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Nov 1, 2007 (Vol. 27, No. 19)

Tackling Financing Challenges in Biotech

Making the Most of All Options for Every Stage of a Company's Development

  • Most biotechnology companies are founded on great ideas. They might have a promising drug, a compound or a family of compounds, or a proprietary technology platform. Within this ever-expanding universe of great ideas, all biotechnology businesses have one key element in common: they all need financing.

    The challenges in funding typically begin the day the business is established and continue through all stages of clinical development, product commercialization, and beyond. To be successful, senior managers at biotechnology companies must keep one eye on development and the other on financing every step of the way.

  • Early-stage Financing Begins at Home

    Options for new companies are limited. Professional investors look for substantial progress in product development before making any decisions. The earliest funding for a biotechnology company is thus likely to come from the founder or founders.

    Some biotech entrepreneurs have gotten their operations off the ground by dipping into their retirement accounts, taking out second mortgages, or running up credit card balances. Given that the road to success in biotech is at best long and uncertain, the more prudent executives will seek to diversify their financing risk early on.

    Friends and family often are the first port of call for early-stage investment in your company. Angels are individual investors who function as venture capitalists because of their interest in early-stage investing or in some case, the biotechnology industry.

    While this may seem like an informal process, it is not. As soon as you are in the position to invite funding from outsiders into your company, you need a lawyer and you need to think long term. Decisions you make now could have serious repercussions in the years ahead.

    For instance, how will you value the company and how much of the company will your investors own? How will your early financers be treated when you reach out to institutional backers for tens or even hundreds of millions of dollars in the future? How much will their original holdings be diluted? How will they be able to cash out?

    It is also important to remember that your angel funding should take you to the next level of financing. You need to acquire enough investment at this stage to position the company for the big leagues—the venture capitalists. Make sure you have the best, most experienced hands advising you even at these early stages.

  • Consider Private Groups and Government Grants

    Another important option is the growing number of private groups that invest public money in start-up companies. Many states and regions have established organizations that specifically back companies located in those areas to promote growth of the biotechnology sector. These groups may have lengthy application procedures but they can be a vital source of financing.

    With investments that are often under $1 million, these organizations help many companies to bridge the gap between angel investors and the larger funding preferred by private-sector VCs. These groups can also often help with business training and support services.

    Many early-stage companies do not take time to consider grants, but they are more widely available than ever. The application process can be complicated and take time, but grants make it possible to access capital without diluting your company ownership. In particular, the SBIR and Advanced Technology Program grants can be a source of significant support.

  • Reaching Out to the Pros

    There are many VC firms that specialize in investing in biotechnology and life science companies. To get them to invest in your company, however, you have to meet and impress them. It is at this stage that the quality of your communications and informational materials becomes much more significant.

    You need to help investors understand the value of your company and your chances for commercial success. Be sure to have a written business plan and a concise executive summary. If you have never written these before, get a consultant who can help you.

    VCs will rate the strength of your technology, intellectual property, development plan, and your management team. Ironically, often they want proof that you could survive without their backing. They see themselves as investors not lifelines. In practice this often means that they will turn you down the first time you see them but may become interested a year later if you return after having made good progress.

    Once you generate some interest among a group of VCs, you will typically need a lead VC to negotiate terms and to help bring in other investors to fill out the financing round. Without a lead, most VC deals cannot proceed.

    The lead VC will move forward in developing the term sheet for the deal. VCs will want to set terms that favor their interests and reduce their risk. You will need to negotiate effectively. Some issues to keep in mind at this stage are provisions related to dilution in the event of future financings, terms related to an IPO including dividend and liquidation procedures, and what happens if the company is sold.

    You might also need to bargain on VC involvement in your board of directors. It is essential that you use a lawyer who has successfully negotiated all these issues and more.

    Remember also that VCs will be thinking about their exit strategy from your company even before the deal is executed. They want to make a return on their investment and get out one way or another. You need to position your early decisions so that your company remains well capitalized until your next financing option. You never want to be acting out of desperation when making such arrangements. The best time to raise money is when you don’t need it.

  • Going Public

    For many companies, the long-term plan is to go public. There are certainly advantages including broader access to capital and the ability to return to the markets to address future financing needs. VCs also will see the IPO as a potential means to achieve liquidity. Biotech IPO valuations in general, though, have declined significantly since around 2000. It is increasingly difficult for biotech companies to achieve significant increases in valuation at the IPO.

    You will face a significant cultural shift as your company transitions from private to public. In some cases, members of your team won’t make the change. If going public is your goal, think carefully about when and how it will affect your operations and your own job satisfaction. Make sure to work with a law firm that has handled IPOs in the past and with reputable bankers.

    Some other issues to consider are that the management team will need to take on new responsibilities related to disclosure and regulatory compliance. Shareholders may want a voice in company operations, and managing shareholder interest and involvement is a critical responsibility.

    With every financing decision, the key to success is to get informed about your options. Learn as much as you can and, above all, work with smart and experienced consultants.

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