The life sciences have historically been one of the most attractive categories for investment. For some investors, being able to support the development of life-saving compounds is sufficiently rewarding. For others, the promise of a high-value return from an IPO or from an acquisition has motivated investment. The investment landscape is evolving with new technologies and investment laws that promise to change who and how they will invest.
To follow is a review of the current state of life sciences investment, how it is evolving, an understanding of crowdfunding legislation (the JOBS Act), and how the future of life sciences investment may change from present practices.
According to Fenwick and West's "Silicon Valley Venture Capital Survey First Quarter 2014", "a total of $8.9 billion was raised by 58 funds in 1Q14, a 82% increase in dollars from the $4.9 billion raised by 53 funds in 4Q '13 and a 9% increase in funds, according to Thomson/NVCA. 1Q '14 was the strongest quarter for fund-raising (in dollars) since 4Q '07 and saw the largest number of new venture funds (25) since 4Q '00." 1
The life sciences' share of MAT Q1 '14 total venture capital investments is 21%; the lowest proportion since 2001 (Figure 2). It may be assumed that is an indication of a reduced interest for the life sciences category in favor of the Software category. [N.B. for the sake of clarity, those categories with less than 10% share for the years plotted were not shown]. 2
Quarter 1, 2014 data for venture capital funding for the life sciences shows $1.7 billion was invested in 173 deals (Figure 3). This compares favorably to Q1 '13 with $1.4 billion invested in 173 deals. (N.B. Life sciences is composed of the "Biotechnology" and "Medical Devices and Equipment" categories as per data source: PricewaterhouseCoopers' MoneyTreeTM Report). 3
Figure 4 illustrates year-on-year percent change in deal value. Life sciences' venture capital investments increased by 15% during the first quarter of 2014, compared with the first quarter of 2013. In contrast, total venture funding jumped by 57%. This is the third consecutive quarter that the growth in total venture capital investment has significantly outperformed those of the life sciences' investments. A upward trend for the life sciences category is the positive inflection over time.
The life sciences' share of total venture capital investments was 17% for Q1 '14; the lowest proportion for a quarter since 2001.
The Life Sciences category is composed of "Medical Devices and Equipment" and "Biotechnology". Figure 6 illustrates the continuing loss of appeal of the Medical Devices and Equipment category for funding (or, is it the overwhelming relative attractiveness of Biotechnology?), as it has fallen from 87% of Life Sciences' funding in 2000 to only 6% in 2014; truly a dramatic fall from grace!
In a report on the state of life sciences' funding, Jonathan Norris, Managing Director, Silicon National Bank, speaking at the December 2013 "Acceleration2013 [sic] Nutter Early Stage Life Sciences" conference, outlined some of the current industry challenges for early-stage companies seeking venture capital:
While VCs avoid investment in early stage life science companies, angel investors frequently step in to fill the void: 4
The Angel Capital Association's 2012 ACA Summit Confidence Survey revealed a high preference for investment in Healthcare as seen in Figure 7. 5
In addition, The ACA highlights that accredited angel investors provide 90 percent of outside equity capital to startups, on top of mentoring and often additional expansion capital. The 2011 ACA Angel Group Confidence Survey indicated that the majority of angel groups preferred to invest in seed and early stage companies, not later stage.
Angel investing in 2013 totalled $24.8 billion, an increase of 8.3% over 2012. The total number of investments (70,730) was 5.5% higher than 2012 levels.4
The share of Angel deals that were invested in the Life Sciences (Biotechology and Healthcare) was 25% for both 2013 and 2012. This is the second consecutive year without segment share growth for the Life Sciences; a likely result of the appeal of Software and Media opportunities for smart phones and internet applications. 4
Biotechnology: Developers of technology promoting drug development, disease treatment, and a deeper understanding of living organisms. Includes human, animal, and industrial biotechnology products and services. Also included are biosensors, biotechnology equipment, and pharmaceuticals.
