Angels in Life Science America

11/13/12Follow @startupboston

What happens when the FDA approval process slows down and imposes higher hurdles, when cost-reduction becomes central to the healthcare provider business model, when clinical trials and commercialization costs for medical devices and biotechnology products spiral through the roof, and when exit returns are compressed by general economic conditions and the decline of the IPO market?

Venture capital funding for early stage life science companies markedly contracts. In fact, venture capital funding for these companies declined consistently over the last few years. Even if federal grant funding for basic research increases, there will still remain the proverbial “valley of death” in funding the necessary first steps of translating research into products and ideas into companies. The emerging life sciences company must find a bridge to the development and commercialization of new life-saving technologies.

So what is a life science entrepreneur to do?

Enter the aptly named “angel investor.” More specifically, enter the new breed of investor who understands the needs and the opportunities of early stage life science companies. According to Dr. Richard D. Gill, a member of Boston-based Launchpad Venture Group, “Over the last 10 years, the angel investment community has stepped into the breach left by the venture community.” At last year’s Acceleration conference held at Nutter, McClennen & Fish, Bill McPhee, a prominent life science angel investor and former venture capitalist, went one step further and declared angels as the keystone to early stage life science funding.

So why do angels do it? 

According to most industry experts, angels are willing to tackle the massive risks of life science ventures because of the opportunity to reap outsized returns and to participate directly in a company through board or advisory roles where they can add outsize value. David Verrill, Managing Director of Hub Angels in Boston, points to the upside: “New England angel groups have had a big impact on local life science startups, with some significant exits recently, including SmartCells and Intelligent BioSystems.”

SmartCells, developer of SmartInsulin, is often considered the poster child of the successful angel-backed life science company. Merck paid up to $500 million after milestone payments on less than $10 million of invested capital, without the participation of venture capital funds.

Leveraging experience

Because of the tighter market for capital, only stronger and leaner companies are making it through the fundraising gauntlet. Said Richard Anders, Managing Director of Massachusetts Medical Angels, a group that focuses exclusively on life science deals: “All companies are having to tighten their value proposition, sharpen their pencils, and figure out how to make a compelling company with fewer dollars and often, for a while, no dollars. The result is stronger, more competitive candidates.”

These leaner, stronger companies are using the success of earlier ventures as their playbook. Many early stage companies rely on the guidance from angel investors, who typically can bring experience from many different entrepreneurial settings to bear on charting the surest path to success. Angels are particularly well positioned to assist companies in adopting a lean startup methodology, offering low angel valuations, and focusing on capital efficiency using virtualization and other outsourced infrastructure models. They can often help steer a company to early market feedback from strategic partners and high-quality clinical data on comparative effectiveness early in their testing programs.

Angels often also help accelerate the fundraising process through introductions to their respective networks and assistance with the preparation for the fundraising process. Leveraging an angel’s expertise can be a critical aid to decrease the process time of fundraising and to maximize the potential capital raise to meet the high needs of life science ventures.

By working with additional angel groups and by engaging regional and national deal sharing processes, angels are able to rapidly raise sufficient capital to help companies achieve valuation milestone inflection points. Said David Verrill, “The Angel Capital Association is stimulating cross-border syndication of life sciences deals in order to find the best deals in the country, and aggregate enough angel capital to meet the financial needs at much more significant levels of funding.”

It’s not all altruistic. Angels are hedging their risks while accelerating venture development by getting actively involved in ventures, providing product and industry expertise, and serving as champions for their portfolio companies. Henry Kay, a leading life science investor with Boston Harbor Angels, noted: “An investor who plays in this space knows the risks and more importantly knows the opportunity and is willing to help a startup company with personal expertise or contacts in the industry. A life science startup should look for these types of investors, typically called ‘smart money.’ They bring more than capital; they bring skills that the entrepreneur can call upon during the development process.”

But a gap still remains…

Even with the opportunities to realize huge exits, to develop life-saving technology, and to deploy their impressive array of scientific and business skills, angels are proving to be only part of the solution. For the first time in decades more dollars are being invested by angels into Internet companies than into healthcare companies. In the first half of 2012, $123.9 million was invested by angels across 70 deals into life science companies. This represents 26.5 percent of the total angel dollars invested and 20.5 percent of the deals, and is a marked decline from the 40.8 percent of total angel dollars invested and 23.3 percent of deals in life science companies in the first half of 2011. It is not clear whether this shift in angel investing emphasis is a market correction to earlier over-funding of the life sciences sector, or if this represents a new and troubling gap in the fundraising landscape.

As this gap has appeared, other players with a vested interest in a healthy pipeline of life sciences companies have begun to respond with new and innovative solutions:

—Universities will continue to fund early research and development and to engage in commercialization efforts as a way to bolster their brands and increase their licensing revenue. Many have reacted to uncertainty about the availability of federal money by partnering with industry in massive collaboration projects around commercializing technology.

