A New Paradigm For Venture Funds

Saturday, September 1, 2007 - 00:00

Editor: Please describe the Life Sciences practice at Goodwin Procter.

Bloom: At Goodwin Procter, our life science practice is integrated, combining corporate finance, intellectual property, regulatory and partnering expertise into one practice group. This enables us to handle the very specific needs of our life science clients, including biotech, medical equipment, medical devices and other healthcare technology. We marry our group's deep industry expertise with our legal expertise.

Editor: Are there any aspects of the legal structure of a startup biotech company that make it more attractive to either another biotech company or financing by a venture firms?

Bloom: No, legal structures do not drive ultimate transactions per se. Most of the entities that venture firms look to invest in are corporations or sometimes limited liability companies. I encourage my venture capital clients and my start-ups to keep it simple. Emerging companies should look to organize in a state that has a well-developed body of law, Delaware for example, and keep the structure and capitalization basic. Do not add any unnecessary complications - investing in biotech is complicated enough.

Editor: How much does the quality of management play in an investment decision?

Bloom: A venture financing is different from an acquisition in this context. Venture investors are primarily focused on the drug or device that is being advanced, what markets the product addresses, the regulatory path, and most importantly, the preclinical and clinical data that suggests that that product is going to succeed. Where is the risk? I think that is by far the biggest concern, tied very closely to how to protect the product in the course of development since, particularly in the case of biotech, large amounts of capital are necessary to bring the product to approval. Management is critically important, however, if there is a good clinical profile with great management, that is wonderful! If there is good management with a poor clinical profile, there is less interest. If there's good data, but the management team does not have the right skill sets to take that product forward, the investors will change the players. In an acquisition, management may be regarded in a different light. If the acquiring firm is mainly acquiring the technology, it may not care about the management team since they may not stay with the company. If a company is acquiring technology where a new platform is being developed by a thought leader who will drive the success of the product, that is a different story.

Editor: If a firm is looking at licensing technology of a biotech company, how important is it to look at how management is developing the product?

Bloom: It depends on the data and the clinical work that has been done. The data is only as good as the integrity of the work and people behind it. It would not be unusual for a large pharmaceutical company that does a partnering deal with a biotech to repeat the biotech's clinical work, or to do additional testing because it has a different way of testing, drawing upon a deeper pocket. When viewing from a diligence perspective, Big Pharma will make an assessment of the technical capabilities of the team that developed the product, which could influence the value of the deal. Structures of partnering deals also influence this. In one scenario a biotech company turns over the development of the product completely to the partner. In another scenario a biotech and the partner collaborate - here there is great emphasis on the quality of the science and the people involved.

Editor: Why is specialized legal representation important when a biotech is undergoing another round of venture financing?

Bloom: Industry expertise is critical, both in preparing a company for a financing or an exit and in anticipating and solving issues that arise. In a biotech so much depends on the interplay between the drug's regulatory path, intellectual property concerns and partnering issues that lawyers who work in this area need to understand all of these areas to properly advise their clients. For example, you must know how to analyze the in and out licenses by the company, all of which can affect the ultimate value of the company and ability to exit. From a venture perspective, if I am investing in a biotech company, my investment goal is to exit in five to seven years at a significant premium. But if the company has done some type of a partnering deal that could potentially be a poison pill to a potential acquisition or limits my ability to sell, that is a problem. Understanding those issues and having the industry background is crucial.

On the IP side, understanding the IP foundation of a company and how that will develop over time and solving any issues early is critical. If the product cannot ultimately be protected, then your ability to sell and the value you will obtain will be significantly impaired if not dimished all together. The same is true in the acquisition context. Lawyers who understand not just the substantive theories of M&A and venture financing but also IP, regulatory and partnering issues and how those can affect both the venture firm's entrance into a company and its exit, are at a premium. A lawyer with a deep knowledge of his client's business will have the ability to advise on industry norms, about accepting risk and making good decisions in negotiations.

Editor: What practice areas are called into play when the Life Sciences group is representing a startup biotech company seeking a financing?

