How far has the psychedelics medicines industry come over the past 12 months? Well, it depends on where you look.

If you look at the stock market, the view isn’t very good: the charts are all down and in the red, and all you can see are psychedelics companies tottering by, doing their best to impress cynical investors.

Similar to most other sectors today, that crumbling of confidence in the sector has trickled down to the private markets as well, slowing down venture dealmaking and further shrinking deal sizes in an already parched venture market.

But if you focus and leave your preconceptions behind, you’ll find that beyond the skein of valuations and share prices, there is a world of spirited dealmaking, ripe with impetus for building a sustainable industry. A recent survey by TechCrunch+ indicates that investors and founders are, instead of simply looking for attractive opportunities, increasingly putting their minds to building the foundations for an industry that can employ the power of psychedelics to change lives.

For Bek Muslimov and Nikolay Tretiyakov, co-founding partners at Leafy Tunnel, the problems currently being tackled by the industry are proof of the nascent sector’s progress. “The questions our industry is grappling with are becoming more refined and nuanced, reflecting the necessary maturation. Amongst these questions are actual costs of therapies, reimbursement coverage, the commercialisation strategy for psychedelic drug development companies, resource bottlenecks with the therapists’ supply and infrastructure, etc,” they told TechCrunch+.

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Regulation is moving forward, too, albeit slowly, with only Oregon and Colorado taking steps to partially decriminalize psychedelics. But even as the industry looks to those states to serve as testbeds for everything from drug development to integration into the healthcare infrastructure, several investors pointed out that the U.S. is not the only place where psychedelics are seeing interest.

“Decriminalization is not the same as legalization at the Federal level. I believe we will continue to see international locations as primary testbeds as the larger question of legalization in the U.S. is discussed,” said Amy Kruse, chief investment officer, Satori Neuro. “The developments in Australia this year are extremely interesting and worth watching closely. As Australia is often a site for clinical trials research in the psychedelic medicine ecosystem, it will be worth watching to see how this develops. Will they take the lead?”

Like several investors we surveyed, Kruse doesn’t solely invest in psychedelics, but they are very much on her radar. The firm she’s part of, Satori Neuro, is a new venture that aims to invest in solutions to address mental health challenges, including psychedelic medicine.

But she and her ilk are among the few investors willing to enter the space, as the majority of investors, especially institutions, still labor under misapprehensions about psychedelics or aren’t interested in risking their money or reputation.

“For most institutional investors, psychedelics continue to be a ‘no can do’ sector to invest in,” said Sa’ad Shah, managing partner at Noetic Fund. “While we can certainly argue for the major strides made and progress on the regulatory front, institutions still need to see it to believe it. Secondly, this sector is still too small. It does not warrant the kind of capital that most institutional investors typically put to work.”

When this could change likely depends on how regulation is framed and how the healthcare industry responds to advances in the space. But that’s not to say the path to commercialization and wider adoption is closed to psychedelic startups and investors at the moment.

Tim Schlidt, co-founder and partner at Palo Santo, explained it succinctly: “Rather than seeking to change how our healthcare system operates, we believe this early generation of psychedelics must transform and adapt to fit within existing infrastructure. Rather than trying to storm the ramparts, we believe a Trojan horse approach is the only means by which these therapies can achieve wide-scale adoption.”

Read on to learn about where these investors are placing their bets, how they decide which companies to back, what are the prospects for M&A in the space, how to best approach them, and more.

We spoke with:

• Sa’ad Shah, managing partner, Noetic Fund
• Ryan Zurrer, founder and director; Ozan Polat, partner; and Daniel Tarockoff, partner; Vine Ventures
• Tim Schlidt, co-founder and partner, Palo Santo
• Amy Kruse, chief investment officer, Satori Neuro
• Clara Burtenshaw, partner, Neo Kuma Ventures
• Greg Kubin and Matias Serebrinsky, general partners, PsyMed Ventures
• Bek Muslimov and Nikolay Tretiyakov, co-founding partners, Leafy Tunnel

Sa’ad Shah, managing partner, Noetic Fund

How has the trajectory of listed psychedelics companies affected private firms and start-ups?

Listed psychedelics companies were highly overvalued in 2021, and the correction in the markets has brought valuations for private companies back to more standard early-stage levels.

Investors are more prudent with capital today, allowing capable founders and teams working on a great product with a good business plan to shine through rather than being drowned out by the noise.

The adjustment of expectations from investors also allows private companies to grow organically and make decisions with good counsel.