Healthcare Services/Medical Devices and Equipment: Includes both in-patient and out-patient facilities as well as health insurers. Included are hospitals, clinics, nursing facilities, managed care organizations, Physician Practice Management Companies, child care and emergency care. Manufactures and/or sells medical instruments and devices including medical diagnostic equipment (X-ray, CAT scan, MRI), medical therapeutic devices (drug delivery, surgical instruments, pacemakers, artificial organs), and other health related products such as medical monitoring equipment, handicap aids, reading glasses and contact lenses.
A current trend in angel investing involves syndicating wherein various angel investor groups collaborate on funding and are able to raise significant funding levels. For many companies, this level of investment allows companies to become revenue producing without ever needing VC involvement.
The Valley of Death (VoD) has been described as "the critical time between early- and late-stage development of new therapeutics, diagnostics, or devices. It is during this time when funding sources can dry up and technologies or interventions with tremendous potential can end up as casualties of an unpredictable and often unforgiving business environment."17 "In the valley of death, additional financing is usually scarce, leaving the firm vulnerable to cash flow requirements. Traversing it requires an intelligent blend of public and private sector investment." 7
Figure 12 illustrates the VoD concept for a pharmaceutical product in development. 8 Other product categories and industries have similar kinds of development, funding components, and associated timings.
The main causes of the VoD are:
A brief overview of each of these factors follows.
The average time needed for drug development ranges from 10 to 15 years8 when measured from target identification through approval. In addition to delaying the availability of a new therapy for patients, the long development time increases the overall cost, delays the time to a return on the investment, and reduces the period of sales protected from generics (which impacts the economics for innovators, investors, and the health care system in differing ways).
Figure 13 illustrates the approximate time needed, work performed, and phase of development for a typical medicine's development and approval as provided in "2013 Biopharmaceutical Research Industry Profile", published by the Pharmaceutical Research and Manufacturers of America's (PhRMA). What is obvious from the chart is the high level of attrition seen in the number of compounds in play from Discovery through the Clinical phases. This process has much to do with increasing both the time required and the chance of failure as will be described below.
In addition to long development times, the biopharma industry has to endure high failure rates for products in development. This increases the overall cost, delays the time to return on investment, and reduces investor confidence and category attractiveness.
In "Clinical development success rates for investigational drugs" by Hay et al, Nature Biotechnology January 2014, the authors reviewed clinical development success rates across the industry and described their work as "...the largest and most recent of its kind, examining success rates of 835 drug developers, including biotech companies as well as specialty and large pharmaceutical firms from 2003 to 2011." 10
Figure 14 summarizes the phase success and likelihood of approval (LOA) from phase 1 by disease data for all indications. The bars represent phase 2 and phase 3 success rates and the line represents LOA from Phase I. The LOA ranges from 28% to 46% for compounds in Phase II and indicates the high level of difficulty historically experienced in drug development. How to improve this process to improve the LOA is the subject of much discussion and debate and will not be resolved soon.
Potentially more troubling is one of the conclusions reached by Hay et al: "The data presented in this study suggest industry-wide productivity may have declined from previous estimates." (Figure 15) This conclusion is based on their comparison of their study data versus that of earlier, similar studies from 2004 and 2010 as reported by their authors. The data reported in Hay et al indicates a worsening of the LOA over time: by approximately 60% since 2004 and by 32% since 2010 [emphasis added].
In 2013, there was a slight up-tick in the amount and number of financings for biotech (Figure 16) compared to 2012, as reported in Nature Biotechnology, May 2014. 11 Though this is positive when compared to 2012, the number and value of the deals are still much lower than those seen in 2006-2008.
The number of venture capital firms decreased in 2013 (Figure 17). Brady Huggett, Business Editor, Nature, who authored the report stated: "It should be noted that these funds are investing in innovative private biotech companies at all stages of development; very few funds remain active in the earliest stages to support startup creation [emphasis added]." 11
As in past years, only about 2% of VC money went to start-ups; the remainder went to companies with profiles matching product development, generating revenue, and/or being profitable (Table 1). Though "...very early-stage start-ups require less money than private companies undertaking the later, more expensive stages of product development"8, these data also point to the preference of VCs to invest in lower-risk opportunities, i.e., anything but start-ups.
No love for early stage...
"...at the earliest stages of the private biotech company pipeline, the pool of VC funding for startups continues to stagnate, and the number of venture funds focusing on early stage is dwindling..."
