Shimasaki Craig D. The Business of Bioscience: What goes into making a Biotechnology Product
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and introductions to others. Having a motivated and excited Angel investor telling
the company story is more effective than the entrepreneur doing it cold. There are
many Angels out there – be persistent in locating them.
Angel investors are motivated to invest in companies because they can either
relate to the market need, have a desire to support biotech in their community, or
because they believe in the CEO and his/her ability to make it a success. At one orga-
nization I cofounded, we raised $18 million during four financing rounds from 50
Angel investors and one small local fund. Raising this amount of capital from Angels
is extremely difficult because of the large numbers of investors needed and the work
to manage and communicate with this number of shareholders. Also, Angels may
require more time to educate since they may have limited experience and expertise in
the field of biotechnology. However, there is a growing number of experienced bio-
technology and high technology Angels who became successful through exits from
their technology company start-ups. For us, going the Angel choice was a natural
choice to get the technology developed because this company was not located within
a biotech hub.
Private Placements or Private Offerings
Raising money for a biotech company is, in essence, selling underlying securities
(stock or equity) in the company. As such, these activities fall under Securities and
Exchange Regulations. These offering are called “Private Offerings” or “Private
Placements” as opposed to “Public Offerings” such as an IPO. Specific offering
documents are needed, and a good securities attorney will take care of the regula-
tory filings when raising capital. However, most of these activities fall under
exemptions of the Securities laws. The most common exemption is called
“Regulation D” and is a Safe-Harbor Exemption. Under these laws, a company may
be exempt from many securities requirements, but there are still obligations and
legal requirements for disclosure. Be sure your securities attorney advises the com-
pany on how to proceed and comply with any filing requirements.
When soliciting investments from individuals, they will expect to see a “Private
Placement Memorandum,” which is your offering document; in investor circles this
is called “the book.” Basically this book contains your complete business plan
along with your financials, your sales projections, a potential return on investment,
and a laundry list of risks associated with this endeavor. Your securities attorney
will review these documents and more than likely help describe the risks, but the com-
pany will be writing the business plan. The business plan is a critical document that
opens or closes the door to interests and investments in the company, so it is impor-
tant to devote the time and effort to developing an excellent one (Business Plans are
discussed in more detail in Chapter 9). When raising money from individual inves-
tors through a private placement, it is wise to accept money only from Accredited
Investor as this assures that the investors understand the risks associated with an
investment. Also, by raising money only from Accredited Investors, if the company
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is unsuccessful, this loss of investment does not significantly impact Accredited
Investors as much as it would others. For more information about securities regula-
tions see the SEC website.
The Venture Capital Industry
Venture Capital (VC) is composed of funds used for the purpose of investing in higher
risk ventures expecting to produce higher rates of returns. In the early 1970s, a phe-
nomenal number or computer chip and electronic industry companies were started
with VC. The success and growth of these companies brought the local establishment
of more VCs, which in turn fueled a myriad of companies in the Santa Clara Valley,
and begat what is now known as Silicon Valley. VC continues to provide the bulk of
funding for the biotechnology industry, especially during the later development stages
of biotech companies where large amounts of capital are consumed.
The size of any venture fund varies greatly, from $20 million to over $5 billion
dollars per fund with over 900 VC funds in existence. VC funds are managed by
General Partners, and the money in these funds usually comes from individuals and
institutions and even other funds. VC fund investors are called Limited Partners.
VC funds are usually set up as LLCs for the protection of the Limited Partners and
for certain tax treatments. There are VC funds directed to most every type of industry
such as IT, Software, Life Science, Therapeutics, Diagnostics, Medical Services,
and some large funds invest in all of the above. In 2006 almost $8 billion dollars
was invested into biotechnology companies by VC (see Table 1).
It is tempting to ask the question, “Why all the interest in VC? Can’t we continue
by getting money from Angel investors?” The answer to that question is, “yes!” Some
biotech companies that operate in a segment of the biotechnology industry (other than
therapeutic companies) with lower development costs, may be able to build a diag-
nostic or clinical laboratory testing company with just Angel investors, but this is
extremely difficult. Though it can be done, it is rare to find a successful biotechnology
company that reaches the market without VC. Growing a biotech company without a
VC requires many more individual investors, and usually these investors do not come
Table 1 Venture Capital Investment in Life Sciences by Sector for 1998, 2000, 2002,
2004, and 2006
Biotechnology Medical Devices and Equipment
Year Deals Amount Invested Deals Amount Invested
1998 276 $1.5 Billion 280 $1.2 Billion
2000 348 $4.1 Billion 286 $2.4 Billion
2002 307 $3.2 Billion 233 $1.8 Billion
2004 374 $4.2 Billion 272 $1.9 Billion
2006 452 $4.6 Billion 352 $2.9 Billion
MoneyTree
TM
Report Q1, 2009 from Pricewaterhouse Coopers/National Venture Capital
Association based on data provided by Thomson Reuters (Thomson Financial is now
Thomson Reuters)
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with the experience of a good VC. Before taking this alternate and less conventional
funding path, first determine whether this capital source can and would be willing to
sustain all of your financial needs to reach commercialization.
