Riding Investment Waves

In Pennsylvania, we currently have the modern day equivalent of a gold rush going on in our state (the Marcellus Shale) after the discovery of the country’s largest natural gas deposit.  To get in on the rush, gas exploration companies are offering vast amounts of cash to landowners in exchange for future development rights.  I say future because the economics of natural gas drilling is not yet on par with gasoline, leaving the widespread adoption of the fuel very much in question.  Yet, even with that risk, large exploration companies are willing to spend considerable amounts of money up-front in the hopes that they will receive a handsome payday in the future. 

The economics of natural gas exploration in Pennsylvania is somewhat analogous to that of life sciences product development, wherein investors are willing to spend large amounts of money up-front on the development of life science products, hoping that those products can tap into future markets that are expected to be in the billions of dollars. 

Taking on such risk, whether in natural gas exploration or life science product development, can be daunting for all but the most intrepid entrepreneurs and investors. 

How does one participate in sexy investment trends, such as natural gas exploration, but not take on the risk associated with it? 

The answer is to identify products and services that support those companies working at the bleeding edge of an investment trend.  In the case of natural gas, that means identifying those companies that provide the infrastructure (raw materials) and logistics (housing, food, transportation) that are required by the exploration companies to prospect for gas.  

Like the natural gas industry, there are those life science companies that swing for the fences, identifying new trends and investing big in them, and those companies that provide infrastructure and services to support the homerun approach of their peers (sometimes even these companies can be home runs).  Below is my analysis of two such companies and the products they created to support the development and adoption of bleeding edge technologies.

Avid Radiopharmaceuticals

With an aging US population, the prevalence of Alzheimer’s is growing at an astonishing rate.  Every major drug developer has tried to develop medicines to treat the disease, but with little success.  A key development challenge for drug developers is that Alzheimer’s, especially in its early stages, can be challenging to diagnose.  Poor diagnosis has meant that drug developers have typically sought later stage patients.  These patients are harder to treat as much of the damage done by amyloid aggregates (I am not mentioning tau or prion in this blog post) likely cannot be reversed by therapy alone.  Early diagnosis is therefore a priority of patients, clinicians, and drug developers. 

Avid Radiopharmaceuticals (an Osage portfolio company) has created a radiolabeled ligand that binds to amyloid-beta, a protein that often aggregates in Alzheimers’ patients brains and is considered by many to be a hallmark for the disease.  Unlike drug developers focusing on homerun therapeutics, Avid chose to develop a diagnostic that could aid clinicians in their ability to track disease progression.  While the diagnostic has yet to be approved, Eli Lilly bought Avid for $300 million upfront and is making the company it the cornerstone of its Alzheimer’s drug discovery effort. 

Embrella Cardiovascular

As percutaneous procedures mature and increase in complexity, device companies and clinicians are attempting to insert ever-larger catheters through the arties of patient’s.  Large catheters have a high likelihood of rubbing against artery walls, knocking off plaque and debris that has accumulated on the epithelium.  Once freed, that flotsam may embolize on its passage through the arteries and into the brain where it eventually could cause a stroke.  Early clinical trials for Transcatheter Arotic Valve Implantation (TAVI) procedures in Europe have confirmed the risk of stroke as several patients did, in fact, have strokes.

Embrella Cardiovascular created a simple solution to the floating debris problem; it developed a small net that catches embolisms when inserted into the patient’s heart.  The product is simple to use, relatively cheap, and provides a nifty solution for decreasing TAVI-associated stroke, which could been a stumbling block for the adoption of TAVI procedures.  Being a relatively simple device, Embrella required only $7 million of capital before it was acquired by Edwards Life Sciences for $43 million.

Summary

There will always be those companies that are willing to invest significant up-front resources in risky projects in hopes of generating a substantial future windfall.  What is often less talked about is the role that numerous other companies play in supporting the efforts of those “wildcatters”. 

