Capital Stepping Stones

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By Deborah Komlos

An ideal funding scenario for Canadian biotechs would see a continuous financing stream, allowing a smooth ride from bench to market. In reality, however, funding comes in waves that propel firms over several early steps. A relatively substantial financial surge is then needed to reach the mid and later development stages.

Not only must firms successfully undergo the critical early stage funding rounds, they must also complete the subsequent and more costly rounds to support clinical trials. Venture capital financing is a key funding channel in a company’s life cycle as it moves toward those later stages.

“If we’re talking about the majority of biotech companies in Canada being human therapeutics — that’s the majority of them — their capital requirements are such that they really need to pursue the venture capital because those are the only sources that can provide the size of funding that they require to move forward,” says Vancouver, B.C.-based Brenda Irwin, director of the Business Development Bank of Canada’s (BDC) (Montreal, QC) Venture Capital group.

While BDC’s overall mandate is to support earlier stage companies, Irwin says the institution also has a good balance in making later stage (i.e., second and third round) investments. BDC’s Life Sciences portfolio — which spans a broad range of sciences from human therapeutics to ag and forest biotech to medical devices — currently consists of 48 firms with greater than $130 million committed to date.



Tough Times

One of the challenges with attracting VC financing is that it’s almost a catch-22, says Shameze Rampertab, a Toronto, Ont.-based senior heath-care and biotech analyst with brokerage firm Jennings Capital Inc. (Calgary, AB).

“The inventor/scientist probably doesn’t know too many of the VCs and there’s only a handful in Canada to begin with. If they like you, they love you. If they don’t care, you’re shut out,” Rampertab says.

Another challenge, Rampertab continues, is securing a good-quality VC who will stick around beyond any initial investment. “I’ve seen situations where companies may have had family and friends put money in or some angel investors, and they get to another milestone. But it still isn’t enough to attract the VCs and they get orphaned because that angel money, family and friends can only take you so far,” he says. “The VCs have the deeper pockets. The VCs can do the multiple rounds of financing.”

Lorne Meikle, president and CEO of biotech management company BioCatalyst Yorkton (Toronto, ON), says VCs today are much more qualified to do due diligence than they were eight or 10 years ago. For this reason, he says, they are also more discerning now than before.

“In a tight money market, their investment deals are probably a little more demanding than they used to be, and it’s a case of they do have a lot of opportunities and because they have a lot of opportunities, they really have to pick and choose,” Meikle says. “What it ends up doing is certain of the VC type of investors get into space that they like and they try not to get out of that because they can understand that space quite nicely.”

A particular “space” that needs financial attention is the gap from early stage to the stages where a firm can initiate and financially sustain clinical trials.

In Canada, companies have struggled to raise funds to support that transition, Irwin says.

“Once they reach a C fundraising mode, the amount of capital required to move a company through the clinic is beyond the current capital resources of the majority of the funds in Canada,” she says. “So you have to go to the bigger pools in the U.S. where . . . they want to do as the first round $7 to $10 million US. There are very few across the country that would even contemplate that in Canada.

“A $12 or $13 million initial commitment would represent too high a percentage of a portfolio, and we’re talking about the first investment, that’s not even cumulative,” Irwin describes in relation to Canadian funds. “Portfolio management for a venture capitalist is you also don’t want to be overexposed in an individual investment from a percentage basis.”

The reality today, Irwin explains, is there isn’t a general capital pool that can support VCs to finance firms through to the point of becoming a public offering, and companies are no longer going public earlier, such as before Phase II, as was the case before the genomics bubble burst.

As a consequence of this lack of sufficient funds, it’s not uncommon these days for a Canadian firm to become acquired by a U.S. firm, Meikle says. “From a business point of view, the people who are shareholders can probably do OK, but for sciences being built in Canada . . . it takes away our ability to raise an industry here,” he says.

To avoid losing firms to the U.S., Meikle says it’s important to find ways to support mid-stage, or gap, financing. “There’s got to be more attention paid to that at all levels — the VCs, the investment community and the governments,” he says. “If we expect to build a community in Canada, we’ve got to have some way of supporting the industry to make sure it pulls through.”

A firm could stay private, Meikle mentions, but when it comes to financing a Phase III round, it’s almost impossible to do so before going public. He gives the example of a company developing a cancer compound.

“Up until Phase II, you might spend up to, let’s just ball park, $8 to $10 million. But to do the Phase III trial, you might be talking another $20 to $30 million, and where are you going to raise that?” he asks. “Privately, it’s very tough to do. So, it drives it to, OK, then who can we partner with or who can we get involved with us to put the money in. Big pharmaceutical companies are one vehicle and they do invest in these companies and keep them private, but even they have so many demands on the amount of money they can invest.”


The VC Scene

Realizing that VCs are not all the same is important, says G. Steven Burrill, CEO of Burrill & Co. (San Francisco, CA), a life sciences merchant bank. With regard to the types of VCs, “Some have a lot of money, some have very little. Some want to put all of their money into one company, some want to put very little money into lots of companies,” Burrill explains.

VCs also vary, Burrill adds, in their capital sources, their agendas, how they operate and their risk tolerance. “It’s all these things that are critically important to this equation of how does the entrepreneur get money,” he says.

