I went to a Wharton Healthcare Alumni event on Tuesday night in New York and listened to a very interesting panel on alternative financing for biotech companies. This wasn’t your “apply for a grant or get a partner” discussion, it revolved around hybrid approaches and alternatives to straight equity or straight debt financing. While I learned a few things about these different business models (Symphony Capital, Fortress Investments, and Cowen Royalty Partners were all on the panel), the most interesting thing which I hadn’t fully appreciated was how the current credit and housing crunch is affecting biotech.

I spoke to a biotech investor at a large diversified hedge fund who mentioned that AAA-rated mortgage backed securities are yielding such attractive returns since banks are dumping them to raise capital that it is hard for the hedge fund to justify investing in risky biotech companies when they can get high yields with minimal risk. Funds who invest in more than just healthcare have several beaten down sectors to choose from with less risk and comparable rates of return. Who would have thought that the mortgage crisis would affect a company’s ability to raise capital?

Private companies are especially vulnerable since these public investors would rather invest in microcap biotechs under $200M market cap with the potential to be liquid than a company that is private and might not get public for a long time in this market. You would risk having to invest more capital to keep the company going rather than simply selling the shares in the public market. These investors can earn venture-like returns by investing in a microcap company that becomes successful, like what happened with Isis Pharmaceuticals in 2005 when it was trading at around $167M and is currently at $1.436B, an ~8.6x return.

These two factors are making the marketplace for biotech financing very difficult, particularly for late stage private biotech companies.