Venture Capital Brings More Than Just Money
A VC investment comes with much more than just cash. Good VCs come with
valuable expertise, contacts, and help in guiding a business through growth, devel-
opment, and market challenges. If you had a choice between $5 million dollars
from a group of individual investors or $5 million dollars from a top VC firm in the
industry, you should go with the VC firm even if it meant giving up more equity
and Board representation. The reason for this is that the level of help, experience,
and contacts that come with good VCs will improve the likelihood of success for
the organization. In addition, VCs have working relationships with other VCs, and
if the company runs into development or market challenges that require much larger
financing rounds later, VCs can bring others to the table to help. Whereas individual
investors do not typically have the capacity to sustain the level of funding required
for a growing organization with expanding financial needs.
Finding the Right VC
Finding the right VC partnership is critical to the ultimate success of a biotech
organization. Notice the term “partnership.” Just as a company should desire to
partner with the best collaborators, they must also seek partnerships with the best
VCs in their industry sector. However, all VC firms are not created equal. Search
for VCs working on successful deals in your technology or market space. Check
out their track record, and research their partners and associates, backgrounds. Do
they have the knowledge, expertise, and good judgment skills that would improve
the decisions made by the company? Talk with VC’s portfolio companies and find
out if they work well with the companies currently in their fund. Do they have the
patience to listen to problems, and offer sound solutions and advice? Do they have
the contacts that can help grow and develop the organization? These are the types
of questions to ask of VCs and their portfolio companies. When searching for a VC,
start with a list of the top five to ten that would be ideally suited for the company,
and then specifically target them for interest. Attracting VC interest depends on
many factors such as the scientific merit of the organization, the development stage
of the company, the capabilities of the company management, in addition to the
number of deals the VC has already funded, and the stage of their current fund.
In general, most large VC firms do not focus on start-up companies unless they start
them themselves; although this varies depending on the economy and capital markets.
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Some VC funds will allocate a portion of their fund to early stage development.
However, focusing all your efforts trying to attract VCs as a start-up company may be
a time-consuming, low payoff, and disappointing endeavor. One reason that VCs do
not typically invest in early stage start-up companies is that they have specific time
horizons for their fund, and a typical fund life cycle is 10 years. It is important to ask
where a particular VC fund is in their life cycle. Ideally, seek a fund that is in the first
third of its life cycle because they will have the longest investment horizon. A fund in
the middle of its investment cycle begins to be selective as to the stage of investment
and the potential length of time to an exit. The final third of a fund’s life cycle is
spent predominantly on follow-up investments and liquidations in existing portfolio
companies, some which are successful and some unsuccessful.
The amount of money that a VC needs to put to work is enormous. A $1 million
investment in a company takes the same amount of time to follow and manage as
does a $20 million dollar investment, and for a $200 million fund, the $1 million
dollar investment would not be a wise time decision. A good use the entrepreneur’s
time during the company start-up stage is to inform selected VCs of your develop-
ment progress, and propose to keep them apprised as you move through your prod-
uct development stages. Let them know that the company is not seeking VC
funding at this time, but would like to know if they would be interested in being
updated on the growth and development of the organization for potential future
discussions. Work to prepare future opportunities, and establish some history and
credibility with these organizations.
How NOT to Find a Venture Capital Firm
Early in my entrepreneurial career while at one start-up company, I presumed that
the greater the number of VCs I contacted, the better my chances of finding one that
will invest. In my mind it was a numbers game. So I purchased an expensive list
containing all the e-mail addresses of Life Science VC firms in the US and over-
seas. I then carefully crafted what I thought was a winning Executive Summary, and
described the steps we were taking to turn this science into a blockbuster product.
I crafted an enticing introductory e-mail, and carefully selected over 200 VC groups
in the Life Science area, then confidently hit the “send” button. I presumed I would
find many eager investors, so I anxiously awaited their interested responses. Out of
the 200 solicitations, only 30% responded. Of those 60+ responses the vast majority
of them were some version of the following examples:
“Thank you for the information regarding your company. Unfortunately, due to •
capital constraints through the bank, we are pursuing very few new opportuni-
ties this year so we will not be able to pursue yours. Best of luck with your
financing efforts.”
