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Validating the Family Office Life Science Investment Strategy

22 Jan

By Max Klietmann, VP of Research, LSN

Anyone following my articles on investor trends in the life sciences arena knows that I am particularly interested in the emerging trend of family offices investing direct in life sciences companies. My interest in this space is that while family offices have a reputation of being very private and opaque, they compose an extremely important investor category. Aside from the findings aggregated by my research time via intensive web research and phone interviews, I try as often as possible to sit with wealth advisors and consultants to family offices to discuss trends we see and compare notes.

I recently had the opportunity to spend some time speaking with a managing director at a multi-billion dollar global wealth management firm focused exclusively on advisory services for family offices and ultra-high net worth private clients. We had a lengthy and involved conversation about the fundamental dynamics that are driving family offices to invest directly in companies, and in particular, life sciences. I wanted to validate two important trends that we have been following at LSN: That family offices are recruiting top wall-street talent and internalizing the due diligence process with institutional operations quality, and that family offices are moving heavily towards making direct placements into private companies, especially in life sciences. We reached a few conclusions based on trends we’ve seen in the market that shed some light on how this category of investors is behaving in the space today.

The trend of family offices broadly beginning to make direct investments began to really accelerate in the wake of the recession; investors became disillusioned with highly non-transparent alternatives funds losing substantial amounts of capital, while still taking a hefty management fee. My conversation partner mentioned that he began to see a heavy trend in recent years of family offices withdrawing their allocations to these asset classes. However, this is not happening because family offices don’t believe in private investment; rather, they want the ability to transparently control allocations. In order to do this in a sophisticated way, they need the operational diligence that was traditionally only reserved for large funds and banks. In recent years, however, it has certainly become a trend that a larger family office will bring this expertise in-house by recruiting top talent (at a premium in terms of wall-street compensation, but for a bargain relative to the fees charged by fund managers).

According to my conversation partner, he has seen a trend of family offices recruiting top-notch institutional operations talent and due diligence capabilities from Wall Street. This allows them to make placements directly in companies in order to have consistent insight and a more compelling return profile. It is primarily the large family offices with total assets above $100 million that are able to justify this sort of institutional approach to allocating their own capital on a consistent basis. This is a key demarcation line, as it is really only above this threshold that a family office can afford to consistently allocate capital on a regular basis towards investments in a substantial way (above angel-sized contributions).

This type of activity has recently seen a substantial increase in several industries, but especially in the life sciences sector. What makes this investor class so appealing to CEOs in the space is that the way in which family offices operate is very much unlike other private investment categories; typically, family offices seek to fulfill a philanthropic mission alongside their efforts towards capital-preservation. This makes direct investment in life sciences a particularly compelling opportunity, because it offers family offices the ability to make a targeted allocation with substantial financial and philanthropic upside.

More importantly, for CEO’s looking to raise capital, family office allocations in life sciences are often heavily motivated by a connection to a particular indication, meaning that they are strategic investors with an emotional motivation to help a therapeutic succeed in coming to market. This attitude was confirmed by our discussion, and it is likely that in a macro-sense this will be an increasingly important piece of family offices’ investment focus, as chronic diseases linked to old age become more prevalent in the coming years. These are not exit-oriented investments by any means, and it is typically the success of the therapeutic that constitutes the most important aspect of the investment.

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Investor Series: Selecting the Right Kind of PE Partner for your Life Science Firm – Part 2: Growth Capital

22 Jan

By Danielle Silva, Director of Research, LSN

Life science firms may often times find it difficult to select the right kind of private equity fund to partner with during their fundraising process. In order to pinpoint the right private equity group (PEG) to work with, the individuals tasked with fundraising at a life science firm must first gain an understanding of each private equity strategy. Last week, LSN offered an in-depth profile on buyout funds. This week, we shift the focus of our investor series, and take a deep dive into growth equity funds.

