Midwest angel investment in life sciences on the rise

Midwest angel investment in life sciences on the rise

Last year, I wrote about the emergence of some new angel groups in Illinois as well as the emergence of a number of new VCs and funds focused on early stage funding. I have been struck by the continued increase in this trend.
There is good reason for this as most of the Midwest’s biotech companies are early stage in comparison to their east and west coast cousins. There has also been a dearth of funding for this type of company in the Midwest.
In fact, as I have previously identified, there are more than 300 biotech companies (this includes diagnostic, medical device, nutraceutical and ag biotech) in the eight Midwest states (of which less than 30 are publicly traded).
If you do the math, there are more than 270 privately held biotech companies. I would venture (pun intended) that more than half of these (some 135 companies) have raised less than $5 million in cumulative funding (excluding from government or state grants) from private investors.
Most venture capital groups don’t step in for the initial funding of a company (the first $1 million to $2 million). Though this model is changing in the Midwest, that leaves a great funding gap. This gap is being filled by emerging angel groups.
Even the mighty Amazon.com, which today is worth a mind-boggling $18.2 billion, was turned down initially by VCs.
Founder and entrepreneur Jeff Bezos turned to angels for financing and was able to raise the first $1.2 million to get the company going. Later, Bezos and Amazon.com were able to get $8 million from VC groups, but this was only after he had achieved his first financing from angels.
According to a 2003 article in the Journal of Private Equity titled “The U.S. Angel and Venture Capital Market: Recent Trends and Developments” by Jeffrey Sohl (director of the Center for Venture Research at the University of New Hampshire), there are 1,000 venture capital funds managing about $175 billion.
These funds invest between $30 and $35 billion annually in entrepreneurial activity and bankroll less than 3,000 companies per year. Many of the financings are for companies already in their portfolios.
A typical VC round of funding is for a later-stage deal where they are investing between $10 and $15 million, according to Sohl. This creates a real funding gap (particularly for early stage companies).
Sohl states: “The first market inefficiency is a capital gap between the needs of early stage ventures and the suppliers of early stage capital. High-growth ventures need patient, value-added equity capital to fuel growth.”
Sohl’s analysis is that angel investors provide close to 80 percent of the seed and start-up capital for high-tech ventures. In 2000, seed and start-up investments in the U.S. amounted to only $2.2 billion (all business sectors) in 382 deals. This represented 2.4 percent of total capital invested and 6.8 percent of total deals that year.

Definition of an Angel

So what is an angel investor? The legal definition is a “high net worth individual” who is usually an “accredited investor” (as defined by SEC rule 501). In plain language, this is someone who invests his or her own funds in private companies at the earliest stage.
These people typically have a net worth of $1 million to $10 million. These investors also bring with them expertise and some affinity or interest in a company’s products, markets and management team. These people are typically willing to take financial risks. According to MIT’s Entrepreneurship Center, there are four categories of angel investors:
1) Guardian Angels: This group brings entrepreneurial and industry expertise. These people have been successful entrepreneurs in the same sector as the new company.
2) Entrepreneurial Angels: This group has experience in starting companies but in different industry sectors.
3) Operational Angels: This group brings industry experience and expertise to the table but from large and established companies. These people may lack firsthand experience in the problems of a start-up.
4) Financial Angels: This final group invests purely for the financial return.
In biotech, I would add that there is a fifth group, which is:
5) Disease-Suffering Angels: This group represents someone who has actually suffered from the disease area in which the new company is working or is a close family member of someone suffering from the disease.
This is a powerful reason for seeking an innovative treatment or cure for disease and to be advised on cutting-edge developments in the science. These individuals often view their investments as a donation to the cause of science or medicine.
According to an October 2002 report by the Ewing Marion Kauffman Foundation titled “Business Angel Investing Groups Growing in North America,” most members of angel groups invest between $25,000 and $100,000 in each deal (but can go as high as $250,000).
Groups may be willing to commit additional funds in subsequent financings. According to market research:

  • 20 percent of angels invested $25,000 or less per deal (in one to four deals per year).
  • 40 percent of angels invested between $25,000 and $100,000 per deal.
  • 25 percent of angels invested $100,000 to $250,000 per deal.
  • 15 percent of angels invested more than $250,000 per deal.
    In “The Angel Investor’s Handbook” by Gerald Benjamin and Joel Margulis, the authors point out that private investors are investing $40 billion a year into as many as 140,000 early stage companies, which is approximately 4 percent of the 3.5 million start-ups in the U.S.
    This further suggests that there are about 400,000 angels investing each year who are filling this capital gap. This pool of investment is growing 14 percent to 20 percent per year versus pension fund growth of only 8 percent per year. The key issue with angel investors is that they must be in a position to lose the entire investment or lose access to it for an extended period of time.
    New companies created 20 million new jobs between 1979 and 1993 (or 67 percent of total job creation) with an additional 12 million jobs created between 1993 and 1997. Start-ups create 27 percent of these new jobs. Small companies represent 47 percent of all sales, 52 percent of business net worth and 99 percent of all companies in the U.S., according to the angel handbook.
    Additionally, 55 percent of all innovation comes through these small companies.
    According to research on angel investors, 65 percent of them like to invest in deals reasonably close to where they live (within 300 to 500 miles). The remaining 35 percent are comfortable with an investment in a company further away so long as the lead investor lives geographically close to the new company.
    Sure, all of the above is great, but what does this have to do with the Midwest? To be honest, I haven’t chartered all the angel groups operating in the Midwest or the areas of industry in which they are interested.
    While we do know of two angel groups in Illinois that have operated for a number of years (Prairie Angels and the Northern Illinois Angels, neither of these groups invest in life science companies. Actually, they hadn’t in the past. I should modify that statement as Prairie Angels has invested in two health care-related software companies.
    Let me show you what I have found in the life science space in the region:

    There are nine groups in three states. That still leaves another five Midwest states to chart.
    Watch for future columns as I just may check out this trend throughout the Midwest. By the way, in its first event for the year, the Illinois Biotech Industry Organization (IBIO) will explore some of these angel groups and their activities in the life sciences at the University of Illinois at Chicago on February 25.

    BIO Notes

    On another note, I saw an article buried in last week’s Chicago Tribune. It mentioned that G.D. Searle’s vacant former headquarters (where I once worked) in Skokie, Ill. (Old Orchard) was sold by Pfizer with an estimated price tag of about $16.5 million. It was sold to Lowe Enterprises, a Los Angeles-based real estate developer and hotel company.
    Together with GE Commercial Finance Real Estate, Lowe will spend about $8.1 million to renovate the 350,000-square-foot complex.
    What the article didn’t say was what they were going to do with the complex. The Pfizer logo will shortly disappear off the building. Still up in the air is the fate of the former Searle R&D center (known as the Parkway facility in another part of Skokie). This is the passing of an era. See you next week!

    Michael S. Rosen is the chairman and CEO of Immune Cell Therapy, a new start-up out of the University of Illinois at Chicago developing cancer vaccines. Rosen is also a founder and board member at the Illinois Biotechnology Industry Organization (IBIO). He can be reached at rosenmichaels@aol.com.

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