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Six steps to successful financing

A serial entrepreneur provides his insights into the pitfalls you may face when seeking financing for your company and some key strategies to avoid them.

Raising funds is one of the most challenging and complicated jobs in the growth of a biotech company. Choices that you make today, as to sources of funds and the terms under which you take them, will have consequences that become apparent over time, often many years later. Such considerations are easy to overlook when beckoned onward by the siren song of a much-needed financing. Here, I provide a few pointers on how to maximize your success when accepting other people's money to finance your dream.

Attracting other people's money

Let's first consider the natural hierarchy of funding for companies—from inception through later stages of development. A typical startup might initially be funded by its founder or founders, preferably out of personal wealth achieved from prior biotech successes, but more typically through personal loans, second mortgages, maxed-out credit cards and the like.

When the limits of those methods, or the entrepreneur's tolerance for a lifetime of debt and poverty, are attained, the next resort often is individual, or 'angel', investors. These may be acquaintances, friends or relatives, or unaffiliated investors—there now are national and regional angel investor organizations accessible over the web or through local directories or biotech associations (see Box 1).

Startup biotech companies are very risky and most people will lose, not make, money investing in them. Also, because most companies ultimately will need to raise hundreds of millions of dollars, usually from institutional investors, it is all but guaranteed that your early investors will be diluted down to a small fraction of their original ownership, unless they can afford to keep investing in each new round. Moreover, because early-stage entrepreneurs tend to value their companies significantly higher than institutional investors at a given stage, angel investors tend to buy in at valuations that are not sustainable when the venture capitalists (VCs) come in for later rounds. Caveat emptor? Sure. But clearly you will want to consider those sorts of issues and disclosures before you solicit your relatives for their IRA distributions.

Once you're at the stage of moving beyond friend, family and angel financing, the fun of touring the VC firms begins. This is more often than not a grueling process. The CEO is responsible for giving the lion's share of the presentation, leaving the rest of the team to sit, listen and nod countless times. The point at which your colleagues begin silently mouthing every sentence before you utter it will be your signal to give them a break.

Grants are another terrific source of funding. Probably one of the best things about them is that the money you get is nondilutive—that is, it does not require the company to issue more stock. Sources in the USA include not only the National Institutes of Health, but also a variety of federal agencies, notably the National Institute for Standards and Technology (NIST) and the Department of Defense, as well as state and local government programs and an array of private foundations. The downside of grants is that they take a lot of time and effort to write and the timelines between application submission and the award may be as long as a year. On top of this, only a small minority of applicants are awarded grants in any given cycle. Still, there are companies that have commanded millions of dollars in grant funding, sufficient to carry them through their initial years. Remember that you can apply for several grants in each cycle, increasing your odds of an award.

Six take-home messages

I've outlined above roughly the traditional ways of raising money—there are several alternative mechanisms that can also be explored—and below I provide a few insights that I have taken away from my experiences as an entrepreneur (see Box 2).

First, most entrepreneurs find that there are just two quantum states for a biotech company seeking VC funding: 'too early' and 'too late'. You generally will hear one or the other when you are being turned down. Amusingly, the VCs you see will tend to alternate as to which is your state at any given time.

Second, there is no bad meeting with a VC. Whether they do a deal with you or not, just getting in the door means that they are intrigued enough by your business plan to spend their valuable time in a meeting. Even if they don't bite, the questions they ask will help you hone both your business plan and your presentation. If you can keep your ego in check and remain open, you should see significant improvements in both as you move from your first VC meeting in a round to the last.

Third, if a VC group turns you down, this does not necessarily mean forever. A VC may tell you that they like your story and would like you to keep in touch. Take them at their word. They will not make the gesture just to be friendly, as they see hundreds of companies a year and will be able to track only a few. A VC investment has much in common with a marriage—they both take effort, and once the VCs have committed, they expect to work closely with you and to continue funding you for several years. And, to use another relationship analogy, the first date often is not sufficient to jump into a long-term commitment. The VCs usually want to see if the company's management is resourceful enough to survive and make progress without their funding. In the case of my company, Acorda, several of the VCs who had turned us down the first time invested after we had achieved the Advanced Technology Program (ATP) grant and the partnership with Dublin-based Elan.

Fourth, you almost always need a lead VC, the one who is willing to negotiate a term sheet, help to bring in other VCs and take responsibility for the round. We saw lots of VCs who expressed interest but did not want to lead. No matter how many interested VCs you have, you don't have a deal until you have a lead.

