by Rebecca Kaufman
Published in 2007 “The first money is the hardest”–a truism to many an emerging biotechnology company executive. “Everyone has an interest but nobody is looking to lead,” notes one CEO currently on the venture capital fundraising trail.

How to survive and make progress in the meantime, i.e., how to bridge the gap, is an important question for many of these companies. And, for some, the related question of how to go it alone– without venture capital– whether by necessity or choice. These questions loom particularly large in the Southeast, where venture capital has been in historically short supply relative to other regions like the Northeast or the West Coast.

A variety of funding alternatives can help emerging biotechnology companies to bridge the gap, including both non-dilutive and dilutive sources, and in some cases, pursue non-venture models. Each, like venture capital, offers certain advantages and disadvantages. While by no means comprehensive, this article reviews some of the alternatives.

Non-Dilutive Funding Sources

Among the most popular sources of non-dilutive funding sources are federal, regional and state-based programs.

The Small Business Innovation Research (SBIR) program is a federal set-aside program for domestic small business concerns to engage in research/research and development that has the potential for commercialization and public benefit.

A related program, the Small Business Technology Transfer Program, makes funding available under slightly different terms. Both programs are an important source of funding for early stage life sciences companies. In 2006, for example, the National Institutes of Health (one agency involved with both programs) made SBIR grant and contract awards totaling over $572 million and STTR grant awards totaling over $68 million.

Vince LaTerza, CEO of NeurOp, Inc. (Atlanta, GA), a preclinical company developing novel small molecule therapeutics for CNS disorders, lauds the value of the SBIR program to emerging biotechnology companies.

“Funding for proof of principle studies is necessary to position a company for institutional financing or partnering but is very difficult to access and costly in terms of dilution to the founders.” LaTerza has been successful accessing SBIR funds for the company, which has raised $1.85 million in SBIR funding to date.

Terry Walts, CEO of Transfusion & Transplantation Technologies (3Ti) (Atlanta, GA), a developer of automated blood analyzer technology, echoes the sentiment. “STTR funding really kept 3Ti alive for a number of years and permitted us to make advances with the technology and to more fully develop our intellectual property position.” Walts recently joined the company and is now actively fundraising from institutional investors.

New changes in the federal programs will soon make more funding available.

Yet, following the federal grant route carries certain risks. Applying for and receiving federal funding is a time consuming process and can slow the company’s progress relative to private funding.

From a venture capital standpoint, companies have a certain (hard to define) “shelf life,” making it difficult for companies known to the venture community to re-introduce themselves once progress has been made.

Regional and state incentive programs also play some role in filling the funding gap. The Georgia Research Alliance, for example, offers Industry Partner awards to support R&D projects conducted jointly by university faculty and Georgia-based companies in certain key areas, including biosciences. 3Ti, for example, was the recent recipient of a $100,000 Phase III award from the GRA. Follow on funding is also available through the program.

The State of Georgia Bioscience Seed Fund, together with Georgia Venture Partners, has made a significant difference in the Atlanta life sciences community. Established in 2000 by the Georgia State Legislature, the State of Georgia Bioscience Seed Fund invests side-by-side with accredited early-stage investors in life science companies based in Georgia.

By leveraging early stage investors, the Bioscience Seed Fund is able to provide additional seed or early-stage capital to companies located within the state on a ratio of one-to-three matching committed investment from accredited investors ($1 from the State Seed fund for each $3 from accredited investors). The Seed Fund, together with GVP, is an investor in Metastatix, Inc., an Emory spin-off developing compounds to treat cancer and HIV. Metastatix recently closed a $35 million series B financing led by Frazier Healthcare Ventures and joined by Series A co investors H.I.G. Ventures, The Aurora Funds, CM Capital, SR One and MedImmune Ventures.

North Carolina has a number of innovative state programs as well. Since its inception in early 2006, NC IDEA program has awarded more than $600,000 to sixteen companies in North Carolina. The program targets companies who need help funding initial product and business plan development to the point where the opportunity becomes more attractive to private equity investors.

The program isn’t limited to life sciences, but extends to a variety of other technologies, offering grants of up to $50,000 per recipient. Oncoscope (Durham, NC), one recent life sciences awardee, is developing an optical biopsy system which would enable physicians to scan epithelial tissue in vivo and detect signs of early cancer.
Regionally, the Southeast BIO (SEBIO) organization is making strides to increasing exposure and funding opportunities for the earliest life sciences companies.

The organization’s annual Investor Forum has long featured an early stage track which has grown significantly over the years to be among the Forum’s most popular offerings. In 2007, SEBIO introduced the BioPlan program, a business plan competition sponsored by HIG Ventures, which offered $100,000 prize to the winning pre-seed company. This year’s winner, Triptcor, Inc. (Atlanta, Georgia), is a pre-seed company developing small molecule therapeutics first discovered at Emory University.

Angel Investment

Both NeurOp and 3Ti have also raised money from angel investors. An angel investor is usually a wealthy individual who invests his own personal money in a given business.

NeurOp recently closed on $500,000 in seed funding from Blue Grass Angels (BGA), a group of angel investors located in Lexington, Kentucky. 3Ti recently raised $200,000 from individual investors participating in the company’s first outside (non-research grant, non-award) funding. And they’re not alone.

Angel funding remain a popular funding alternative for early stage companies. The traditional sources– friends and family– remain popular but have been supplemented by more organized angel groups formed in the region in recent years.

One example is Piedmont Angel Network, a member-managed angel fund focused on seed and early stage venture financing, primarily in the Piedmont area of North Carolina and secondarily in other regions of NC.

Chris Matton, a partner with Kilpatrick Stockton and angel investor, notes that the many of the organized angel groups have been relatively quiet in recent months. He expects activity to pick up with liquidity events anticipated in 2008. Notably, however, market conditions, and perhaps the formal organization of angel investing activities, may be driving angel investors toward post-seed deals going forward, he observes.

Overall, the most important thing for entrepreneurs to remember as it relates to the intake of angel funding is to structure the investment in a manner appropriate to permit the possibility of future venture capital investment For many, this means structuring the investment as convertible debt, notes Matton.

Early Stage Deals

Alliances offer yet another source of alternative funding for emerging biotechnology companies. Preclinical, lead and discovery based deals between emerging biotechnology companies and big biotech and pharma are increasingly common. Valuations are also on the rise, with the average value of a preclinical deal (including up fronts, R&D, milestones and equity) rising from $50 million in 2002 to well over $200 million in 2007.

“Pharmaceutical companies are becoming more aggressive at in-licensing assets to bolster their thinning pipelines,” notes Garheng Kong, a partner with Interouth Partners, a venture capital fund based in North Carolina. “The competitive landscape for deals allows for young companies to perhaps achieve some value earlier.

As a result, explains Kong, a young company may be able to gain some “runway” through upfront and milestone payments to prove out the rest of the technology platform or advance second and third programs. This may also reduce the capital requirement needed overall, but a young company “must be equally confident in its second and third programs before it goes down this path,” he notes.

Chris Kroger, a partner with the Aurora Funds, a venture capital fund based in North Carolina, notes the potential impact of early deal making on the longer term availability of early stage venture capital. “Big pharma moving to earlier stage acquisitions will help the venture funds,” he observes. “With a strong trend toward early partnering, early deals could become significantly less risky; attracting more capital to early stage technology deals both from within and outside the region. For the region the early success will hopefully help to spawn more good management teams as well.”

Rebecca Kaufman is a partner with King & Spalding LLP and the Marketing Chair for SEBIO.

 

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