The Biotech Micro-Bubble

Back to Contents of Issue: October 2001


Biotechnology in Japan is hot among investors -- though not among foreign ones. Does this country have a good chemistry with the industry?
by Sara Harris
Bio is suddenly a hot topic in Japan, especially among VCs. To an industry watcher away from the country for two years, Japan's current biotech scene would be unrecognizable. The period has seen, by some estimates, a doubling in the number of biotech startups, as well as the birth of several industry-focused investment funds. Meanwhile, the ground rules for taking a company public have undergone a revolution, and by all accounts investor interest in this sector is booming.

But the market here is significantly different from the one that created the biotech boom in the United States or Europe. While growth in the global biotech industry is assured -- the pharmaceutical sector, for one, is undergoing a sea change, with profound consequences for the field of medicine -- success in Japan is by no means guaranteed.

The biotech venture market, in particular, remains fragile, lacking an infrastructure that would serve as the foundation for long-term growth. This will require a serious investment of both time and money to build. Japan is significantly different from Western markets in structure, and smaller. It must carve out a niche by drawing on domestic expertise and networks, or tie up with foreign interests to break into a world market already following the lead of the States and Europe.

Nonetheless, as the science of microbiology advances, and as researchers, VCs, and businesspeople exploit the opportunities that such progress presents, it is ventures that are, in some respects, best suited for the quickly changing business environment that biotechnology has become. The amount of information and variety of applications are so vast, and the pace of new developments so quick, as to have created a new paradigm of technology transfer and business development.

But what, exactly, is a biotech venture? Insiders complain that there's no consistent definition, and, indeed, thanks to the fluid terminology, estimates of the total number of biotech startups in Japan range from 10 to 200.

Generally speaking, bioventures are companies with technologies -- systems, processes, tools, or basic supplies -- for aiding DNA or protein-level research or for storing and processing the data that such research produces. Of course, bio isn't limited to people. The technologies used for research into the human genome are equally applicable to plants, other animals, and bacteria. Applications for drug discovery and medical treatments garner the greatest attention because of their potential for making money.

The "standard" bioventure model in Japan is not two geeks in a garage, but a specialized department of a large corporation being spun off into its own company. The government is also a bio-business player, funding 13 consortia that support private research into unusual diseases that wouldn't have otherwise gained market support on its own.



Some insist that any company created before 1994 -- about the time the Japanese government got serious about supporting the field -- is not a true biotech venture. Only recently founded startups with cutting-edge original research, sound development goals, properly managed IP, and an established management team really fit the bill, they say.

Now that the search is on for the genes that play a role in the onset of disease or affect the course of it, many of the ventures created in the last two years are counting on the growing need for their detection services, databases, information processing, research tools, and supplies in this market.

But first, they need funding. Estimates of the amount of capital now available in Japan for biotechnology investment range from $500 million to $1 billion or more. This compares to some $20 to $30 billion in the United States. Bioventures in Japan typically capitalize with $1 million or less. Robert Kneller, a professor in the University of Tokyo's Research Center for Advanced Science and Technology (RCAST), conducted a study of nine Japanese bioventure companies over the course of 2000 and found that while in the United States a biotech IPO might bring in $80 million, a more likely figure in Japan is $5 to $10 million. The trend here, he says, is to follow a "low risk, low return" strategy.

Successfully developing the bioventure market in Japan, says Eugene Takagi, chairman of biotech investment fund and consulting service Bio-Xcelerator, will require finding competitive companies and coaching them through the process. Such assistance might include help with patent applications, marketing strategy, or networking. The best scenario, Takagi argues, will be to achieve 20 to 30 percent of current US investment levels in 10 years.

Five years ago, Takagi, impressed by the biotech opportunities in the US and Europe, sold the small pharmaceutical company he used to manage overseas, came back to Japan, and took on the mantle of "biotech VC." It wasn't an easy sell, he says: "No one wanted to talk to me about biotech or venture capital. Everyone said it was impossible, too risky for Japan." At the time, he recalls, there were large-scale investors -- banks and securities houses -- and individuals, but nothing in between.

The lack of biotech VCs at the time is understandable. One of the biggest factors holding back the industry in Japan and abroad is the sheer technical challenge of understanding the science behind the business. This isn't HTML -- it's DNA. The complexity of the subject causes hesitancy on the part of investors, and has meant Japanese bioventures have struggled to find qualified personnel.

But are biotech VCs and ventures even necessary in Japan? Innovation in this country, after all, often comes from large corporations, and everyone from brewers to pharmaceuticals to computing and electronics companies has created a division to pursue the biotech aspect of their business. It isn't uncommon for a parent company to spin off these divisions to become subsidiary companies in their own right. In fact, this is considered a typical model for business development, known as the "Japan-style venture company." Such "ventures" have a secure line of capital and their employees need not risk their job security. Furthermore, they're a stabilizing force in an unstable venture world, helping to build wider interest and infrastructure from which smaller, more independent companies can benefit.