While most of his firm’s investments are in the U.S., with none currently in Canada and about six or seven in Europe, geography in fact does not play a role, Burrill says. What matters is where the company can go to get the best deal. But this may not always work for many investment firms, he says, which tend to be relatively small and prefer to work regionally.

Standard attributes that Burrill & Co. look for in a prospective investment include “a quality of the management team at one level, technology and its protectability, the size of the market and the barriers to get their clear in the regulatory pathways and the risks in development. And we have to satisfy ourselves of all of those things, and whether they’re in Toronto or Detroit, we don’t much care,” Burrill says.

He emphasizes that it is the attractiveness of being able to get companies on the public equity market that causes VCs to invest.

“Part of the issue, then, in investing in Canada is whether it has as good access to liquidity in public equity markets as we do in the U.S.,” Burrill explains.
“Then there’s an argument that yes you can probably go public in Canada earlier, that less mature companies are able to access the public equity markets,” he continues. “But you also have to ask whether the values in Canada are as high or as robust as they are in the U.S. . . . and whether that liquidity is real because you may get a company public but that doesn’t mean there’s enough liquidity in the market to take out a sizeable position.”


Forecasting Financials

Based on the current Canadian funding scene, in which very few firms can be financed through to the point of becoming a public offering, Irwin says what she and her syndicate partners look for in a prospective investment is M&A potential in the long term.

“The shift over the last couple of years has been less on an expectation of an exit through a public offering and more on acquisition,” Irwin says. “When a venture capitalist is looking at an investment, it’s more about what’s the market precedent and M&A activity for this type of company, this type of technology. And it doesn’t mean necessarily we would be selling this to somebody else, we could be merging this with somebody else or building it with other groups as we move forward.”

Rampertab does not foresee much upcoming M&A activity for early stage biotech firms. “Because,” he says, “who runs these biotech companies? Founder scientists, CEOs. This technology has been their brainchild. They spent years and years developing it; there’s a lot of ego attached to it.”

This means there is a reluctance to sell the technologies, “And unfortunately, a lot of technology will just end up sitting on the shelf and fading away. Or, in a pseudo-windup situation, will get purchased by someone for next to nothing because guess what, the company just ran out of money,” Rampertab says.

C. Justin Stephenson, managing partner of Galiano Ventures Inc. (Vancouver, BC), offers a different forecast.

“I think that mergers and acquisitions are going to be the name of the game in the future where it makes sense because there are too many small undercapitalized companies that have lost investors’ interests over the last few years, and the best way for them to survive is for them to develop critical mass with like-minded entrepreneurs in other companies that might have complementary science and intellectual property positions,” Stephenson says.

A venture capital, private equity and management services firm specializing in the biotech and life sciences industries, Galiano Ventures formed an agreement in June with Haywood Securities Inc. (Vancouver, BC) to raise a fund aimed at addressing the later-stage funding gap for Canadian firms. The fund, called Galiano Life Sciences I Ltd. Partnership, is aiming to raise between $10 million and $50 million, and will have its first closing by the end of this year, followed by an institutional closing mid-year 2005, says Toronto, Ont.-based Blake Corbet, managing director of Investment Banking at Haywood.

The fund is covering four areas: cardiovascular diseases, infectious diseases, cancer, and diseases of the central nervous system such as Alzheimer’s and schizophrenia. Stephenson says the fund will stay focused on these areas because they are the largest unmet medical needs with the highest growth rates in the world.

As a bottom line, Stephenson says that in order for the industry to “thrive and survive” in Canada, more funds and bigger funds are needed. “I think there are over 470 Canadian-based private and public life science companies today and I would say that over half of the private companies and many of the public companies are critically undercapitalized,” he says.

“In the States it’s different,” Stephenson says, “because it’s such a bigger marketplace, there are many more competing funds and the government, frankly, provides funding to startups and entrepreneurial professors at universities to get their products to a much later stage of development before the venture capitalists come in.”

A more immediate source to address the mid-stage funding gap is a fund that closed in October — a partnership between the Teachers’ Private Capital (Toronto, ON), the private equity arm of the Ontario Teachers’ Pension Plan, and specialist life sciences venture capital firm Bioscience Managers Ltd. (London, U.K.). Called the BML International Maple Leaf Fund I, the new fund will focus on private equity investments in mid-stage Canadian life sciences companies, and plans to be a lead investor in syndicated financing rounds of about $20 million to $30 million. The fund is actively seeking investment opportunities.

Despite the described funding difficulties, “if things continue on the way they’re predicted right now, there should be several approvals by the end of this year or the first quarter of next year,” Meikle says of Canadian products. Also, with several U.S. firms having submissions to the U.S. Food and Drug Administration, “there are things that are on the horizon and that could change the landscape . . . because people will jump on the bandwagon with the approvals,” he says.

Burrill acknowledges that the U.S. markets are “pretty difficult right now,” but he foresees improvement in the coming year. “I projected now publicly that I think I’ll see an industry that does between 30 and 40 IPOs in the U.S. next year, that raises well in excess of $20 billion in the U.S. next year, and that not only are the VCs active, but the public market is going to be active both on the IPO level and on the secondary convertible debt level,” he says. “I think the industry is going to have a good year in ’05.”