Having defined what your company is to do, you need money to allow you to start. Very few biotechnology ideas can be realised in a way that requires no investment. Sometimes the investment is 'only' a few tens of thousands of pounds (or dollars or ecus) to make the first material you can sell. More usually it will take tens or hundreds of millions. Very few individuals can afford such sums, so you must convince other people to put money into your idea. These other people are the investors. There are several different types of investor depending on the stage your company is at and they will fund you in stages. Understanding this path and the motivations of the people that you will meet along its way is important if you are to get your biotechnology company funded. An investor should not only be a source of funding. From an early stage, the investor should also help you found and run the business. They should provide help with issues such as employment contracts, location, finding funding for expensive equipment, securing the intellectual property and having discussions (or arguments) with all the other parties involved such as university technology transfer officers, patent lawyers, and the many researchers at the founding institution who have not had the courage to do this themselves but now want a piece of the action. All this can be pushed on to the business co-founder.
Seed investment
An increasingly common route to developing an idea into a company (which includes all the processes we alluded to in session 2) is to seek seed funding. Seed funding provides enough money to set the company up, acquire key patents, negotiate the graceful exit of the founding scientists from their current job and create a corporate entity. It also pays for planning and writing the business plan, a time consuming and skill-intensive business, often in terms of the investor's time and involves hiring lawyers, patent agents and accountants. Such seed funding is provided by private investors (see below) or specialist, professional seed funding companies, which are still rare in Europe, although more common in the USA. There is a general dearth of seed funding to take potential companies from 'I have this great idea' to 'This is a company you can believe in'. In part this is because the risks at this stage are huge and the rewards very uncertain. Merlin Ventures is the largest dedicated seed funding enterprise in Europe (as of mid 1998), and in two years we were able to seed only eight of the hundreds of companies that probably lie nascent in the British research establishment alone.
Private funding for biotechnology
Once you have a company it will probably need substantial amounts of money to pursue its product development goals. Start-up companies are usually funded privately, through investment by private transactions between the company and individuals or groups of individuals. Typically, such investments are through the issue of new shares, so new investors become shareholders and all the previous shareholders are 'diluted' (i.e. have their share in the company reduced). Once the company exists, it can receive more substantial funding to carry out its plans as articulated in its business plan. This 'first round finance' (seed funding does not count as real money) comes from one of two sources:
Private investors These are people with sufficient wealth to be able to put substantial amounts (usually at least $250,000) into the company, take some active part in helping the company in financial or commercial terms and, most importantly, take the risk that they will lose their investment.
Venture capitalists (VCs) These are people or companies who specialise in investment in risky propositions, usually early stage companies. They set up a fund into which people put their money and then the venture capital 'fund managers' invest that in high-risk ventures. This is exactly analogous to the investment trusts and funds that are common savings routes for the general public but with far higher risks and, the investors hope, far higher returns.
Both types of investor will want to check your business over for criteria which include the people involved, their 'due diligence' study on the science, the return on investment, exit route, and whether anyone else is willing to fund the idea.
People
Most VC groups will invest in people as much as in science. This is because the science on which a company is founded will almost certainly go wrong, and when it does it is the people who will either put it right or give up. The former is preferable. How someone goes about this is as much a matter of their general experience and personality as the specifics of the programme they want to get funded. 'Good' things in the scientific founders of a company are a demonstrated willingness to change fields, learn new expertise, collaborate with people from different disciplines, think of lateral things to do when challenged. A desire to make a lot of money is also good and a desire to be famous is usually bad, because it often ends up as being famous at the expense of the company rather than to its benefit. Often a VC will also look for 'management', specifically a Chief Executive Officer (CEO). This person will have experience in running a science-based, commercial operation of some sort, will be accepted by the scientists as their company leader and is a credible person to put in front of bankers, accountants and other city professionals. A few VCs can perform the role of 'the suit' themselves (Merlin Ventures can, and does, for example), but most will not be willing to run the day-to-day operations of the dozen companies in their portfolio, and so will insist on at least a skeleton management being in the company from the start. This role can be played by the business angel or other seed investor.
