The View Beyond Venture Capital
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BUILDING A BUSINESS The view beyond venture capital Dennis Ford & Barbara Nelsen Fundraising is an integral part of almost every young biotech’s business strategy, yet many entrepreneurs do not have a systematic approach for identifying and prioritizing potential investors—many of whom work outside of traditional venture capital. re you a researcher looking to start a Why and how did the funding landscape During the downturns, it quickly became Anew venture around a discovery made change? apparent that entrusting capital to third-party in your laboratory? Perhaps you have already The big changes in the life science investor alternative fund managers was no longer an raised some seed money from your friends landscape start with the venture capitalist effective strategy, and investors began to with- and family and are now seeking funds to sus- (VC). In the past, venture capital funds were draw capital. The main reason for the with- tain and expand your startup. In the past, the typically capitalized by large institutional drawal (especially from VCs in the early-stage next step on your road to commercialization investors that consisted of pensions, endow- life science space) was generally meager returns would doubtless have been to seek funding ments, foundations and large family offices across the asset class; despite the high risk and from angels and venture capital funds; today, with $100 million to $1 billion in capital long lockup periods that investors accepted in however, the environment for financing an under management. Traditionally, the major- return for a promise of premium performance, early-stage life science venture looks strik- ity of these institutions maintained a low-risk, VCs were often not returning any more capital ingly different from that familiar landscape low-return portfolio of stocks and bonds that than investors would have earned by making of past decades. offered predictable and stable returns. A few more liquid investments in the public small Following the economic downturns of decades ago, fund managers adopted a strategy caps market. Returns from venture capital 2008 and 2011, the profiles of those invest- of putting a small portion of the assets under funds have not outperformed the public mar- ing directly in biotech startups have changed; management into higher-risk, higher-return kets since the late 1990s (ref. 1). A second rea- many traditional investors have curtailed vehicles, such as hedge funds, private equity son was that returns earned by investing in VCs their mandates and reduced their alloca- funds and venture capital funds. This generally were offset by substantial costs; fund managers © 2013 Nature America, Inc. All rights reserved. America, Inc. © 2013 Nature tions to early-stage life science companies, worked well until the 2008 and 2011 economic typically charged a 2% management fee on the and new types of investment entities have downturns. money they received. This of course is palatable emerged in their stead. Entrepreneurs also npg have to come to grips with the shifting regu- latory environment that defines how private Box 1 State and federal fundraising regulations in flux capital is raised, who can serve as liaisons between entrepreneurs and investors and The US National Institutes of Health has redefined who can qualify for Small Business the type of individuals who can participate Innovation Research (SBIR) loans, opening the program up to companies who have venture in financing a startup (Box 1). capital investors, which was formerly a barrier to qualification. In addition, the passing of If you are seeking funds for a startup, you the Jumpstart Our Business Startups (JOBS) Act has added complexity to the regulatory environment surrounding financings, with Title II of the Act allowing companies to raise need to be aware of the range of investors capital through general solicitation of accredited investors and Title III allowing companies and investment vehicles available, as well to crowdfund equity investments from unaccredited investors. Federal and state laws have as the pros and cons of each route. In this heavily enforced regulation on exactly who can invest—only those above a certain income article, we provide a brief primer to help you and net worth can be deemed an accredited investor. Currently, these two new exceptions navigate your path through the new inves- created by the JOBS Act cannot be used together as part of the same fundraising round, tor landscape and find the right investment which leaves startup companies in a contradictory legal landscape. partners for your company. In addition, the Financial Regulatory Authority and the Securities and Exchange Commission have clearly stipulated that any person or entity representing buyers and sellers of securities must be licensed to do so. As an aspiring entrepreneur in the life science arena, Dennis Ford is founder and CEO of Life Science you will encounter a myriad of finders of capital, professional deal sourcers, third-party Nation, Boston, Massachusetts, USA. Barbara marketers, broker