Growth equity funds, as their name suggests, supply an injection of capital into firms who are looking to expand or grow their businesses. Life science companies may be seeking this kind of capital in order to finance a major merger & acquisition, partner with a firm that has operational expertise, reduce personal guarantees on loans, or enter into new markets.

So why would a life sciences firm partner with a growth equity fund? Usually, because their business plans have been halted due to lack of available capital. As an added benefit, growth equity funds provide guidance at the board level. This means that one or more members of the private equity group will sit on the management board of their portfolio companies. Furthermore, growth capital funds usually take a non-controlling minority stake in firms, taking up to a 40% equity stake in a firm. This is because they prefer that the current management team continues to run the business.

Growth capital firms sometimes act like venture capital by providing companies with capital that helps them to accelerate the firm’s growth. However, unlike venture capital funds, growth equity funds only invest in established companies that have recurring, predictable revenue streams. For this reason, growth equity funds will not invest in an early stage, pre-revenue company. In the life sciences space, for example, a growth equity fund would invest in a medtech firm that already has one or more devices on the market. On the other hand, they would not invest in a medtech company, for instance, who has a prototype of their product, but does not have any products on the market.

Growth equity funds also vary greatly from buyout funds. Buyout PEGs typically generate revenue through restructuring a business, while growth capital investors hope to achieve returns by growing the business. Buyout funds also sometimes fully buyout a business owner, and thus do not prefer to keep the majority of the management team, whereas growth equity funds typically prefer that the current manager does stay with the firm and run the company.

Growth equity funds also have a much shorter-term holding period for their portfolio companies than both buyout and venture capital funds. Typically, growth equity funds will only hold a portfolio company long enough for their growth plans to be executed, and will then sell the business shortly after this expansion starts generating revenue.

Conversely, private equity funds typically hold businesses for longer time periods because it frequently takes longer for cost-cutting or restructuring measures to make firms increase their profitability. A venture capital fund typically has a longer time horizon than a growth fund because the firm is investing in an early stage company, and it tends to take a long period of time for these firms to become cash-flow positive, especially in the case of firms that are investing in pre-revenue companies.

Growth capital funds often focus due diligence efforts on forecasting the feasibility of the expansion that they are financing, rather than looking at the long-term attractiveness of the company as a whole. The expectation is that profits will be generated through the expansion of the company, and these profits will be used to return the capital that was provided by the fund.

When profits from the company’s expansion are not able to cover the capital that was provided by the growth equity fund, growth equity funds will employ an add-on strategy (similar to buyout funds) which will involve the acquisition of a smaller company, thus making the firm a larger player in their respective industry, with a larger market share. The cash flow that is generated from the company that is acquired can then either be used to increase the percentage of the fund’s equity stake in the parent company, or can be used to return capital to the fund.

Growth capital funds typically exit a company through a merger, or through an initial public offering (IPO). Therefore, because these funds seek to make exits through M&A or through an IPO, they typically work with larger and more established firms. Growth equity funds in the life science sector then, for example, would work with a biotech therapeutics company that currently has at least one product on the market, but would most likely not invest in a company that only has one product that is going through the clinical development process. Growth capital funds, consequently, can be very valuable partners for life science companies that are seeking to retain their current management team and are cash-flow-positive, providing these firms with the capital necessary to grow and expand their operations.

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Hot Life Science Investor Mandate 1: VC Arm of Larger Fund Looks to Grow in 2013 – January 22, 2013

22 Jan

A fund located in North America with around $200 million in current AUM will grow to $400 million in assets by the end of 2013. The fund is the venture capital arm of a larger fund with AUM upward of $50 billion. Over the last 12 months, the group has allocated to more than 10 firms, making the VC number one in its region. The firm is currently looking for new opportunities in the life science space within the next 6-9 months. They typically allocate anywhere between $500,000 and $50 million per firm. The group is a lifecycle investor, which allows them to deploy capital throughout a firm’s entire financing lifecycle, and thus participate in every round of financing.

