Catalyst - Winter 2009 - Life Science Financing: A Needle in a Haystack? Investment Experts Weigh in on Myriad Funding Strategies
hile experts say there's plenty of reason for caution in this economic market and a real need to focus on core competencies — rather than pie-in-the-sky ideas — right now, there is one glimmer of light shining down on the biotech sector. According to the MoneyTree™ Report from PricewaterhouseCoopers (PwC) and the National Venture Capital Association (NVCA) (based on data provided by Thomson Reuters), the biotech industry inched out the software sector for top billing as the number one industry sector in terms of dollars in the third quarter of 2008 with $1.35 billion invested compared to $1.34 billion invested in software companies.
Now, strap yourself in because the roller coaster ride is about to take off. What goes up has to come down, too, right? Based on number of deals, software remained the top industry with 214 companies receiving funding in the third quarter of 2008 compared to only 114 biotech companies. In fact, while the life sciences sector (biotechnology and medical devices combined) saw a 10 percent increase in VC investing in the third quarter (with $2.2 billion going into 207 deals), it was an eight percent drop in deals from the second quarter of 2008. This decrease is attributed, according to Money Tree, to declining investment levels in the medical devices sector.
Going forward, it's anybody's guess what's going to happen in this sector…in this region…in this economy. But four healthcare investment experts were happy to offer some ideas — even some advice — for life sciences companies struggling to raise capital and stay afloat in an ever-changing market.
Brian Friedman is co-head of investment banking at the National Securities Corporation in New York City. His company reported $130 million in equity healthcare financing in 2007.
Zev S. Scherl is a general partner of NewSpring Health Capital and NewSpring Capital in Radnor, Pa. With significant experience in principal investing, corporate management and finance, he is focused exclusively in the life sciences and health care industries.
David Sable M.D. directs healthcare investing for the Special Situations Funds in Manhattan and is portfolio manager of the Special Situations Life Sciences Fund.
Phillip Chan M.D. leads investments in healthcare and life sciences for the NJTC Venture Fund. Starting in January 2009, he will be the interim CEO of MedaSorb, a publicly-traded medical device company testing its proprietary CytoSorb blood purification resin in human clinical trials to treat sepsis.
Q: What do you define as traditional vs. non-traditional routes for financing for biotech and life sciences companies?
FRIEDMAN: Traditional has come from private equity and/or VC firms as well as the capital markets in the form of IPOs. Nontraditional would be reverse mergers as well as funding from hedge fund community and friends, family and angel investors.
SCHERL: There continue to be many sources for early stage including, grants, angel and state-driven initiatives, such as the Edison Innovation Fund. Venture capital continues to be the traditional source of financing for intermediate stage. For both VCs and angel investors, milestone-based financing remains the norm.
SABLE: The distinction between traditional and nontraditional depends on who is writing the dictionary. In a "traditional" model private companies used seed funding and serial venture rounds, then went public through an initial public offering. The resulting public company raised money through secondary offerings of registered stock. Other traditional forms of financing failed in biotech. Convertible debt, for example, worked for larger companies but hurt many of the small companies that tried it; the convertible put a ceiling on the common stock price by making it a derivative of the convertible through convertible arbitrage. Some of these companies never recovered. More recently, PIPEs, or private investment in public equity, became the most common form of financing for small public biotech companies.
CHAN: Traditional pathways to raise money for early life science companies have typically been venture financing and government/ foundation grants. Later stage companies have the ability to raise capital from not only the private equity markets, but from going public in an IPO and then in secondary public offerings and PIPE transactions. Strategic partnerships have also been used to bring much needed capital for companies. From a non-traditional perspective, we see a lot of companies looking at venture debt financing as well as reverse mergers and SPACs (Special Purpose Acquisition Companies) as a means to access capital. Going public on foreign exchanges like London's AIM is less common.
Q: Is this market pushing one route over another? Which is easier right now?
FRIEDMAN: In the current market environment, sources of capital are extremely limited as opposed to what was available from 2003 to 2007. In today's environment, companies must pursue all potential avenues for raising capital.
SCHERL: This market isn't necessarily pushing one over the other. Both are equally challenging. On the positive front, NewSpring is still putting capital to work in its target areas, which include biotech. Though the financing is extremely challenging, innovative opportunities that solve clinical problems are still worthy of investments.
SABLE: The current market has been brutally disruptive to the biotech cycle of raise, value inflection, raise, value inflection, raise. Who wants to buy a piece of a biotech company when the future financing infrastructure of the industry is in danger of disappearing? Investors want some form of tangible asset, and the companies want to minimize their exposure to financing uncertainty. At the same time, large pharma companies have maximum leverage to pick and choose the specific assets they want and to dictate deal terms.
CHAN: Even the pharmaceutical industry -- the main driver of life science activity with historically strong cash flows and deep pockets -- has been hit with the perfect storm of patent expirations of blockbuster drugs, generic competition, a stricter and risk-averse FDA, product liability, pricing pressures, and a host of other factors, including looming healthcare reform. These critical issues have directly impacted profitability, forcing pharmaceutical companies to retrench and make layoffs, while their stocks trade at multi-year lows, making it harder to finance deals.
