By Michael Quigley, Research Analyst, LSN

Throughout the existence of this newsletter, LSN has discussed at length the trend of family offices moving towards direct investments in the life science space. However, family offices remain an obscure investment entity to many of our readers. In this article, I want to shed some light onto what exactly constitutes a family office, why their numbers are growing, and why they are such a crucial player in small- and medium-sized enterprises.

To begin with, traditional wealth advisory and asset management firms provide clients with advice on investments, and may provide insight into insurance, tax, and budget-related decisions. Family offices, on the other hand, act as personal CFOs for ultra-high net worth families – and individuals handling all of these issues – as well as generational wealth management, philanthropic donations, legal issues and management of tangible assets. Each family office is unique in that its services are a function of the demands, skills and financial requirements of the family or individual whose money they manage.

These organizations exist primarily in two basic forms: Single Family Offices (SFOs) and Multi-Family Offices (MFOs). SFOs – as the name suggests – manage the finances for a single family or individual with a net worth generally over $100 million, with an average of around $600 million. MFOs, which have been recently gaining popularity, serve the same purpose, only they cater to the needs of multiple families with a minimum net worth around $20 million and an average of about $50 million.

The amount of capital held by family offices has been growing recently as a result of an increased demand for complete personalized financial management, SFO’s expanding to multiple clients, MFO’s lowering their asset requirements, and as traditional wealth managers (following the market demand) are offering more holistic services, transforming their business model to become MFO’s. Industry experts estimate that there are currently over 4,000 family offices in the United States alone, with well over $1 trillion in combined assets under management, making them a very significant source of private capital. (1)

Historically, family offices have been the funders of alternative assets such as venture capital and private equity funds, thus stimulating small- and medium-sized enterprises. As discussed in a previous LSN publication entitled “The Perfect Storm,” family offices have been discouraged by the performance of these alternative investments, and are beginning to bypass these types of funds and invest directly into privately-held companies themselves.

Many family offices involved in this trend are utilizing the skills and knowledge of the particular sector that made the family its fortune to identify strong investment opportunities, where they also have to ability to add value beyond capital. (2) What’s more, as long as family offices have been in existence, the majority have maintained a portion of their clients’ capital for the purpose of philanthropic allocations. Recently, philanthropy is becoming less of a donation and more of an investment focused on a measurable, positive social impact on society as a gauge of ROI. With this mindset, family offices are investing directly into industries like life science, where a scientific breakthrough could have a massive, lasting positive impact on a global scale. (3)

Family offices are both increasing in number and in involvement in direct private investments. There are many factors contributing to these two trends, and one of the biggest beneficiaries will be private companies fundraising for the growth of their enterprise. Family offices looking for an impact with their investments do not have the same standards for ROI as traditional investment firms who are under immense pressure to generate consistent returns by shareholders, and are therefore offering better terms with less stringent restrictions on time-to-exit than traditional private investors.

1 http://familyofficesgroup.com/Report.pdf

2 http://www.familyofficereview.com/family-balance-sheet/investments/article/753/direct-investing-taking-care-of-business

3 http://online.wsj.com/article/SB10001424127887323551004578441002331568618.html

By Dennis Ford, CEO, LSN

The Good

I like crowdfunding for the life science arena because this industry already has a proven global audience that “votes with their feet” through a vast web of charitable platforms that raise money for research. Take, for instance, the crowds on any spring/summer weekend walking for this or that cure; the fact that everyone is in some way affected by disease makes these crowds not only readily available – but also relatively knowledgeable – potential investors.

Another unique value that these potential investors possess is that they emphatically want to change the world and help mankind. The fact is that almost everybody already donates in some capacity to research that aids in fighting disease, be it the extra dollar at grocery store checkouts or a planned donation to a charity or foundation. The question is whether or not crowdsourcing portals channel this worldwide source of capital in an adroit and compelling way. Basically, the net/net here is that crowd sourcing is already alive and well – and working. However, the biggest question is if the model can be transferred into the general population of potential investors made accessible by the jobs act, not just the accredited ones.

A side effect of this medium is that when you get onto the grid with your fundraising campaign, and are now in the mix and published, you are visible to everybody, which means an investor (or syndicate of investors) can come over the transom and write a big check and solve the fundraising issue by including you in a portfolio of life science assets.

