Bioe News

Published online: 18 November 2004, doi:10.1038/bioent838

Angel investors shy away from biotech

*Aaron Bouchie is a news editor for Nature Biotechnology in New York

Budding bioentrepreneurs should try to attain seed funds from both angel investors and venture capitalists in tandem.

People who invest their own money into private equity, called business angels, are integral to the financing of technology-based startups. Images.com/Corbis

Angel investors often avoid biotech startups because of long and costly development times of biotech products, as well as a tendency for venture capitalists (VCs) to set over-diluting terms when entering in follow-on financing rounds. These trends are exacerbating an early-stage funding gap in the biotech sector, which is unlikely to be remedied unless angels return to a disciplined form of collaboration with VCs when investing in seed-stage rounds.

In October, the Center for Venture Research (CVR) at the University of New Hampshire (UNH) in Durham released financial data on US angel investing in the first half of 2004. Total investments by angels in that time frame were $12.4 billion across all sectors, compared with $18.1 billion for all of 2003. Approximately 135,000 individuals invested in 27,500 ventures in the period of study, projecting annual increases of 23% and 31%, respectively, compared with 2003. "These numbers represent good news," says Jeffrey Sohl, director of the CVR. "The angel market is growing at a sustainable rate; there are no crazy influxes in investors and deals like during the 2000 bubble."

Although these numbers bode well for startups, not all trends are rosy. Sohl points out that VCs, who normally fund firms after the seed stage, are moving their investments downstream¹, creating a "post seed-funding gap." This forces angels to use more of their funds to provide follow-on financings for their portfolio companies. He says that 2 to 3 years ago, about 80% of all angel dollars went to seed stage companies; that number has now dropped to about 60%. "This redistribution of angel funds is bad for startups" because it decreases the amount of money available for them, says Sohl.

Whereas these trends spell trouble for startups across all sectors, biotech startups also have problems of their own. According to the MoneyTree Survey, about 18% of all VC dollars invested in the first half of 2004 went into biotech firms, and an additional 7.5% went into medical devices. But, according to CVR data, only 8% of angel dollars went into biotech firms compared with 13% into medical device firms in that same time frame.

Prem Das, director of the office of technology licensing at Harvard Medical School in Boston, explains that biotech is not a "sweet spot" for angel investors because it can take a very long time to get a product close enough to market and to exit the investment, such as by entering the public markets or by being acquired. "An angel can often exit a device firm after a couple of years because it is easier to get those products close to market. A biotech company can take 5 to 7 years before reaching an exit point for its initial investors," says Das.

Another aspect that can concern angels about biotech investments is the amount of money required to reach an exit. According to James Geshwiler, chairman of the Angel Capital Association, an angel industry group headquartered in Kansas City, it often takes 8 to 12 years and over $20 million until a seed investor can exit a biotech firm. "Angels don't have that kind of money, and they must go to VCs to fill out a round or for follow-on investments," explains Geshwiler.

		"VCs, who have the larger cash coffers and hence the upper hand in such a deal, often demand follow-on financing terms that yield the angel very little return on investment should the company achieve a successful exit."

But VCs, who have the larger cash coffers and hence the upper hand in such a deal, often demand follow-on financing terms that yield the angel very little return on investment should the company achieve a successful exit. Indeed, many delegates at a recent technology transfer investor conference in Boston² were grumbling about how difficult it is now to find an angel investor to take a long-term risk because VCs have "screwed them over too many times." Sohl puts it a little more eloquently, saying that he recommends angels look for merger and acquisition exits to get a good return on investment, because VCs often "overdilute the angel's ownership value."

Geshwiler's advice to bioentrepreneurs is to work with both angels and VCs from the very beginning. He says that because angels typically lack the amounts of cash needed to take a biotech firm to exit, an inventor should work with an angel to jointly obtain funds from VCs right then. "You don't need to get it all immediately, but if you are guaranteed enough money to reach profitability or an exit point upfront, then both your venture and the angel's ownership terms will be much more secure," he says.

If this scenario is not possible, angel funds are still worth attaining. Sohl says that angels are getting much better at creating value with less money, which gets them higher returns when they approach VCs for follow-on funding. He cites CVR data that angels fund only about 10% of all business plans that they see, down from about 25% in 2000. Angels are also spending about 3.5 months performing due diligence on potential investments, which is longer than they used to spend. Sohl says that these trends show that angels are getting more careful with their money, which will help them and their portfolio companies in case hard times come again.

References

1. Ward, M. VC war chests for biotech startups continue to grow. Bioentrepreneur 19 June 2003 doi:10.1038/bioent752.

2. Tech Transfer Investing: Venture Investing in IP Commercialization & Research Spinouts, Boston, MA, November 4–5, 2004 (http://www.ibfconferences.com).