Biotech funding in Finland in 2018: a vicious circle
Seed funding for biotechnology start-ups can usually
be found in Finland. In contrast, there is a critical funding gap for companies
doing clinical trials. This results in an absence of a biotech community and a
consequent lack of biotech venture capital.
Drug development is expensive. Recent
estimates have indicated that the median cost of a drug approval is between 1.5-5
billion € and this price has been increasing constantly. One relevant aspect of
this phenomenon which causes pressure on health care system globally, is that
the cost of approved drugs also incorporates those drug development projects
which fail. Although expedited mechanisms are being developed, formal approval
usually requires a successful phase 3 trial, or several, which needs to be
preceded by phase 2 trials, which in turn are preceded by phase 1 trials and
preclinical work. At each stage there are costs and attrition.
Thus, the more expensive each trial is, the
higher the cost of each approved drug. Unfortunately, regulation has increased
continuously over several decades, resulting in what Venture Capitalist (VC)
legend Peter Thiel called Eroom’s law. Eroom is a deliberate backwards spelling
of Moore to underline the opposite trend that has been seen in drug development
in comparison to non-bio forms of technology. Pharmaceutical companies take
this into account which results is a continuing increase in the cost of
approved drugs.
History of the biotech
One notable development over the past 2-3 decades
has been the consolidation of pharmaceutical companies into huge global
conglomerates. Mid-sized companies have almost disappeared and markets are
controlled by a dozen or so “Big Pharmas”. Although initially the rationale for
the mergers and acquisitions was probably to streamline marketing,
administration, supply, distribution and research, in fact only the first four have
been successful. The ability of Pharma giants to innovate has been surprisingly
low. The reasons are partly unclear, but it could be that large organizations
have so much internal bureaucracy, administration reshuffling and politics,
that disruptive innovation is difficult or goes unnoticed.
As drug development has long been too expensive
for academics, there was a window of opportunity for a new type of company, the
biotechnology company. The classic example is Genentech, founded in 1976, which
was one of the first and certainly one of the most successful biotechs. In the
context of oncology drugs, the chemotherapy generation of drug development,
which ended around 1995, was still controlled by R&D laboratories of
pharmaceutical companies. In contrast, biotechs already contributed in a major
way to the targeted therapy generation, which began in the 1990s. Most
recently, the biggest leaps forward are being made in immunotherapy, and most
of the innovation is done in biotechs.
The role of biotechs is to take discoveries
from the laboratory, often located at a University, to phase 1-2 clinical
trials. These trials aim to establish the safety and preliminary efficacy of a
drug. If the results from such trials are promising, the company can be sold,
or product licensed to a Big Pharma, whose expertise is completing the critical
phase 3 trials and obtaining regulatory approval. Big Pharma has a virtual
chokehold on regulatory approvals for “big diseases” such as common types of
cancer, but their real expertise is marketing. It is not enough to have a
successful clinical trial. To generate sales, marketing to oncologists (and
patients to some degree) plays a key role.
Biotech: a risky business
The journey from a theoretical scientific
idea and very early-stage start-up to a credible company developing treatments
for human clinical use is a long, multiphase process. This is true not only for
company operations but funding as well. A company seeking financing needs to
have a thorough understanding of the market it plays in; who its potential
customers are and how cash flow will be generated. In the words of AG Lafley:
“Where to play and how to win” is the essence of any corporate strategy. There
must be a solid business case with a clear plan of using the invested money for
growth over a period of time.
It is often proposed that 75-90% of
start-ups fail and that usually this happens in the first 3-5 years. Definite
statistics are not available, but these numbers ring true to people involved in
the start-up world. However, looking at the few studies that have been done on
start-up failure, it is interesting that failures seldom occur because of scientific
or technological reasons, which constitute only 17% according to a recent
Forbes study. It is more common that companies implode for lack of market need
(42%), internal reasons (23%), or competition (19%). Of note, the second most
common reason for failure is running out of cash (29% of failures) while
inability to find investors/finance is listed as a separate entry (8%). Taken
together, funding issues thus constitute 37% of start-up failures.
Exit is the goal
When the company grows from a small
startup, each funding round will generally dilute ownership by at least 20-30%.