Due diligence
After assuring themselves that the people are at least potentially suitable, the VC will carry out an external test of the science, by calling up experts, having any patents checked out by lawyers, asking around at meetings and conferences, and checking the perceived strength of the company's science, technology and people. This is known as 'due diligence' (after a legal phrase meaning in essence 'I have done whatever I can'). Due diligence can vary from a few chats in a bar to a full-scale consultancy project costing hundreds of thousands of pounds. The due diligence process gives the VC an estimate for how reliable the current science is and what the market might be. Usually this will differ materially from the scientists' view. It is critical for the calculation of the 'value' of the company today, and hence a calculation of the Return on Investment (ROI, also sometimes called the Internal Rate of Return--IRR). This is the amount of money they will get out compared to the amount they put in, and is usually expressed as a percentage annual growth rate (like a bank might offer eight percent to its savers). VCs usually look for ROIs of 50 percent per annum or more: this is not greed (or not only greed), but reflects the fact that this is the ROI they will get if everything works--usually, of course, it does not and they get an ROI of less than zero percent.
It is also worthwhile for an entrepreneur to do 'due diligence' on the VC to see what they have done for people in the past, in terms of help with management, guidance in business and scientific strategy, building the company up so it can cope with its own success and contacts in the world of finance. Most say that they can do this, although it is the sad truth that few do.
Exit route
No-one putting money into a start-up biotechnology company expects to be paid back from the company's profits, at least for a minimum of 5 years, so there must be some other 'exit route' by which they get their money back. This can be - privately selling your share in the company to someone else;
- getting bought by another company (merger or acquisition being different versions of a similar process);
- floating on the stock exchange (when the company is big and stable enough) and so in effect selling your shares to the general public.
All are possible for any company, if they are successful, so the question here is when will it happen. The 'when' is critical for calculation of ROI--a 100 percent gain in value in one year is 100 percent per annum ROI: a 200 percent gain in 4 years is a 50 percent ROI, even though the absolute amount of the latter is higher.
Funding stages
VCs usually invest when a company has already gained some seed funds, has developed its business plan, hired a couple of people, but has not got seriously under way. This is known as 'first round' or 'first stage' finance, and is typically between £0.5 million and £3 million. This is the riskiest end of venture capital. This money will typically take a company engaged in drug discovery and development through 1.5 to 3 years' work, and take the science from some basic research to a proof of principle. Then the company will need to raise more money, arranged in a second round finance with companies that specialise in that stage of investment. Second stage finance houses tend to lean more heavily on formal due diligence studies, look for an experienced management team in place, and look to the detailed timing of when they can float the company and so get their money back. Second round funding usually raises between £8 million and £15 million. If all goes well, the company will then be floated on a stock exchange in another two or three years. This should raise £10-30 million. However it may need a 'top-up' funding to get it there--this is termed Mezzanine financing. Alternatively, things may go wrong with the science, requiring another round of private funding.
Corporate partners
The other main source of funds for your new company is other companies, and usually much larger ones. These may be clients (i.e. ones who buy your products) but, in the early days, most biotech companies have no products. So larger companies may become partners with you in order to help you develop products. They benefit because you have something that can help them innovate. You benefit because they provide skills or infrastructure you do not have, such as the problem alluded to previously of distributing. Often corporate partners will also fund, organise and perform later stage clinical trials (which can be hugely expensive and complicated) as well. In essence a corporate partner is a combination of collaborator and client. You get funds and resources, they get new programmes or products.
There are a huge variety of corporate partnership arrangements, from simple purchase of goods to outright purchase of the company. However the things that corporate partners will look for in your company are surprisingly similar to those a VC will look for, as illustrated in Figure 1. Bear in mind that few companies have all of these--however if your start-up has none of them, you will have some problems getting it funded.
