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This is a student paper from the 2009 final projects in the NIH Foundation for Advanced Education in the Sciences’ TECH 366 — Biotechnology Management. The students were asked to tell a story based on the course lectures, and to expand with general lessons on biotechnology company management.

Financial opportunities for early stage biotech companies

Tammy Jones

One of the aspects of entrepreneurship that interests me is the process of early stage financing.  What are the options of financial backing and the advantages and disadvantages of these opportunities? There is a wide variety of financial support for early start-up companies.  The entrepreneur can obtain money through friends and family and him or herself.  Support is also available through Angel investors, incubators, Venture capital, federal and state funding. These investors are considered high risk investors because of their early stage involvement.  The company is high risk because the technology is in the development stage and there are no more academic resources this is also known as the “Valley of death”.   The investors fill in that financial gap so the company can remain productive in getting the product to market. The funding is allocated at different phases of the project. The money is not guaranteed from one phase to another.  To get to the next phase of funding, the company must show progress in the form of reports and also proof of concept.

Self and friends and family are the least recommended form of funding.  Because a return or a profitable return is not likely and a loss is guaranteed, friends and family are not a good alternative.  But sometimes it is the only alternative when your company does not interest other investors.  An example of this is Bonnie Robeson, founder of Spectrum Bioscience.  She used her own money and friends and family to partially fund her venture because her company did not have the appeal for big investors.

Incubators are programs that provide start-up companies with support in the way of resources, services and contacts.  Start-up companies that participate and complete the program are more likely to stay in business for the long term.  The incubator can provide space for very little rent.  They can also provide equipment, support staff and group rate for insurance which would help the company’s budget.  The amount of time the space is available is not indefinite, it usually is about 3 years and when the milestones are met for graduation.

Angel investors are another form of financing.  They are individuals that invest their own money and usually like to remain anonymous.  The funding usually ranges from $150,000 to $1.5 million. Angel investments are about $20 billion to $50 billion compared to $3-5 billion of venture capital investments per year in the U.S.  Angels expect a return in 5-10 years. The advantages of an angel investor are that it is easier to persuade an angel to invest in your company, due diligence is less involved and a lower rate of return is expected (smallbusinessnotes.com).  Our guest speaker, Ajoy Chakrabarti, senior director of Emergent Biosolutions, is an advocate for angel investors. He spoke about Angel groups which are individuals that pool their resources for investments.  They form groups in a certain specialized area.  This is good for a company in that specialized arena but it also means there will be more people to convince to buy in to your idea. Some feel angel groups are ad hoc VCs, because of the VC like behavior when dealing with entrepreneurial companies and they also have formed alliances of angel groups such as The Angel Capital Association and the Mid-Atlantic Investment Network were they exchange ideas and information.

Angels, as with other investors, expect certain things in return for their money and that ranges from a board position, weekly or quarterly reports, 5%-25% stake in the business.  They also request stock.  Some want the company’s convertible debt or redeemable preferred stock.  This is advantageous to the angel but not to the company because the company would have to repay the investment plus interest.  Angels may also request to be the first to opt out of the next round of financing and that the business can’t make certain decisions without approval of the Angel investor.  All of these requests are in part to protect their investment (smallbusinessnotes.com).

Technology Development Corporation (TEDCO) and the Center for Innovative Technology (CIT) are economic development organizations that provide state and federal funding to start-up companies.  TEDCO and CIT usually finance the company between phase I and II of the SBIR funding or when the SBIR ends completely and while the company is awaiting Angel or Venture capital resources.  TEDCO requires that the start-up have fewer than 16 employees and 50% of them must be employed in Maryland and the start-up is a university spin-off that is in business for less than 5 years and before the company sees a profit or it receives funding from other resources.    It awards up to $75,000 for early stage technology development.  The company is required to repay in the way of 3% of its revenue or 40% of the award over five years. Again, if there is a downturn in the economy, the repayment can be a problem.  The start-up company keeps the intellectual property and the commercialization rights of the technology when dealing with TEDCO (marylandtedco.org).  CIT offers business acquisition, commercial real estate financing, franchise financing, construction loans and business succession financing.  The amount of the loan is from $350,000-$10 million, financing up to 85%-90% and with terms up to 10-25 years (cit.com).

