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Strategic Investors Aggregating Early Stage Assets

29 Jan

By Max Klietmann, VP of Research, LSN

Recently, two major trends have surfaced in early stage life sciences investment; the concept of the virtual pharma and private equity aggregation of early stage portfolios. According to several conversations I’ve had with these two categories of investors over recent months, these entities are beginning to employ a new strategy to take advantage of the plethora of promising early stage assets available. The basic idea is to grow a synergistic portfolio around a specific silo (indication, technology, etc.) over time. These portfolios of complimentary assets can then be brought directly to market (via third party distribution) or sold into large pharmaceutical companies, whose pipelines are increasingly suffering from a myopia leaving significant market opportunities unaddressed.

The concept is quite simple and intuitive: In the case of a virtual pharma, a group of highly seasoned life sciences and pharma experts raise capital to buy a portfolio of promising early stage academic assets, vet them, and shepherd them through clinical trials via a very lean model relying heavily on CROs and outsourced development. By focusing on only fast-moving, highly promising assets (and strategically divesting those that aren’t), a very lean pipeline is maintained. This keeps capital allocated exclusively on getting product to market as quickly as possible. Then, either through licensing or third party distribution via a rent-a-salesforce, the products are sold into the marketplace.

Similarly, highly strategic mid-market PE investors (who typically invest in large scale opportunities closer to phase II or III) are making very small $1-5 million investments spread across a very broad range of very early stage assets, including academic laboratory research. The assumption is that by maintaining a hands-on approach and scrupulous focus on performance, a fund is capable of maintaining a portfolio of companies that not only have a promise of success on an individual basis, but as a collective whereby the whole is more valuable than the sum of its parts.

This approach allows investors to follow big pharma and provide solutions to upcoming pipeline gaps. It is also a more attractive opportunity for buyers down the line, because it is a fully integrated and curated portfolio with a strategic orientation towards marketability. The end result is a more efficient flow of capital through the industry, stronger drug development pacing, and an improved return profile for equity holders in life sciences companies that constitute the portfolio constituents.

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Creating a Target List of Qualified Investors

29 Jan

By Brian Gajewski, VP of Sales, LSN

Many firms that are looking to raise capital in the life sciences arena have the difficult problem of finding a place to start – that is, figuring out how to gather a list of potential investor candidates to reach out to. As with most firms, the first pass at raising capital is with friends, family, and industry colleagues. This is a great category for the first couple million, but moving past this stage becomes a difficult task for many firms because of their lack of experience in raising capital.

Once a firm has exhausted the investments from that first stage of capital raising, the next step is to create a complete list of qualified investor leads that they can then begin reaching out to. LSN refers to this as a Global Target List (GTL). The fact that the life science arena is a global marketplace justifies getting past the regional mentality for fund raising efforts.

One of the first ways to start collecting investors is to target those that have invested in companies similar to yours over the past 5-10 years of financing rounds (another reason for the global approach). For that reason, it is very important to take the appropriate amount of time in performing research.  One best practice is to start by finding firms that are look-alikes, which are firms that have similar profiles to yours. This allows you to identify major investors in the space that have invested in similar firms based on therapeutic or device indication. For example, within the LSN platform, our clients are able to search through the past 12 years of financing in the life science industry by filtering the series & type of financing, as well as the date, sector, and phase of the product.

The next step in creating your Global Target List of investors is to create a list of foundations that might have an interest in your area of development. Foundations are a key investor in the life science industry because it fills two of their investment mandates – one being capital preservation, and the other, their philanthropic portfolio of investments. What is more interesting is that the donor lists to these foundations are in the public domain. The astute marketer can peruse this list and hopefully parse the high dollar donors and find a few nuggets that would be worth researching for an introductory call or meeting. The premise of this exercise is to remember that donors to foundations have a desire to move the science along for treatments and cures. Foundations are great vehicles to help move science along, despite being held back by process and bureaucracy. However, for some donors investing directly, companies that are moving the science along may be just as compelling.