The firm is currently looking for companies in the information provider space, and is particularly interested in healthcare IT firms. The firm has a global investment mandate, but prefers North American targets for allocation.

The firm almost entirely invests in companies that are pre-revenue, but will consider companies that are not cash-flow-positive. The fund will consider firms with products on the market on a discretionary basis, but has no strict requirements in terms of their EBITDA or annual revenue.

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Emerging Trends in the CMO World

22 Jan

By Alejandro Zamorano, VP of Business Development, LSN

Competition among the CMO world is at an all-time high. With one of the largest electronic providers in the world recently announcing that it would be spending an additional $2b to expand its operation in Seoul, some are left wondering when the arms race will stop.

Since 2004, CMO’s have seen strong growth as the industry has shifted to contract organizations to complete non-core functions. Despite the recession and a dwindling amount of investment in the biotech field in recent years, CMO’s have remained resilient. The CMO space is a crucial component in the biotech world today, and below are four emerging trends that will bear fruit in 2013:

  • Patent expiry of blockbuster drugs will force the industry to become increasingly price-competitive. Because of this, CMO’s will see lower margins, but higher volume, as manufactures increase production capacity to build economies of scale. [1]
  • Big pharma will continue to outsource non-core functions as they become leaner organizations. In the next couple of years, big pharma will begin to form strategic partnerships with CMO’s and CRO’s as they become increasingly reliant on their services. [1]
  • The CMO industry will see strong growth in emerging markets where skilled labor is considerably lower. China and India will see the strongest growth in the space for the next five years. [1]
  • The CMO space will see vertical consolidation as major players try to increase service offering. The next generation of “CMOs” will also specialize in drug discovery, toxicology, clinical research & development, and manufacturing.

The CMO industry is expected to grow at an annualized rate of 12.5% for the next three years, making the industry worth around $40b by 2015. Despite the optimism, the CMO industry is starting to suffer from increased competition and lower margins. The next generation of CMO’s will need to grow quickly and leverage their relationship with their existing customers in order to maintain a competitive edge. [2]

 

[1] Downey, William. “Bio-CMO Industry Trends – Contract Pharma.” Pharmaceutical and Biopharmaceutical Contract Servicing & Outsourcing – Contract Pharma. N.p., n.d. Web. 21 Jan. 2013. <http://www.contractpharma.com/issues/2012-05/view_features/bio-cmo-industry-trends/&gt;.

[2] Auerbach, Mike. “Contract Manufacturing Trends.” Pharmaceutical Processing. N.p., n.d. Web. 21 Jan. 2013. <http://www.pharmpro.com/articles/2011/02/business-Contract-Manufacturing-Trends/&gt;.

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Hot Life Science Investor Mandate 2: Large Family Office Looking for Opportunities in Medtech Subsectors – January 22, 2013

22 Jan

A family office located in the Western US with around $100 million in assets is looking for a compelling opportunity for allocation within the next 6-9 months. The office invested in more than five deals in 2012, typically between $1-5 million per firm.

The foundation is most interested in medical devices, and will look at firms within the full gamut of medtech subsectors. Typically, the office allocates to firms that have at least one product on the market. They have no strict criteria in terms of a firm’s EBITDA or revenue, but require that any firm in which they invest has goals to lower the cost of healthcare.

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Hot Life Science Investor Mandate 3: Generalist PE Fund Interested in CRO’s, CMO’s – January 22, 2013

22 Jan

A private equity fund located in the Central US with roughly $1 billion under management intends to make allocations in the tens of millions on a case-by-case basis over the first half of 2013. The firm is generalist and invests across sectors, but has a specific interest in life sciences & medical technologies. Within this space, the firm is opportunistic in almost every aspect, but does require that an issuer be EBITDA-positive. This means that a firm must have at least one product on the market generating revenue to be of interest. Though the firm has looked at and invested in therapeutics and medtech companies historically, a primary interest currently is service providers such as CROs and CMOs.

