that extra group, and that’s been helpful. And the bad news is you own less of the company then, and then when it goes public and you go to your limited partners to explain it, there’ll be some younger person, and when I say younger, I mean people that are under 50, who will point out that if you had owned more, you would’ve done better.

And you will have to suffer through that indignity, usually smile, kind of nod your head, one of those things.

Aaron: Sounds like a unique experience altogether.

Keith: Yeah. Yeah. So I think one after another, just one more indignity on the road to success, you know? And I think as you progress through that, in the biotech industry you don’t see, and again, I’m not a tech media telecom venture capital person. You can tell because I’m not wearing black. Sorry. But, you know, you hear stories there about, you know, one deal in year 12 that somehow pays off the entire fund by 3 or 5X or something, and those do happen. But I think in biotechnology, you know, generally you might very well have a third of the things that you work on are gonna go public and have a fair amount of success.

Maybe a third are gonna get sold before they go public, and you’ll do okay on some of them and not so much. And then maybe a third aren’t gonna work out initially. So I think the notion of trying to stay in the game for that one big hit is not…And I know, obviously we just had one of those. So I’m not gonna not cash the check on that one, just to be clear. Gotta make sure we put shoes on the feet of our limited partners’ children, or the whole thing will come to an end.

Aaron: But that’s where I think you guys have innovated in a way that, you know, my understanding, your latest fund, you don’t walk into investors…

Again, I don’t know what that’s like, but you don’t walk into investors talking about seed, series A, series B. A lot of venture funds sort of come in, ​“We’re seed investors. We’re early stage investors.” I think now, you have to have the scale, which you now have. You’re all the way through, including pre-IPO.

And you tell investors, ​“We keep doubling down in the science that we believe is worth it.”

Keith: Yeah. I would say in our first 15 years, you know, I’d say the first three to four funds, we were seed and early stage investors, so we were sort of there for the early money and maybe the series A, and maybe we had a little bit in the B.

I would say it was an observation, though, at that time, you know, what’s the difference between the junior varsity and the varsity? Well, the varsity knew that they had to schedule reserves for the later rounds, whereas the junior varsity, we didn’t know that. We always thought that we were on the brink of having the thing break open, and it was all gonna be great.

Aaron: Took a little longer than you thought. Yeah. Yeah.

Keith: Almost always was harder and took longer, even though the exits were still, you know, substantial. So our model has evolved over time and, and I think we’re comfortable with the idea that we have a series A, B, and C. We’re gonna be in all those at our pro rata.

We’re gonna own maybe 20, 25%-plus of the company. We’re gonna have other good syndication partners. And then when we get to the IPO, we’ll start the IPO process with the insiders having committed half of the capital that’s on the book of the IPO.

So that basically puts the company in a situation where they can go public any time they want, assuming that the bankers– I hope there’s no bankers in the audience here, ​’cause if there are, I’ll…

Aaron: There are a few.

Keith: All right. Well, hold your ears. Okay. If the bankers do their goddamn job you should have, you know, at least a couple X book.

Aaron: Yeah.

Keith: And then I think the part we’re still, I would say learning about a little bit is the aftermarket, which is another couple of million shares. And I think the lesson for me on that is that we have to kind of have a company that can raise a banner that it can march behind a little bit as a leader and get out there and have a almost like a public relations type of profile that helps bring in some of those general investor types.

Aaron: In many ways as I hear your story and as we’ve spent some time together, and Sanjeev talks about your conversations with him as well, you’ve moved from a science-led organization, still very much that, but also capital markets is a key part of how you have organized the firm and how you think about scaling these companies.

And I think in the broader climate space that we’re all involved in, it’s a similar sort of duration. Things just take a long time to get to market. Would that be an accurate reflection of how think about the firm?

Keith: Yeah. I mean, I think we’re very much anchored in swinging from the chandelier with the scientist part, and kind of being excited about starting new things in important areas, and being the builders, if you will.