For the U.S., there has not been an increase in the number of SBIR or STTR grants to pick up the funding slack (Figure 18). Both the number of firms receiving grants and number of grants provided have been essentially decreasing since 2004. The grants have increased in size relative to inflation: $280,000 in 2003 is worth $350,000 inflation adjusted to 2014, compared with the $418,000 average value awarded in 2013 (a 19% inflation-adjusted increase). Though the amount awarded may be higher, there is more competition for fewer awards; again indicating the increasing difficulty for securing early-stage funding. 7
In "The View Beyond Venture Capital", Nature Biotechnology, January 2014, Ford and Nelson lay out why they believe access to funding has become more challenging, especially for startups. They suggest the following as the main reason for the pull-back in funding for early-stage life science companies: 12
"The main reason for the withdrawal (especially from VCs in the early-stage life science space) was generally meager returns across the asset class; despite the high risk and long lock-up periods that investors accepted in return for a promise of premium performance, VCs were often not returning any more capital than investors would have earned by making more liquid investments in the public small caps market. Returns from venture capital funds have not outperformed the public markets since the late 1990s."
Missing from their New Life Science Investor Landscape are the accredited investors enabled via Title II of the JOBS Act and crowdfunding participants via Title III (once TItle III is finalized and approved by the U.S. SEC).
This all leads to the next logical questions: What is crowdfunding and what are the differences between Title II and Title III investors and investing?
In its simplest form, crowdfunding (sometimes called crowd-sourced funding, crowd financing, or social funding) is asking a group of people to fund a new venture.
"An Internet-enabled way for businesses or other organizations to raise money in the form of either donations or investments from multiple individuals."
Investopedia defines crowdfunding as: "The use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of friends, family and colleagues through social media websites like Facebook, Twitter, and LinkedIn to get the word out about a new business and attract investors. Crowdfunding has the potential to increase entrepreneurship by expanding the pool of investors from whom funds can be raised beyond the traditional circle of owners, relatives and venture capitalists." 14
The big deal is that until passage and enactment of the JOBS Act, crowdfunding (and the internet) could not be used to offer or sell securities to the general public. "The Act eliminates the prohibition against general solicitation or general advertising in any offering of securities pursuant to Rule 506 under the Securities Act for all purposes of the 'federal securities laws,' provided certain conditions are met." 15,16
"Crowdfunding itself is not new. Websites like Kickstarter and Indiegogo help all sorts of businesses, organizations and people raise money through small individual contributions for an identifiable idea or business. Issuers and intermediaries relying on Regulation Crowdfunding expect to further democratize investing in start-ups, because any investor, whether or not accredited, may invest in these securities." [Note: nonaccredited investor investing is covered by Title III, not yet in effect.] 18
Crowdfunding is only possible and legal in the United States by the lawful processes described in Title II and Title III of the Jumpstart Our Business Startups Act (JOBS Act) [discussed below], signed into law by President Obama on 5 April 2012, and as regulated by the US Securities and Exchange Commission (SEC).
At present, only Title II (for accredited investors only) of the JOBS Act has been enacted; equity crowdfunding under Title III [for unaccredited (aka most people) investors] has not been approved as the SEC continues to solicit and assess comments from interested parties.
Title II approval means that companies can now publicly advertise on web portals on the internet that they are looking for funding. Title II also allows for nonaccredited investors to invest money in new opportunities (within certain limits and under discrete conditions). Likewise, under Title III, accredited investors can now seek out opportunities (now able to be freely advertised/solicited) they wish to fund on their own, without having to be a friend or family or part of a sophisticated investment group or organization.
What remains to be seen is whether the Title III portion of the JOBS Act will ever gain final approval and enactment by the SEC and if it does, how significant it will be as a source of financing for life sciences companies. Given the presumed regulatory burdens that will be in place for funding portals, the limits on the amount of a donation by individuals, and the typically large sums needed by life sciences companies, Title III funding may prove to be of little significance. There is a much higher likelihood that Title II portals will prove to be significant sources of funding.