Sa’ad Shah, managing partner, Noetic. Image Credits: Andrew

At the same time, generalist investors burned by investing in bad apples could now have developed an adverse view to investments in the space, costing good companies backed by deep tech venture firms access to additional pools of capital. The inability to raise more capital in this environment has caused many good companies to shelve or halt promising programs and prioritize survival over rapid growth.

Other than disagreements over prices, which factors have impeded M&A activity in the psychedelic space in the last 12 months?

There are three main factors impeding M&A activity:

1. Isolating the magnitude of efficacy: While there are clear signs of efficacy in clinical trials, the magnitude of the effect being assignable to psychedelics alone is still a work in progress. Big pharma awaits more data on this front before an M&A move. In the meantime, pharma and big biotech VC firms are more interested in exploring the non-hallucinogenic psychedelic pathways.
2. Intellectual property uncertainty: Due to the 18-month window of uncertainty in filing patents and being granted one, there is some hesitation with acquisitions.
3. Maintaining cash balances: In this environment, biotechs are focusing on prioritizing and rationing their cash for their lead programs and are being more deliberate than before when making big moves.

Drug development is very costly, and start-ups are having a harder time raising cash. Does this make psychedelics startups that aren’t developing any drugs more attractive to investors than those involved in drug development?

Business models that can generate revenues with low burn rates have always been more attractive to the traditional investor than non-revenue generating businesses like drug development. However, there are investors who still understand the unique risk-reward profile in each case, and hence, founders need to be able to approach the right investor.

There are drug development companies that continue to raise capital at higher valuations due to the continued validation of efficacy and the “optionality” that exists in their program — i.e. they are pursuing several promising leads/molecular pathways. What is riskier, especially at this point in time, are pure drug discovery companies that don’t have any leads to take into trials anytime soon.

Whether developing a drug or not, a company would be attractive to investors if and only if it is addressing a key problem in the market that cannot already be solved by incumbents efficiently. Several non-drug development companies touting to be “specific to the psychedelic industry” would only be successful in the long term if they have a unique and differentiating value proposition, can develop a sustained economic moat, have a proven track record of raising capital, and have the right team to execute.

How has your approach to the psychedelics sector changed since our previous psychedelics survey a year ago?

Our view of the markets from a year ago has only been validated by what has transpired in the psychedelics market.

Our overall focus is and has always been on central nervous system (CNS), and we are agnostic as to the modality, be it psychedelic drug development, other pharmacological approaches, medtech devices, or digital therapeutics.

When it comes to the psychedelics sector in particular, we feel this industry has clearly matured from being a toddler in its terrible twos to an adolescent, but there is still a long way to go. We continue to focus on the non-hallucinogenic approach to psychedelics, as it has the most promising prospects of being commercialized with much less scrutiny while adhering to current standards of care.

We were not surprised by the closure of several ketamine clinics, as we stated last year that given the industry’s life cycle, we are too early for “downstream” opportunities to have a viable chance of succeeding.

What we weren’t expecting was the level of headwinds the markets are facing overall, which is affecting money-good companies from raising additional capital to shepherd their plans through. This is very much a Darwinian model being played out. The strong and most adaptable are the ones that will survive.

We have to accept that the failure rates for a startup in a new industry such as ours will be high, especially in light of the macro backdrop. As such, our approach is to have a high-conviction portfolio and lean on/back the companies that have the ability to execute well in any given environment.

We also feel that the simple ‘pick a molecule and an indication’ strategy that was easily funded in 2020/2021 will go extinct, as it is not a viable business model. To survive, you must show safety and efficacy, protect your IP, be differentiated, and have a team that can execute on the science and business in order to commercialize and scale.

Colorado and Oregon voted to partially decriminalize psychedelics, but there are caveats. Should these U.S. states be considered testbeds for what might happen in this space globally? Why or why not?

If we want to talk about testbeds, we should first and foremost look at Australia, which has been the first out of the gate to legalize MDMA and Psilocybin for therapeutic use under proper protocol and compliance.

In jurisdictions where psychedelics are being decriminalized, it is likely that psychedelic-naïve individuals would access psychedelics outside of the medical system. To reduce any unforeseen risks in these cases, it is imperative that effective pre-screening protocols and post-session psychotherapy and support be implemented to ensure people have safe and effective access.

Additionally, a reliable source of information to educate individuals would be required. It is therefore our goal to focus on the regulated paths (e.g., FDA, EMA, Health Canada) to usher in psychedelic-assisted psychotherapy to patients in a safe, efficacious and accessible manner.

It is imperative that the decriminalization process ensures that the right safety checks are in place. This requires proper education about psychedelics and safe protocols to follow.