Federal funding is another avenue for a start-up company to obtain money. Government grant funding is given by way of the Small Business Administration through Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. SBIR and STTR programs are given through federal agencies with over $100 million and over $1 billion, respectively, in their extramural research and development budgets. Both programs require that the for profit business have 500 or fewer employees, be at least 51% individually owned and controlled in the United States.  The differences are that the SBIR requires the principle investigator be employed at the company at the time of the award and the duration of the project.  The principle investigator may be employed by the research institution or the company for the STTR award.  Also the STTR requires that there be a CRADA between the company and the research institution where 40% of the work is performed at the company and 30% of the work is performed at the research institution (sbir.gov). Both programs are very good for small business.  The programs award money for phase I and II.  The funding amount in phase I, which is dedicated just to research, is between $70,000-$150,000 for 6 months from SBIR and 12 months from STTR. Phase II is focused on research and development and the funding ranges from $750,000-$800,000 and in some instances $1 million.  Phase II bridge provides funding of $1 million/yr for 3 years and this is to fill in the financial gap between phase II to product commercialization.  The downside is that other aspects of the company such as the protecting and growing the company’s intellectual property are neglected.

Venture Capital (VC) provides funding to early stage biotechnology companies in late phase II and early phase III. Venture capital usually comes from institutional investors and high net worth individuals pooled together by investment firms such as Toucan Capital. The return usually comes in the form of IPO or sale of the company in 2-3 years.  This is seen as a disadvantage and quite stressful to some entrepreneurs who feel rushed into going public or selling their company.  Another disadvantage is the entrepreneur will no longer have 100% ownership of the company, the VC takes a percentage.  In order for a company to get the attention of a VC, the firm must believe that the company will operate in a billion dollar market and have potential to make $100 million in sales in five years and be sold for $400 million, the exit, (allbusiness.com).  Because of such high standards, many good start-up companies can’t get VC funding such as Spectrum Bioscience. It is a service company providing a much needed service and it doesn’t meet the criteria of a VC. Once the company has VC funding, an advantage of the funding is that it allows the business to expand and not be pigeonholed into just research and development.  The company also can get management support to guide the product to market.  Another is that it is not a loan that needs to be repaid.

Depending on the entrepreneur’s objective for the company, venture capital and federal funding are both good ways to get start-up money but because of the criteria to receive federal funding it is impossible to receive both simultaneously. If the company is 51% or more owned by VCs, then the company can’t qualify for federal funding, SBIR. Venture Capital has been at odds with the SBA for years because of the restrictions placed upon the grantee.  Venture Capital firms think this restriction is foolish and it adversely hurts the government and the tax payers because VCs are funding the more promising start-ups and the less promising start-ups are getting SBIR money.  This is perceived as such a problem by venture capital firms that the National Venture Capital Association and the Biotechnology Industry Organization got the House and Senate involved to change the restrictions (bostonvcbolg.typepad.com). As it stands currently, the house supports the VCs and the Senate favors some restrictions to VC owned companies (bizjournals.com).  An informal poll taken showed that about 80% of small companies were opposed to large VCs owning and controlling small businesses competing for SBIR funding (zyn.com). If this movement is successful, the question that comes the mind of many early stage companies seeking financial backing is will there be enough SBIR money available for non-VC funded start-up companies?  Jonathan Cohen, CEO of 20/20 Gene Systems, a guest speaker, is opposed to the elimination of the restrictions because VC funded companies would have an unfair advantage over early start-up companies. VC companies are more established and more likely to succeed and a company just starting out hasn’t had the opportunity to establish themselves and the SBIR funding is for that purpose.

