Is The Psychedelics Sector In Decline? This $30M VC Fund Says HOLD

This article was originally published on Microdose and appears here with permission.

Recently, there has been an exciting discussion in LinkedIn posts and Microdose PsyCap events regarding the presumed declining status and dire future of the psychedelic medication industry. In summary, these are the primary contentions made by proponents:

  • There are too many psychedelic companies competing with each other in a limited market by using the same compounds (e.g., psilocybin) to treat the same mental health conditions. These companies are led by inexperienced management teams without proper pharma backgrounds.
  • Recent results of the Compass CMPS Phase 2b study showed an unacceptable level of serious adverse events in the higher dose (25mg) treatment group, particularly suicidal ideation. Such problematic effects will prevent psychedelics from being used as first line treatments for people with depressive disorders. Therefore, all these startups address a small addressable market ($1bln)
  • Due to 1) and 2), 90% of psychedelic companies will go out of business in the next 1-2 years, and investors will lose their money
  • The recent meltdown in public psychedelic companies’ stock value, where most of the companies including more mature companies (ATAI, Compass, etc) lost 50-70% from their 2021 highs, is a proof that the above is correct

We would like to share Negev Capital’s view based on our experience, feedback from our portfolio companies and investors.

First, we agree that the psychedelic medication market is still in an early stage of development and is experiencing “growing pains” as do all emerging sectors. However, we believe there is much to be optimistic about. The year 2021 was an incredible one for psychedelic medicine: an entirely new asset class was created and has the potential to disrupt global mental health therapeutics. Let’s look at each thesis in detail:

  • There are too many psychedelic companies in the market. We believe that the number of psychedelic startups is appropriate to this stage of psychedelic science and potential. There are a number of unique aspects of psychedelic medicine that support such rapid growth. Primarily, this class of medication appears to be effective transdiagnostically, meaning that it is likely that ultimately there will be multiple indications for them. Further, early evidence suggests that effects are persistent for at least 3 months, which is a unique and highly desirable quality. Finally, neuroplasticity and anti-inflammatory effects, as well as the role of the psychedelic experience and/or psychotherapy, are in the early stages of scientific exploration, and hold enormous therapeutic potential.
  • Many companies emerged last year, targeting multiple different indications. The mental health crisis is not just about depression or anxiety, but includes many different diseases, including orphan ones that were completely ignored by Big Pharma for decades. In order to progress, large numbers of pre-clinical and clinical studies must be completed, with the expectation that just under 10%of them will succeed. During the past year, at Negev Capital, we had more than 100 meetings with different psychedelic drug development startups and carefully assessed their assets, including management teams, proper drug development processes, and IP strategy. Through our very intensive due diligence, we invested in 20 companies that have competitive advantages and what we feel is the proper approach to improve the probability of success.
  • Recent results of Compass Phase 2b study are too bad for psychedelics to become the first line treatment, because it has 10% serious adverse effect rate. At Negev, we believe that those results are very good. Treatment Resistant Depression (TRD) is the one of the most difficult clinical challenges, and the effect size Compass demonstrated was excellent and clinically significant. TRD requires non-response to multiple different medication trials, and such patients frequently exhibit adverse effects, especially if they didn’t respond to the treatment or stopped using a partially effective antidepressant. It is unlikely that a small number of patients who described suicidal ideation were exhibiting a psilocybin-related side effect, as this has not been seen in any other studies. We fully expect this “side effect” to be minimal with further research.

We at Negev believe that psychedelic startups will not only prove efficacy of psychedelic treatments to FDA, but also improve upon the effect size demonstrated by Compass and moreover, the scalability of the treatment. The Addressable market is huge: 1bln people without proper medicine and this number has been constantly growing

  • 90% of psychedelic companies will die. It’s a common startup statistic across all sectors – 90% will probably die. In venture capital you cannot succeed without failures and all professional investors are aware of Power law - a small minority of investments produce most of the returns. Keeping that statistic in mind we believe that our selective approach to portfolio creation provides us an excellent chance of generating a decent return to our investors. Key standard factors of success are as follows:
    • Do your due diligence with your own scientific team and don’t rely on external scientific advisors or social media hype.  
    • Have a diversified portfolio of companies with the best teams, science, and drug development process. 20-25 companies are enough.
    • Be patient. Psychedelic drug development is not a Cannabis 2.0. It’s a long-term game and we’ll see positive results not earlier than 2024-2025
  • Recent meltdown in public psychedelic public stock is a proof thesis above is correct. Disagree. It’s not about psychedelics only, but about a broad sell-off of high-risk assets:
    • Most of recent IPO companies in high-growth tech sector have been crushed amid the broader sell-off. Some are down by more than 50-70% since November 2021
    • About 100 biotech companies are currently traded at market cap below their cash at the bank. Psychedelic companies, as a subsector of biotech, are traded at much better levels currently

We consider the current meltdown a healthy recalibration of the market overall in terms of reasonability of entry valuations and “down to earth” negotiations with the founders. The moment provides a very good long-term opportunity. So, we keep watching and analyzing carefully each company for increasing the Fund’s exposure in the most promising ones.

We fully agree that most of the psychedelic companies went public too early. But what kind of other options did they have 12 months ago? They were fortunate to raise funds from public investors in Canada when there was not enough capital from professional VCs. Now these retail investors and hedge funds dumped their stock because it didn’t grow as Cannabis. And a lot of companies will struggle to raise additional funds this year and most probably will run out of cash.

To address this issue we advise our portfolio companies to become private again and buy out their short-term shareholders with a new long term capital. We believe that companies with high quality management teams and assets should be focused on drug and business development, but not to spend most of their time for to promote their share price to non-professional investors.

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Posted In: CannabisSmall CapMarketscontributorsNegev CapitalPsychedelic MedicationPsychedelics
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