By Linda Rubinstein
This article is the first in a two-part series about fundraising strategies for life science companies.
- A Menu of Financing Alternatives for Life Science Companies
- Fundraising Choices in Life Sciences: What, When & Why?
Life science companies, from emerging to evolved, therapeutics to diagnostics, solo or partnered, are constantly fundraising. Each enterprise must make strategic choices along the way about its desired funding composition and timing, target investor mix, and how they build value.
At FLG, as a Chief Financial Officer, I’ve had the good fortune to advise a wide range of biotechnology, life science tools, genomics, and diagnostics companies about how to raise capital, manage operations, and chart their strategic direction. FLG is a great solution for life science companies, whether they need an experienced, full-time CFO or are at an early stage and don’t want to bring in a full-time CFO but need senior-level talent and advice. I’ve seen firsthand how making the right financing decisions, particularly at life science companies, can broadly benefit an entity, maximizing the probability of success in the challenging business of drug discovery and development, optimizing value for investors and other stakeholders, and even helping to recruit key talent – from board members to key hires.
What is Meant by “Life Science” Companies?
The “life sciences” industry refers to a wide range of companies that variously address therapeutics, diagnostics, genomics, tools and reagents, and contract research. Even within a category of life sciences, companies can pursue a range of business models. They may develop proprietary products; work in partnership with larger pharmaceutical companies; source their discovery from, or in collaboration with, academic research institutions; provide services for a fee; or combine multiple of these in a hybrid. For purposes of this article, we will focus on companies discovering and developing their own therapeutic or diagnostic products as their principal value driving activity. We won’t address medical device companies, which often have different time to market and capital needs, or fee-for-service contract research organizations, which have a quicker path to revenues and profitability and are more analogous to peers outside of life sciences.
What Financing Options Do Life Science Companies Have?
Life science companies have a multitude of options to raise capital. In these articles, we’ll review these financing alternatives and their appropriateness based on company objectives, stage and other attributes including:
- Pharmaceutical licensing
- Royalty monetization
- Fee-for-service revenues
- Tax incentives
- Mix and match
We’ll also review key considerations for selecting which financing mechanism is best for a given company at any given time. Among others, these include:
- Cost of capital, e.g., investor equity returns in the form of stock appreciation or dividends or lender returns in the form of interest, upfront and final payments plus sweeteners such as warrants
- Ability to reach key milestones
- Financial and operating covenants
- Other operating restrictions that may constrain future activity such as a security interest or negative pledge on intellectual property backstopping a loan or an exclusive license that ties a program’s fortunes to a specific partner.
Equity is the primary source of capital for most emerging life science companies. Seed-stage companies start with equity, perhaps a grubstake from friends and family or early funding from venture capital (VC) investors. Young companies in incubators may trade equity for in-kind services and benefits. Most early-stage biotech companies eventually take venture capital with the goal of raising successive rounds at increasing valuations, culminating with an initial public offering or trade sale. Beyond providing capital and adding value as board members, VC investors can bring valuable networks, enhance a company’s visibility, help to recruit key hires, and land business development (BD) opportunities.
Sources of venture capital include institutional venture funds, family offices, hedge funds, and sovereign wealth funds. Specialist investors may include impact investors such as non-profits looking to fund development of therapeutics for particular diseases or populations or by companies operating in specific regions.
Private companies typically issue convertible preferred stock. Warrants can be issued as a sweetener in certain financings. Once public, companies typically issue common shares. Larger or more mature companies may issue convertible securities, broadening the universe of potential investors. IPOs are typically an important but not the final financing round for life science entities and rarely represent an exit for existing investors.
Many biotechnology companies obtain grants from the NIH and other government agencies and private foundations. While many of these non-dilutive funds support early-stage R&D, some grant programs provide larger awards to support clinical trials and later product development.
Many life science companies allow third parties to access to their platform technology or obtain rights to develop and sell their product candidates. These business development (BD) transactions can take the form of fee-for-service research and development (R&D) or intellectual property licenses that combine some or all of an upfront fee, ongoing R&D support, contingent payments tied to R&D, regulatory and commercial milestones and royalties on product revenues. A potential pharmaceutical or large biotech partner may provide R&D support and other payments during a trial period after which the larger company may have an option to license certain assets.
