For The Entrepreneur
Key Considerations in the Hunt for Venture Capital
While entrepreneurs face numerous challenges, one that many find most daunting, especially in the startup phase, is raising capital. The hunt for venture capital can be frustrating and intimidating, but it can also be exciting, interesting and ultimately successful. There is as much art as science involved in raising capital, and every entrepreneur faces his or her own unique set of circumstances. However, a few simple tips can greatly increase your likelihood of success.
“This may be the single biggest determinant in how successful you will be in securing an investment,” says Joseph Gitto, Managing Director of Geller & Company’s Emerging Business Group. “Different venture capitalists (VCs) invest in different types of businesses and at different stages in their evolution.”
Start by Doing Your Homework
Visit a number of VC websites, and tap trusted advisors for help in understanding the positives and potential negatives of the various capital sources available in the marketplace, suggests Ryan Ziegler, an investment manager at Edison Venture Fund. “Too many capital sources around the table is hard to manage; it’s what we call a ‘syndicate fallacy,’” he says.
Determine how much money you need to support your execution plan over the next 24 months—the “capital efficiency argument,” Ziegler calls it. “You need to find the right balance. If you over- or under-capitalize your business, you have the potential to diminish future returns.”
As you narrow down the pool of potential VC backers, learn as much as you can about their individual investment strategies. Focus on the ones whose strategies are most closely aligned with your business plan. For more on raising capital, click here.
Hone Your Presentation
You should be able to present your case in a clear, concise and compelling manner in the Executive Summary section of your business plan. Ziegler suggests presenting it in a problem-solution format. “What is the business problem? How does your solution solve this problem? Demonstrate your knowledge of the marketplace, and be able to explain why you are unique,” he says.
During face-to-face meetings, stay focused on the reason you are there, which is to raise money, Gitto advises. “Your motive is to convince your listeners that investing in your opportunity offers them the best potential return among all the other opportunities they are considering,” he says. “Zero-in on the business case and stay there; don’t worry about ‘wowing’ them with your technology, service or product. They are already convinced that it’s got some potential or they wouldn’t have agreed to the meeting.”
“VCs want to know everything they can about you, your management team and anybody else who is critical to the venture’s success. At the end of the day, the decision to invest will be heavily weighted by the confidence the VC has in you and your team. Investors bet on the jockey, not on the horse.”
Based on the research you did earlier, map your business plan to the VC’s investment strategy. “Give the investor a reason not to say ‘no’ because you’ve aligned your company’s plan with something they believe in,” Ziegler says. For more on how to perfect you presentation, click here.
Demonstrate Management Team Self-Awareness
Potential investors are most interested in the people behind the opportunity. “VCs want to know everything they can about you, your management team and anybody else who is critical to the venture’s success,” Gitto says. “What is their track record in similar historical situations? Can this management team execute at the level required?”
Naturally, you want to paint the most positive picture possible, but make sure you can back it up, Ziegler warns. “Be candid about your strengths and weaknesses both, and be ready with an answer on how you plan to address the latter,” he says. “Provide client references, case studies and real sales pipeline data to back up what you say.”
Needless to say, VCs will weigh your proposal from the perspective of whether or not it will produce an acceptable return on their investment, so your presentation must be able to make that case. But it’s not just about pie charts and sales graphs, Gitto emphasizes. “At the end of the day, the decision to invest will be heavily weighted by the confidence the VC has in you and your team,” he says. “Investors bet on the jockey, not on the horse.”
For more information, please contact Joe Gitto at jgitto@gellerco.com.
Capital Trends
Challenges are Greatest for Early-Stage Life Science Companies
The cost of developing and bringing to market a novel therapeutic technology can reach a fully burdened expense of up to $800 million, according to a life sciences strategic action plan developed by the state of California. Finding that kind of money can present big challenges for life sciences firms, especially for early-stage companies.
The current venture capital model is in some ways inconsistent with the capital requirements of life sciences startup companies, since traditional venture capital typically requires an exit strategy in the relatively near term. On average, clinical trials and FDA approval for a single therapeutic agent can take up to nine years. Even then, a startup company faces significant additional hurdles before it has a marketable product. For many venture capitalists, that timeline is simply too long.
A Struggle for Funding
“The biggest challenge for early stage biotechnology companies is figuring out how to get funded,” says Steven A. Elms, managing director of New York-based Aisling Capital and former principal in the Life Sciences Investment Banking Group of Hambrecht & Quist. Besides the long time frames involved, life sciences investments also entail a high degree of risk: About 50% of Phase 1 drugs fail, he notes.
In “Science Business: The Promise, The Reality and The Future of Biotech” (Harvard Business School Press, 2006), author Gary P. Pisano, a professor of business administration at Harvard Business School, argues that there is a “fundamental and deep struggle between the conflicting objectives and requirements of the science of biotechnology and the business of biotechnology.”
Disconnect Between Revenues and Profitability That conflict spans many areas, including differences in cultural norms, values and practices, Pisano notes, but at its core is the disconnect between revenues and profitability in the biotech sector over the past three decades. While revenues reached about $36 billion by 2004, the overall sector remained in the red through most of that period and only began generating meager profitability halfway through 2003, according to Pisano’s research.
