Raising capital will enable you to rapidly develop your great new technology and grow your company, but this can be a lengthy and overwhelming process. Included below you will find information on sources of capital for life science companies in Washington State, as well as a few tips and guidelines that should be considered in the fund raising process. In addition to this resource on raising money, be sure to review the related Executive Summary and Pitch pages as well.
Sources of Capital
Typical sources of capital based on the stage of the company are provided in the following Table, and are further described in the respective sections that follow.
Friends & Family
While this is often the source of early capital, care must be taken in all rounds of fund raising as there may be unforseen consequences on future rounds or potential exits. The issue of accredited versus non-accredited investors is particularly concerning with friends & family. Issuing securities to non-accredited investors can create many difficulties, including an increase in the level of required information disclosure and a potential hindrance in future acquisition. Whenever possible, stick to accredited investors at every step of raising capital and closely take the advice of your legal counsel.
An angel is an accredited investor who provides capital to early stage startups, usually in exchange for convertible debt or preferred equity. There are several non-profit and for-profit angel networks in Washington State that host regular member meetings where early stage companies can pitch their investment opportunity. However, there are a limited number of knowledgable life sciences angel investors in Washington who are willing to take the 'lead' in the investment, and so local angels typically do not invest in the life sciences. Depending on the technical foundation of your business, doctors and lawyers can frequently serve as knowledgable and accredited investors in your business.
Local angel networks include:
- Alliance of Angels (non-profit | Seattle)
- WINGS - The Washington Medical Technology Angel Network (non-profit | Seattle)
- Keiretsu Forum (for-profit | Seattle)
- Zino Society (for-profit | Seattle)
- Seraph Capital Forum (non-profit | Seattle)
- Puget Sound Venture Club (? | Seattle)
- Tacoma Angel Network (non-profit | Tacoma)
- Bellingham Angel Group (for-profit | Bellingham)
- Delta Angel Group (non-profit | Spokane)
If you are actively seeking an angel investment round and can not identify a local lead investor, consider reaching out to the Life Science Angels of the San Francisco Bay Area or other angel groups specializing in early stage life sciences investments.
Venture Capital Investors
Points to consider Venture Capitalists (VCs) usually raise funds from endowments, pension funds, and a variety of other sources that serve as Limited Partners to the VC fund. The fund typically has a duration of 10 years, within which time the Limited Partners expect a return on their investment from the VC fund. This means that the VCs expect a liquidity event (e.g., merger, acquisition, IPO, or winding down) to take place within this time frame from your company. Consequently, it is imperative that you do your homework on the fund profile of VC firms from whom you seek funding. A few issues to consider are:
- Are you seeking money from a fund that was raised within the past 3-5 years? If not, you are likely outside of their active investing window. And if you are the last company to be funded in their portfolio, you better be prepared to be pushed even harder into a liquidity event as the fund is wrapping up a few years from now.
- Is your technology within the scope of their expertise and typical portfolio company? VC firms are interested in sectors they know well and rarely invest outside of their comfort zone.
- Is the amount of capital you are seeking in line with their typical investment size?
- Will this investor serve as an active lead or a passive syndicate in the deal?
Most active firms investing in Washington Active VC investors into Washington State life sciences companies are listed in the following figure, many of whom have offices in Washington.
Most active firms in the US In addition to the local VC community, the most active life science VC firms nationwide have recently been compiled and profiled by FierceBiotech. You should do your homework on these VC firms and find a solid introduction who can refer your Executive Summary to the most appropriate group. One thing to be aware of is the dynamic nature of VC firms, especially recently, where many VCs have stopped making Life Sciences investments. PureTech Ventures compiled a list of active vs. inactive Life Science VCs, published Dec. 4, 2012.
Research grants are a great source of non-dilutive capital that can enable you to further de-risk the science and technology that serve as the foundation of your business. Additionally, they can be an effective way to externally validate your ideas and research plan. The downside is that the funding process is lengthy and serves more like a contract to do research rather than a source of capital that will enable you to rapidly develop the technology and grow your company. Tips on obtaining small business grants are included here.
Structure of Funding
Early stage investments typically come in the form of a Convertible Note or Preferred Equity. There are pros and cons to both choices, and so there is much debate over which form is better for Angel Investment rounds or earlier. As with all corporate matters, be sure to get the advice of experienced attorneys, entrepreneurs, and investors. You want to avoid making bad decisions and agreeing to terms in early stage financings that may preclude you from getting subsequent rounds of funding.
