Financing life science: The ongoing saga

04 Dec Financing life science: The ongoing saga

The world of financing life-science companies has changed radically since 2001. This reality makes it difficult for new and emerging companies, as they analyze past trends, to figure out how to raise money. The rules have changed!
Let’s start with the Initial Public Offering (IPO) market, which is how many investors used to make money (those that had invested in prior financing rounds and used this as an exit). There used to be periods of 6 to 10 months when an IPO window would be open and there would be an intense flurry of activity and a lot of money raised in that window. If you missed the “window” (the time period to go public), you had to wait until the next one, which might mean waiting for at least a year.
A strange phenomenon has taken place: we have had a continuously open IPO “window” now for about three straight years. The problem is that during this period there have been perhaps 60+ life science IPOs, but only a select few have raised gobs of money. The rest of the companies have taken pricing “haircuts” or they have had to issue more shares, and they have ended up raising lower amounts of money than anticipated.
Even worse, precious few have seen stock price increases that get investors excited. So much for the IPO market! Another problem here is that the IPO used to provide an exit for a number of earlier investors but because pricing is down, these investors have to wait a much longer time to sell off their position (far beyond the normal “lock ups”).
The second radical change has been in the venture capital market in the U.S., which has gotten much more risk averse as funds have gotten larger and they have tended to invest in later-stage companies or companies that already have done major deals with corporate pharmaceutical or biotech partners. The result has been a paucity of financing at the very earliest of stages except perhaps in California and Massachusetts, where the venture bet is on the serial entrepreneur that previously made money for the investor. Start-up and seed-stage financing by VCs has been like the magician’s disappearing act.
Mitigating factors
This situation would call for an immediate cry of alarm if it weren’t for other financing phenomena:
• The increased amount of money that both Big Pharma and Big (and medium-sized) Biotech will pay for access to products, and the number of deals that are taking place (also on the rise).
• The growth of angel investing groups, which together represent an investing force at least as large as total VC investment and fills the early-stage and start-up financing space previously owned by the VCs. This growth is fueled in part by an increasing number of states, such as Wisconsin, Maryland, New Jersey, and Missouri, which have created unique incentives for small investors to get involved in early-stage companies in their state.
• Investment by hedge funds into privately-held companies; previously these companies would limit their investments to publicly-traded companies but now, as they have gotten so large, they have increasingly placed some of their funds in privately held companies (in part due to the fact that it takes longer to go public now than in prior years).
• An increase in reverse mergers where a stronger private company will merge into a weaker public company (often a “shell”) to obtain access to the public marketplace; this last measure is not for the faint of heart, so be prepared to answer a lot of questions as to why you went this route (although it is becoming more common).
To provide you with quantitative analysis on all of the above would make for one long article, but let’s at least try to provide an idea of VC financing in the U.S. for the first three quarters of 2006, still an important measure of overall company financing and development.
According to our friends at PriceWaterhouseCoopers MoneyTree® report, $6.2 billion of venture money funded 797 deals during the third quarter of 2006, or an average of $7.8 billion per deal. This amount was eight percent lower than the amount in the second quarter, $6.8 billion which funded 907 deals (or an average of $7.5 million per deal), but still broke the $6 billion level for the third consecutive quarter.
VC on the rebound
To put this into perspective, overall VC investment was up 11 percent versus last year’s third quarter, and 13 percent over last year for the nine-month period. By the way, at $19.2 billion for this nine-month period, 2006 is painting itself as the best venture capital year since 2001.
The life sciences portion of this investment, which includes both biotech and medical devices, was strong: $1.8 billion, or 29 percent of the total, which funded 177 deals (or an average of $10.2 billion per deal). The biotech sector alone now is the largest industry category with $1.14 billion, or 18 percent of the total, while medical device investment was very strong and grew 12 percent from the third quarter over the second quarter.
Seed and early-stage investing grew 10 percent from quarter to quarter and combined represented $1.28 billion, or 21 percent of total VC money, funding 278 deals (or an average of $4.6 million per deal). This result is a reversal of prior trends, where this segment had been shrinking.
Before we get all excited here, the start-up/seed financing component, which represented $329 million of VC investment, was up a very strong 12 percent, but this group only represents 5.3 percent of total VC investment! Ninety deals were done in this segment versus last year’s 76 (up 18 percent). The average investment per deal was $3.7 million.
The early-stage component was a bit more robust with $849 million, but up only nine percent versus last year. Twice the number of deals were done in this segment: 188 deals with an average deal size of $4.5 million.
For the first time, the report identified American VC investment in international companies:
• $221 million in 18 Chinese companies ($12.3 million per company).
• $203 million in 18 Indian companies ($11.3 million per company).
• $46 million in 11 Israeli companies ($4.2 million per company).
Regional picture
Now, what you have all been waiting for: VC investment by region! This is a result that we can almost predict without looking, but it still is a worthwhile exercise.

Source: PriceWaterhouseCooper’s MoneyTree® Report – Third Quarter, 2006
Wonder of all wonders: California packed in $2.8 billion of the total for the quarter, or 46 percent of the total nationwide, with four different regions! Remember that the Midwest in PWC’s nomenclature is comprised of two regions: the Midwest and North Central, for a total of $338 million. This amount only represented 5.5 percent of the U.S. total. The 53 deals, with an average deal size of $6.4 million. were much smaller than the average deal in California.
In the next article, I will try to profile the different Midwestern states to pinpoint trends; additionally, we will look at life science funding around the U.S.
See you soon!
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