dealers and investment banks all aiming to connect you with capital. Nelsen is founder of Nelsen Biomedical, St. Paul, The important take-home message is caveat emptor, or buyer beware. The gray space Minnesota, USA. surrounding the legal environment is in flux, and thus the viability of the entities involved in e-mail: [email protected] or the raising of capital must be vetted and understood when entering into agreements. [email protected]. NATURE BIOTECHNOLOGY ADVANCE ONLINE PUBLICATION 1 BIOENTREPRENEUR / BUILDING A BUSINESS ab Acquisition or Startup & Series D+ or strategic Startup & Series D+ or seed Series A–C Series B–D Series C–E acquisition partnership seed Series A–C Series B–D Series C–E acquisition Large pharmaceutical/biotech companies Large pharmaceutical/biotech companies/corporate venture Private equity Private equity & hedge funds Foundations Family ofces/foundations/venture philanthropy/patient groups Venture capital Venture capital* Angels Angels *Though many venture firms claim Investor type Investor type 'active' status at the early stage, Family/friends Family/friends research suggests that few are actually engaging in deals. R&D Preclinical Phase I Phase II Phase III On market R&D Preclinical Phase I Phase II Phase III On market Product development phase Product development phase Figure 1 The life science investor landscape. (a) The traditional landscape. (b) What the new landscape looks like. when a manager is returning great profits but is as patient groups and philanthropic venture relationships that can create outsized returns. not such a strong proposition during a period funds have entered the space formerly occupied They aim to maximize capital efficiency and of consistent losses. Yet another reason for the by underperforming VCs. create a lean portfolio of high-quality assets withdrawal, and the most troubling, was that a Corporate pharmaceutical companies are primed for market entry. general lack of transparency and long lockup also undergoing drastic strategic changes. periods turned many funds into ‘capital traps’ Facing aging portfolios of on-the-market Focused investor mandates versus from which investors could not withdraw and drugs and an impending patent cliff, big opportunistic investors were unable to influence the decisions of the pharma must restock the pipeline with inno- Two investment strategies dominate in today’s managers. vative assets, and many companies are turning investor environment. One is based on using Many VCs failed to prove to institutional to academic research collaborations, licensing, traditional market analysis and creating a struc- capital managers that they were capable of investment—through corporate venture capi- tured mandate to invest in a particular sector’s identifying and vetting winners in the life sci- tal—and mergers and acquisitions as an alter- products and/or services. Typical considerations ence sector despite being paid handsomely to native to in-house R&D at the early stage. This include determining which key indication areas do just that. That said, of course there remains a cherry-picking strategy of plucking innovation or phases of development will bring the greatest subset of early-stage VCs who consistently pick emerging from academia has become a ubiq- return on investment. This type of ‘deep dive’ winners and have outperformed through these uitous strategy among the top pharmaceutical market analysis will consider major epidemio- tough times, but these well-known firms are in firms globally. Big pharma not only offers a logical, macroeconomic, demographic, regula- © 2013 Nature America, Inc. All rights reserved. America, Inc. © 2013 Nature a distinct minority. Lack of returns and steep huge source of capital for early-stage companies tory and reimbursement shifts. The result is a management fees became a bone of contention but also provides access to distribution chan- so-called investment mandate. The investor has that prompted a lot of institutional investors to nels for the market, discovery and development predetermined what sector, indication and stage npg withdraw their capital from the fund manag- expertise and many other resources. of development they wish to pursue and formal- ers and instead do their own alternative invest- In addition, across the space, many of the ized the resulting research data into a specific set ing. Thus, VCs lost a valuable funding source remaining active VCs, new virtual pharma- of criteria for investment. Remember, investing (a Kaufmann Foundation report details one ceutical firms (for example, Eli Lilly’s Chorus in an early-stage venture means getting in for institution’s reflections on backing away from Group, based in Indianapolis; Karolinska less capital and more risk, and these two factors VC investments)2 and, as a result, institutional Development, based in Stockholm; Accelerator are all part of the bet. The goal of any life sci- investors and large single- and multi-family Corp., based in Seattle; Apple Tree Partners, ence entrepreneur is to find an investor that is a offices often do direct alternative investment— based in Princeton, New Jersey; and Velocity fit.