It is important to remember that when your firm is raising capital, you are not just selling to people, but you are also selling to them a way to potentially affect the world. The most powerful reason for investors to allocate capital is that you are developing a cure for a disease that has affected them, their family or their people in their orbit.

Not only do you want to target foundations that might have an interest in your target indication, but also the major contributors to those same foundations. We are finding that more and more families are becoming interested in investing directly with a life science company.

Finally, you have to think globally, and create a Global Target List, but you must act locally – meaning, draw that two-hour road trip circuit, and figure out how many investors on your GTL are a short trip away. This is an excellent way to start to learn who your good targets are, and to give you the practice you need to make your presentations more compelling.

Now that you have a list of investors that have a specific interest in your type of company, it’s time to make sure you have the bandwidth to begin reaching out to them and tracking your success.

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Hot Life Science Investor Mandate 1: CROs, CMOs Prime Targets for Opportunistic PE – January 29, 2013

29 Jan

A healthcare investment firm based in the Eastern US, which runs both a private equity fund and a hedge fund, is currently looking for new investment opportunities for their second private equity fund, which recently closed at $200 million. The firm has more than $500 million in assets, and has raised two private equity funds and one hedge fund in the past year. They have plans to invest in 3-5 new firms by the end of 2013, typically making equity investments ranging from $10-25 million.

The firm is currently most interested in firms in the biotech R&D services and medtech space. Within biotech R&D services, the firm is looking for contract research organizations (CRO’s) and contract manufacturing organizations (CMO’s). They have also recently started looking for firms within the medtech space, specifically those that are producing medical devices. The firm mainly invests in US-based companies, but has allocated to international firms in the past; they would consider European firms on a case-by-case basis.

The firm provides growth equity, expansion capital, and engages in buyout and recapitalization transactions. The firm only invests in established, cash-flow-positive companies. With that being said, the firm will not consider any companies in the medtech space that do not currently have a device on the market.

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Hot Life Science Investor Mandate 2: VC Promises Fast Allocations – January 29, 2013

29 Jan

A venture capital fund in the Eastern US with around $20 million in total assets is currently looking for new opportunities in the life sciences space. The fund was created by its state legislature to promote economic growth. The organization has an evergreen structure, which means that they provide companies with incremental payments throughout the development phase of the product or company, rather than providing all of the capital to a firm upfront in one lump sum, which is the model that venture capital funds typically follow.

The fund, which is quasi-public, would allocate to a firm within the next six months if a compelling opportunity were identified. The firm’s typical investment size ranges from $300,000-500,000 per firm. Specifically, they are looking for medtech firms developing medical devices. The organization will allocate to firms that are pre-revenue, but the firm does need to have a prototype of the device. Additionally, they are interested in the healthcare/IT space.

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Hot Life Science Investor Mandate 3: Corporate Venture Fund Seeks Therapeutics with Companion Diagnostics – January 29, 2013

29 Jan

A corporate venture fund with offices worldwide – one of the oldest in the world – is interested in the biotech therapeutics and diagnostics space. The fund has invested more than $500 million in the life science space since its founding, has an evergreen structure, and deploys capital on an opportunistic basis, pulling money directly from their main fund as investment opportunities are uncovered. They typically invest in up to 10 firms per year, usually allocating $1-10 million per company.

The firm is most interested in novel therapeutics, and would be especially interested in therapeutics firms that are developing a therapeutic with a companion diagnostic. They are also very interested in small molecule-based therapeutics, as well as companies producing medical devices. The firm has a global investment mandate.

In terms of their interest in therapeutics, the firm is looking for companies whose products are in the preclinical, Phase I, or Phase IIb (proof-of-concept) stage of development, and for medical device companies, the firm will look at firms that have a product in development or companies that have a prototype of their product.

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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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