Adjunctive technologies, when applied to bleeding edge markets, can often generate significant interest from strategic acquirers as those companies seek to build out their product offerings and expertise around a specific development area, such as Alzheimer’s or TAVI.  Identifying trends and products that companies need to better facilitate the development and adoption of core products around a growing trend is a surefire way to start a company that will have significant strategic value to potential acquirers.

List of Funding Sources for Life Science Startups (Part II)

Over the past few weeks I have been putting together a list of capital sources for life science start-up companies.  My list is broken down into 4 categories: 

• Large VCs (AUM >$200M)
• Small VCs (AUM <$200M)
• Angel & Regional Investment Groups
• Strategic Investors

I did my best to cull through various lists of capital sources to produce a list of about 300 investors that are (1) still active, (2) have websites, and (3) are likely to lead or co-lead financing rounds.  

Over the coming years I will continue to update this list and publish it on the Osage blog.  I encourage readers to post errors and omissions in the commentary portion of this blog.

Capital Sources for Life Science Start-ups

List of Funding Sources for Life Science Startups (Part I)

At Osage University Partners, we are often asked by entrepreneurs to help identify and make introductions to venture capital firms that are capable of leading investments.  Finding the right venture capital firm to pitch is important, as entrepreneurs only get so many chances to knock on the doors of VC funds before their deal becomes long in the tooth.  Therefore, finding the right VC fund that is interested in a specific sector and company stage is of critical importance to any startup.

Finding the right investor does not necessarily confine startups to venture capital firms.  Angel groups, strategics, and regional investors can also provide capital.  With so many funding sources out there, it is hard to figure out which to first approach.

Over the next couple of weeks, I will begin rolling out a comprehensive list of venture capital, angel, strategic, and regional investment groups that seek to lead investments in life science companies.  I intend to continually update this list and expect there to be errors in my lists as my information is likely imperfect.  As people read my lists I would appreciate clarifications and omissions in my data, and comments should be directed through the discussion portion of this blog entry.

The first list I am publishing is a list of venture capital firms that prefer to be the lead or co-lead investor in their deals.    

List of Life Science Venture Capital Firms

Early Stage Investing, University Startups Feel the Pinch

I recently spoke at NYC Medical Technology Forum, a regular gathering of medtech folks from the greater New York City area, hosted by the law firm Kaye Scholer.  During the meeting I was asked why Osage had partnered with universities - which have an acute need for early stage funding support – yet had chosen to invest half of our fund’s capital in later stage university companies.  One of the reasons that we have chosen to spread our investment dollars across early and late stage companies is to address capital risk, which is the risk we assume as investors that we might lose a portion, or all, of our investment dollars.  With regards to early stage investing, we are willing to take on more capital risk in some companies because they offer the prospect of a higher return on our investment.  The opposite holds true for late stage companies. 

Investing in early stage companies requires patience and capital.  When making early stage investments, VCs must assume that they will need to support an investment for 6-9 years and across multiple financing rounds.  Because of the length of time and unpredictable future capital needs of a company, it is essential that VCs form healthy and supportive investment syndicates around early stage companies.  However, forming solid early stage investment syndicates has never been harder for most tech and life science investors. 

As you can see by the VC fundraising data above, the number of VC funds and capital raised by those funds has declined significantly over the last few years.

When less capital is in the VC system, VCs generally become more concerned about capital risk and therefore become more risk averse in their investments.  This typically translates into less VCs making early stage investments and more making later stage investments.

Pumping new money into the system is essential to support early stage investing as VC funds are more likely to take long-term investment risks early in their funds’ lives. Without new money in the system, VCs are more inclined to invest in later stage companies, which typically have shorter holding periods and require less capital – thus taking a greater portion of the capital risk off the table. 

With early stage capital scarce, the effect on university startup company financings has been somewhat dramatic.

At Osage, we track almost 1,000 university startups from over 50 different research institutions.  From this group, I selected eight premiere institutions (balanced by geography and research focus) and aggregated their startup company fundraising data from the last few years.