The disadvantage, says Takagi, is that large corporate labs in Japan, unlike their counterparts overseas, don't look to invest in innovative startups. "There is no culture to get technology by investment," he said. "The big pharmaceutical companies want to do it themselves." As a result, he says, Japan also lacks networks that would facilitate the development of the industry as a whole.

That's changing with increased investor interest in biotechnology. Biotech-related funds are now frequently offered at local banks. VC funds have been popping up right and left. (BioFrontier Partners, established in 1999 with JPY10 million, was Japan's first and remains the largest.) Several big pharmaceuticals have jumped into the investment game. Bio-Xcelerator and a Softbank fund focused on the life sciences opened their doors within the last year.



All this activity did not come out of thin air. Yoshihiro Ohtaki, formerly an investor at JAFCO and now president of BioFrontier, scoffs at the idea that there's been a change in investor willingness. "I was at JAFCO 12 years doing bio investment," he says. It's just that "no one else understood the technology before."

Nonetheless, due to pressure from international scientific and business developments, government investment (particularly in big efforts like the Millennium Project, which in part targets research into diseases more prevalent among the elderly in an effort to prepare for the future of Japan's rapidly graying society), and the publication of the human genome sequence last spring, biotech is undeniably hot in Japan's investment world right now. The July 6 Nikkei Shimbun published the results of an in-house survey showing that out of 116 VCs surveyed, 84 percent considered investment in the biomedical field promising -- compared to 7 percent the year before.

Much of the excitement in biotech is due to developments overseas -- few believe Japan's bioventure market will go anywhere without drawing on the resources of foreign companies, labs, and individuals -- but it would be a mistake to look past what's happening in Japan. Since March 2000, BioFrontier's Ohtaki has managed an "investor enterprise partnership" with funds of JPY5 trillion for investing in companies in Europe, Australia, the US, and Japan. He filled his 20 percent goal for domestic investment within the first year. Now he manages two new funds that will invest 100 percent in homegrown life science companies, including one fund worth JPY3 billion started this July at the behest of Sumitomo spin-off SC Biosciences.

Still, the reality of Japan's bioventure market, investors will tell you, is that there is almost zero foreign investment. The venture infrastructure is about 15 years behind in its development compared to the US, and, relatively speaking, the size of the consumer market here is quite small.

The biotech boom in the United States can be traced to 1980, the year Congress passed the Bayh-Dole Act, which requires university scientists to identify research findings that have market potential.

Recently, Japan has tried to cultivate a US-style system -- for example, by providing for technology licensing offices (TLOs) in a 1998 law. The Cell Effector Institute, out of the University of Tokyo, became the first venture company to be created from a university TLO. And there are now 20 at universities, both public and private, around the country.

But while the interest is there, the structure for technology transfer is stuck in another era, argues the dean of Tokyo University's Institute of Medical Science, Dr. Ken-ichi Arai. He terms the old academic structure, based on a strict hierarchy and divisions between disciplines, controlling and feudal. "This is, in my opinion, killing the potential for bioventures," he says. Promising researchers, he notes, either "escape" to another country, or "surrender" to the strictures of the system at home.

Furthermore, since professors are typically not required to license their discoveries through the TLO, these offices can get left with less attractive intellectual property. And older professors tend to stick with the traditional methods they find more familiar. "I know good national universities [that] have worked hard to make [TLOs] work," says Kneller, but are having a hard time "because faculty won't cooperate."

From the user side, there is also the problem of access, notes Ohtaki. A company looking for appropriate technology to license must go to each of the 20 TLOs, which operate independently. "There needs to be a central system to access the information," he argues. Right now there is a window of opportunity for change, but, Arai says, scrapping the old to build the new never works in Japan. The better strategy is to build the new alongside the old "and let people choose." To that end, he is advancing the idea of university-affiliated institutes that would train researchers and allow them horizontal mobility between academia, established industry, and venture companies. Arai envisions such institutes more flexibly accommodating scientists from foreign countries as well. He already has approval for a new Advanced Institute for Medical and Clinical Sciences, on which construction will start next year. The institute is part of a five to 10 year effort to build a "translational" research center (to "translate" academic discoveries into marketable products) in tandem with a more flexible academic hierarchy, so as to "leave room for curiosity-driven research."



The university structure is changing in other ways, too. In April 2000, for example, the Diet passed the "Law to Strengthen Industrial Technology," which allows national university professors to develop the fruits of their university research on the side as consultants or management.