“Does not fit into present portfolio, will keep for one year and if position •
changes we will contact.”
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“Unfortunately, we do not feel that this business would be a suitable investment •
for our funds and we are therefore unable to pursue this further. However, I
thank you for giving us the opportunity to review this proposal and I wish you
success with the fundraising.”
“After careful review we have determined that this opportunity is early for our •
portfolio. We typically invest in later stage technologies that have some clinical
trial data. Please keep us apprised of your continued progress.”
“While we find your business proposal has merit, unfortunately it does not meet •
our investment criteria of the funds from which we are making new invest-
ments at this time. Should there be significant developments which you feel
might warrant reexamination of your business plan at a future time, please con-
tact us through our website or via e-mail.”
“Thanks for the information. Unfortunately, we are not interested in pursuing •
this opportunity because it is outside our area of geographic focus which is the
mid-Atlantic region. Good luck in your fundraising efforts.”
More responses continued to trickle in over the next 3–4 months, with an occa-
sional request for clarification, or forward to a more appropriate partner in the
organization. Encouragingly, I finally received seven “maybe” responses. I was
excited that one of these could be my next financial partner for our new start-up
company. Some correspondence continued with these seven, including an occa-
sional phone conversation. In the end, I received one weak interest for a presenta-
tion. I flew to their office to give a presentation. I was confident that they were
going to invest in our start-up company. This effort resulted in no investment. The
partner I was talking with initally had only moderate interest, which was not shared
by any of his partners. At the end of this 10-month process, I had no deal, and no
money. After this disappointing experience, we then focused on local interest from
high-net worth Angel investors and raised two rounds of capital, $1.25 million, and
$2.4 million each. I share this example with you to emphasize the importance of
spending time with the right VC at the appropriate time of company development,
and specific to the VCs sector of interest and geographic location.
After securing a start-up and seed round, it is worthwhile to explore interest
from selected VCs that like to invest in early stage development companies. It is
important to have enough capital from a seed round, and a low capital consumption
rate (otherwise known as “burn rate”). Make sure that the capital will at least sus-
tain the organization for 12–18 months while exploring additional Angel and VC
interests simultaneously. During this time, focus on making significant progress
toward milestones to increase the likelihood that funding prospects will improve.
Additional information about VC in the US can be obtained from the National
Venture Capital Association (http://www.nvca.org). VC information in the UK can
be obtained from the British Venture Capital Association (http://www.bvca.co.uk);
in Europe, from European Venture Capital Association (http://www.evca.com); in
Canada, at Canada’s Private Equity and Venture Capital Association (http://www.
cvca.ca); in Germany (http://www.bvk-ev.de) and in Japan, at Japan Venture
Capital Association (http://www.jvca.jp). Links to VCs in other countries can be
found at http://www.nvca.org.
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The Dark Side
Just as in all industries, there is a “Dark Side of the Force.” Some entrepreneurs
have termed these individuals as Vulture Capitalists, because of their aggressive
opportunistic behavior, although this group comprises a very minor segment of the
VC industry. A colleague shared with me an encounter with an opportunistic VC who
actually believed that it was their life purpose to crush or punish the former investors
as a condition of investing – just because they can – not because it was reasonable.
However, this is not the mindset of the majority of venture capitalists. Just as one
encounters good and bad mechanics, realtors and doctors, one will also find good and
bad venture capitalists. However, do not be naive; VCs would not be in this business
if they were simply purveyors of goodwill. No matter how much they like an entre-
preneur, they cannot make unwise financial decisions with their institution’s funds.
Seek a VC partner that plays two roles – an investor and a strategic advisor.
A good VC must possess the experience and insight to add greater value to a grow-
ing business moreso than what a company could do without them. Sometimes a
company does not have a choice in VC because sometimes only one avenue for
financing presents itself. For this reason, it is important to start a VC search early,
and target only those VC groups that fit with the organizational goals of the company.
Ideally, search for a venture fund with general partners and team members that share
similar goals, ideals, and values, because these individuals become partners who will
be providing help, expertise, and guidance in the future direction of the company.
How Do You Approach Venture Capital?
Many VCs will say that the best way is to reach them is through an introduction
from someone they know. Having an experienced biotech start-up attorney usually
comes with the benefit of personal contacts to high-net worth individuals and VC
firms. Your corporate attorney may be able to provide a valuable VC introduction,
which is a good way to get a business plan in front of a VC firm. VCs receive
numerous unsolicited business plans each year, and most get rejected. One VC
partner told me that they see on average 1,000 business plans each year, then
do further research on about 2 dozen. Of those 20–30 plans, they invite 10 for
presentations and invest in 2–3 deals. It is easy to see that these statistics are not
favorable for random deals, so it is important to have as much going for the company
in order to secure VC funding. Diligently find ways to get an introduction to the
VCs you are seeking, but if you still cannot find a contact, reach out to them
directly anyway with key information that you believe will catch their attention.
VCs are extremely pressed for time. They usually sit on several Boards of their
portfolio companies, which have needs and problems that require their help. VCs
also have Limited Partners to report to and communicate the progress of their port-
folio and their fund’s returns. Also, VCs usually have families. With limited time
and attention, be sure to cut to the chase and give VCs the most important information
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that is of interest to them. However, do not ignore the personal nature of a relation-
ship, because at the end of the day, the VC partners need to like, rather than loathe
working with you if you expect to have a chance of them funding a deal.
It is important to realize that VCs see many business plans containing many differ-
ent technologies. Understand that anything sent to them should be considered public
information or nonconfidential. For confidential information that still needs to be pro-
tected, it is best to describe briefly the information in a nonconfidential manner. Do not
expect a VC to sign a confidentiality agreement to review your business plan. It is
unrealistic to presume that any information sent to a VC will be held in confidence –
this is just not possible to do while reviewing the massive amounts of information that
they receive. Some VCs are very considerate and may actually ask permission before
sending your plan or material to others. Regardless, expect that anything sent to VCs
may be circulated to others from whom they may need an opinion.
Before VCs reach to an investment decision, you will be invited to meet them and
give a couple of presentations to them and their partners. Face-to-face meetings are
important opportunities to increase their interest in you, your technology, your mar-
ket, and your company. In Chapter 4, we discussed five key elements that are critical
to a successful biotechnology company. These are virtually the same elements that
VCs will be looking for as they meet you and assess your opportunity. Refer to these
elements and take steps to improve each one. If your business attractiveness is not
great right now, a year or two later it may be a fundable VC deal. There are many
books on the subject of VC funding, and it is worth the time and money to purchase
and review them. Finding the right VC takes time. If you are seeking your first round
of VC capital, it would not be unusual to expect a period of 1–2 years from initiation
to final funding, as you search for the right VC partnership.
The Term Sheet
Successful investment interest from a VC firm will result in a “term sheet.” The “term
sheet” is a list of broad terms and conditions under which the VC group is willing to
invest in the company. The terms outline the amount of money they will invest and
under what conditions or “terms” they will invest. There are many conditions included
in a term sheet, and some of the more common terms include the following:
Type of stock: preferred, Jr. preferred, common, warrants•
Liquidation preferences•
Dividend preferences•
Redemption rights and price•
Conversion rights•
Antidilution provisions•
Rights of first refusal•
Price protection•
Voting rights•
Registration rights•
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The definitions of these terms are included in the Glossary. This is not an exhaus-
tive list of terms, but it includes some of the most common ones seen in a VC term
sheet. Some of these terms are negotiable and some are not. This is where your
attorney will assist by helping you understand these terms and their impact on your
company and future fundraising efforts. Also within the term sheet will be an
implied assessment of your company valuation. This is the amount of money they
estimate your company is worth, and is used to calculate the equity ownership of
the new money, and amount of stock that the investor’s will receive (see Chapter 9
for a discussion of Company Valuation). You can obtain an example of a standard
term sheet from the National Venture Capital Association’s website, in their
Resources Section under “Model Legal Documents” (http://www.nvca.org).
What Is Due Diligence? How Long Does It Take?
Once a term sheet is received, the next step is for the VC group to perform due dili-
gence on the company. Due diligence is a detailed review and thorough examina-
tion of technology issues, intellectual property, market assumptions, and corporate
structure and agreements. Completing due diligence requires considerable time and
effort from both the company and the interested investment group. This process can
take between four and six months of work for a team and corporate counsel. Once
due diligence is completed, any uncovered issues need to be remedied before clos-
ing. If successfully dealt with, a closing date will be set for funding. Closing is a
joyous occasion, and the actual process is not too dissimilar to closing on a new
home – just more paperwork.
The Funding Chasm: Bridging from Angel to Venture Capital
The funding stages discussed in this Chapter may appear to be presented as a steady
continuum of raised capital throughout the company’s development; however, this
is not always the case. The two most common biotech funding groups, Angel inves-
tors and VCs, have vastly differing financing capabilities, and typically invest at
different stages of a company’s development. Since Angels typically invest between
$25,000 and $250,000 and VCs typically invest in the range of $3–$25 million dol-
lars or more (usually in syndicate), a potential funding gap exists for investments in
the range of $1 million to as much as $5 million dollars. During the technology and
market decline in 2000, these two investor groups spread further apart without much
overlap, because of the huge losses sustained by VCs during the dot-com era.