Once you have that lead, you need to negotiate the term sheet on which the deal will be based. The terms will include not only price, but a host of preferences, or terms that apply specifically to the shareholders in that round. These preferences usually will favor the current round of investors to the detriment of those who invested in earlier rounds (hence the term 'preferred' stock, and a key reason that your early angels usually get the short end of the stick).

Be sure to have a highly experienced lawyer advising you, one who previously has negotiated many VC term sheets. Some of the terms that may seem innocuous to you may come back to bite you in the future, even years later. Terms to be aware of include the ways in which antidilution provisions may be calculated, as well as 'qualifying IPO' and dividends and liquidation preferences, or how the proceeds are allocated if the company is bought. If these terms aren't clear to you, ask your lawyer.

Fifth, the lead VC or VCs generally take seats on your board. The number of seats is part of your term-sheet negotiation. Here again, access to experienced counsel is critical in guiding you regarding what is normal and customary. Where possible, try to negotiate that the VCs nominate qualified outside directors, rather than themselves, to bring needed skills to the governance of the company. These might include commercial, operations, development or clinical and regulatory skills. Some VCs may try to negotiate 'observer' rights, in which they may attend board meetings and receive all materials, but without voting status.

And finally, always be aware that the VCs' job is to make a high return on investment, which means getting terms that will protect them as much as possible from the inevitable setbacks or outright disasters along the way. As with any negotiation, you are in a better position if you have more than one potential lead that wants the deal. If you have only one, it will be harder to eke out terms you can live with. Speaking of which, you should keep in mind that desperation is your worst enemy. Never want the deal so badly that you will accept any terms to get it. Again, I emphasize the importance of having experienced counsel who can guide you as to the future implications of the terms that you are being asked to consider. And, just as the VCs do due diligence on you, be sure to do adequate diligence on them to ensure that you can live with their terms and collaborate with them personally and effectively.

Closing thoughts

Now that you've raised your VC round and had your closing dinner, replete with expensive wine, good vibes and mutual affirmations of eternal love and the great things you will soon accomplish together, it's all blue skies and fair winds ahead for you and your new investors. That is, at least until the following morning, when your key confirmatory experiment fails, or the US Food and Drug Administration contacts you with a major concern, or a competitor files a patent infringement claim. By virtue of its extended product development timelines and extraordinary regulatory requirements, the biotech/pharma industry just may contain the greatest number of lurking threats that can debilitate a company. And when things go wrong, as they certainly will, it's remarkable how quickly the good feelings give way to terror and perhaps just a touch of surliness and recriminations.

You can best prepare for those times by making a practice of communicating as much and as well as possible with your VCs, whether or not they are on your board. A good metric would be that if you feel you are already communicating to the point of excessiveness, double it. Having made my share of mistakes in this area along the way, I can say with confidence that this is a must. Make sure your investors share in the 'ownership' not only of your stock but of the strategy and the key decisions. With luck, this will given them an incentive to share ownership of the challenges, as well.

For those of you who have advanced through the gauntlet of early and VC-stage financings and made it through to the envied status of public company, “Congratulations!...and condolences.” On the positive side, public status brings liquidity, access to capital and a fungible currency that are unmatched in the private world. On the negative side there is...just about everything else. Having experienced life as a public company in the early 1990s and again now, I am struck by how much has changed, virtually all of it in a way that makes my executive life more challenging, and in certain ways significantly less gratifying. We are living in the era of Sarbanes-Oxley and Regulation Fair Disclosure, in which there have been profound increases in the day-to-day complexity and costs of regulatory compliance, as well as in management's personal liability. In addition, public shareholders, primarily large hedge funds, are increasingly likely to intervene directly with management and boards. Remember that your VCs will tend to be life science specialists who are quite knowledgeable about the biotech space and prepared for its attendant risks and long timelines. Public investors in general may be more likely to advocate strategies and timelines that reflect their need to realize returns on a quarterly basis.

To summarize, the costs of raising capital are high, not only in dollar terms, but in the mental, emotional and even physical demands that are imposed on the management team. These demands include regular communication with your investors, before, during and after rounds of investment, even as you work on matters of almost equal importance, say, for example, advancing your company's business plan. At a minimum, until your company is profitable (and often not even then), these demands will be inextricably linked, and effective management of the funding, and funders, of your company will be a key determinant of your ultimate success.

Acorda Therapeutics Timeline

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Cohen, R. Six steps to successful financing. Bioent (2007).

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