—Pharma and medical device industry giants have begun their own incubation programs, ranging from in-house venture capital, to creating stand-alone entrepreneurial enterprises, to acquiring a portfolio of options in early stage companies in exchange for distribution and acquisition rights.

—States have begun stepping into the fray. Understanding the link between new venture creation and economic development (and a stable tax base), states have increased general venture capital support (such as Massachusetts recent refunding of MassVentures).  Additionally, given the “sticky” nature of life science companies and their necessity of onshoring key jobs, states have also increased funding specifically for life science companies (such as the debt programs from the Massachusetts Life Science Center).

—Entrepreneurs are likely to seek out a broader base of capital through crowdfunding as securities regulations are relaxed under the recent JOBS Act, although it is critically unclear whether obtaining such early stage capital, at possibly inflated valuations, will inhibit or reduce the opportunity to raise the follow-on capital that is required for such companies.

—Some angels are bucking the traditional tax-efficient strategy of growth capital for the risk (and return) reducing strategy of investing in income streams generated by early medical product and health IT companies—although this is clearly a strategy that will not adequately address the needs of biotech entrepreneurs.

—For-profit life science companies may begin to have increased access to grants and program-related investments (PRIs) from private foundations, particularly as new L3C and Benefit Corporation type structures evolve.

What will happen to the angels in life science?

It is entirely possible that one result will be a realignment of expectations around angel investment returns. In a market in which broad-based public equity and debt indexes are returning tiny, if any, returns, interest rates are at historic lows, and venture capital portfolios have been in the doldrums, angels may begin to target their portfolio returns in the 15-20 percent range … Next Page »

Jeremy Halpern is a partner with the Boston law firm of Nutter McClennen & Fish LLP, specializing in emerging companies. Follow @startupboston

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  • Johnny Stine

    Could someone forward this fantastic article to the Alliance of Angels? Although if they don’t read the article, it will be consistent with their interest in my slides.

  • Takuro

    One question. In a deal that will need lots of VC money later on, how can angels get avoiding being squeezed out, or facing significant dilution?

    • Johnny T. Stine

      Angel investments are typically small by comparison to institutional investors so you, like the founders, will be squeezed out. The key is to not invest in something where the exit is being bought out or going public as it takes multi-milions to get there. The investment Angels should be looking for in life science biotech companies are those that have technologies that can rapidly get to value inflection points without spending the mega dollars to get there. For example, a company that can inexpensively find high value, fully human antibodies in a short amount of time and with low cost can be an easy, no-brainer investment to an Angel investor provided that they understand that space. Because at that point, the exit is an out license or a partnering deal with big pharma – both of which will easily get you 5-10X on a very simple $250-300K investment.

      • Takuro

        Thank you for the comment.

  • Laura Hales

    Awesome article Jeremy! At Nutter’s Acceleration event last week, I was talking to Don Freeman about the “NewCo” model that may be gaining popularity, whereby a life science platform technology company spins out assets and Angels invest in those individual assets, which have a better chance of getting partnered for a quicker exit. He thought it was a great idea, and I am wondering what other Angels think about that. Also, I feel compelled to point out that MassVentures is a fantastic idea overall; however, they unfortunately do not invest in life science companies (the closest is healthcare IT). The other unfortunate thing is that the Mass Life Science Center is not given enough money to have programs to help fund early stage life science companies. States like Pennsylvania have BioAdvance and BFTP, which have convertible note programs to provide true seed funding. This kind of program, or something like the matching seed grant program offered by Maine Tech Institute would really accelerate innovation in our great state of Massachusetts.

    • Johnny Stine

      Laura,
      I went to our local Angel communities here with this idea – investing in programs or asset generation so that they can benefit from a quicker, more obvious exit. The education curve out here anyway is not just a curve, it appears to be as steep as Mt. Rainier. I thought i had a “no lose” situation for them – I mean come on, antibodies sell! But they still left the meeting thinking that it would take hundreds of millions in order for them to get an ROI. I was shocked. I did my best. And I realized that maybe I’m just not talking to the right Angel group. But yes – I still think it’s a great idea and should be pursued further.

  • Jerry Bird

    Great article Jeremy! In the global economy Massachusetts has an enviable position in life sciences, education, and providing healthcare. If angels can step in and help fill the gap left by the venture community and provide value through lean start up methodology, even better. Our state and our leadership position is constantly under assault from other states who watch us invent something and work hard to move those companies and technologies to their state for commercialization. The situation is not as bad as people often say but there is strong evidence that companies focused on social media are finding it easier to get funding, talent, and a head start in other states such as California or New York. Staying true to our strengths and having the angel community step up to the plate is exactly what we need. MassVentures is the state-backed venture firm focused on funding early-stage Massachusetts startups, what we need is continued support throughout the community to grow and keep these companies here in the Commonwealth. -Jerry