For example, if the founder or founding team has 100% initially, they will have
70% after the first round, then 49%, then 35% and so on. At “exit”, the founders’
share is typically 10-30% or even less. Professional investors are good at
negotiating terms, and in the end, for example with an approaching exit,
ownership structure and contracts tend to get very complex. As opposed to most
other fields of tech, biotech companies typically never generate revenue. The
business operates on investments and loans until sold or listed in a stock
exchange. At least in theory. The mentioned outcomes are the most desirable
successful exits but they are realized in less than a third of companies. In the
remainder, some other form of liquidation occurs. Sometimes, revenues can
result from licensing or partnerships with eg pharmaceutical companies.
Biotech funding sources
There are quite a few funding sources, both
public and private, available for early stage biotechnology start-ups, but the
critical funding gap seems to be when trying to initiate their first clinical
trial. This has been called the Biotech Valley of Death. Timing of funding
rounds with respect to clinical trial milestones is critical to avoid running
out of funds before or just after completion of a key milestone.
Generally speaking, Finnish biotechs seem
to suffer from chronic lack of funding that limits their growth. Pre-clinical
mouse data can be generated on an academic basis but getting funding for the
first clinical trials with humans, which typically costs between 5-10 million €,
can be quite difficult. Unfortunately, there appears to be no academic source and
very few investors of this type in Finland. Next, I’ll discuss the funding
sources available to biotechs.
The start: Friends, fools and family
These are useful sources for initial
“pre-seed” funding. However, it is difficult to raise more than 100 000€,
including the founder’s own cash, which is an important demonstration of
commitment.
Angels from heaven
Business angels can be valuable due to
their networks and prior experience as entrepreneurs. However, they are also
often quite savvy investors unlikely to put their eggs in too few baskets.
Thus, raising more than a few hundred thousand can be challenging.
Non-dilutive Grants
Grants, such as from the EU Horizon 2020
program can offer useful non-dilutive funding. However, even the largest grants
of a few million form only a small proportion of funding needed. Grants usually
require partial funding from private sources. Also, funding rates are typically
single-digit so a business cannot be based on grants. Business Finland has a
wonderful grant program for early stage companies.
Crowdfunding: a viable intermediate option
Crowdfunding can be used to raise funding
mainly from retail investors in the 200 000 – 2.5 million € range. Conventionally
crowdfunding has been viewed as potentially problematic from the point of view
of VC investors. If the ownership base becomes wide, governance issues may
emerge, which can be problematic in negotiating typical VC investment terms.
However, the type of shares granted influences the impact of a large number of
investors – silent shares without voting rights rarely disrupt company
operations.
Debt: Business Finland is the key
The European Investment Bank is one not so
well-known source for funding, which has been successfully utilized by some
Finnish companies. However, EIB funding requires typically that the company has
already their own sales or have raised a significant amount of capital. There
are also European venture debt mechanisms available to a select few companies.
Generally, debt funding is difficult to get
for early stage biotech companies because the company won’t make any operative
profits for many years. Conventional debt requires collateral, which is
typically absent in biotech companies who don’t sell anything. Of note,
government backed Business Finland loan mechanisms are of key importance for
Finnish start-ups. One might claim that without them there would be no biotech
in Finland. However, they rarely cover the full amount of money needed by
companies; their loans are typically for 50-75% of total project costs. Also,
in the context of biotech it is of relevance that they currently only fund the
first clinical trial.
VCs will control the company
Globally, VCs are one of the most effective
mechanisms for growing biotech companies. A “series A” round, sufficient to
gain initial clinical data and prepare the company for growth, can be between
10-50 million €, although in the US we are currently seeing 100+ million USD
rounds. The lack of a Finnish life science dedicated VC funds creates a problem
for domestic lead investments and increases the need for early contacts to
foreign specialized VC funds. With a good business idea and solid founding
team, early stage financing up to 1 million € can frequently be raised in
Finland, with the mechanisms described above. For subsequent financing rounds,
investors often need to be found outside of Finland. There is a great deal of knowhow
related to health technology in Finland, but a lack of investors who could
invest several million euros into such companies. There are only a few biotech
success stories in Finland which results in a vicious circle. A lack of a
biotech community results in the absence of biotech VCs, which results in
difficulty in growing biotech companies.
VC funds (I’m using “Series A” type VCs as
an example; funds aiming at the very early stage may have different policies) typically
have a defined timeframe to exit and prefer tight governance control. When
their exit-window is closing, they can force an exit, regard less of how other
owners feel about this. VCs investing will certainly require preferred shares with
voting rights, and with liquidation preferences, drag along rights, and the
multitude of other tools that VCs use to exert control over the company, even
in situations where they are minority owners. Giving away control of a company
to a VC might still be useful, if they can inject the capital needed to make
the company ready for Big Pharma acquisition or maybe an initial public
offering (IPO). One thing to keep in mind is that VCs always need an exit.
