Bridging The Real Gap in Biotech Venture Funding: the Elusive Series B

Posted in General Venture Capital

Biotech pundits often talk about the challenge of raising an initial round of capital for drug discovery startups, highlighting the perceived “gap” in early stage funding.   And it certainly isn’t easy raising that first significant round of institutional capital.  But I don’t think it’s the hardest one to raise, as there are plenty for firms willing to back a fresh plan or new asset.

I think the biggest challenge in biotech fundraising today is the Series B round.

There are lots of reasons for this:

  • Data, data, data.  Seed and Series A rounds are typically raised around the promise and potential of a “shiny new toy”: exciting Nature or Science papers from a hot academic lab, brilliant concepts for how to tackle a disease, early chemical or biological equity as foundational substrate for a program.  But Series B’s are raised around results: does the technology or program work as advertised in its first couple years.  This is the round where fancy powerpoint slides are replaced by audited study reports.
  • You can run, but you can’t hide.  Since the initial round of funding, a management team has had the chance to build a track record of execution, or lack thereof.  The Series A pitch has probably been dusted off and reviewed by the venture firm a few minutes before you show up for the Series B pitch.  Did the team execute as planned and if not, why not?  You can’t escape the track record of execution.
  • Series B’s aren’t in vogue.  Venture firms today seem to like to say they are either a “Series A” investor or a “Late stage” investor.  I never hear venture colleagues bill themselves as “great Series B players”.  I’d bet the number of firms focused on primarily Series B’s is probably smaller today than the number of A-round or late stage round firms. Series B’s risk being boring: they aren’t typically the neat-to-exit pre-IPO/pre-M&A financing, and they don’t have the sex appeal of the “founding” Series A round.
  • Boardroom cluster headaches.  Big, dysfunctional, over-syndicated A-round boards aren’t very helpful for raising Series B rounds.  Too large of a Board can make governance less clear and accountable.  Too many Series A VCs are also a turnoff.  There are certainly exceptions to this (e.g., Avila had a large but very functional Board with 5 VCs).  But in general, big boards create higher hurdles for new investors.
  • Deal economics matter.  A new investor has to negotiate with the realities of an established capitalization table and often higher-than-normal pre-money valuation expectations.  If the prospective Series B lead has a target ownership threshold they’d like to achieve on a fixed amount of capital, the issue of valuation is paramount.  And this issue gets exacerbated by the fact that many Series B’s are for companies with lead programs that are still very early.

For my colleagues and me at Atlas, the latter two reasons drive why we typically have a very high bar for Series B’s: governance and ownership.  No more than 10% of the deals we’ve done since 2006 are traditional B-rounds.

So what can a startup do to complete a successful Series B fundraise?  Here are a few rather prosaic suggestions that come to mind:

