Monday, November 26, 2018

Biotech funding in Finland in 2018: a vicious circle

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.


·             Hemminki, Akseli, Crossing the Valley of Death with Advanced Therapy, Nomerta Publishing, 2015.

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


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.