Points to consider beyond valuation and
size of investment include governance control, VC connections to other
high-class VC and Pharma, and the personnel the VC would like to place on the
Board. How much added value would they bring? What would be the cultural match
between the VC and the company? Would the marriage work? If not, it may be
better to seek other alternatives, as the VC will typically have almost
complete control over the company until exit or other liquidation. Interestingly,
only 3% of start-ups obtain VC funding, but in successful start-ups, defined by
an exit for example, the rate is more than 10%, but still notably low. This
suggests that not all entrepreneurs like to give away control of their
business.
Geography also matters as US VCs usually
invest in US companies and European VCs in European. Although science and
finance are global, networks are local, and the latter tend to be more
important in the VC world. From a practical point of view, it is much easier if
a VC partner is nearby, because they will likely also be on the Board, and
there are usually also other regular communications between the management and
the main owners. Late night teleconferences or flying to the US for Board
meetings can become exhausting and counterproductive to work-life balance. If
the start-up biotech survives its initial 5-7 years, and is successful in
raising a “Series A”, soon it is time for a “Series B”, often in the 40-100m€
range. The main sources are VCs and private equity. An exit can be an
alternative to a “Series B”.
IPOs are too small for drug development
biotechs?
An initial public offering (IPO) is a risky
funding method for life science companies in Finland, but can also create a
positive pressure for investors to close their investments in a publicly
defined time schedule. However, looking at the size of IPOs at First North
Helsinki, which average 12 m€, this approach may not be optimal for biotechs,
which need to raise much more before any sales. The ability of publicly listed
companies to raise further funds depends on difficult-to-control factors such
as share price and the macroeconomic situation. Drug sales require regulatory
approval, which typically requires phase 3 trials typically costing hundreds of
millions or euros.
Hidden diamonds
In summary, while there are many sources
for pre-seed and seed funding in Finland, growing a drug development company
from pre-clinical to clinical stage is difficult due to lack of local sources. European
VCs are perhaps the most likely source of funding for the rapid growth phase,
but companies need to be prepared to release control of their future to the VC.
As a personal opinion, there might be market opportunity for a Finnish biotech
specialized VC fund. Valuations of Finnish biotechs tend to be much lower than
comparable companies residing at biotech hubs, so there could be hidden
diamonds awaiting investment.
This
text constitutes an edited summary of a Business Strategy Project (BSP) final
report: “Optimal funding strategy and structure for a Finnish biotech start-up:
TILT Biotherapeutics Ltd. as an example”, Aalto University Executive Education,
Aalto Executive MBA 2017-2018. Authors in alphabetical order: Hemminki A,
Karvinen M, Sipilä T, Smagin J, Stumpf E. The editing was done by me (Akseli
Hemminki), so all the mistakes and inaccuracies are mine as well.
References
·
Hemminki,
Akseli, Crossing the Valley of Death with Advanced Therapy, Nomerta Publishing,
2015.
·
http://fortune.com/2016/05/13/big-pharma-biotech-startups
·
https://www.cnbc.com/2014/09/08/is-there-a-cure-for-pharmas-innovation-problem.html
·
https://www.investeurope.eu/media/711867/invest-europe-2017-european
Interviews
performed by the BSP team
·
Ahopelto
Timo, Founding Partner at Lifeline Ventures
·
Hämäläinen
Eija-Riitta, Senior Advisor at Business Finland
·
Janhonen
Juuso, Specialist Finnish Innovation Fund Sitra
·
Karikoski
Mika, Equity Capital Markets Finland at Carnegie Investment Bank
·
Karsikas
Joni, Investment Manager at Tesi (Finnish Industry Investment)
·
Kettunen
Joel, Senior Client Manager at Invesdor Ltd
·
Koponen
Petteri, Founding Partner at Lifeline Ventures
·
Lahti
Toni, Investment Director at Springvest Oy
·
Marttila
Pauli, Senior Lead, Finnish Innovation Fund Sitra
Acknowledgements
I would like to warmly thank my eMBA BSP group members
for enjoyable and effective teamwork, and all of the interviewees for donating
their time and expertise. Thanks
also to all commentators and professor Markku Maula (Aalto University) for
advice during BSP.