So, the good is: it will work for launching a firm. However, you cannot raise over $1 million per year, and over $500k requires extensive filing and compliance, which can easily become an administrative headache.

The Bad

The main issue here is the numbers game that one has to play in order to reach a seven-figure goal, which translates to a large volume of required investors considering the SEC limits on investments in equity crowdfunding (see chart at the bottom of this article) – not to mention how to create dialogue and manage ongoing relationships with a group of investors of this size.

Crowdfunding is a paradigm shift. However, the ante into the game is where the biggest questions of all arise. Some sites are showing a very greedy edge, with equity positions ranging from 2 to 10+%, and/or a piece of the monies raised (between 5 -20%); that’s a pretty steep business model for a virtual company profile and a three minute video. As I look at the first batch of crowd sourcing portals and their associated business models, I am reminded of the Wild West and the stereotypical cast of characters. The mantras from the entrepreneurs who run these portals are pretty much all the same: “the risk to the investor is low because the investment dollar amount is low,” with the lofty slogan “the people will decide what makes its way into the market”.

Translating this into experimentally based life science technologies may be tricky, as the general public isn’t necessarily going to grok the subtleties of therapeutic biomarkers, or mechanisms of action, or physics-based, next-gen medical devices. The obvious candidates for this kind of funding, therefore, are easily understood healthcare IT solutions and/or simply comprehensible medical devices. The trick then for the therapeutic technologies is to take the high road, and use a similar easy-to-understand, high-level approach when pitching their technology.

Keeping it simple and using crowdfunding as a tactic for part of the strategy for early stage capital raising will be fine. However, it won’t be the full-blown solution to the industry’s capital needs.

The Ugly

How ugly can it be if you cannot see it yet, and where does crowd funding really fit? In my opinion, the fog has not been cleared on the regulatory side, and we have to wait for the rules and regulations to come down from on high. As of July 2013, no one knows what crowdfunding for equity investment currently really looks like!

I can speculate that because of the associated regulations, the best bet is as follows: if you need less than $500K to jump start your company, then you do not have to make the considerable investment of filing audited financial statements, which may also include compliance issues like keeping track of all communications through phone, email, and face-to-face meetings, etc., which translates to a very large administrative overhead.

The Bottom Line

The big challenge for the translational scientists is simplifying their message to a wider, less technically versed audience. Science needs to move through the experimental process step by step, and therefore, trying to get funding step by step is a reasonable approach if it is part of an overall fundraising strategy. What I mean by this is avoid the guardrail-to-guardrail, fits and starts approach, and have crowdfunding as a tactic in your overall strategy. Find small dollars to demonstrate efficacy, and then move on to the traditional groups and the new direct family offices and institutional investors for the larger capital needs.

At the end of the day, the scientist-entrepreneur has to understand that if he wants to play, he has to educate his or herself in the world of capital allocation, and the map that they use to do this has to be fresh and accurate and not dependent on the old models of fundraising, but rather reflect all the options, and how those options may map to the company’s needs over the next 5-7 years. The real take away from this discussion is that you need to create a strategy that covers all stages of your company’s financial needs by drawing the map of investor prospects for each stage.

By Danielle Silva, Director of Research, Life Science Nation

Over the past couple of weeks, I’ve been speaking with many entrepreneurs developing medical devices regarding LSN’s upcoming Redefining Early Stage Investments Conference. What has struck a chord with many of these entrepreneurs is when I mention that we’re targeting non-traditional investors to attend our conference, such as family offices. Surprisingly, it’s not just because many of these medtech firms are looking to get in front of family offices – it’s because a good deal of them already have.

What I’ve heard from many of these companies developing medical devices is that family offices have been the first round of capital that they have received after gathering up funds from friends and family. This week, I spoke with a west coast based-company developing a medical device where this was the case, but have had countless conversations with other medtech companies that have echoed this trend.

If we take a deeper dive and further examine these two groups (early stage medical technology companies and family offices), they actually have a great deal in common. Early stage medical technology companies are often times in “stealth mode” – they don’t want other companies to know what they are doing, and certainly do not want their competitors replicating any IP that hasn’t been patented yet. Family offices are also incredibly secretive; as such, many of them don’t have websites, and their physical addresses typically can only be found by rifling through hundreds of SEC filings. The majority of the family offices that do have websites do not boast their portfolio companies on their website (like private equity funds or VCs typically do), or even mention what asset classes they typically allocate to. Thus, because family offices like to fly under the radar, they are a perfect fit for stealth mode medical device companies that want to keep their technology – and their investors – undisclosed.

