Going for the gold: Seeking biotech financing

Every company seeking start-up or expansion capital encounters challenges in attracting the right amount of money from the right

"Things are getting back to normal after the dot.com bubble burst. Biotech firms are finally finding it easier to compete for funds now that the temptations of fast returns from dot.com firms are a thing of the past. Biotech investing, with the long lead time before biotech firms typically become profitable, requires a more patient investor and one who understands the industry process," advises Mike Roer, Publisher of Angel Investor News, an e-publication for angels and entrepreneurs, based in Fairfield, Conn. "Seek out investors with an understanding of the industry, its terminology, and unique characteristics so that they are prepared to assess the investment potential of a high-tech company idea or product."

According to Roer, the biotech industry seeks critical mass - Clusters of biotech firms are locating in certain regions of the country such as New Haven-Yale, where university research, existing industry, and scientific and management pools of talented people are readily available.

"There's a lot of buzz about biota in these areas and a higher concentration of bio-savvy angel investors and biotech venture capital firms in the major research centers. This is where to begin looking for capital. From the other side of the coin, many areas of the country are seeking to build up or start a biotech industry base because it creates a significant economic development engine with a great multiplier effect with high-quality, high-paying jobs; home sales; and attraction of related businesses and services," says Roer.

A recent poll taken by Angel Investor News reflects that despite September 11 and threats of an economic slowdown, 79 percent of angels polled across the country plan to invest more during the next six months than in the past six months. That percentage is only down slightly from a high of 86 percent in the same poll taken before September 11.

"It's not that easy for biotech firms to attract the amount of capital they need to develop their products. The national venture capital community is a small group - under 5,000 people, with only a small percentage invested in the biotech industry," warns Martin Tilson, Jr., chairman of Southeastern Life Science Association board of directors and chairman of the technology practice at Kilpatrick Stockton LLP, in Atlanta. "The industry is very science-driven and the long period of testing burns a lot of money before investors see a return. It's takes a special kind of investor to understand the industry. While the rewards can be tremendous, it's not for the faint-hearted investor."

For the past four years, the Southeastern Life Sciences Association has sponsored an investor forum, inviting 20 companies representing the best of breed to make presentations to potential investors. Biotech companies make their case for their product or idea in front of a number of investors interested in the biotech arena.

"Seek guidance from professionals who have helped accomplish capital funding of biotech companies before. They are experienced in the transactions and often have the contact networks to attract capital in the first place," says Tilson.

SOURCES of FUNDING

"Understand the various sources of funding and understand that it is very important to approach the right source of funding at the right time," advises Stephen Ferruolo, co-chair of the Life Sciences National Practice Group of the law firm of HellerEhrman in San Diego. "Develop a viable strategy for obtaining the money you need at the right time."

According to Ferruolo, it is very important that the company defines itself. Many companies that started with a product or idea are not viable businesses. You need to develop a vision on what it takes to develop your product or idea and transform that vision into a commercial venture. Any serious investor will look to see if the founder and management understand the commercial aspects of their biotech venture.

"Early-stage funding often goes the 'Three F' route- friends, family, and fools. This is typically not enough money to get you where you need to be in order to be attractive, but it may be your only option in the beginning. Be careful not to give early investors terms that can mess up your chances of attracting venture capital funding sources down the road," says Ferruolo. "Use experienced advisors to keep your capital structure flexible so that it does not have to be undone or restructured later. Early-stage funding can help develop your idea or product, and a proven track record makes you more attractive for future venture capital funding."

There are a number of other early-stage funding alternatives that can help you grow to the venture capital stage. Several incubators around the country specialize in biotech startups or can help biotech firms get their feet on the ground with a variety of services and resources.

ATTRACTING CAPITAL

Bio/Start, a biomedical business incubator in Cincinnati, is working to assist entrepreneurs whenever possible. "We provide newly-formed life sciences companies with a mix of low-cost, stateof-the-art wet-lab space; office space and services; business and scientific expertise; and a supportive entrepreneurial culture vital to any fledgling enterprise," says Carol J. Frankenstein, president of Bio/Start. "Major benefits of locating in a biotech incubator include turnkey Class A laboratory facilities, lower capital investment through shared equipment and services, reduced time to market, valuable university research base ties, and access to industry and support service sponsors."

Bio/Start offers services such as business plan presentation, small business know-how, biomedical resources, information on investment tax credits and economic development incentives for new and expanding firms, access to seed and early-stage capital programs such as SBIR (Small Business Innovation and Research) grants, local and regional angel networks, and venture capital funds. For example, competitive SBIR grants can provide $100,000 for Proof of Concept and between $750,000 to $1.2 million for further research, depending on the sponsoring agency.

Frankenstein advises biotech entrepreneurs to avoid four major pitfalls in attracting capital: 1 . failing to properly define the size and growth potential of the market and competition, 2. overestimating the value of the company and its product, 3. not having an experienced management team in place and 4. presenting poorly conceived goto-market strategies.

"Our location in Bio/Start provides us access to high-quality lab space at below market rates and the opportunity to meet with angels investors and venture capital groups," says Frank Zemlan, CEO of Phase 2 Discovery, a leading provider of discovery research and development services for pharmaceuticals and biotechnology companies.

