Michael B. Gray
Last year was a record 12 months for venture-backed biotech and pharma companies, with deal activity rising to $28.5 billion from $17.8 billion in 2019. As vaccines roll out, drug development pipelines return to normal, and next-generation therapies continue to hold investor interest, 2021 is on pace to be another blockbuster year.
The median step up in valuations from seed to Series A is now 2x, higher than in all later rounds. As a result, biotech startups will continue to attract more investment at earlier stages from a larger, more diverse pool of venture capitalists.
This may also change the nature of biotech founders themselves: As a blog post from Y Combinator suggests, these founders are trending younger and perhaps less willing to cede control to VCs and hired executives than they might have in years past (i.e., via the “venture creation” model so predominant among early-stage biotech companies).
As longtime members of the biotech startup community — as executives, entrepreneurs, advisors and legal counsel — we’ve seen our fair share of founder missteps early in the fundraising journey result in severe consequences.
In this exciting moment, when younger founders will likely receive more attention, capital and control than ever, it’s crucial to avoid certain pitfalls.
Clarity trumps creativity
Founders are some of the most creative people out there, but legal documentation should be anything but. Keep it as simple and clear as possible. That means using National Venture Capital Corporation documents that everyone knows and understands, as well as keeping organized documentation for employee intellectual property (IP) assignment and NDAs, option grants, independent contractor agreements, tax documents and other key contracts and paperwork.
This clarity is especially important when it comes to IP, the backbone of most biotech startups. Making sure IP is clearly lodged with the company and not with the founder(s) is critical. Investors and purchasers will do extensive due diligence on IP during venture financings and M&A.
Another common mistake on the founder equity front has to do with incorrectly filing a tax document called 83(b) elections, which basically enables founders to avoid paying taxes on their stock when it vests (and which, at that time, has hopefully grown in value). It’s critical to file 83(b) elections on a timely basis after equity grants to avoid catastrophic potential tax issues later.
Find the right investors, not just those offering the best terms
As Lara Sullivan, CEO of Pyxis Oncology, told us during a recent webinar: “The biggest learning for founders is that you want to get enough equity, but you don’t want to hold on to it so tight that you can’t attract business talent and future investors or develop a clear growth plan.”
This is especially true in a capital-intensive space like biotech, where, according to another webinar participant, Geeta Vemuri, founder and managing partner of Agent Capital, “it requires 40, 50, or even 100 million dollars before someone else can transact on it.”
Founders should expect to have their equity diluted by an average of 20%-35% per round of financing. If they can approach it with this mindset, it’s much easier to select the right investor, and worry less about terms, dilution and valuation.
Biotech researchers venture into the wild to start their own business
Sullivan related the experience of a biotech company whose founders had majority control post-seed funding round. The company had attracted a well-regarded VC group, but additional funding was highly gated by the founders, who were worried about diluting their shares. Though the VC firm eventually extended the financing, once the startup’s internal champion left the firm, they found themselves without any other relationships with potential VCs and facing a difficult road ahead.
“You want to protect yourself, but also have to recognize you have to give things away to help the company move forward,” Sullivan said.
The “right” investor will be in for the long haul and have extensive experience in the space. To that end, they should, as Vemuri noted, “understand the importance of keeping subsequent capital reserves for the company as they get through subsequent stages.”
As this process gets underway, founders should also think early on about forming relationships with potential strategic buyers so that when the time comes, they can seize the opportunity.
Know when to leave the leading to others
Biotech founders have every reason to want early control over their company. They’ve likely spent years in the research lab producing, testing and refining their innovation. But the qualities that engendered their success so far are not necessarily transferable to running and managing a company, especially for first-time founders.
That’s why it’s critical for founders to know when and how to pass the baton. For instance, a well-composed board with experience running other companies is a must. A smaller group (think: five), can make it easier to ensure everyone’s rowing in the same direction. Identifying executives that founders can trust is another crucial step.
As Sullivan told us, “One of the biggest pitfalls is not knowing when to let others nurture your baby. They say success has many fathers, and that’s really true in the biotech startup world.”
Key takeaways
- Clear documentation helps avoid future issues.
- Select the right investors over “best” terms.
- Know when to pass the baton of leadership.
Comment