By Michael Quigley, Research Manager, LSN
I am always excited when I come across unusual life science investment models in my investor outreach. Recently, I learned about a fund whose primary investor, a philanthropic foundation, is providing the other investors in the fund with a “partial loss protection guarantee.” Under the guarantee, a first loss of up to 20% of invested capital is fully covered and 50% of any subsequent losses is also covered. This fund structure makes the risk/return profile for the investment much more attractive to investors and in theory will draw more total capital than in a traditional loss–sharing investment model. Basically, in an effort to get more investors to provide capital towards a specific indication, the foundation is voluntarily taking a bigger slice of the potential down-side.
This model known as “first loss capital” or “FLC” has been seen in other impact industries and social investments, such as education, home ownership for low-income populations, and healthy food for poor countries. Providers of FLC historically have been endowments, foundations, and government organizations looking to catalyze a positive social outcome. These investors tend to have a deep focus on a specific target sector, and often a better understanding of the underlying risk associated with an investment than the generalist investors they wish to attract. By agreeing to cover a portion of the downside risk, they have the ability to bring more dollars to their primary cause.
The life science space is positioned for FLC to become a major financing solution. Increasingly, endowments, foundations, and government organizations are looking for ways to increase their impact by directly investing in emerging life science companies. If successful, FLC could be a tool for these organizations that stimulates innovation and growth in the biotech space by lowering the financial risk in a sector that is often perceived as high risk. The ideal outcome would be to attract the more financially motivated investors and bring more capital into the space.
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