Finding Capital in the Early Stage Funding Gap

By Michael Quigley, VP of Investor Research, LSN

The majority of companies that we see at LSN have already secured some SBIR/STTR grant funding and/or have raised seed capital, generally from friends, family and angels (FFA). This funding tends to be used to cover incorporation fees, initial IP costs as well as some additional technical development to further de-risk their technology, making it more attractive for investors in a larger round.

What comes next, and when most companies come to LSN, is referred to as the “Valley of Death”. This is the area between FFA and significant VC investment, a gap that many companies fail to bridge. If you are plugged into daily news on biotech and life science venture rounds (which I would highly recommend for any fundraising entrepreneur) it is not uncommon to see Series A’s to the tune of $20 million or more. What is important for entrepreneurs to understand is that these large rounds represent the minority of Series A investments. In LSN’s Financing Round Database that tracks life science investments we have identified 134 Series A financing rounds that have been made thus far in 2017. Of those identified raises, 85 (or just about 2/3) were under $20 million. 57 were under $10 million. What is also important to note here is that LSN’s data is comprised of financing rounds that have been reported, and in LSN’s experience many of the smaller rounds do not get reported. Therefore, there is a high probability that these stats are underestimating the number of smaller rounds.

Of the rounds that raised $20 million or more, about 75% of them included what can be considered one of the top 25 venture capital firms based on total assets (AUM), investment track record, and name recognition. Many entrepreneurs are familiar with these VC’s, though few have real relationships with them. As a result, these VC’s have unprecedented deal flow allowing them to be extremely selective. Many of them are investing into companies in which they have been tracking the science and team since academia. In other words, unless you have a pre-existing relationship with these groups, truly getting their attention and having them take a hard look into your technology is a challenge, particularly if your technology description doesn’t include a hot topic word like immuno-oncology, microbiome or gene therapy. However, these high-caliber investors do show up at LSN’s RESI Conference events and you can meet them there, either via an ad hoc meeting, at a panel or in RESI partnering.

Companies that land these large rounds with top tier VC’s often discuss how easy it was to raise capital. “I just called my old business partner at fund X and we had a term sheet in two months”. While this is great for companies that can raise capital that way–and if you can then by all means do!–it can create a false sense of what fundraising is like as these are the deals that generally get the most press. Additionally, many of these funds are so large that they look to put significant capital to work in each investment, so this creates an inflated sense of the size of typical Series A rounds. In general, I would suggest entrepreneurs looking to raise capital outside these big players to target whatever is needed to get to the next significant value inflection point. This helps broadcast your grasp on capital efficiency to the investment community, as well as an understanding of the space beyond the headlines.

For companies that cannot raise from the top 25 VC groups, which represents the majority of rounds raised, they have a much bigger task at hand to raise capital then making a few phone calls.

LSN’s Research team is currently in dialogue with over 375 investment groups looking for preclinical – phase II therapeutics companies that fall between angels and the top 25 VC’s. These include what we can call mid-tier or new VC funds, PE groups starting to look earlier, family offices now going direct, strategics, their corporate funds, and venture philanthropy groups. This is essentially LSN’s bread and butter; helping entrepreneurs identify and connect with these more low-profile investment groups. While it is a positive that there are so many of them, it does make fundraising a larger task when you have many more emails, calls and meetings to take before you can find a partner.

For first-time entrepreneurs and those without deep networks into the VC community, the pool of capital represented by these investors outside the big-name VC firms represent your greatest potential chance of securing investment. Many of these VCs don’t have the same name recognition and established deal flow channels as the top 25 funds. If you can connect with relevant strategic groups, you will often find that they have deep scientific experience in your field as well as a need to fill their pipelines. These dynamics can all benefit the entrepreneur when looking to work with these less prominent groups, but identifying who these groups are and which ones are likely a fit for what you are doing is where the challenge lies.

There is indeed life in the Valley of Death, and with the right tools and contacts it is possible to find investment. It’s a challenge, however, as anyone who has gone through the process will tell you. You need to really put yourself out there both on the phone and in person to start dialogues, get meetings, build relationships and ultimately sign terms.

Click here for a PDF of the book “The Life Science Executive’s Fundraising Manifesto”.

Click here to see a list of investors who are signed up for RESI Boston.