Wednesday, Oct. 28, 2009 | Each October in recent years the biotech industry association Biocom has hosted an investor conference. The event gives companies a chance to pitch their products directly to venture capitalists and other investors, and provides the investors with one-stop shopping for what might be the next big thing.

Last year an apt title for the confab would have been “The Deer in the Headlights Ball.” The credit markets were in a deep freeze, venerable financial institutions were failing — or almost failing — by the week and stock markets were heading toward a low not seen since the mid 1990s.

The 2008 participants went through the motions at the Hyatt Regency. Company presenters touted their breakthrough discoveries, and investors listened intently. But nobody moved on anything. Fear ruled. Cash was king.

This week the same folks were again roaming the Hyatt’s halls. And though you could still catch a whiff of the fear, the mood was considerably brighter. “The atmosphere is very different,” said John Watson, a member of Tech Coast Angels, a locally based angel investor group. “You see a lot more smiles in one day than you did in a week of meetings last year.”

But plenty of grimaces were mixed in with the smiles, as entrepreneurs acknowledged that the easy credit days are gone, perhaps for good, and that financing for the youngest of companies is scarce, and will likely stay that way for the foreseeable future. And there were grumblings that venture capitalists are playing things too safe.

Overall, however, attendees said things are looking up. CEOs said the big players that have traditionally bet on biotech are gradually pulling their money out of their proverbial mattresses and putting it back in the market.

“This year the dedicated healthcare investors are back,” said Ted Schroeder, president and CEO of Cadence Pharmaceuticals, a San Diego-based company that is developing an intravenous form of acetaminophen, a pain reliever that is the main ingredient of Tylenol. “And you are starting to see a toe in the water from the general investor.”

To a degree the stats bear out Schroeder’s assertion. Venture capital investment in San Diego County-based healthcare companies, which include start-up drug companies, medical device developers and healthcare service providers, from $44 million in third quarter 2008 to $120 million during the same period this year, according to data compiled by Dow Jones VentureSource. That amounts to a 173 percent year-over-year increase.

That figure is still down from the quarterly totals that the industry had grown accustomed to. The average amount invested by quarter from 2003 through 2007 was $208 million, according to the Dow Jones data.

“The fear is gone, but the recovery will not be anywhere near as fast as people have said it is going to be or want it to be,” said Adam Wade of Dow Jones. “It will be a slow recovery and a lot of players will be lost along the way.”

The recovery, however, wouldn’t be so slow if venture capitalists behaved like they should, said Martin Sabarsky, the San Diego-based CFO and COO of HR BioPetroleum, a virtual biotech that is a leader in developing algae as a biofuel. He said quite bluntly that investors don’t want to take venture risks, but still want venture returns.

“Venture capitalists need to step up and do their jobs and take the risks to justify the high returns they expect,” Sabarsky said.

Although no one else chided investors in quite the same manner as Sabarsky did, others had similar sentiments. Venture capitalists have all but abdicated investment in early-stage companies, preferring instead to invest in companies that they’ve invested in for years, and in companies that are well beyond the initial start-up phase.

The Dow Jones VentureSource data shows this. None of the third quarter deals highlighted in the data were early-stage deals. As a result start-ups are increasingly relying on government grants for their money, or having to either pay much higher interest rates or give up much more of their company in order to get financing.

Long-time investors like Watson and Jack Florio, who is also a Tech Coast Angels member, said investors are enjoying a buyer’s market like few they’ve ever experienced, and one that can’t continue over the long term. Last year, Florio said, a company could get financing at a 20 percent cost — meaning that for every dollar raised, the company had to pay investors 20 cents in the form of discounts on the stock and the investor equivalent of stock options.

“Now it is up to 40 percent,” Florio said. “This is not sustainable — money can’t come at such a high price.”

And because initial public offerings, which have historically been the biggest carrot a company can offer an investor, have become non-existent, start-ups being forced to pay interest on debt held by investors at interest rates approaching credit card levels. A year ago investors would expect 8 to 10 percent on convertible debt, these days they can expect 12 to 15 percent, Watson said.

The potential ramifications of this new — if only temporary — reality are dire, everyone from Florio to Sabarsky acknowledged. It could mean that innovation no longer pays — the risks for an early-stage entrepreneur will become too great, and the rewards too small.

“We need to have investment at this critical juncture,” Sabarsky said. “We have to hope that people get some steel back in their spine.”

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