  • Set realistic milestones in the Series A and hit them.  Seems like common sense, but often the A-round goals stretch reality and that creates a legacy of missed expectations.  For instance, starting a de novo NCE program and having an IND in 20-months is probably not credible.  30-months would be heroic.  Some of our best companies hit the 40-month mark.  Most Series A proposals are optimistic, which is fine, but an unrealistically naïve set of goals is a flag about the team’s credibility when the Series B pitch also says 24-months to an IND.
  • Raise a Goldilocks Series A round.  Raise enough to achieve meaningful progress over a couple years, but not too much as to create a valuation challenge.  This depends entirely on the nature of the project, but a tranched 30-40 month financing is probably the sweetspot.  Its impossible to predict where an early stage platform or program will be in 30+ months, but that makes it all the more important to have the runway to figure it out.
  • Spend cautiously during the early Series A period.  Tranching may force this upon a company, but overbuilding a fixed infrastructure can create a real burn rate challenge as a company marches towards its out-of-cash-date. Furthermore, the pace of progress in early stage biotech, like most science, isn’t always a function of spending more: like pregnancy, it may take 9 months (or more) to get a technology ready for prime-time regardless of how much you spend.  ”More thinking, smarter doing” is much more likely to create value than “more spending”.  Be mindful of the inefficiencies of over-capitalized early companies.
  • Build a syndicate that can do an insider Series B.  The best leverage is to not need an outside lead.  A three-handed Series A with a good group of firms that have enough dry powder to comfortably power the company for another 2-3 year period is quite valuable.  And they should have a shared  commitment to the “patient capital” view of building a company over the long run.
  • Get a validating partnership during the Series A.  Don’t wait until the middle or end of your Series A runway to ramp up a BD process; it should probably start right away, in particular around market education and awareness-building.  Even without data, you can introduce a story to future partners.  Good VCs will help here.  But securing a partner that brings the troika of “market validation”, non-dilutive capital, and high value expertise can position a company well for driving a good Series B.   And if you can keep a major portion of the economics in such a deal (like MiRagen’s deal with Servier) the Series B is obviously even more compelling.
  • Make sure what you’re selling is what they’re buying.  Mike Gilman at Stromedix often says this, and its dead-on true.  Don’t talk to 50 VCs because they happen to do biotech.  Research the types of deals they’ve done and only talk to firms that have done deals (and preferably made money from deals) that look like your company.  Furthermore, make sure they have capital to invest; many VCs today are walking dead and “saving their last shot in the fund” for the miracle cure for cancer.  Any firm that tells you they have only one more shot in the fund is probably lying; they have no money.  More time is wasted and pain endured by management teams talking to VC firms that have no interest or ability to do a deal like theirs.

Startups following these suggestions will likely find it “easier” to bridge the biggest gap in biotech: getting that 2nd institutional round of financing.

So if you send us your Series B plan, I hope you’re ready to talk about the comments above.

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  • http://twitter.com/Nanostring Nanostring Founder

    Excellent bullets! You seem pretty sharp, yet allow me to
    challenge some of the conclusions. If you presume that a Series A would not realistically
    result in an IND, then by definition this is a preclinical discovery program,
    i.e. a science project. And in science you don’t measure execution by achieving
    preset goals, but by gaining insight; plus insight is not the same as data.

    If the founding discovery was done with the flashlight an
    NIH grant provides, then the Series A is the floodlights than can better illuminate
    the underlying biological phenomenon. And nowadays, with systems biology and
    high data throughput data acquisition, a good scientific team has really powerful
    tools to disperse the Fog of Science and gain insights, hopefully translatable
    into further IP.

    Unfortunately, most financial types are extreme linear
    reductionists and would evaluate progress as a black box with binary output:
    did it work or didn’t, and where’s the data that it worked. But often you discover
    things that don’t fit into such thinking, yet they are very valuable: i.e.
    there is another ligand activating the same pathway, or redundant pathway, or off-target
    activation, or a splice variant, etc…

    The declining success rate for Phase II trials (down to 18%
    now) is well-documented, but I find it very perplexing: we have such powerful
    tools now to illuminate the system, the success rate should be going up, not
    down. Perhaps one of the reasons is this type of Series B heuristics that
    rewards and pre-selects early positive data and companies that did exactly what
    they were expected to do, even though early preclinical “success” has no
    statistical power, and mice ‘lie’ most of the time… Early scientific insight,
    as messy and unexpected it may be, is probably a lot more valuable than early
    positive data.

  • http://jaycaplan.wordpress.com/ Jay Caplan

    Great advice.  You can find a list of healthcare VC’s that have capital to invest on my blog: jaycaplan.wordpress.com  

  • http://jaycaplan.wordpress.com/ Jay Caplan

    Great advice.  You can find a list of healthcare VC’s that have capital to invest on my blog: jaycaplan.wordpress.com  

  • Kbosley

    Hi Bruce -
    agree w/ all of the above – one add’l variation on your last point (“make sure what you’re selling is what they’re buying”) is to continue to build the dialogue with key potential funders between A and B (and C and further down the road).  if you know what it would take for someone to invest (what kind of data, what kind of progress) early, you have a better chance to either generate it – or stop talking to them if their expectations don’t line up with what you & your current investors think is important.
    -Katrine