The JOBS Act subtitled Title III of the legislation as crowdfunding. However, colloquially the term is used rather interchangeably for funding via an internet portal whether it is in accordance with Title II or will follow Title III when it is in effect. So, a word of caution: make sure that you understand which crowdfunding type you may be discussing with someone as they may be using a different definition.
Most sources indicate that there are two basic types of crowdfunding; each with their own subtypes: 15,16,17
Some reported estimates of the current value of crowdfunding:
"The SEC estimates that at least 8.7 million U.S. households, or 7.4% of all U.S. households, qualified as accredited investors in 2010, based on the net worth standard in the definition of "accredited investor." 20
Wefunder.com reports "Only 3% or 256,000 of the 8 million accredited investors in the US are active angels, and those angels invest $21 billion each year." 26
The Angel Capital Association states, "The best available estimates are that over 300,000 people have made an angel investment in the last two years (including accredited and non-accredited investors) [N.B. There is no date associated with the report or the data it mentions.]. Many more people could become angels - based on a net worth of $1 million or more, the potential number of angel investors is 8 million." 21
Assuming that 3% of the eight million accredited investors invest $21 billion, would it be possible that the balance of these investors (the 97% on the sidelines) then be able to invest $700 billion? If current investment participation just doubles from 3% to 6%, then another $21 billion might be put into investments. Might greater acceptance and awareness of accredited crowdfunding facilitate this level of investing?
On April 5, 2012, President Obama signed the JOBS Act (Jumpstart Our Business Startups Act) into law to encourage funding of small businesses by reducing securities regulations and by helping them get access to capital in new ways. 24,25
"The Jumpstart our Business Startups Act ("JOBS Act") was a bipartisan effort to create jobs by making it easier for start-up companies to deal with securities laws when raising capital. The major provisions of the JOBS Act:
The following panels were developed by reproducing content from the Morrison/Foerster document. They provide key comments and further details on each element of the first three parts of the JOBS Act; Title IV-VI will not be covered in this communication.
Table of changes in disclosure requirements.
|Prior to JOBS Act||Under the JOBS Act|
|Financial Information in SEC Filings||
|Communications Before and During The Offering Process||Limited ability to "test-the-waters"||EGCs, either prior to or after filing a registration statement, may "test-the-waters" by engaging in oral or written communications with QIBs and institutional accredited investors to determine interest in an offering|
|Auditor Attestation on Internal Controls||
||Transition period for compliance of up to 5 years|
|Accounting Standards||Must comply with applicable new or revised financial accounting standards||
|Executive Compensation Disclosure||
|Say-on-Pay||Must hold non-binding advisory stockholder votes on executive compensation arrangements||Exempt from requirement to hold non-binding advisory stockholder votes on executive compensation arrangements for 1 to 3 years after no longer an EGC|
The proposed full text of the JOBS Act and its amendments may be accessed here.
The Official Bill Summary of the JOBS Act from The Library of Congress may be accessed here.
How soon for Title III?
"Title III would provide a means for nonaccredited investors to begin investing in these companies. It is in process but not likely to be implemented any time soon. The restrictions proposed by the SEC, including additional costs for compliance and heightened liability, would probably not appeal to the best startups that are better served raising capital from accredited investors."
|Title II [Rule 506(c)]||Title III (Crowdfunding)|
|Individual Investor Limits?||No||Yes|
|Aggregate Fund Raise Cap?||No||Yes: $1 million in one year|
|Advertising Allowed?||Yes. Companies can use any type of media they like.||No, once legal, issuers will not be able to "advertise the terms of the offering, except for notices which direct investors to the funding portal or broker."|
|Eligible Investors?||Only accredited investors||Both accredited and nonaccredited investors can participate.|
|Broker or Intermediary Required?||No||Yes|
Mark Roderick, an attorney at Flaster/Greenberg, has developed what he calls "A cheat sheet on crowdfunding". It is provided below and provides a succinct and practical overview of the area.