The financial chasm in the funding of a life science company must be crossed to
have the opportunity to reach the biotechnology Holy Grail – product commercializa-
tion. This financial chasm is the transition from Angel to institutional or VC funding.
A scene from Indiana Jones and the Last Crusade, depicts Harrison Ford’s character,
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Indiana Jones passing two deadly obstacles on his way to reach the Holy Grail, only
to face a third more challenging obstacle – crossing the chasm. In the movie, he closes
his eyes, takes a leap of faith and a potentially life-threatening step, finding he is sup-
ported by an imperceptible surface, and safely passes the deadly chasm. This scene
conveys a similar degree of potential fear and trepidation that an entrepreneur may
sense, approaching this financing gap during critical stages of development. Many
companies run right up to the funding edge and have no alternatives remaining. Some
refer to this financing period as the “Valley of Death.” It is the stage of development
where a company comes closest to capital exhaustion, even though major investments
have been made into the technology and product’s development.
Some companies never make it past this investment chasm. Therefore, it is
imperative that the company work toward doing any or all of the following prior
to facing this investment chasm:
1. Find Angel Investors that have more than the typical capacity of $25,000–$250,000
to invest in your organization.
2. Attract greater numbers of Angels that have the typical investing capacity.
3. Supplement the need for Angel funding with large SBIR grant awards such as
those in Phase II.
4. Keep overhead low in order to focus existing capital toward advancing the technol-
ogy to reach significant funding milestones with less capital to attract VC sooner.
5. Search out VC funds that specialize in early stage development. Find those that
are familiar with your technology area and have been successful in these fields in
the past.
6. Plan to initiate early the VC relationship search, to jump-start the time to reach
and secure investment from these groups.
7. Make use of many new transition funding opportunities available for high tech-
nology companies from state and local government.
Plan for funding gaps – especially this one. Work on as many alternatives as pos-
sible to extend your time to reach the next stage funding sources. A temporary
funding gap option one may need to consider is Convertible Bridge Notes (described
in Chapter 9).
Nonprofit Foundation Partnerships
A relatively new funding source for biotechnology companies has opened up from
nonprofit foundations. In the past, disease foundations traditionally funded basic
research through grant awards for researchers at nonprofit institutions. Recently,
disease foundations have started funding drug development in biotechnology companies
that are working on drugs targeting their specific disease interest. The rationale is
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that instead of putting all their money into basic research where the opportunity for
a new drug is 12–15 years away, they can fund drug development in existing com-
panies with drugs already in development where the potential exists to see an
approved drug sooner. One example is the Cystic Fibrosis Foundation that has
funded several early stage companies focused on drug development for Cystic
Fibrosis. Cystic Fibrosis Foundation’s Therapeutic, Inc. invested tens of millions of
dollars in companies at early stages of drug development when few other investors
were willing to invest. These foundations help move potential drugs one step closer
to the market in exchange for a royalty on future sales. Many other foundations are
following this funding model, such as the Juvenile Diabetes Research Foundation,
Michael J. Fox Foundation for Parkinson’s Research, Multiple Myeloma Research
Foundation, Muscular Dystrophy Association and the Huntington’s Disease
Foundation just to name a few. If your research and development is in a disease area
with a nonprofit foundation focus, it may be worthwhile to look into this type of
financing assistance. More foundations are supporting biotechnology companies
long-term, and this financing strategy may begin to play a more significant role of
biotech drug development in the future.
Industry Corporate Partnership
Another source of significant capital comes from equity partnerships with pharma-
ceutical companies, or other organizations that can back a biotech company finan-
cially. These are corporate partnerships with organizations that collaterally benefit
from the development of a company’s product. These can be pharmaceutical com-
panies, collateral industry benefactors, or large national laboratories. The biotech
company must possess something of value to a corporate partner. It may be a prod-
uct that provides increased sales of existing products, or gives them a complemen-
tary product in their existing market, or leverages their existing distribution and
sales channel, or potentially something competitive to their existing products.
Typically, entering into a corporate relationship with pharmaceutical companies
and large industry partners occurs at later stages of product development. However,
it does not hurt to solicit interest from these organizations early on, as they may
have a special interest in earlier stages of development. Also they may have need
for your particular product and technology to fill their product pipeline (corporate
partnerships are discussed in Chapter 12).
Institutional Debt Financing
This funding avenue is one not typically available to start-up companies, but is
directed toward companies having products in the market or near market introduction.