But I think we’ve had to kind of almost as an unconditional moral imperative learn about the other steps because, you know, that’s the thing that you wind up with if you do the job early that you hope for. And then I would say the last part is just the global nature of the business. And, you know, not every big idea happens on either coast, needless to say.

I mean, we’re here in Chicago as well. I don’t know if you’re familiar with the Hotchkiss Theory from Star Trek about parallel universes?

Aaron: I’m not, but please.

Keith: Does anybody Star Trek? You guys probably weren’t alive in the ​’70s.

So they ran out of material to do Star Trek episodes, I don’t know if you’re aware of this, after like 40 of them or something, or maybe it was only a dozen. So they developed this Hotchkiss Theory of parallel universes so James Kirk and Spock could meet the Roman emperors because on other planets, societies emerged essentially on some parallel- path. I don’t know about the scientific underpinnings of all this. But just roll with me.

Aaron: I, well, I like it.

Keith: So if you put that onto scientific innovation, I would also prepare to make another estimate that when you see an invention, there are at least a dozen other leading groups somewhere around the world that are doing exactly the same thing at exactly the same time.

And part of our job was to go out and find those people and basically consolidate the intellectual property and the expertise to kind of stand up a leader. So I think that’s the other part of the business, is that when you get a little bit bigger scale, you’re able to sort of reach into different parts of the world, find those folks.

For the scientists, the leaders, you know, the top scientists. Well, number one, if you go to a group of academics and you say, ​“Everybody who’s a leading academic, raise your hand,” they will all raise their hands. And again, I apologize to the bankers and to the academics that may be in the room here. But the notion would be that we’re trying to consolidate that and trying to take that global perspective, and we have roles, responsibilities, and incentives that have been developed to enable that.

Same point on capital, because it may be folks in Japan that have a special strategic interest in, say, the ag applications of biotech, and if you’re not in conversations with them, you won’t be

able to slice that salami piece, which may be the difference between riding through the downturn.

Aaron: The Valley of Death, yeah

Keith: And not. And then there’s, where’s the capital come from, you know? The third largest pension system in the world’s in Korea, for God’s sake, right? So you need to know where the money is. We’re in the Middle East type of thing. And then, you know, hopefully your venture people on the board are providing good governance to help scrub the decisions and the strategies that are being made, and informed by their experiences.

And then hopefully they can make those introductions, so that you have the opportunity as an entrepreneur to go in there and pitch with them to try and bring the folks in.

Aaron: Yeah. I know we’re coming up on time, but I had promised that I would ask a question about GLP-1s. Obviously, part of your exit was taking advantage of that cycle here. But we have a number of food industry executives in the audience, how do you see this developing from a scientific probably perspective and a venture fund perspective?

Keith: Yeah. I think they’re gonna get a lot better.

Even if you look at cell and gene therapy, they were kind of the first Cas9 gene editors. Today there are dozens, and they’re much smaller, and they’re easier to be delivered and so forth. So I’m expecting the same thing both for the existing pathways that are targeted by peptides right now, and then other pathways that are being teased out.

And I think, you know, being fit and not obese are good things for longevity. Sometimes people ask me if people are gonna live forever, just given that I’m…

Aaron: Is this a prediction?

Keith: I think some of their organs will. We can’t promise the full human at this point. So you just have to pick your organs.

I think we’re starting with skin probably. So if you guys want good skin, we can help you.

Aaron: Wow. Okay. I think we’ll end it there. Thank you Keith. Really appreciate it.

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Tonya: This podcast is for informational purposes only and should not be construed as legal, business, tax, or investment advice, nor should it be used to evaluate any investment or security. It is not directed at, or intended for, any current or prospective investor in any investment vehicle sponsored by S2G. Investing involves risk, including the potential loss of capital.

References to specific companies are for illustrative and educational purposes only and do not represent an endorsement or investment recommendation. The views expressed by podcast guests are their own and do not necessarily reflect the views of S2G. Keith Crandell was not compensated for participating in this podcast or for speaking at the S2G Summit. For additional important information, please visit: s2gin​vest​ments​.com/​d​i​s​c​l​o​sures.