Phase 2 Discovery employed another capital-saving tactic to get its business off the ground - It purchased a compound from a major pharmaceutical firm.

"It is less expensive to purchase compounds, which do not fit a large pharmaceutical firm's strategic focus or meet its projected sales cutoff criteria of a half a billion dollars in annual revenues, than to develop them from scratch ourselves. An estimated one third of all compounds developed are available for purchase," said Zemlan.

While some firms like Phase 2 Discovery acquire their compounds and potential products from large pharmaceutical companies, others partner with major drug, medical device, and biotech companies to further develop their products and ideas. The small firm brings to the table a particular application in which the large firm has a market interest, while the larger partner provides needed capital funds plus management and regulatory expertise to get the product successfully to market. It's a win-win situation.

PARTNERSHIPS

"Be very careful in planning and drafting partnership and strategic alliance agreements. Make sure you don't give away the shop," says Jonathan Lourie, a partner with Edwards & Angell LLP, in Boston. "Protect your own piece of the technological pie and your ability to make future partnership agreements. Identify how many uses your technology platform can potentially be used for before entering into any partnerships, because a particular partner's expertise may not stretch beyond one or two areas."

Lourie points out several advantages of partnership arrangements. First, an entrepreneurial biotech firm can typically get easier terms from an alliance partner than from other financing sources. Alliance partners usually do not want board seat representation, more than a 20 percent stake in the firm, or various antidilution clauses such as preferred liquidation. Second, due to the above, the period of negotiation can be shortened dramatically. Finally, successful partnerships can help the company achieve a significant milestone event in the development of its product and market application, which helps create marquee value and venture capital interest for future development funding.

Robert S. Hillman, Ph.D., cofounder and COO of La Jolla, Calif.-based Activx Biosciences, Inc., and co-founder of a number of other early-stage biotech firms, offered this advice for attracting capital: "Of course, you start with a core of good technology and back that up with a brain trust of talented scientific founders and consultants, good management personnel, and a legal team which can provide patent protection and help implement the idea. This puts flesh on the bones so that the investor can see the potential of your idea.

Southwest Michigan First, a 501 (c) 3 corporation formed by Fortune 500 CEOs and higher education leaders to promote economic development, is one company willing to invest in biotech firms. "We have targeted life sciences firms in the Kalamazoo area because we have a strong employment base in the life sciences industry, a strong history of university applied science, a network of quality management talent in the biotech industry, and strong business infrastructure to support and grow new biotech firms," says Barry Broome, CEO and executive director. "We have backed this up with a $100 million early-stage venture fund actively seeking brilliant business plans, a $135 million university business technology and research park, 60,000-square-foot facility featuring wet-lab space and the quarterly Investing in Innovation Forum Series."

One of the companies Southwest Michigan First took interest in was NephRx Corp., a biotech start-up that researches and develops therapies for acute kidney diseases.

"Michigan First looked at me as a bankable CEO, able to take NephRx through the product-- launch stage based on my past experience," says Peter Croden, CEO of NephRx. "The firm had licensed technology from the University of Chicago and moved to Michigan, which is investing aggressively to build up the its 1-94 biotech corridor. Southwest Michigan First provided the ideal atmosphere and wet-lab access for our start-up operation." NephRx received $750,000 from venture capital seed funds and two angel investors, and another $500,000 from a patent rights agreement with a major pharmaceutical.

Biotech firms can also tap the power of the internet to find sources of start-up and expansion capital. Websites such as www.vFinance.com match up entrepreneurs and high-net worth individuals interested in investing. If you don't yet have your own circle of venture capital contacts, vFinance allows entrepreneurs and investors to search by industry, geographical location, net worth, and deal size.

"We get over 10 million hits per year with a worldwide audience searching for investments in new technologies and new companies. Entrepreneurs can post their business plans and search for the right angel," says Victoria Santaella, director of research for vFinance in New York. "For deals in the $10 to $100 million range we can provide individualized investment banking services such as mergers and acquisitions, financial advisory, and private placements."

KEEP SEARCHING

While other biotech firms have had to search long and hard to obtain proper capital financing, Houston-based Xeotron Corp., a manufacturer of flexible, high-performance, cost-effective biochips (microarrays), had to turn away money and potential investors when it looked for its first round of funding.

"We originally intended to seek $1 million in order to draw on nonequity money to grow our technology base. We quickly realized that we were in a fast-paced, highly competitive industry and opted for $9 million in initial funding and had to turn away investors," says Dr. Martin Lindenberg, chairman and CEO of Xeotron. "There is a delicate balance between obtaining the right amount of funding to keep your competitive edge and taking too much and giving away too much of the company."

Investor confidence in Xeotron appears well-founded. Prior to seeking funding, the firm had already garnered a U. S. Department of Defense grant, which led to applying the firm's flat-panel-display technology to biomolecules and DNA. Also, the biochip market is projected to grow to between $1 billion and $3 billion in annual revenues over the next five years.

"A lot of venture capital funds had heard of our technology, track record, and market before we went to raise money. That certainly made our capital funding options easier," says Dr. Lindenberg.

While the money taps may not be flowing as freely for every biotech firm seeking start-up or expansion capital, there is gold to be found with solid technology, innovative products, a good track record, solid management, and prudent advance planning. Go for the gold.