Creative Financing Approaches in Life Science

By Andrew Levitch, Mark Murray, Patrick Nugent, Linda Rubinstein

This article is the third in a 4-part series reviewing financing solutions for the Life Science sector.

As Life Science company valuations have fluctuated significantly over the last two years, and investors have become cautious due to economic turbulence and market uncertainty, fundraising is taking longer. Equity financing has been hit hard.  Financing rounds that used to take an average of 3 – 4 months now take 6+ months. There is also an element of haves versus have-nots, with not all companies being able to raise needed capital.

Life Science company leadership needs to think creatively about financing to survive. They can no longer rely solely on traditional methods like selling shares in a plain vanilla equity round.

The Life Science sector experts at FLG Partners have helped navigate several companies through creative financings, both recently and in past challenging markets. We share some of our journeys here.

Thinking Outside the Box: Successful Financing Strategies for Private Medtech Companies

These private Medtech companies effectively secured financing during tough fundraising periods by getting creative.

Example #1: Early-Commercial Stage Company
One private Medtech company was in its early commercial stage and in the middle of a pivotal clinical trial. While the company had enough cash for the trial, it wanted more capital to speed up its commercial opportunity. The company had not hit any major milestones since its last financing and knew this, coupled with tight market conditions, would dissuade traditional VC investors.

Solution: The company used an inside term sheet (current investors) and only marketed the opportunity to targeted strategic investors (large Medtech companies). The result was successful financing led by insiders and a new major strategic. The company achieved a significant step-up in valuation and increased the size of the financing by 30%.

Example #2: Private Pre-Pivotal Stage Company
Another private Medtech company was in pre-pivotal clinical trials. The plan was to raise funds for the initial study, access data, and raise additional financing to fund the subsequent pivotal study.

We quickly learned, however, that while investors were interested in the opportunity, they asked that we return once we had the pre-pivotal clinical data in hand.

Solution: Based on this feedback, we changed our strategy entirely. The company targeted funding for both studies concurrently, doubling its funding target. This resulted in a successful financing with a large crossover investor as lead and a structure that included an up-front round and one tranched milestone.

The Role of Bankers in Financing

As was the case in both examples above, private companies may not need bankers or another placement agent. However, private companies can benefit from building relationships with banks and sharing knowledge that will benefit both parties.

For many biotech companies, leveraging investment bankers for access to capital through public markets is important. Knowing when to go public and how to do so is crucial.

• When to Go Public
  While most public biotech companies see an increase in available capital and a broader range of financing alternatives relative to what they could access as a private company, going public too early can be a total show-stopper. In recent years, many early-stage preclinical companies that went public have struggled because they don’t have the programs or data flow to sustain their valuations.

• How to Go Public
  How to go public is just as critical. For example, combinations with special purpose acquisition companies (SPACs) used to be a recommended pathway. However their popularity has plummeted due to SEC regulatory changes and cost.

• Choosing the Banks
  Be judicious in selecting the right investment banks. The lion’s share of financings for companies that are already public are executed by investment banks. These include private investment in public equity (PIPEs), underwritten offerings, at-the-market offerings (ATMs), and much more).

• Executing the IPO or Follow-on Financing
  Management teams should also prepare to contribute to putting together the investor syndicate and structuring the financing.

[Watch this recent roundtable on preparing for a Life Science IPO that includes accounting, financial reporting, planning, governance, investor relations, capital planning, and other considerations.]

Examples of Creative Financing Structures

Life Science companies can benefit from cultivating multiple financing sources, such as equity, pharma licensing, grants, government R&D funding, and royalty interest financing, to increase optionality and minimize the cost of capital.

1. Structured Equity Financing
   

   Structured equity financing often involves adding features to a preferred stock or common stock offering. This can include providing warrants or giving investors a ratchet, allowing them to receive more equity if the company issues shares at a lower price. Many small-cap public companies have engaged in very dilutive financings with investors who focus less on the underlying biotech business and look only to the structure to provide the value.  These structured financings can weigh down the issuing company for years.

   In contrast, in recent quarters, multiple public biotechs have successfully executed PIPEs with warrants, where the warrants are exercisable only for cash at a premium price if the issuer meets prespecified milestones. In many cases, these PIPE-with-warrant deals have been favorably received.

2. Physician Endorsement and Convertible Notes
   

   Sometimes, doctors are the greatest advocates for Life Sciences technology. This was exactly the case with a healthcare company that recently partnered with FLG Partners, and the medical community provided widespread support.

   The company decided to approach physicians who understood the value of its technology. Utilizing convertible notes raised significant funds from thousands of doctors. This financing was completed under an SEC 506 ruling. The company multiplied with this funding, reaching $50M in revenues within three years.

3.  Tapping Non-Traditional Equity Investors
   Some companies use unconventional methods to access capital. For instance, a drug/delivery company that was eventually acquired by a Big Pharma company initially received funding from investors who were not traditional life science investors but believed in the company’s mission. This allowed for less pressure on the company’s valuation.

   Subsequent financing rounds involved convertible notes from high-net-worth investors who were passionate about the company’s solutions for patients. In a strategic move, we engaged a Big Pharma company in an equity round with an option to purchase the company later. The company created two equity series — one for the Big Pharma at the purchase price and another for high-net-worth investors at a fraction of the valuation. This ensured that the company would be funded even if the acquisition did not happen.

   Ultimately, the company was acquired by the Big Pharma, and the remaining equity funds were shared with investors.

4. Grants
   Grants are a great source of non-dilutive funding for Life Science companies. One client funded most of its R&D with grants, allowing it to progress to early-stage commercialization with minimal dilution
5. Out-Licensing
   Out-licensing is another financing option. Companies can retain value while funding further development by out-licensing an asset with specific limitations. For example, a company out-licensed a Phase 2 asset with restrictions on its use in the US market, enabling it to fund its Phase 3 clinical trial and eventually sell the company.
6. Revenue Interest Financing
   Revenue interest financing, or royalty financing, is gaining popularity for late-stage clinical biotechs. There are dozens of investors who invest in biotech revenues by buying a royalty strip or a revenue interest, which is like a synthetic royalty. Most royalty investors are willing to invest only after the underlying biotech product has been approved, or at least has registrational data that will support an FDA BLA or NDA filing, or maybe to finance a Phase 3 trial in a new indication for an approved drug. However, a growing handful of royalty investors will provide Phase 3 development financing and do so in size.
   
7. Government R&D Tax Incentives
   One early-stage client funded all its preclinical and IND-enabling R&D through a combination of grants and the Australian R&D Tax Incentive, which provided cash rebates for certain R&D spending in and even outside Australia. The client raised its first equity round only when it was ready to start Phase 1 clinical trials, which it planned to conduct in Australia.

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In 2024, funding for life sciences companies will continue to be difficult to secure. Their survival depends on creative financing that takes measured risks and thinks outside the box. Companies that balance innovation with financial responsibility have the best chance to be successful in the ever-changing world of life sciences.

These are exemplary illustrations of how creative financing structures can help Life Science companies access capital and achieve their goals.  For additional FLG Partner commentary about trends in financing for Life Sciences companies, please view our recent Panel Roundtable, Creative Financing Solutions for Life Science Companies.

Part I. Trends in Financing in Life Sciences: 2024 Updates
Part II. How to Successfully Extend Cash Runways to Growth in Early Commercial Stage Life Science Companies