Grants
Occasionally agencies that provide grants to academics to perform research will also provide grants to biotechnology companies. However much more common is other types of government grant support aimed at such 'SMEs' (Small to Medium-sized Enterprises). The biotechnology industry is knowledge-based, clean, rapidly growing, and based in the West's long investment in its scientific and technological infrastructure. Also, much of it is addressing healthcare, probably the only sector of the economy to grow every decade this century. So biotechnology is seen as 'good', both socially and economically, and is encouraged with various degrees of vigour by governments. This has led to a profusion of types of government support for new biotechnology from which start-up companies can benefit. These include:
Technology transfer schemes. These are schemes to help transfer science or technology from (usually) a university setting into a commercial one. Following US models, European technology transfer offices are now becoming better equipped and better skilled to find the most appropriate route for commercialisation. Small company support schemes, such as SMART and SPUR in the UK. These are generic schemes to help small companies get off the ground with government financial assistance. Regional development support. This is government support to try to encourage industry to settle in one region rather than another. Only occasionally are these places where the best science and scientists are already based. National and international co-ordination efforts. These are attempts to get the technology policy or regional support geographically integrated. There are some commercially based schemes, such as EUREKA to encourage pan-European commercial developments. Major infrastructure programmes with biotechnology relevance. In both Europe and the USA the government supports major programmes of work which have biotechnology spin-offs, such as genome projects. These are usually 'pre-competitive'. These can provide very substantial sums for companies especially if they are in areas of Europe targeted for economic development such as Liverpool or Sicily. However it is generally true that if the company is depending on grants to survive, then it was a bad economic idea from the start.
The stock market and biotechnology
More established companies can raise money from the general public by selling shares on a stock market, where suitably regulated brokers trade shares on behalf of their clients. Public funding in this way has very different constraints from private funding. It is very closely regulated to stop companies or brokers defrauding the public.
Shareholders have statutory rights that mean that they are the ultimate arbiters of the company's future, and many company brochures will talk about 'increasing shareholder value' as recognition that these people actually own the company. In principle shareholders can fire the board of directors (see session 4), or demand the company accounts for its actions, although in practice only major investment funds, which hold large blocks of shares, are in a position to exert any control over how the company is run.
In order to get a biotechnology company 'listed' (i.e. have their name put on the list of shares available for trade), the company has to demonstrate that it is suitably stable. In the UK this means having a trading record for several years, or having at least two products in clinical trials, or a number of other criteria. It also means having a prospectus that has been verified by lawyers to say that every statement in it is demonstrably true, even down to the definition of chemical or medical terms. Part of this process requires an external group of experts to write a report on the company, which in essence says that they, experts in the field, agree that what the company says makes sense--this is known (unsurprisingly) as 'the experts' report'. Accounts have to be presented and audited, company directors have to sign legal forms that they are suitable people, and have to be checked out for past fraud offences and so on. This is all to protect the public from the worst excesses of entrepreneurship.
When and where you float your company is an arcane art. There are many different stock markets that can list a company, and listing in market one does not imply listing in any of the others, as they all have slightly different rules and constituencies. Although their enthusiasm for biotechnology investments waxes and wanes roughly in unison, there can be substantial differences.
Valuing biotechnology companies
Public and private financing is by selling shares in your company. In essence, you sell a part of the company to someone in exchange for funds. But what are your shares worth? If someone is willing to give you £4 million, does this buy five percent of your company, or 95 percent? It depends on whether your company is worth £80 million or £4.2 million. Valuing your company appropriately is therefore important. The details of how a value is placed on a company is beyond the scope of this article. In summary:
- There is no rational way of valuing a start-up company. You have some ideas, some patents, some people, and no premises, products, established programmes or track record. The overwhelming objective factor is the chance that your crucial first product will fail, scientifically or commercially, and this probability is a matter of opinion. Values are dominated by 'feel' and your credibility.
- When the company has been in business 3-4 years, has 40 employees and two products in late development, we can 'guesstimate' its value by working out what the company will be worth when it reaches its final goal and the chances it will make it there. Your goal may be to be bought out for $550 million or to generate a stream of new drugs that you will sell to a big pharmaceutical company. This gives you a final figure, and a guess for how long it will take to get there. You then multiply this by the probability of achieving it (<<1), divide it by return that you could have earned investing money in a 'safe' investment over the same time (>l), and that is your value.
- If you are a public company, your value is the number of outstanding shares multiplied by whatever people will pay for them. This can lead your company to suddenly losing value because the share price drops and is the reason that reporters say that falls in the stock market have 'wiped billions off the value of industry'.