The Japanese government eagerly supports the development of biotechnology -- the amount it has dedicated to funding research is comparable to the US -- but it can't shake a reputation for always being one step behind. Critics argue that even with high-profile efforts like the Millennium Project, government money often goes barking up the wrong tree. Bureaucrats may identify a hot new technology or area of research, the criticism goes, but by the time the idea is approved and the funds are allocated, the research has lost its edge.

Nonetheless, the government remains a respected arbiter of quality. TUM, a venture that has developed an electrochemical DNA chip (see page 29), was selected this March to be part of a three-year National Energy and Industrial Technology Development Organization (NEDO) consortium project to develop a diagnostic chip. "Investors would rather we not do government work," says TUM president Takatoshi Miyahara, because it takes away from the time the company can spend on private R&D. But their participation, the very fact the company was selected, does reflect well in investors' eyes. "It's a sign of recognition and stability," Miyahara confirms.

The government has also used its resources to create 13 venture consortia, such as Helix Labs and the Agene Research Institute (a company the Health and Welfare Ministry funds in conjunction with four pharmaceutical companies). Typically the research, while valuable scientifically, is too obscure to attract enough venture capital on its own. Agene, for example, explores the genetic basis for aging, focusing on a premature aging disease known as Werner's Syndrome.

In late May, a government proposal surfaced that would encourage ventures based on university research. With a goal of 1,000 ventures in three years (including, but not limited to, life science), the proposal has sparked keen interest on campuses across Japan.

Dr. Takehiko Kitamori, a professor at Tokyo University, heads up a METI committee set up to facilitate technology transfer. The original target of the committee, which began meetings this summer, was to find a faster way to get the fruits of university research to large corporations where they could be developed. With interest in the venture option booming, however, the focus changed. "We must actively promote the venture option," Kitamori says, "but how is not yet clear."

The 1,000 ventures initiative has not yet taken shape, but insiders are examining the prospects with a wary eye."Venture business and government are completely different animals," says Hiromichi Kimura, president of database services bioventure HuBit (see page 30). And the development of venture business, he argues, is an issue that should be shaped by the private market -- "not a matter to be decided by the government's industrial policy." To have this much government input, in fact, is embarrassing. "As a businessman," he says, "I'm ashamed."

Kneller of RCAST argues that by focusing on a nice, big, round number like 1,000, government officials miss the point of developing venture company strength in Japan. "It's easy to form venture companies, but getting them to be successful is hard," he says. Instead, the government "should shoot for 50 to 100 that are successful -- that have a revenue stream or substantial sustained private investment. That would be a much more meaningful goal and would set a precedent for more."

Meanwhile, local governments around the country have tried to hitch their own prospects for regional growth to the bioventure star. This spawned such efforts as Chiba's Kazusa Academia Park and the Kanagawa Science Park outside of Kawasaki. Osaka will start construction soon on a new park opening in 2004. Whether these regional efforts prove to be truly effective at encouraging the domestic biotech industry or just more regional pork-barrel politics remains to be seen.



Despite bullish METI predictions for a domestic biotech market of JPY25 trillion by 2010, the reality is that the market here is still fragile, and progress uncertain. At the heart of this developing industry is the tension between the quick payoff and the process of building a foundation that will support long-term growth. The country has a strong science base -- even Nobel-class research -- "but once we start thinking about linking Nobel ideas to industry, we are lacking infrastructure," says Takagi. The need for "infrastructure" and "a system" comes up time and again when discussing the biotech market in Japan. "It will take four to five years to make a system," says Ohtaki, mentioning specifically law, finance, IP, technology transfer, and the market. "The question is how to organize this."

For this "system" to emerge, a wide range of biotech-focused professionals is needed -- lawyers versed in intellectual property management, venture-savvy financial officers and managers, a critical number of researchers willing to work both in Japan and outside of academia, and graduates with both PhDs and MBAs. In addition, reform-minded legal changes, like the ones that established university TLOs, need to be fine-tuned.

In the meantime, many fear that if in the midst of booming investor interest too much is invested too soon -- or if there are well-publicized failures -- the market could collapse before companies have taken hold or reached maturity.

The future may not be readable, but many note that the paradigm that brought Japan its past industrial success is long gone. A model like Sony's, the argument goes, doesn't fit a market like biotech. Because change is so fast, "a small company works better," argues Ohtaki. Biotechnology is not just a matter of making more or making it bigger; in fact, "companies shouldn't aim to be big," he says. What they should do instead is stay flexible, use a network, and aim to build a high-profit industry.

From the post-IPO side of the fence, the president of DNA chip-maker Precision System Science, Hideji Tajima (see page 31), has this advice: "From now on, because the bio field is so broad, there will be a variety of seeds. Specialize in one thing, one area where you absolutely cannot fail. If a company can't clearly place their focus on a (certain) technology, I think it will be very difficult to go IPO. If you're small, be small and aim for the top share in your niche. I think this is the right way to be a venture." @

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