Not surprisingly, life sciences entrepreneurs recognize the scope of the challenge they face. In a 2006 survey of chief science officers at biotechnology companies conducted by the life sciences practice of Pepper Hamilton, a Philadelphia law firm, 100% of those polled cited securing financing as one of their top concerns.
“The biggest challenge for early stage biotechnology companies is figuring out how to get funded. Early-stage companies are usually focused on research and development and faced with the prospect of spending a lot of money before they ever get a product approved, which is why there are so few profitable firms in that segment.”
Nonetheless, many life sciences enterprises are successful in securing the financing they need each year, sometimes accomplishing that feat in novel ways. As Elms points out, it is important to acknowledge the distinction between profitability and return on investment for backers in any discussion of life sciences financing.
“Early-stage companies are usually focused on research and development and faced with the prospect of spending a lot of money before they ever get a product approved, which is why there are so few profitable firms in that segment,” he says. “However, there are other ways for investors to achieve ROI in this sector, including merger and acquisition activity and, for companies with Phase 3 clinical products with reasonable market expectations, public offerings.”
Unique Strategies to Secure Financing Large pharmaceutical companies sometimes are willing to partner with early-stage biotech companies whose products they consider promising, and some big drug companies have launched venture capital arms to invest in startups. In addition, there are a number of life sciences specialist firms in the venture capital field, although most favor investments in mid-stage or later companies.
Because of the high failure rate for Phase 1 drugs, early-stage life sciences companies face the toughest hurdles. Companies with products in Phase 2 and Phase 3 clinical trials—where the results are likely to reveal if the drug will be efficacious—have more access to venture capital.
“For early-stage companies, focusing on securing government grants and working out of universities can be effective strategies,” Elms says. “Once you get into clinical development, you open up a whole new realm of investor. There is a lot of money available for mid-stage development, as long as the drug is unique. Investors will take efficacy bets if there is good clinical data pointing them in that direction.”
For more information, please contact Stash Lisowski at slisowski@gellerco.com.
Financial Reporting
Life Sciences Companies Have Special Needs in Professional Services
Life sciences companies are subject to the same financial reporting standards as any other type of company, and they must comply with all applicable rules and regulations. That said, there are a number of financial reporting and legal issues that may have particular relevance to companies in the life sciences sector, depending on their specific circumstances. Additionally, there are factors life sciences companies should consider when choosing professional services providers, such as accounting firms and legal representation.
Intellectual Property Is a Key Issue
“There are a lot of different roles professional services providers play for life sciences companies, and the nature of intellectual property figures large in most of them,” says Leslie Gladstone Restaino, Esq., an attorney with Sills Cummis Epstein & Gross, P.C., and herself a scientist. “The nature of intellectual property raises issues in both the legal and financial reporting arenas.”
Among those issues on the financial reporting front are questions relating to revenue recognition, collaborative agreements, net-vs.-gross treatment of revenues, expensing of research and development costs, and merger and acquisitions.
“The situation can become very involved very quickly where intellectual property is concerned, and intellectual property is at the core of most life sciences companies,” Restaino says. “For example, if you are the holder of intellectual property, you may be a licensee, a licensor or both. You have to report any revenues flowing from the licenses involved, but you may also be paying royalties to yourself in some cases. That’s a tricky situation from a financial reporting perspective. It can become very convoluted, and it’s something that must be considered carefully.”
“It is really important for life sciences companies to find professional services providers that are familiar with the entire industry, well-versed in both the science of the technology and what it takes to leverage it, and capable of analyzing and providing guidance on all relevant regulatory and reporting requirements.”
Regulations and Guidance
Issues such as those mentioned by Restiano can crop up in a variety of financial reporting areas. A sampling of some of the regulations and guidance that may apply includes, but is not limited to, Staff Accounting Bulletin No. 104, Emerging Issues Task Force No. 99-19, Emerging Issues Task Force No. 00-21, Financial Accounting Standards Board Statements Nos. 2, 141 and 142, and other generally accepted accounting principles (GAAP) guidance.
SAB 104, for example, deals with recognition of various revenue elements in a collaborative agreement, something common to many life sciences companies. EITF 99-19 provides broad guidance on net-vs.-gross treatment of revenue, but interpreting it appropriately for a life sciences company’s specific situation requires specialized skills and expertise.
Finding a Professional Services Company with Deep Expertise
“Therein lies the problem,” Restiano says. “One of the things I have seen is that many life sciences companies retain professional services firms that may be good at certain things, but are not well-versed in all the important issues affecting this sector.”
For example, a company might retain legal counsel that is skilled at writing patents, but not at understanding the issues involved in leveraging intellectual property commercially and managing product lifecycle—two big issues for many life sciences firms, she says.
“The same thing applies on the financial reporting side,” Restiano adds. “It is really important for life sciences companies to find professional services providers that are familiar with the entire industry, well-versed in both the science of the technology and what it takes to leverage it, and capable of analyzing and providing guidance on all relevant regulatory and reporting requirements. I’m not sure enough of them do that.”
In subsequent issues of Finance & Accounting View, we will examine other financial reporting and professional services issues unique to the life science sector in more detail, with a focus on the challenges involved and how companies can meet them.
For more information, please contact Stash Lisowski at slisowski@gellerco.com.