What is also quite surprising is that these medical technology companies are not just receiving capital from small, single-family offices (SFOs) that are making one-off investments in the space; many are also being funded by multi-family offices (MFOs) that are institutional-quality investors, and have several hundred million in assets under management. These MFOs are actively looking to invest in a number of medical technology firms annually, and are not just making one-off investments in the space. I recently spoke with a family office based on the east coast that is actively looking to allocate to several medical technology companies before the year’s end.

So the question still remains – why are family offices so in love with early stage medical device companies? We’ve spoken at great lengths in previous articles about why family offices are attracted to the life science space as a whole, and we’ve touched upon the fact that these groups have a dual mandate – they are obviously focused on ROI, but also generally make philanthropic donations as well, and investing in life sciences fulfills this dual mandate. However, what makes investing in the medical device space so attractive to family offices is that understanding if a medical technology investment is attractive doesn’t require as much scientific knowledge compared to determining whether or not a therapeutic product is a sound investment. Also, what makes the medtech space more attractive than the therapeutics space for family offices is the fact that medical devices receive FDA approval much more quickly compared to therapeutics.

Another reason family offices have become more and more attracted to life science in general is that often times, a family member will be afflicted with a certain disease and thus the family office will attempt to push along the science in a particular area by investing in a company developing a product targeting this disease. This makes family offices particularly unique investors in the medical technology space – as most traditional investors in the space are not indication-oriented. The traditional investors in the medical technology space (like private equity firms and VCs) invest in a medical technology company based on the kind of device they are developing (for example they will look solely for companies developing active and implantable devices). As aforementioned, family offices are more indication-oriented, and so are less focused on how the technology functions and more concerned with what disease the device targets.

So if you’re an early stage company developing a medical device, it’s time to think outside the box, and start targeting non-traditional investors in the space like family offices. You should especially start to consider raising funds from this group of investors if you are a company in stealth mode that has not raised capital from institutional investors. From what I’ve been seeing and hearing over the past several weeks, it seems as if the family office love affair with investing in medical technology companies will only grow stronger.

By Max Klietmann, VP of Research, LSN

In the domain of early stage biotech and med-tech innovation, point-of-care facilities are typically not where one would expect to find nascent translational technologies. However, some highly innovative hospitals and clinics are taking a novel approach to the healthcare arena by not only providing care, but also by actively driving new therapies into the marketplace. These entities are leveraging physicians and specialist staff to vet technologies and ideas in their earliest stages of development, and choosing the best to shepherd through the clinic and onto the market.

Why are they doing this? As hospitals are under increasing cost pressures, it serves as a natural way to create a competitive edge in the marketplace, and can create long-term commercial value, as well as a measurably higher standard of patient care. What makes this trend particularly interesting is that the vetting is done by boots-on-the-ground doctors – those who are addressing real-world medical challenges that they encounter on a regular basis. This is a significantly higher level of insight than any traditional provider of capital could bring to the table when evaluating commercial viability. Essentially, this means that they have an edge when it comes to picking winners, and that we can anticipate some of the leading sources of commercialized products in the future will be coming out of research hospitals.

One large hospital group that began implementing this strategy less than ten years ago serves as a perfect example. The Ohio-based institution has made tech commercialization a priority, and is finally seeing some very impressive results: the group has registered approximately 500 patents, and has created over 50 new companies. Those figures are the result of excellent vetting done by experienced specialists who understand the patient needs from the very beginning. This allows selection of the best science, which can then be backed by the capital of a major institution with a long-term orientation.

So what does it mean for the industry? First, this is a solution to one of the biggest issues in life sciences today: that there are so many emerging companies that it is difficult for anyone to know what is truly leading technology and how to vet it, leaving many early stage companies with great science to perish in the valley of death. Research hospitals can vet technologies better than anyone, and help to cut through much of the “noise” in the early stage space.

What’s more, these “pre-selected winners” can then access the capital required to move them past the early stages and into a position to be spun out or sold to a strategic buyer. This allows for more fair valuation, a partnership approach, access to resources on a massive scale, and will undoubtedly move science along faster and more effectively than by traditional means. This trend is poised to be a major disruptive factor for the life sciences at large, and will shift much of the industry dynamics.

By Michael Quigley, Research Analyst, LSN

With the number of Biotech IPOs in 2013 having already doubled the number in 2012, this year is shaping up to be the biggest for biotech in the last decade. These kinds of numbers are leaving many investors and companies alike wondering what exactly is fueling this wildfire. General investor confidence across the market paired with low interest rates could be one answer. However, other industries are not experiencing the same growth that biotech has been seeing as of late. Over the past three years, the NASDAQ biotech index is up 128%, which is leagues above the S&P 500’s return of 52%. (1) These returns are one result of the FDA’s recent increased willingness to approve drugs, paired with an improved understanding of the molecular substructure of diseases, which contributed to drug approvals in reaching their highest levels in over a decade in 2012.

These numbers – however promising – do not tell the whole story on this IPO eruption that we are seeing as of late. The JOBS act of 2012, for instance, plays a part in this development. Included in the act was a clause that allows for companies looking to IPO to speak with investors months before making a public declaration of an IPO, a strategy known as “testing the waters”. This lets investment firms effectively premarket an offering before any SEC filing, which allows them to address the interest of the fund’s own investors in a biotech company’s equity. This streamlining of deal structuring in the space is what has delivered the vast number of successful Biotech IPOs this year –  companies have seen as many as two-thirds of investors participating in their IPOs coming straight from their one-on-one meetings. (2)

A continuation of this IPO trend will push big pharma to invest in earlier stage companies to keep pipelines robust, unless they wish to compete with the prices offered by public markets for mergers and acquisitions. This additional exit option will also put increased pressure on investment firms, as they will no longer be able to offer deals with less-than-favorable terms to companies they look to invest in (for fear of losing them to the public markets). Just as with pharma, this could push these investment firms to look to develop relationships with earlier stage companies in the space long before thoughts of IPO are on the table. The bottom line is, this surge of IPOs is adding a new supply of investment in the biotech space that will increase competitiveness among current investors, causing them to offer better terms – and look to earlier stage companies – for their newest investments.

1. “Strong Biotech Market Fuels IPO Surge.” NVCA Today. William Blair & Company, n.d. Web. 25 July 2013.

2. Herper, Matthew. “Why The JOBS Act Is A Lifesaver For Life Sciences Companies.” Forbes. Forbes Magazine, 19 July 2013. Web. 25 July 2013.

By Danielle Silva, Director of Research, LSN

As you may have already heard, the SEC voted 4 to 1 on Wednesday July 10, 2013 in favor of implementing section 201(a) of the Jumpstart Our Business Startups (JOBS) Act. The act lifts the ban on solicitation, as well as on certain restrictions regarding the advertising of private offerings that have been in place for around eight decades.

In the past, in order to openly raise money, a company would have to go public, a difficult milestone for many early stage life science firms to attain – especially if the company does not have a product on the market.

In my research, I’ve encountered a large number of firms in the biotech and medtech space that have chosen to pursue this route (with no products on the market), which ultimately leaves them with a penny stock on an obscure or over-the-counter exchange, providing little legitimacy to investors, and forcing the company to raise all subsequent rounds through PIPES (private investments in public equity). Therefore, the approval of this section of the JOBS Act is great news for firms in the life sciences space – especially early stage firms that are struggling to bridge the valley of death – who will now be able to adopt a more aggressive outbound marketing campaign.

Outside the realm of marketers for alternative investments, many individuals and firms are not familiar with the legality that in the past was associated with private placement offerings. Before the approval of 201(a) of the JOBS Act, companies had to establish a “relationship” with an investor before they could attempt to obtain funds. To illustrate, imagine this scenario: a life science firm seeking capital e-mails a family office that they believe would be interested in their technology. In order to be in compliance with the regulations surrounding private placements in the past, the firm could not reach out to the investor again (even if they seemed interested in investing) for 30 days. The section of the JOBS Act that was recently approved, however, completely eliminates this so called “cooling off period,” which was originally implemented because companies soliciting investments were required to have established a prior relationship with an investor.