One bright spot is the venture capital industry which fortunately raised $60 billion in 2007 and 2008 alone in spite of the market meltdown. These firms have the ability to put that money to work in an investor-friendly environment where company valuations are weak.
Q: What is your outlook on the IPO market? Do you see that changing anytime soon?
FRIEDMAN: The window for initial IPOs is currently closed and in order for the life science sector to receive any attention from the IPO market, there would first need to be a turnaround in the overall global market. There needs to be a movement toward more speculative investments that offer a greater risk-reward profile such as those in the life science and biotech arena.
SCHERL: It is general knowledge that the IPO market for biotech and life sciences has dried up and valuations continue to be affected. However, M&A opportunities for liquidity events do exist. Cashrich pharmas that are lacking pipelines are still out there looking for acquisition opportunities.
SABLE: The problem with the IPO market is that public equity prices are completely disconnected from underlying value. Funds have liquidated positions across the board to meet redemptions, and good stocks are being sold in a price insensitive manner. Hedge funds with cash are waiting for their over-leveraged colleagues to blow up so they can buy their positions cheap. In this environment, the auction dynamic that drives a successful IPO market is highly unlikely.
CHAN: The life science IPO market has been historically cyclical. It will undoubtedly improve, but will likely do so gradually given the magnitude of the recent market losses. It will take some time to restore investor confidence. Before the IPO window opens, one would expect public life science companies trading at significant discounts to absorb much of the initial investor demand. If the market bottoms in this range, perhaps we will see some life in the IPO markets, particularly for strong, well-financed companies, at the end of 2009, but more likely 2010.
Q: What are biotech and life sciences primarily using financing for these days?
FRIEDMAN: Most companies that have capital right now are scaling back some of their R&D efforts and focusing capital expenditures on more core activities. They are picking only their lead compounds and lead products and progressing with those clinical trials versus spending money on non-core, earlier stage R&D projects.
SCHERL: Conserving cash is extremely important in today's economy. As a result, the main focus we're seeing is the optimization of existing development programs to ensure that those programs grow and are well funded. With all VC s pruning portfolios and companies, the programs that get funded are the ones most likely to lead to well defined, value enhancing milestones and exits.
Q: Are collaborations a strong alternative funding option right now?
FRIEDMAN: Right now, collaborations are the most logical source of capital. This is driven by two different factors: the small and mid-size companies that are technology rich but capital-starved and larger pharmas and device companies that have access to capital but have a more limited pipeline of early stage projects in development. By coupling these two factors, we see the 2009 outlook as one whereby most companies will fund their R&D through either pure M&A or joint venture activities.
SCHERL: Collaborations and licensing arrangements are core to biotech financing. When a big pharma is not yet prepared to acquire a biotech company, the licensing route is pursued. We believe the licensing option can be beneficial for all constituents.
SABLE: With very few exceptions, every biotech company needs a series of partners as they evolve from idea through development to revenue. Some partners bring nothing but cash to the table; others bring operational ability. Most companies start with a core competence, whether based on a preclinical platform or experience in clinical development, and need to add in different aspects of clinical trial expertise, regulatory experience, and commercialization capabilities. And they have to hope that the financing window will be open each time they need to step up their spending. Collaborations are not an option. They are a necessity.
CHAN: Larger companies have cash, resources and credibility to make a major difference for small companies. With drug and product pipelines getting thin, larger companies are motivated to do deals with promising smaller companies. However, we are anecdotally seeing a slow-down in licensing and partnership deals, as cash is king and as consolidation occurs amongst larger companies, making smaller deals less of a priority and more difficult to get done in a timely fashion.
Q: There's been much written about the fact that now isn't even the right time to look for funding. Some are telling biotechs to "hold tight," so to speak, and spend the money a company has wisely and frugally. What areas should money be focused on in these difficult times?
FRIEDMAN: Now is the time that smaller companies are entering hypothermic stages whereby they need to focus all resources on core activities to sustain capital as long as possible. They need to curtail earlier stage and ancillary development and focus solely on those projects that are furthest along in development.
SCHERL: Capital efficiency is key and outsourcing will become a valuable alternative in optimizing biotech business models.
SABLE: Development stage companies should spend money wisely and frugally regardless of the condition of the macro economy.
CHAN: The investment bank Rodman and Renshaw recently reported that 113 public life science companies have less than a year of cash left, up from 68 in the first quarter. This doesn't include private companies. In an environment like this, it is never too soon to raise money. We just don't know when things will get better. And, in the meantime, they may in fact get worse. Funding means survival and one of the biggest mistakes a company can make is to try to raise money when the company is almost out of cash. In this funding environment, companies need to reserve at least nine months to close a deal. In the meantime, it always makes sense to cut costs and tighten budgets where appropriate.
EisnerAmper's Catalyst: Winter 2009
Welcome to Catalyst
Nurturing New Businesses
New Jersey's Thriving Incubator System Aids Entrepreneurs
A New Way of Thinking
Varied Funding Strategy Gives PTC Therapeutics 'Multiple Shots on Goal'
Fresh Ideas in Times of Economic Uncertainty
Life Science Financing: A Needle in a Haystack?
Investment Experts Weigh in on Myriad Funding Strategies
Venture Capital and Private Equity: Influencing Growth and Exit