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Branding, Messaging & Identifying Investor Targets in the Life Science Sector

15 Jan

By Dennis Ford, CEO, LSN

The Importance of Marketing Collateral

When it comes to fundraising in the life science arena, your commitment to marketing collateral must be central to your campaign. This is because it is essential that your firm presents itself in a professional manner – everything from your logo and tagline, to your brochures and e-mail canvassing is a direct reflection of your life science firm. Investors want firms to demonstrate that they are savvy and understand that every aspect of their outward identity will be intensely scrutinized. For this reason, the professionalism of your firm’s marketing material is every bit as important as your concept and your business model. There are several areas of marketing that are pivotal to focus on in the life science arena, and therefore, these aspects of marketing must be addressed when launching a fundraising campaign in the space.

Positioning

Many life science firms face a dilemma; they have one compelling technology that simply has too many marketable uses. Positioning is the idea that only one application of your product is the most important; you need to pick one and stick with it, even if there are other practical uses. This does not mean that you have to abandon the other applications a product may have, but you cannot lead with three main product applications.

Positioning also has to be simple. Your product is a novel treatment, an orphan drug candidate, a better device – in a word, it has to be easy to understand. You can’t just mix-and-match products and markets on the fly. This leads to confusion, and dilutes your product’s marketability. The idea here is to make yourself relevant; using old tactics will yield familiar results. You must be competitive and self-aware in order to transcend the noise of a crowded marketplace.

Branding

When branding your firm, the value of simplicity cannot be overstated. For this reason, it is essential to adopt one simple, easy-to-understand message that encompasses your firm as a whole. Have you revolutionized a time-tested treatment? Your message is how. Did your firm develop a cheaper alternative to a prohibitively expensive drug? This should be the focus of your marketing campaign. Although this is a seemingly intuitive concept, as with positioning, the idea is to choose that main identifying factor and build your image around it, and it can be easy to lose sight of that. At the end of the day, you, your team, your message, and your company are a brand, and you must develop them well. This starts with a simple message.

As important as a central tagline is to delivering your message to the right people quickly, investors are necessarily going to want more information, and it is just as important to get these things right. However, this does not mean your firm should hinge itself on being thorough – simplicity is still the most important tool in marketing. As such, all life science firms should aim to have the following things in their branding portfolio:

  • An elevator pitch: 3 to 5 sentences describing who you are, and what you do
  • An executive summary: 1 to 2 pages tops
  • A power point presentation: 10 to 12 pages tops

Your tagline gets you in the door; these tools help make sure you stay inside. And their importance cannot be understated. Any marketing effort must be well rounded.

Creating a Global Target List

An important part of having a well-rounded strategy is to focus on the right targets. Marketers often make the mistake of attempting to reach out to as many investors as possible. However, this is usually not the best course of action. By adressing a wide audience of investors during the fundraising process, your firm is taking time and resources away from targeting a smaller number of investors who will ultimately end up being a better fit.

One way to concentrate your efforts is to create a global target list (GTL). A GTL is a list of all prospective investors that are a good fit for a life science firm, either created by your firm’s internal research team, or by a dedicated third party marketing firm. With a GTL, your fundraising team can roughly gauge the types of investors that would be most interested in your product based on its stage of the development process.

It is important to note that when using a concerted marketing strategy such as a GTL, life science CEOs should focus outbound fundraising efforts not only on the investor base that is a good fit for current capital raising efforts, but also those that will be a good fit two or three capital raises further down the line. Thus although your firm will be targeting a large list of investors, the return on the time you invest in reaching out to these investors will be much greater than typical brute-force canvassing. By establishing a concise dialogue surrounding your product early on, you can effectively streamline the financing of your life science organization, reducing the amount of effort and resources ultimately required over the organizational lifecycle.

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