The entrepreneur must know the criteria when dealing with these various finance opportunities. The entrepreneur/founder must know when and how much control they want to relinquish, as in running the company or the company going public when dealing with Venture Capital firms. Federal funding and Venture capital provide money that does not have to be repaid but the trade off is that the 51% requirement of both entities makes it difficult for the entrepreneur, leading to the SBIR, VC controversy.    Angel investors seem to be the more persuasive and lenient, even though they do have expectations, but as the economy tightens so does the angel investors’ money as well as the other investors.  The company must leave the Incubator after graduation or maybe before if the benchmarks are not achieved but the company has longevity after leaving. With TEDCO and CIT, the company has to repay the money but it can keep IP rights and ownership. The opportunities of early stage financing have its pros and cons attributed to them.  The entrepreneur must find what is appropriate for them.

I will be opening the Business Matters for Scientists program at Johns Hopkins Carey School of Business on March 6th 2009. My focus will be providing an extensive overview of the biotechnology industry and insights on paths to entrepreneurship and business planning considerations. In addition to laying out the fundamentals for success, I will also address practical considerations in developing biotechnology companies and illustrate the diversity of entrepreneurial approaches and cases of unforeseen hurdles in biotechnology business development.

For those who cannot make it to Baltimore for the certificate program, two other options exist:

  1. Biotech-U.com is an online biotechnology education platform offering self-directed courses covering the scientific, legal, regulatory, political, and commercial aspects of biotechnology.
  2. My book, Building Biotechnology, is a comprehensive biotechnology industry primer.

After months of effort, I’m pleased to announce the launch of Biotech U, a biotechnology education resource featuring web-based lessons on biotechnology business, law, IP, politics, regulations, and science.

Biotech U is based on Building Biotechnology, the leading text used in business-of-biotechnology courses. The online-learning structure is designed to meet the needs of busy professionals who seek a robust educational resource but lack the time to attend traditional classes. Feel free to try the sample course, an Introduction to Biotechnology, and I hope you enjoy this new resource.

After an extended struggle Mark Emalfarb, the founder of Dyadic has regained control of the firm. He was originally ousted by the board after an accounting scandal at a foreign subsidiary. By forming a coalition with other shareholders, representing a majority of the company’s shares, Emalfarb was able to dismiss the board members who had ousted him in a court-ordered annual shareholder meeting.

Guest content from Sandy Graham, managing partner at Sequoyah Associates:

Can you “see the field” of opportunity? Have your clearly defined your plan to achieve your entrepreneurial dreams? Have you mapped out the strategic direction to attain your plan? Have you envisioned your market and know how to position your business to acquire it? Do you still have that “entrepreneurial flame” that caused you to spend nearly every wakening minute working ‘on” your business or have you succumbed to the daily chores of working “in” your business? Too often, new entrepreneurs and small business owners get caught up in the “day-to-day” running of their business, and find themselves unable to focus on their passion and keep the “entrepreneurial flame” going in the attainment of business initiatives, envisioning the market, reaching the optimal strategic direction, and seeing the field of opportunity.

The Golf Analogy

A new venture entrepreneur or small business owner who can “see the field” of opportunity is much like the PGA Professional who “sees the field” when he stands in the tee-box and looks down the fairway to the flag stick. He envisions the best approach to the green, determines the strategic direction to get there, and focuses all his efforts on attaining the goal of getting to the green and setting up a short birdie putt. The result is success, and if continuously repeated, will lead to a very strong finish. The great Bobby Jones was said to be the best at this. The present day version is Tiger Woods. In business, I believe we can achieve the same ‘vision’ as Tiger and Bobby if you can ‘see the field’ of opportunity.

How you ‘see the field’ of opportunity will largely determine your level of success. It is here you have the decision to make to either work ‘on’ your business, or work ‘in’ your business. Positioned to work ‘on’ your business keeps your entrepreneurial flame burning, fueled by the passion that first inspired you to leave corporate or blue-collar America and take that entrepreneurial leap-of-faith. Conversely, if the field of opportunity is clouded, foggy and difficult to see, then you likely will succumb to the notion that it is better to work ‘in’ your business to keep it going. There is certainly nothing wrong with that, except it means status quo and not growth.
компютри втора употребаThe Consequence of Not Seeing the Field

Now I am not a biology wiz, but I do know this; in the natural world, if an organism stops growing, assimilating and adapting to its environment, and basically reaches a point of accepting a natural status quo, decay sets in and the result is not good. The same goes for a new venture or small business enterprise. The ability to “see the field” of opportunity is critical to your ability to be successful; where growth, assimilation and adaptation come about through preparation, planning and execution which are extricably linked to how well you see the field of opportunity, followed by how you achieve it.