Bloom: There are several key components. One deals with the actual terms of the financing and the financing itself. This typically falls within the domain of the corporate finance team working with management. The venture firms will likely do intensive business, legal, and IP due diligence on the company. We help our clients organize themselves for the due diligence investigation by preparing an IP audit to identify any issues of concern for a potential investor so that we can address them up front. When we present the issues with an action plan to solve them, we can often eliminate the problem and keep it from becoming a bigger concern. Similar types of issues, depending on the nature and the stage of the company's development, come up in the regulatory area also. For example, if our client is a medical device company that has a product prototype for which it is seeking regulatory approval, that will be a critical focus for due diligence by the investors and it is where our regulatory group gets involved.

Our licensing-and-collaboration group gets involved to make sure that there are no glitches in the foundational agreements which might be problematic to a new investor looking at the company: Does the company own the technology? Does it have the right to use it? Are there any impediments to the company's ability to sell, such as consents requests from third parties which could impact value?

When you get to an exit scenario where the company is being sold, all those areas come into play again along with additional areas such as labor and employment, tax, real estate - all of those other disciplines that might impact any company purchase, and we have all those capabilities as well.

Editor: What additional disciplines are called upon if a company is acquired?

Bloom: Depending on whether it is a private or public company, corporate governance and fiduciary duty issues can play a significant part. Depending on the transaction size, the acquisition may be subject to special regulatory approval referred to as "Hart-Scott-Rodino." This approval can also apply to certain licensing transactions and antitrust expertise is critical

Editor: What advice do you offer a startup biotech to assist it in tailoring itself for either another round of funding or for an acquisition?

Bloom: My advice is to be careful not to tailor yourself too much for an acquisition or another round of funding. Companies should focus on building value, and if they build value - either by developing a new device with a large market or by advancing a drug through clinical trials - they will not have to worry about their value in terms of being sold or attracting funding - it will be there. Business should not be built just to take advantage of a funding opportunity - that doesn't go very far at the end of the day. You need a business plan and a long term vision.

Editor: In serving clients of startup biotechs, what reliable sources for funding are available?

Bloom: Not many. One of the biggest issues we see is the difficulty in attracting early stage funding in the biotech space. Venture investing has shifted away from early stage, new idea investing to less risky later stage investing. It is very difficult for a preclinical-stage company, and in many cases even a Phase-I company, to get financing. There is fascinating technology coming from our universities which is not at a stage where a venture investor is willing to invest - it is considered too much of a science project. Five-ten years ago those types of projects would get funded on a more regular basis. Interestingly, venture firms have taken many of these types of early science projects in-house and have created companies around them. However, many companies with interesting technology are passed over as too "early." Is there a way to fund these companies at a lower level to get them to the next step where they are ready for venture investment? To me, that's the big obstacle, and I don't think there are a lot of reliable sources of capital right now.

The issue the venture industry has with early-stage investing is that they have to invest so much money to bring these companies along, and the public markets are not what they once were in providing liquidity or returns. Looking at a company that wants to develop, for example, a new oncology drug, to get it through to phase II might require $50-75 million. Someone investing at a very early stage - say, putting $5 - 10 million into a company, would have to raise more money at the risk of being diluted along the way, making value creation very limited.

Editor: How has the venture capital industry changed over the past several years?

Bloom: The venture industry has changed quite a bit, particularly in life sciences. It is very difficult to invest in new early-stage technologies in biotech because it is so risky as compared with investing in some of the new telecom or software companies. The cost of capital in getting those companies up and running pales in comparison - and they have revenue almost immediately. In biotech, most companies are net users of capital. They are constantly raising money, and many of them will never be profitable. Venture funds have become more interested in bigger, safer deals, such as carve-outs from large pharmaceutical companies that might come with people, technology and even products. Another trend we are beginning to see is the development of a company in-house, where venture firms are becoming company builders themselves, with, in many cases, the partner at the venture firm being the CEO who is putting it all together.

Please email the interviewee at mbloom@goodwinprocter.com with questions about this interview.