Young life science companies can leverage business development funding and the expertise they gain in working with BD partners to build out their platform technologies and to develop proprietary product candidates. BD funding can extend a life science company’s cash runway and provide external validation, bolstering valuation. Partner relationships can also bring valuable expertise (e.g., clinical development and other general R&D, therapeutic area, commercial or regulatory) to the younger company.
Debt financing can be tricky for young life science companies, which typically lack recurring product revenues and profits to pay interest and repay principal.
Venture debt is one vehicle for a venture-backed life science company that wishes to extend its cash runway in order to achieve a milestone or have more time to raise money. A venture debt deal relies on the borrower’s venture investors to backstop the company’s ability to repay a loan by investing additional equity if necessary. Venture debt can be less dilutive than equity when the borrower repays the debt with non-dilutive financing or equity raised at high enough premium to the last round. Venture debt can be more dilutive than equity when the borrower fails to raise equity at a premium and the debt must be repaid with more expensive capital. In addition, debt adds financing risk, as interest and principal amortization are fixed, and debt may add operating constraints including financial and operating covenants and the requirement to pledge assets as collateral.
Debt financing can also be an attractive option for advanced biotech companies looking to finance to a milestone such as product commercialization and launch that can lead to self-sustaining cash flows. Debt can also work in situations where a life science company borrows money backed by a royalty interest; using debt instead of selling the royalty is one way for the borrower to retain upside from the royalty interest. Other kinds of debt that life science companies may contemplate include capital equipment financing; working capital or cash flow based financing for more mature, revenue-stage companies; and bridge financing, which often takes the form of debt convertible at a discount into a later equity round and may be useful if a company needs time before completing a fully priced round.
Life science companies with marketed products can sell a royalty interest, agreeing to pay a percentage of revenues on an ongoing basis in exchange for one or a series of upfront or other contractual payments. Future revenues or royalties can also be monetized by using the royalty stream to support a debt financing as described above. Royalty investors are increasingly looking at earlier stage investments, including obtaining royalty rights to products before they enter FDA registration trials.
Fee for Service Revenue
Life science companies can bootstrap their proprietary programs or build out their platform technologies by selling R&D services. For companies whose principal business is developing their own product pipeline, these R&D revenues are rarely enough to offset significant clinical development expenses unless they lead to a larger pharmaceutical license arrangement.
A number of jurisdictions offer tax incentives to entice life science jobs and spending. Of particular note is the Australian R&D tax incentive. This tax incentive enables Australian companies, including wholly owned subsidiaries of companies located elsewhere, to obtain cash funding equal to 43.5% of spending on approved R&D projects. At least 50% of the value of these projects must be conducted in Australia; the balance may be conducted in other countries under certain conditions. The cash rebate is available to Australian companies which are part of a consolidated enterprise with less than AUD $20 million in revenue in a given year; if revenues exceed this threshold, the Australian company obtains a tax credit instead of a cash rebate. A key requirement is that the Australian entity own the upside from its activities, which typically involves transferring certain IP or commercial rights to the Australian subsidiary.
These tax incentives can be financially powerful. I’ve worked with companies whose Australian subsidiaries have funded GMP manufacturing and toxicology and Phase 1 clinical trials.
Mergers & Acquisitions
A less frequent source of capital for life science companies is to combine with a second, well-funded company whose products have failed and with cash that can be redeployed and investors seeking an opportunistic home for their capital. These companies can be private or public and may come with obligations including ongoing operations that need to be shut down or merged as part of the combined business. These complex transactions, which may take the form of a reverse merger, can be expensive and time consuming to consummate. There are typically many bidders for such opportunities, making them a potentially expensive source of capital. Such a business combination may make sense for life science companies that can’t raise equity in a traditional round. For example, this may be the case if existing investors are tapped out and the only alternative would be to raise money from new investors in a recapitalization.
“Mix and Match” Financing
Most life science companies use various sources of financing over time, and many also combine various sources of financing into a single transaction. One example is a product license that generates upfront payments, research and development support, milestone payments and a royalty stream plus a concurrent equity investment and even debt funding. Debt financing can include warrants and royalty payments as sweeteners for creditors, and an equity financing can also include warrants or other contingent payments to investors.
In our second article, we’ll dive into key considerations which should guide life science companies when making decisions about which form of financing to use, when and why.