What doesn’t change, at least, with the passage of the most recently approved section of the JOBS Act, is whom firms can market their private offerings to. This means that firms will still only be able to raise capital from accredited investors, or those investors that have at least $1 million in liquid assets (for example, $1 million, not including their house, cars, etc.) or investors that have attained at least $200,000 in household income consistently over the past two years. Companies raising capital must take reasonable steps in order to ensure that the investors that they target are in fact accredited.

As one of the most controversial components of the JOBS Act still waiting to be ruled on by the SEC, this section covers the issue of crowd funding, which we covered in a previous article. If this section of the JOBS Act were passed, it would mean that startups could receive funding from the general public, i.e., unaccredited investors. As it stands, currently soliciting investments from unaccredited investors in exchange for an equity stake in a startup is still illegal.

Even if the crowdfunding piece of the JOBS Act is passed, it is questionable whether or not these platforms will be a valuable fundraising tool for life science startups. By fundraising through crowdsourcing, an entrepreneur may be forced to give up a great deal of equity, which in the end would obviously hurt the entrepreneur if the company gets bought out. Equity dilution is also of course a huge red flag to institutional investors, so after a firm raises capital through crowdsourcing it may be very difficult to get additional funding from larger more sophisticated investors. Furthermore, crowdfunding may lead to additional headaches for startups, like having to answer to hundreds of LPs instead of just a handful.

What further complicates the JOBS Act issue is the fact that the definition of an accredited investor may be subject to revision in 2014 as a part of the Dodd-Frank Act. What this means is that if the crowdfunding portion of the JOBS Act is not approved, companies may have to start raising funds from a new tier of investors next year.

So what are the overall implications for companies in the life sciences space? Basically, life science firms that are looking to raise capital will be able to implement an aggressive outbound marketing campaign, and be able to follow up & meet with interested investors as soon as possible instead of waiting the required 30 days to follow up with a potential investor. Although the definition of an accredited investor may change next year, the approval of section 201(a) of the JOBS act will certainly make the fundraising environment in life science arena a little bit easier.

By Dennis Ford, CEO, LSN

LSN has been tracking the emergence of new investor categories in the life sciences arena, as well as the trends surrounding the activity of existing investor categories. The basic underpinnings of LSN’s view of the capital markets surrounding life sciences has been that the VC’s lack of funding (although that trend may be reversing) has left a void that is being filled by other emerging categories of investors. Among these emerging sources of capital are hedge funds and private equity, which are largely misunderstood by life science entrepreneurs, especially when it comes to early stage activity. This article will help readers who are seeking to raise capital understand how these investor types can be productive sources of investment. These three categories of investors have begun to blur the lines around their traditional definitions, and it is becoming increasingly important that biotech and medtech CEOs understand these investor groups.

Hedge funds are traditionally thought of as players active only in public markets. However, as fund managers have come under increased pressure to generate alpha (outsized returns), many managers have turned to more VC- and PE-like strategies, and have gotten more creative when it comes to making allocations. For example, some hedge fund managers maintain a portion of investable funds for private direct investment. This can either be in the form of one-off “side pocket” investments on an opportunistic basis, or as an integrated piece of an investment special situation strategy. There are a number of hedge funds that have begun to make this sort of “crossover investment” in the life sciences arena, and a quick glance at the list of investors in some of the largest private placements in recent history make that clear.

Private equity is also challenging the historical map – PE is traditionally thought of as the restructurers of larger, post-revenue companies. However, this is changing, especially in the life sciences space. Biotech and medtech opportunities have a highly compelling potential for returns, and PE firms have a higher tolerance for the long time horizon to commercialization. Many firms have therefore begun implementing strategies to aggregate assets and shepherd them through the pipeline. This portfolio of assets can then be passed to a large strategic partner as a one-stop solution to a pipeline gap, where a full portfolio of drugs is worth more than the sum of its parts.

To distill it down to a single idea: The lines are blurring between VC, PE, and hedge funds from a life science entrepreneur’s perspective, especially when the hedge funds admit and commit to the need to take a long term approach to the investment. To add to the topsy-turvy nature of the future life science investment, a deal might even have a combination of some – or even all – of these three entities in it. All of these players have begun orienting themselves (at least in part) towards early stage direct investments. This is good news, because these players have large capital reserves, and can bring a significant amount of investible cash back into the early stage marketplace. However, as these lines begin to blur, it is more important than ever for an entrepreneur to understand the landscape and exactly where to go when it comes to raising capital to move products and services forward.