Investor Series: Selecting the Right Kind of PE Partner for your Life Science Firm

15 Jan


Identifying the right kind of investor to partner with can often be an arduous task for many life science firms. Private Equity Groups as of late have emerged as major players in the life science space, filling the funding gap that was created by many Venture Capital funds halting investments in the sector. Private equity funds typically have a long-term investment horizon, and because of their appetite for longer-term investments, they have recently been investing in younger firms in the life science space than they have in the past.

There are a number of different strategies that private equity groups employ; because of this, determining what strategy would be the best fit for your life science firm can be a daunting endeavor.  For this reason, Life Science Nation’s Newsletter will be running a series over the next three weeks written by LSN’s Director of Research Danielle Silva that will give in-depth insight into three of the most common private equity fund strategies, and will provide insight into what types of funds are best for life science firms depending on the firm’s financial situation and management team. The three–part series will run on the following dates:

  • Buyout & Recapitalization: 1/15/2013
  • Growth Equity: 1/22/2013
  • Mezzanine: 1/29/2013

Part 1: Buyout & Recapitalization Funds

For life science companies looking to raise capital, identifying the correct type of private equity (PE) group to partner with can often times be a challenging task. One of the first steps a life science company must take in order to select the right kind of private equity group to partner with is to gain an understanding of the different kind of PE fund strategies. Some of the most common private equity fund strategies include buyout, growth equity, mezzanine, distressed/turnaround, and special situations.

A buyout transaction is the most commonly used strategy amongst private equity funds. Buyout funds will typically purchase a company and hold them for four to six years[1]. Because buyout funds are long-term investors, many funds with this strategy have started to invest in younger companies in the life science sector, which traditionally have longer-term investment horizons. Additionally, there are more opportunities in the space due to many VC funds halting investments in the sector, with the remaining few opting to invest in later stage opportunities. For this reason, buyout funds may be a good fit for earlier-stage firms – for example, pre-revenue therapeutics companies that are seeking additional funding to get the firm’s product through the clinical development process.

Buyout funds usually buy companies through a leveraged buyout, meaning the private equity group will finance a portion of the purchase price using equity, and will use debt to fund the remainder of the transaction. The private equity group will pay back this debt by using the operating cash flow of the firm that was acquired by the fund. The firm will also increase the acquisition’s future valuation by reducing costs, increasing sales, and making strategic acquisitions (which are sometimes referred to as an “add-on” or “tuck-under”).

The term buyout, however, is almost counterintuitive because the fund does not necessarily buyout the firm’s stakeholders entirely. Some funds will entirely buy out a firm’s stakeholders. However, many firms use a technique known as a recapitalization (“recap”), which is a transaction where debt and equity is reallocated in the capital structure of a company. In a recap, a private equity group will take a majority stake in the business by buying out most (50% or more) of the business owner’s stake in their firm. A complete, 100% buyout would best suited for life science business owners who are looking to retire from the business. However, a recapitalization may be a better structure if the life science firm’s owner would like to remain involved.

In a recap, the owner has the chance to have an upfront liquidity event for the equity that is bought, as well as the opportunity to stay involved in the business with their remaining equity stake. This way, they can also have a second liquidity event after the private equity group sells the business. If the investment goes well, this structure should give the owner a larger total payday. This is an attractive option for life science business owners who may not want to retire, but have put up a large amount of personal guarantees to grow the business, or just need additional capital expenditures and management support to take their business to the next level. An example of this would be a business owner in the biotech therapeutics space who has been able to finance the discovery and lead optimization phases for the product they are developing, but needs further capital in order to fund the clinical trial portion of the development process. This structure is often also favorable for private equity groups as it is often the owner who has the technical knowledge or management skills that have been able to develop the product and grow the business to where it stands currently. Having that owner stay with the company with the incentive of growing their equity stake can help the private equity group ensure that the owner will continue to have an interest in growing the business.

Therefore, for life science business owners, a fund that uses a complete majority buyout strategy (i.e. a 100% buyout) may be an attractive option for an owner who wants to retire, or would like to move on to a different venture. A buyout fund that employs a recapitalization strategy, on the other hand, may be a fitting option for a life science firm owner who has taken on a significant amount of personal debt in order to grow the business, and needs further capital to cultivate their firm and their product or service to the next level. A recap thus would be most suitable for owners in the life sciences space who wish to still be involved in the firm’s management but doesn’t have enough capital to grow the company or feels it would be unwise to take on greater financial risk. Thus private equity buyout funds can prove to be an invaluable partner for many different kinds of life sciences firms, whether the owner is looking to retire, start a new venture, or wishes to remain involved in the business that they have built.

[1] Ribet, Michael B. “Understanding the Private Equity Recapitalization Opportunity.” Focus Capital Advisors Accessed January 14, 2013.

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