The Importance of Preparation and Planning

To “see the field” of opportunity, in my opinion, involves spending the requisite time to properly prepare and plan how you are going to attain your entrepreneurial goals, envision your market, and determine the strategic direction to achieve them. In business, any business be it biotech, telecommunications, software, medical, manufacturing, or even golf, preparation involves and includes sound strategic planning, market analysis, profitability assessment, and finally looking at your financing status, options and position.
At Sequoyah Associates we can work with you to review your business objectives and initiatives, and recommend the best strategy for attaining them, both in the near- and long-term. Of course, if there are current growth needs or issues, we can help with those as well. Our service offerings range from strategic planning that includes business plan development and business expansion strategy, to market and opportunity analysis, profitability analysis and financing assessment. Whatever your situation is as a new or growing small business, Sequoyah Associates provides the services that can help you attain your goals. Please feel free to peruse our site at www.sequoyahassociates.com and do give us a call for confidential, FREE, no obligation discussion of your business.

Gerald S. “Sandy” Graham
MBA, MS Economics
Sequoyah Associates
813-389-2725
sandygraham@sequoyahassociates.com
www.sequoyahassociates.com

Sandy Graham is Managing Partner at Sequoyah Associates, with over 20 years of progressive senior level experience with some of our Nation’s leading organizations and Fortune 50 companies, as well as new ventures and small business enterprises. His experience includes business strategy, planning and development; new business solution development and delivery; client services delivery; and engagement management. Sandy’s academic credentials include an MBA and an MS in Economics, and is a recipient of the Ewing Marion Kauffman Foundation Internship in Entrepreneurship. In addition, he is a contributing author on Free Cash Flow. Since 2005, Sandy has been driving winning business strategies that have met client needs using consultative, coaching and advising skills to deliver the right business solutions for the small business firm and new venture enterprise.

The science of biotechnology is tough. R&D can be unpredictable, and most products need regulatory approval before they can be sold. But biotechnology companies also need to worry about other problems, like management issues. The case of Dyadic’s illustrates some of the often-overlooked challenges in commercializing biotechnology.

Mark Emalfarb founded Dyadic in 1979 as a supplier of tools for stone-washing jeans. When cellulase enyzme technologies for stone-washing emerged, they threatened Dyadic’s use of pumice stones. Rather than fight this change, the company sought to out-innovate early cellulase suppliers and developed a promising fungal expression system with the potential to produce large quantities of complex proteins and enzymes, including cellulase. Opportunities also exist in cellulosic biofuel production and drug manufacturing.

As is often the case in dynamic industries, innovators can be blindsided by unexpected challenges. In spring 2007, Dyadic became aware of operational and financial improprieties at its Asian subsidiaries. An investigation conducted under the supervision of the board of directors audit committee found that Emalfarb had willfully concealed facts relating the improprieties, which led to his termination.mebeli [a representative from Dyadic opted not to comment on this case, and instead directed me to their press release archives]. A report detailing their justification for firing Emalfarb does not imply direct malfeasance, but claims that Emalfarb did not take strong-enough action to stop off-the-books and tax-evading transactions.

Emalfarb, who maintains his innocence, is the largest shareholder of Dyadic, and has been fighting to regain control of the firm. In February 2008 Emalfarb and two hedge funds, who collectively own more than 50% of the shares, issued a letter to the company demanding the resignation of the new CEO and two board members. Interestingly, despite the protests of this group representing a controlling share of the company, the battle for control continues.

Sadly, this is a case with no clear winner. Regardless of who will direct the company in the future, the share price has been decimated and growth opportunities have certainly been missed. Rather than focusing on developing applications of Dyadic’s core technologies, the founder and company are engaged in legal battles.

[Update: Emalfarb regained control of the company]