As the Osage data indicates, VC investment in early stage companies has decreased substantially over the last few years while late stage investing has remained somewhat constant. 

Blending early and late stage data together (second chart below), you see a significant decrease in overall university startup financing activity.

How to close the early / late investment divide

As early stage investment dollars have become increasingly scarce, many venture funds have started to negotiate somewhat aggressive valuation terms for university spinouts.  Unfortunately, without a robust early stage investment ecosystem, many tech transfer offices are left with little choice but to give into such demands. 

To avoid being squeezed on valuation, some universities are finding novel ways to fund their startups at reasonable deal terms.

The tech transfer office of one of Osage’s University Partners (I will refrain from naming the institution in this blog post) has developed a novel solution to enhance company value and defend against predatory terms.  Several the university’s startups have successfully formed partnerships with local CROs to exchange services for future equity.  This is an ideal partnership for both parties as the CRO gets a future client with an equity kicker and the startup generates more data to support a higher future company valuation. 

Generating third party data and validating some of the academic work takes a bit of the technology risk off the table for VCs and investors more likely to consider the startup for investment.  Bruce Booth of Atlas Venture recently posited a similar strategy in his March 28 blog post.  I am delighted to report in this post that one of our University Partner’s is ahead of the curve! 

A second idea is for the Small Business Administration to launch an early stage SBIC program focused on tech and life sciences with fund sizes capped at $75-100 million.  Smaller funds are typically more nimble, geographically focused, specialized, and willing to shoulder more risk than larger VC funds.  Also, smaller funds are able to make smaller bets in capital efficient businesses, which can be a challenge for larger VCs (funds >$200 million) that need to put $15-30 million to work in any given deal.  Having a series of targeted SBIC funds could help address some of the early stage company funding issues. 

Early stage tech and life science investing is going through a bit of a funk right now; however, the challenges associated with early stage investing for the venture community opens the door for novel funding strategies to emerge as evidenced by the CRO model of one of our University Partners.  By leveraging novel funding strategies, promising startup companies should be able to advance their technologies to meaningful inflection points that can take enough capital risk off the table to entice venture capital funds to invest in their startups.  

Startup incubation goes in-house with UPenn’s UPStart program

The economic downturn had a significant impact on the US economy, and the technology transfer industry was no exception.  With licensing revenues declining and VCs largely sitting on the sidelines, many tech transfer offices decided to take action.  This shift in practice, what I would refer to as the transition from tech transfer version 1.0 to version 2.0, could have a significant impact on how universities view their role in the incubation of university technologies and formation of startup companies. 

Becoming a facilitator of early stage company formation and incubation is a departure from the core competency of tech transfer offices, which had traditionally been to license technologies.  While some universities have historically been very active in startup formation and mentoring, such as Yale University’s New Venture program, other universities, including Columbia University’s Venture Lab, Georgia Tech’s VentureLab, USC’s Stevens Institute for Innovation, and the University of Utah’s Venture Bench program, are just starting to ramp up their efforts.  A common thread among the startup-oriented tech offices is that they have dedicated venture teams focused on taking ideas from the bench and making them “investment ready”. 

One of the more innovative programs I have been introduced to is the UPStart program at the University of Pennsylvania’s Center for Technology Transfer (CTT). 

With an aggregate research budget just south of a billion dollars, Penn creates a lot of great early stage technologies.  However, Penn has not previously had a method for assisting in the commercialization of these technologies through entrepreneurial ventures.  As early stage investing, particularly on the life science side, has decreased over the last couple of years, there is now an increased need for proof of concept programs to support commercial validation studies of these early stage technologies.  To address this fundamental issue, Penn’s Center for Technology Transfer created the UPStart program.

Being a non-profit institution, there are many challenges associated with having a program that essentially facilitates the formation of private startup companies.  The CTT staff, spearheaded by the UPStart group, has done a fantastic job to create a structure that enables CTT to fully support the creation of startup companies while playing within the rules and regulations that typically govern a large academic research institution.