In exchange for the risk taken on by the early stage investor, the recipient of the Convertible Note will have the option to convert their investment into Preferred Equity upon a future financing event at a discounted rate. The advantage to a Convertible Note is that a valuation for the company is delayed until a subsequent round of funding when the company is more mature and a Venture Capital (VC) Investor will set the valuation. Many VCs prefer that Angel rounds and earlier are Convertible Notes as this allows them to set a price that they deem to be more accurate. Among the down sides to the Convertible Note is that the subsequent VC Investor may not honor the terms of the Note. Also, the holder of the Note is incentivized to get the lowest valuation possible for the company so that their investment converts into the largest number of shares possible.
Funding rounds with VCs, and occasionally Angels, will typically be in the form of Preferred Equity. As such, the pre-money valuation of the company is determined through negotiations between the company and investor. When the price is set, Preferred Shares are issued in exchange for the investment being made. Preferred Shares provide the Investor with rights and privileges, as outlined in the agreed upon Term Sheet, that the founders and other holders of Common Stock do not have. If the price is set too high in early funding rounds, a down round may result where the pre-money valuation of the company is less than the post-money was on a prior round. This can be avoided by using Convertible Notes as the financing structure in pre-VC deals.
Amount of Funding
The amount of money you raise should be driven by the financial requirements of achieving the next value added milestone. Value added milestones are generally associated with stages of development where you have significantly reduced the technology and business risk associated with your venture. Use this level of funding to guide your selection and targeting of funding sources. Due to the large amounts of funding required to get to these value added milestones, life science investments will typically be tranched where the investor commits to providing portions of the capital being raised as smaller de-risking milestones are reached.
In the early stages, life sciences investors recognize that there will likely be subsequent rounds of funding required to get to a positive exit event. For example, if you are in the pre-clinical stages of evaluating a new therapeutic and will need to file for an IND, make sure that you are raising enough money to adequately prepare the company for clinical trials. Closely evaluate the stage of your technology and ensure that you are raising enough money to reach key value adding milestones. This way, subsequent rounds will be 'up-rounds' where the new pre-money valuation is higher than the post-money valuation was on the previous round. This means that you have used your investors money to create value in the company, which makes everyone happy.
In the process of raising money, you need to think about what your idea and proof of concept are worth. Scientist entrepreneurs are notorious for having unrealistic expectations for the value of their idea or technology. Remember, the value of your company is related to the remaining technology and business risk that need to be overcome to get your product to market or a positive return for your investors. The valuation that is given by potential investors is a reflection of the risk that must be overcome for the company, and their investment, to be a success. If you are early stage in the life sciences, there is a substantial level of risk remaining. While valuation will be on the top of your list, do not overlook the other critical Terms that can significantly effect the outcome of your business.
Valuations in early stage life sciences companies have been hit hard by the current economic environment. In recent years, typical pre-money valuations have come down considerably according to compiled data from law firms active in private company financings. Refer to the Terms and Valuation Resources below to see what current valuations are in the private financing markets.
The following is a crude approximation of rules of thumb compiled by Silicon Valley Bank that you can expect on the upper end of valuation in a life sciences venture. Given the recent economic environment, you may expect to receive less than these ballpark valuations. 'At the earliest stage of research, companies might get $1 million for a seed round. An A-round company in pre-clinical stages might get less than $5 million. A successful Phase 1 clinical trial might get the company somewhere between a $12 and $15 million pre-money valuation from investors to get it through Phase II.' Keep in mind that these values can change dramatically with market conditions and company specifics and may be drastically different from what you are offered.
In the process of raising money, you may be offered term sheets by potential investors. While you may be focused on the valuation not being as high as you think it should be, do not make the mistake of ignoring the many other terms such as Liquidation Preference that likely will have a more significant impact on your share of the pie in a future liquidation event. Work with your attorney and check out a variety of Terms and Valuation Resources listed below to fully understand the implications of the terms to which you are agreeing. Additionally, several of these resources are compilations of data from recent financing events that include current market terms.
Terms and Valuation Resources
- Cooley Godward Kronish Venture Financing Report Q1 2012
- Wilson Sonsini Goodrich & Rosati Life Sciences Report Spring 2012
- Brad Feld Term Sheet Series with details on terms that you are likely to encounter in the process of raising money for your startup