Important questions for biotech founders to consider before raising the next round of funding.
Often times, startup founders assume that more funding is always better. This is not true, because funding and the act of acquiring it both require trade-offs. Funding may be in exchange for equity and raising capital is in exchange for all the time it takes up. Still, this “always raising” mentality is pervasive in the startup ecosystem. In this article, we discuss important questions for biotech founders to consider before raising the next round of funding.
Topics we will cover:
🔬 Learn about: Funding Options for Biotech Startups
Finding funding for a biotech startup (or any startup) is challenging and time-consuming. Convincing individuals or firms to exchange their money for ownership of your unproven startup is a tall order. Generally, the research and development you perform will lower the risk of your startup failing, and the lower the risk, the easier it will be to get investors interested.
Investors decide whether or not to invest based on many factors, including the valuation of the company. Valuation means what the company is estimated to be worth at that time or in the future. The process of determining this is complicated and often fraught for early startups, but a fair valuation will determine how much an investor must pay for a certain percentage of equity.
The main reason that investors choose to put money into a company is because they believe they will get a return on their investment, or ROI. This means they think it is likely that the company will be successful in reaching an “exit,” or point at which the investors are able to recoup their investment and relinquish their stake in the company.
Fundraising occurs in what are called “series.” Each subsequent series is for more money than the last. It is common for companies to raise Series A, B, and C rounds prior to their exit. However, if the company chooses to continue raising money from investors they can have more rounds, or fewer if they reach an exit earlier.
Before getting to Series A, many startups will raise a smaller amount of money from friends and family and/or from angel investors. This is called a “seed” round. The risk to investors is highest here, as the company is unproven. Investors in the seed round will generally put in relatively smaller amounts of money, with the round totaling in the hundreds of thousands of dollars. Series A will frequently be in the range of millions of dollars to tens of millions of dollars. Series B and C are similarly larger than the rounds that came before. While angel investors may participate in the seed round, venture capital firms are usually thought of as the entities that invest in subsequent rounds.
🔬 Read about: Finding Funding for Your Biotech Startup
The question of whether it is going to be easy or hard to raise money based on external factors is the least important of those we will address here, but it should be considered. Some times of the year, for example, are more favorable. Closing a round in December is often thought to be a good idea because investors may have tax benefits for investing in that calendar year. However, since the amount of time it takes to close a round is so variable (6-9 months), that can be difficult to achieve.
The funding climate can also be thought of in terms of how desirable biotech companies are seen to be in terms of investability. In 2015 when the Theranos scandal was all over the news, many biotech startup founders were afraid it would make investors shy away from funding their companies. In contrast, the pivotal role biotechnology has played during the COVID-19 pandemic is generating increased interest in biotech startups.
The funding climate, whether it is thought of in terms of seasonality or current opinion, should not be the deciding factor for a company to raise or not. However, founders should understand that the climate can have an effect on how difficult it will be to raise.
🔬Learn: Where to Find Life Science Investors
As explained above, the classic order of fundraising from investors is: friends and family, then angel investors, then venture capital firms. However, according to research performed as part of an angel investor’s recent PhD thesis, that only happens for about 4.5% of biotech companies in the Boston area. Venture capital firms have begun forming biotech startups themselves rather than waiting for founders to come to them. These VC-founded startups and those coming from well-known academic founders receive the majority of venture capital funding, and completely skip over the friends/family and angel investor stage. This information comes from Boston, but it is likely to be true in other regions as well that the canonical transition from angel funding to VC funding may not be as common as once thought.
So what does this mean for your company if you are not venture-founded? This means that fundraising from VC’s is likely to take even more time and effort than originally thought, and you might be better off going back to your angel investors to see if they are interested in a follow-on round. If you’re going back to the people who just gave you money, then it becomes even more essential to demonstrate that you can deliver results.
If you are about to go talk to angel investors for the first time, it may behoove you to discuss the possibility of future follow-on funding now rather than waiting. Then, if you are in a position to choose which angels you would prefer to work with, the potential for follow-on can be part of that decision.
🔬 Read: 9 Angel Websites to Find Investors for Your Startup
This question is mostly aimed at startups where the CEO is involved in the day-to-day lab work. Sometimes if a startup is just two or three founders, the CEO will work at the bench and participate in experiments. That would mean that R&D might take a hit if the CEO were to focus on fundraising for the 6-9 months required to raise a funding round. If you have no funding to continue R&D, then the only choice is to bring in more money. But if you are sacrificing progress in order to build up a store of cash because you foresee needing it in the future, you are likely better off focusing on the science. Use your current funding to reach your next milestone, and then you will have a much more convincing case when you do go out to raise the next round.
The best answer here is that you would use the money to enable an inflection point for the company. You need one pivotal pre-IND study, for example, because your preliminary data is so convincing that this one last puzzle piece will put you in a position to talk to the FDA. This is a great reason to fundraise because you have a clear plan supported by data that will increase the value of your company.
If, however, you need the money because you overspent your budget or an experiment didn’t go the way you thought it would, it’s probably not the best time to raise a new round of financing with new investors. This is where what’s called a “bridge” round comes in. A bridge round acts like it sounds it does--it helps you close the gap between where you are and where you need to be to raise your next round. The bridge may come from investors who participated in the previous round and don’t want to see their investment go down the drain, or if the company has built up credit they may be able to apply for a loan. Either way, bridge funding should still serve the purpose of getting your company to the next round in the most efficient way possible.
Raising a funding round takes between 6-9 months on average, so hopefully your startup has at least that. If you have much more than 9 months worth of runway, then in general you are probably better off focusing on meeting the milestones that your company needs to achieve. Instead of raising another round, take a second look at your budget and see where you can safely cut costs. Don’t sacrifice the quality of your work, but maybe the founder(s) can take a pay cut for a few months, or instead of buying a brand new freezer you can purchase a used one.
It’s tempting to fundraise now so you won’t have to later, but your job as a startup founder is to lower the risk involved in investing in your company. The best way to de-risk is to find out if your technology works the way you think it will. In the moment, watching your cash dwindle feels riskier, but don’t let that reaction convince you to focus on raising before you need to.
Grant funding, though non-dilutive, is also difficult as the competition is steep. Each year, the funding rate for Phase 1 SBIR grants from the NIH is less than 20%, and that is only including the grants that are actually reviewed. The number that are submitted but not reviewed due to mistakes is probably much higher. Writing grants is also time-consuming, though not as much as fundraising. Plus, much of the work can be outsourced to professional grant writers. Therefore, it can be easier to write a grant and keep your company on track at the same time.
If you have already received grant funding, winning additional grants becomes easier. Not only do you know how to write a winning application, but grant funding agencies will also see your previous awards as a sign that you know what you are doing. And if that previous award was a Phase 1 SBIR, by all means, apply for the Phase 2.
🔬 Find out more: 9 Strategies for Winning Grants at the NIH and Beyond
Although there are many things to consider when deciding to fundraise, there is no such thing as the perfect time. As with most big decisions, all you can do is to look at the information at hand and make the best choice possible at that moment. Use these questions to guide your decision making and then once you choose to raise, give it your best effort.
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