"Series A Crunch"? Some Suggestions

Editorial Advisory Board member Les Funtleyder expands on his comments to the 2013 Pharm Exec Dealmakers Roundtable with some advice on how early stage companies can build their best case to accredited investors - get all your ducks in a row at once with good documentation and make foolproof trial design and implementation the center of your pitch.

Recently, there has been an uptick in newsflow around the “series A crunch”/ “the valley of death” in regards to financing. Because of who we are (a firm that connects investors with private equity investments); we at Poliwogg see a lot of the “crunched” and “valley-dwellers.” We have some good news. The good news is that we are seeing increased interest on the part of accredited investors who have not invested in private companies before and who are now more open to the idea in light of lackluster returns in other asset classes. Aggregating this group of investors allows for investments in the range that are too large for a traditional “friends and family” round but are too small for traditional institutional investors where the crunch is most pronounced. The caveat is that companies need to be ready to meet the demands of this new crop of investors. Probably, what will be required will be more stringent than what companies have been asked for in the past. On the plus side in exchange for more requirements, these investors are often more patient and more passionate (especially in the disease categories) than traditional investors.

A few observations about what we are seeing (we view mostly healthcare companies):

• Asset prices seem fairer than they have been in a while especially when compared to the prices of similar assets in the public market; spurring investor interest.

• There do seem to be a large number of companies that raised seed rounds (sometimes in substantial sizes) from friends and family. That said given the lack of arms-length transactions the supporting documentation ( e.g. possessing an accountant and law firm, audited financials) often seems a bit lacking in our view and can make a more institutional looking round challenging if not impossible. More disclosure is always better.

• Too many business plan that look like a Rube Goldberg contraption. A simple business plan is easier to diligence and also easier to explain to investors. That is not to say that a complex business can’t work it’s just that we have to deal with the realities of the market and the market prefers simple but elegant solutions to business problems.

• Managements don’t always understand their target market well enough to explain the value proposition. In general this is a more common oversight with digital health companies than with biotherapeutics companies. We always like to point out to our technology friends, that healthcare is different than technology despite all of us wishing the two were similar. Often times this gets glossed over by entrepreneurs. But, investors especially those familiar with the sector, tend to pushback when the rules of the healthcare road are broached.

• Generally, biotherapeutics companies who have had the support of foundations or the NIH have had to explain their position in a treatment pathway in some detail so they have an understanding of the market. Biotherapeutics, however, are not completely off the understanding-the-market hook as they need to be realistic about trial design and time to data when explaining their value proposition to investors. Contrary to belief of some entrepreneurs, investors with an interest in the development space often have more realistic expectations that companies might believe. As biotherapeutics tend to need larger tranches of investments, identifying cohorts of interest becomes that much more important for them in order to expand the pool of eligible investors.

What seems to work best (defined as the ability to get funded) is the ability to be transparent and to work with investors as partners as opposed to looking at them as a source of capital. We live in a very risk-averse time owing much to the well-publicized market issues over the fast few years. Anything companies can do to articulate the risks (the return side is well known) of their enterprise will lead, ironically, to greater comfort (in our judgment) on the part of investors and make completing a financing easier. We think there is great interest on the part of investors looking to make investments in private companies serving needs they (accredited investors) know and care about. So the stars may actually align and capital will find investments it seeks, in size and time frame it requires.