The main thrust of UPStart is to mature technologies to a point where they can attract private investment or be licensed to a corporate partner.  To do that, UPStart offers a robust service offering to aspiring entrepreneurial faculty members and their co-founders.  

1. Company Formation Agreement:  Outlines the rules and responsibilities for both parties – scientific founder and UPStart – relating to the development and commercialization of a technology.  UPStart does take board seats at the time of company formation but upon venture or corporate investment, UPStart will roll off the board at the request of the investors.
2. Clawback: UPStart reserves the right to pull the plug on the startup project should the founders fail to abide by the Company Formation Agreement.  This is an important clause as it keeps everyone honest and dissuades those who might improperly use or develop the technologies.
3. LLC Formation: UPStart forms a Delaware LLC through an agent.
4. File Registrations:  All companies need to file forms with multiple agencies in order to do business with the government.  UPStart will file various forms – EIN, DUNS #, CCR.gov, grants.gov – for the startups so that the founding team members can do what they do best, develop their technology.
5. Bank Account: Open no-fee company bank accounts with PNC Bank.
6. Marketing Materials: Help the founders develop an executive summary, science overview, and VC/corporate pitch deck.
7. IP Strategy: Work with outside counsel.
8. Entrepreneur Recruitment: UPStart maintains an active database of entrepreneurs that they match with the faculty inventor and his or her promising technologies.
9. Grant Writing: UPStart has partnered with a local incubator, the University City Science Center, to provide SBIR grant writing assistance as well as future incubation space for startups.
10. Value-added services: UPStart works with a consortium of accountants, attorneys, business advisors, regulatory consultants, etc…that are willing to forgo payment or accrue payment until the company is funded in return for the opportunity to build a relationship with the numerous UPstart companies.

In creating the UPStart program, there were several challenges that CTT needed to address.  Below is a quick summary of some of the challenges the program faced and the creative solutions that UPStart came up with:

• Private use: Universities are typically limited in the amount of private (i.e. for profit) work that can be performed in their labs.  To avoid being counted against the university’s private use quota, UPStart company meetings are held at the CTT office, which is in an off-campus building.
• Fiduciary duty: Being a Delaware LLC, UPStart is able to define the fiduciary duties of directors, which states that the UPStart directors are first loyal to the university, and then second to the company.  Penn obviously wants its startups to succeed, but at the end of the day the UPStart directors are university employees and are therefore university proxies during company negotiations. 

• SBIR Requirements: While the faculty inventor owns 51% of the equity at the time of filing an SBIR application (which satisfies the grant criteria), the inventor’s ownership will be diluted by the time the grant is awarded with the hiring of a company principal investigator/business manager. The technology can then be optioned or licensed to the company since the inventor is no longer a majority owner.   
• Conflict of interest: The university prefers to not have its faculty in a fiduciary role for the company. At the time of licensing, the company is not expected to have the inventor be a majority owner, be on the management team, or be on the board of the company.  Instead, the inventor acts as the scientific advisor to the company and assists in directing the commercial research toward product development. 

“Not a license, a partnership” 

It is too soon to tell if the UPStart program will be a success, but early signs point to the program having some traction with the VC and corporate investment communities (6 deals closed to date).  Success may ultimately be judged based upon the ability of the program to create successful startups that generate revenue for the university.  However, just like a venture fund, the program runs the risk that it could do everything right and still not provide the financial returns to justify the management costs. 

I would argue that critics should not gauge UPStart’s success, or any other startup creation group within tech transfer offices, by revenue alone.  In evaluating the success of such programs, I would encourage universities to employ a basket of metrics such as the increased number of invention disclosures by faculty members that would not have done so otherwise, the recruitment and retention of key faculty members, and the benefits to the local economy through the creation of high quality jobs.  Incorporating such metrics provides a better snapshot of the overall value that venture creation programs produce for universities.

In tech transfer version 2.0, UPStart and similar programs will help better facilitate technology transfer and promote the development and commercialization of technologies that can improve the lives of mankind.