Mark Roderick's crowdfunding cheat sheet as of June '14.
|Title II - Rule 506(c)||Title III||Title IV - Regulation A+||Existing Regulation A||Rule 504|
|In Effect Today||Yes - since 09/23/2013||No - Regulations have been proposed but not yet finalized||No - Regulations have been proposed but not yet finalized||Yes||Yes|
|Maximum Dollars Raised||No maximum||$1 million per 12 months||$50 million per 12 months||$5 million per 12 months||$1 million per 12 months|
|Permitted Investors||Only Accredited||Anyone||Anyone||Anyone||Anyone|
|Per-Investor Limits||None||Yes - depends on income and net worth of investor||Yes - 10% of income or net worth, whichever is more||None||None|
|General Solicitation Permitted||Yes||Yes||Yes||Yes||Yes|
|Exempt from State Registration||Yes||Yes||Yes||No||No|
|Sold Through Portals||Yes||Yes||Not explicitly||No||No|
|Portals Required to Register||No, provided activities are limited||Yes||Only licensed broker/dealers||Not applicable||Not applicable|
|Portals Allowed to Pick and Choose||Yes||No||Not applicable||Not applicable||Not applicable|
|Pre-Sale Information Required||None||Substantial||Very substantial, akin to a mini-registration statement for a public company||Very substantial, akin to a mini- registration statement for a public company||None|
|Audited Financial Statements Required||No||Sometimes - depends on size of offering||Yes||No||No|
|Pre-Sale Approval Required||No||No||Yes - submission must be approved by SEC||Yes - submission must be approved by SEC||No for Federal purposes|
|Available to Foreign Issuers||Yes||No||Only Canada||Only Canada||Yes|
|Available for Sale of Owner Shares||No||No||Yes||Yes||No|
|Subject to "Bad Actor" Disqualification||Yes||Yes||Yes||Yes||No|
|Ongoing Reporting||None||Moderate||Substantial ongoing reporting, akin to a mini-public company, but waived depending on number of investors||None||None|
Mark Roderick is an attorney at Flaster/Greenberg PC concentrating his practice on the representation of entrepreneurs and their businesses. He maintains a Crowdfunding blog, which he believes contains news, updates, and links to important information pertaining to the JOBS Act and how Crowdfunding may affect your business. For more information from Mark, email him at email@example.com, or follow him on twitter@CrowdfundAttny, or visit his blog at www.crowdfundattny.com.
The JOBS Act states that only accredited investors are eligible to participate in Title II funding. The definition of an accredited investor from the U.S. Securities and Exchange Commission (SEC): 5
InvestGeorgia.org has estimated that there are between 3.3 and 8.5 million accredited households in the U.S. [FYI: Georgia and Kansas are two states that have launched their own equity crowdfunding rules]. 34
"Crowdfunding's Potential for the Developing World", a 2013 report published by the World Bank, focused on crowdfunding in the developing world. Given the rather immature nature of crowdfunding in most countries, what the report stated regarding crowdfunding has relevance in nearly all countries, not just the developing world: 13
The third point, related to laws and regulations, has naturally the greatest potential impact. In the US, Title II is legal and operable, while Title III is not yet approved and its revision and approval process continues.
For the start-ups and other life science companies needing funding, Title III crowdfunding can only provide up to $1 million per year. Though not insignificant, most companies in this space will quickly evolve to need much higher amounts to continue development (entering the Valley of Death phase). This is where the promise of Title II "Crowdfunding" shines brightest. Title II is solely related to general solicitation rules, but the mere act of removing those prohibitions allows using the internet to advertise solicitations, i.e., by definition, crowdfunding. This is where the accredited investors sitting on the sidelines (remember, it is estimated that only 3% of accredited investors are active) can now more easily participate in investing. Internet-based Title II funding portals will enable those 97% of accredited investors, who may not be well-connected and/or located in areas of high VC activity (Silicon Valley, etc...), to have access to review and participate in funding life science opportunities with ease.
Promising: Title II & Crowdfunding
Internet-based Title II funding portals will enable those 97% of accredited investors, who may not be well-connected and/or located in areas of high VC activity (Silicon Valley, etc...), to have access to review and participate in funding life science opportunities with ease.
For life sciences to continue to attract future investments, success will hinge on the value proposition of the investment opportunity. Though crowdfunding methods will make investing easier and more accessible, future life science opportunities must continue to offer more significant potential value than other category opportunities. After all, for most investors, the return on investment is the force driving their investing.
Additional reading and sources of information; provided in no particular order: