Bridges, Piers, and Financing Tidbits
It’s May 2022 and the market has had a rough few weeks. Quite frankly, the biotech sector has had a rough year. Valuations were through the roof a year ago, but nearly all of the companies that went public during that period have seen their valuations cut in half (or worse). On the other hand, most of them probably raised enough money to weather the storm. By year end conventional wisdom was that we could be in for a rough period, and that companies needed to start thinking about cutting costs and bringing in new funds as soon as possible, with the thought that this downturn could last awhile. Who knows. I’m not a market pundit.
Many of the companies I’ve been working with (or looking at) are still pre-commercial or in the early stages of commercial growth. Most of them realize that they probably will need to be acquired to achieve their goals, as it’s just challenging to raise enough money to build up substantial commercial infrastructure, and it also takes time, and involves a lot of “execution risk”, such as hiring capable people.
In this context, many are out raising relatively small rounds ($0.5 to $2.0 million), typically in the form of a convertible note (a debt instrument) or a SAFE (simple agreement to buy future equity). The two vehicles are pretty similar, as in both cases the buyer/lender is getting an agreement to be able to buy equity in the future, usually at some discount to the future price, typically with the valuation of the next round capped at some level to provide more opportunity if there is a big upswing in valuation, and sometimes with warrant coverage. In the case of the note there is also an interest rate that is usually quite favorable to attract investors. My sense is that the convertible note is a bit more attractive to investors (vs. the company raising the funds), but the SAFE is really simple, and sometimes that’s more important to an investor.
In either case, the decision to invest still comes down to an assessment of the status of the company and their plans/capabilities to achieve their future goals. Since the amounts being raised are relatively small, and all anticipate some future equity event (either a financing or an acquisition), these are intended as “bridge” events to carry a company over to that next equity offering. As an investor you some comfort that you are actually participating in a “bridge” and not a “pier” (a bridge to nowhere, that leaves you swimming in the deep when the funds run out).
I tend to stay pretty focused in my comfort zone with respect to sectors, so I’m typically looking at life science and healthcare opportunities, mostly involving research tools, diagnostics, medical devices, or biopharma. Virtually every company takes longer to achieve their goals than stated in their plans, and these days I’m more interested in companies that can actually get to a liquidity event in 2-3 years (as opposed to 7-10). Some of the key things I look at include:
Leadership team: Have they been successful before? Are they clearly knowledgeable about their product and their target markets? Do they inspire confidence that they understand what it takes to succeed, and have the hunger and drive necessary to pull it off? And to do so even when they encounter what I call the “inevitable unexpected events”?
Product status: Whether it’s a product or a service offering, are the end user customers clearly defined, do I believe the product offers a compelling and differentiated solution in a large enough marketplace? How far along is it in development? Can I see a steady history of progress over the past year or two? Does the plan going forward make sense to me, and are the technical risks manageable? (no laws of physics need to be broken to succeed)
Commercial plan: Is there a well developed path to market? Are there any regulatory or reimbursement hurdles, and if so, is the company clearly far into the process with no obvious roadblocks ahead? Have they already performed beta trials or clinical studies, do the results look promising, and have the PI’s who participated become fans and supporters of the company? Are there partners in place (or about to sign up) that provide further validation that the product is likely to be a success?
Financing: Does the company understand its true burn rate and upcoming cash requirements, and in that context, is the amount being sought now reasonably sufficient to bridge to the next equity event (offering or acquisition)? Are the terms of the offering attractive enough given the risk? There must be a conversion cap whether it’s a note or a SAFE, and ideally there will be a discount to the next round (and interest on notes), and/or some degree of warrant coverage. Are all of the prior investors standing behind the product and enthusiastically participating (especially the lead from the last round)? Is senior management putting some skin in the game too? Are there other people I know and trust who are investing?
If all of these questions are answered to my satisfaction, and I’m not yet fully allocated for the period, then I’m likely to participate. I’m sharing all this not because I’m seeking new investment opportunities, but to help other entrepreneurs understand how many angel investors will view their attempts to raise a bridge round. Having said all of this, I know plenty of angels who will simply “bet on the jockey”, or have some other rule of thumb they follow that doesn’t involve all this diligence and allows them to make quick decisions and move on.
On the other hand, I also know of plenty who have much more rigorous procedures they go through, and often work together through informal or formal angel networks. These can be challenging for small companies who need funding on a short timeline, and where top management is also focused on executing on their plans (i.e., the CEO doesn’t have the luxury to be devoted full time to fundraising).
Any early stage CEO should be keeping and constantly updating a list of contacts who represent prospective individual investors. This can start with classic “family and friends”, but over time grow to include business partners, employees, investors, advisors, directors – literally anyone who may have enough confidence in you and your enterprise to consider writing a check in the range of $25k to $100k or more. Your target investor list expand significantly if you are fortunate enough to have any kind of successful exit, as angel investors like to invest with people who have made money for them in the past.
If you’re launching a bridge financing you need to reach out to all of these people, and you need to encourage all of your Directors and your fellow senior management to reach out to their contacts, regardless of the size of their list. You just never know, and you shouldn’t make any assumptions (positive or negative) regarding whether (or how much) any individual might invest in a round. You need to talk with them, usually after sending a very concise and compelling letter/email describing the opportunity. This can be a very time consuming process, as will be ongoing communication with your investors (which is critical!), so in the ideal situation you want as few individual investors as possible.
The last tidbit I’d like to share comes from a YouTube video I recently watched that was produced by Y Combinator. They have a great channel, and I’d encourage early stage bio entrepreneurs to watch it regularly. They tend to be more focused on “tech” companies, but most of the lessons are completely transferable. The title of this one is “Investors Said No, Now What?” (https://youtu.be/euZH0tVotPQ)
Some of the really good pieces of advice they provide for any first time CEO include:
- Don’t let “no” get you down (you’ll hear lots of “no”)
- Listen to the reason, if one is given, but don’t necessarily believe it; don’t knee-jerk change your plan based on whatever reason they state
- Act as if you are an experienced CEO, or at least aspiring to be one; show some enthusiasm and passion about your business; show that you know what you’re talking about (NOTE: this isn’t “faking it”, but rather showing a level of experience, commitment and passion, as well as some indication of leadership)
- Take the “no” politely, thank them for their time, and keep in touch; keep sending them brief monthly updates on real progress; that’s what gets their attention, and as they watch you execute over time perhaps they’ll decide to invest next time.
Happy Fundraising!