Psychedelics Provide New Frontier For Venture Funding, But Nuances Prevail

When investor Brom Rector started Empath Ventures in September 2021, the biotech world buzzed with excitement about the potential of psychedelics.

Months earlier, two of the largest psychedelics companies in the world, Compass Pathways and MindMed, went public. They also began working with drug regulatory industries worldwide to develop a better pharma candidate for depression and anxiety than the antidepressants based on science from the 1950s.

This move effectively legitimized a set of drugs, some of which the U.S. considers more dangerous than cocaine, for potential medical use.

It was a sharp turn from the mindset that drove the U.S. to criminalize psychedelics during the War on Drugs in the 1970s. This, along with how clinical trials were conducted, shuttered early research into psychedelics as treatment for depression and alcoholism.

But the tides are turning.

States like Oregon and California are working on legislation to slowly decriminalize psychedelics, and the Food and Drug Administration is looking into a handful of psychedelic-based therapeutics that may soon bolster the high-stakes, high-reward pharma industry.

In fact, psychedelics-related startups have raised over $236 million between July 2021 and July 2022, largely allotted to drug companies as the FDA continues to move psychedelic therapeutics through the clinical trial pipeline.

This is compared to $96 million funded between July 2020 and July 2021, according to Crunchbase data. Clearly there has been growth in the sector.

The start of Empath Ventures

As a teenager, Rector renounced his Christian upbringing and became an atheist. This decision proved a catalyst for his pursuit of a spiritual experience without the complexity of organized religion.

After years of witnessing post-war mental health issues on the military base where he grew up, and reading research about treating PTSD with psychedelics, Rector laid down blankets on the balcony of his house and took 200 micrograms of LSD when he was in his early 20s.

“I really do kind of see myself before doing psychedelics for the first time and me after doing psychedelics for the first time. It’s kind of like a transition point,” Rector said.

Rector left his job at a hedge fund before his 30th birthday and months later founded Empath Ventures. Armed with $2.1 million collected over time from a handful of angel investors in VC, cryptocurrency and neuroscience, the firm has invested in several startups that intersect with psychedelics. These include wavepaths, a music integration platform to guide people through a psychedelic experience, and Nue Life, a telehealth platform that specializes in guided ketamine therapy.

Empath also invested in a handful of early-stage therapeutics startups, but navigating the private market world of psychedelics is tricky.

Ethical quandaries over whether to invest in startups that support or discourage the decriminalization of psychedelics are at the center of Rector’s (and others’) investment theses.

The patent debate and question of decriminalization

Untangling the golden age of psychedelics research from the U.S.’ checkered history of criminalizing drug use has made Rector wary of certain drug startups.

Pharma companies often want to pursue so-called composition of matter patents, which allow them and them alone to manufacture and market a drug for a period of time.

From a business perspective, drug companies rely on patents to pay for the costly clinical trial process used to convince the FDA to approve its therapeutic. Composition of matter patents must prove unique and original, though what is “unique” is up to interpretation.

For example, while it’s technically impossible to patent a mushroom that grows from the ground, Compass Pathways came under fire for a patented form of psilocybin that some organizations said was too similar to natural psilocybin, better known colloquially as magic mushrooms. The judge threw out the case in June.

MindMed received a patent for an MDMA-LSD combination that had already been known to recreational users as “candy-flipping.”

“You see a lot of companies that are creating these very, very simple tweaks on things like psilocybin that really don’t create any meaningful difference, but it’s technically different enough to get a patent,” Rector said. “And so we try to avoid those companies.”

If the patented drug is too similar to the recreational drug, it may incentivize pharma companies from decriminalizing psychedelics because their drug would compete with the recreational market, Rector said. That competition also doesn’t give the company a competitive advantage, and wouldn’t bring back overwhelming returns on investment.

Former MindMed co-CEO JR Rahn garnered controversy in 2020 for saying efforts to legalize psilocybin may hamper research in the field.

“It’s almost like saying the success of our business depends on us continuing to put people in jail for using drugs, which to me is an unconscionable thing,” Rector said.

However, it can be argued that the very commercialization of psychedelic-based drugs could butt heads against decriminalization, patent lawyer Graham Pechenik of Calyx Law said. A drug that is chemically different from psilocybin but provides the same effects could, theoretically, be a competitor.

Commercialization and legalization

But historically, drug commercialization and legalization have gone hand-in-hand. Most states that legalized cannabis for recreational use started with medical marijuana ID cards.

The Multidisciplinary Association for Psychedelic Studies (MAPS), a drug policy and drug development group that emerged in the ’80s, has long insisted the decriminalization of psychedelics hedged on the widespread use of commercial drugs. MAPS is also pursuing FDA approval for an MDMA-assisted psychotherapy treatment.

“Decriminalization actually works in favor of companies that want to bring an FDA approved compound to market because they’re not necessarily competing for the same people,” Pechenik said. “Like my parents, I don’t think, would go to a dispensary where they can buy legal mushrooms and take them at home. But they may go to a therapist to obtain them.”

To date, Compass Pathways and MindMed far outpace their competitors in terms of funding, raising $116 million and $176 million, respectively, before their IPOs.

But while pharmaceutical-grade drugs are more expensive to create, the cannabis market has boomed.

Cannabis startups, including various cannabinoids like THC and CBD, have garnered $803 million in funding between July 2021 and July 2022, according to Crunchbase data. This is a sharp contrast to the $236 million funded to psychedelics startups mentioned earlier for the same time period.

Meanwhile, a slew of startups in psychedelics are working to carve their own niche in the growing industry.

The next generation of startups

Several startups have sprouted under the shadows of Compass and MindMed with the purpose of manipulating psychedelics for new drugs.

California-based Delix Therapeutics, for example, is looking to create treatments from psychedelics that don’t have the hallucinogenic properties.

Mindstate Design Labs, a biotech startup founded last year, wants to map out the biologics of various psychedelics and understand what compounds or molecules produce different states of “altered consciousness” that may allow patients to better open up and process traumatic experiences.

“We have these altered states of consciousness that we know about, that just come from drugs that were laying around, they grow in nature, we happened to discover them already and tried them. But that doesn’t mean that the altered states of consciousness are limited to those drugs that we know about already,” said Dillan DiNardo, CEO of Mindstate. “That’s what Mindstate is particularly interested in in the future, discovering these states and intentionally designing these states in a way that’s targeted to a particular therapeutic.”

There’s also CB Therapeutics, a synthetic biology startup that was awarded a patent in May for its process in procuring molecules from psilocybin. The patent solidifies the startup’s place in psychedelic drug production, as it allows it to extract specific molecules in their purest forms for drug companies to use.

“We are the company that wants to empower other companies to do clinical trials, but obviously not every company can afford a few kilograms of psilocybin or DMT, whatever it may be,” said Sher Ali Butt, co-founder and CEO of CB Therapeutics. “Having this gives them an option to get access to these molecules very quickly.”

Rector has sifted through several startups like these. They’re not like Wavepaths or Nue Life, which exist as ancillary services to the psychedelics market; they require a closer eye to understanding the science.

“If I’m going to invest in a pharma company, I want to invest in a company that’s actually trying to invent a new drug because then there’s no generic version that’s available, right?” Rector said. “It’s not competing with magic mushrooms. It’s like its own thing.”

Illustration: Dom Guzman

Learn More