In the Unites States, universities and research institutions are the bedrock of healthcare innovation. Federal agencies have enabled this by pouring in billions of dollars annually to fund academic research leading to the discoveries that have resulted in new therapies that save lives. Leading this funding has been the National Institutes of Health along with other agencies depending on the therapeutic area including, the Defense Advanced Research Projects Agency (DARPA), Biomedical Advanced Research and Development Authority (BARDA), and the Advanced Research Projects Agency for Health (ARPA-H). Commercializing discoveries into a drug can span 15 years with high development costs, significant risk and unpredictability, high regulatory hurdles, market competition, and complex reimbursement systems. Raising the necessary capital for a product to reach fruition—which, when accounting for failures, can reach $1 billion or more—is a major impediment to transitioning a scientific discovery from academic labs into a commercial drug product.
Funding for drug development can be divided into the world of the haves and the have nots. Big pharmaceutical companies (Big Pharma) have anemic product pipelines and commercial products facing patent cliffs but a large amount of cash, while early-stage biotech companies, which are fueling innovation, are often cash-constrained. This difference is exacerbated when the economic and market environment are not favorable to raising funds for nascent biotech companies.
There are some factors beyond the control of a biotech company when confronted with capital raising. In today’s environment, major sources of funding that might have considered the biotech sector are attracted to investing in artificial intelligence (AI) and cryptocurrency companies, which are receiving frothy valuations from investors clamoring to get into these investments for fear of missing out. In addition, “generalist investors,” who are those that do not specialize in biopharma investing and who at times are major funders in the biotech space, have basically exited the biotech market. Even venture capitalists (VCs) are holding back on new investments, preserving their capital for existing investments in light of the current economic environment.
Exacerbating the funding environment further is that Big Pharma has determined that investing in early-stage biotech programs has not panned out, and these companies are more focused on acquiring drugs at the near commercialization stage. The failure of a drug trial of a certain class can have a ripple effect on other drugs in development in the same class. Additionally, governmental policies seeking to impose price constraints on pharmaceuticals can have a depressing effect on capital raising. And there are times when public markets for initial public offerings (IPOs) are non-existent, and Big Pharma is no longer enamored with a certain therapeutic area, making a licensing transaction or the sale of the company difficult. But even in the best of times there are major factors that have the potential to make it difficult for biotech companies to raise capital to fund their therapeutic pipeline.
Drug Development Funding Stages
In general, biotech companies receive funding from multiple sources depending on their stage of development. These can take many forms such as venture lending, royalty-based financing, clinical research organization (CRO) financing, and structured drug development financing. However, for a biotech company in its early stage, typical seed funding comes from the inventor, “friends and family,” and angel investors (high-net worth individuals). These investments tend to aggregate under $5 million. Government and philanthropic grants can also provide funds, which do not dilute the investments made by these early investors. Entities known as “incubators” are another source of early financial support that also provide lab infrastructure and experienced executives.
The next stage of funding is usually provided by institutional venture capital firms in the range of $20-30 million (so called “Series A” rounds), leading to early-stage clinical trials. More recently these investments have tended to be larger, reflecting the concern of the investors that the next round of financing would be more dilutive to current investors in light of the difficult financing environment for the biotech sector since 2021. As a company’s clinical trials continue to progress, the next “Series” rounds tend to be larger, reflecting the increase in costs for later-stage clinical trials. Success in these trials generally leads a company to consider raising capital in an IPO, a sale of the company (an “M&A transaction), or a licensing transaction with Big Pharma.
Preparing to Raise Capital
To transition a scientific discovery into a commercial product requires attracting the sources of capital mentioned above. This journey necessitates the preparation of materials that distill complex scientific information into a language that will resonate with investors. This is done by preparing a presentation, which is referred to as a “pitch deck,” that will communicate the value of the proposed program to potential investors. In any given year, over 25,000 new inventions come out of universities and research institutions, many of which seek to attract financing. Thus, potential investors are bombarded with pitch decks and any of a myriad of factors can account for an investment being rejected.
Factors That Can Result in Project Funding Rejection
Approaching the Wrong Investors
Often an inexperienced founder fails to explore whether the investment being sought is of the kind and size that the potential investor typically makes. Therefore, it behooves the company to review databases that give an indication of the prior investments that the investor has made before. A select group of larger funds invest in companies from early stage through to IPO. However, most investors only invest in certain stages of development and rounds. For example, there are investors dedicated to only seed-stage investments or only Series A or B rounds.
Lack of a Clear Value Proposition
It is important to establish that the proposed drug to be financed has a high likelihood of commercial success based on its science and that it is either first in its class or best in its class (a significant improvement over the existing therapeutics). It is very challenging to obtain financing for a drug that is marginally better than the competing drug. In addition, the market size needs to justify the investment sought, or it will likely fall flat with investors. This involves addressing the competitive and the payor and insurance reimbursement landscapes.
Scientific Impediments
While there are therapeutics on the market where it is not known how the drug works, investors are not likely to be willing to take on the additional investment risk unless a drug’s mechanism of action is understood. Researchers need to validate early stage biology to achieve a path towards a proof of concept. At times there are certain therapeutic areas or indications where there has been a saturation of funding or where programs that have failed in the past or were overly difficult to reach fruition. These may turn investors off from even considering an investment. Also, if it will be difficult to identify and recruit patients—for example, for a rare or ultrarare disease, or there are too many programs competing for the same patients in clinical trials—investors will shy away from such an investment. While founders may find the science promising, they often fail to consider that the risks to commercialization of the potential drug are not commensurate with the anticipated return on the required financial investment.
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Approaching Investors Too Early
Timing can present a reason for investors to reject a program. For example, if a clinical trial readout that will establish potential efficacy is forthcoming, investors will defer funding the company until the results are available. Also, some investors are not known to “lead” an investment round, so approaching them without having attracted a lead investor will be an exercise in futility. However, it is useful to establish relationships with the right set of investors early on. This is especially true for first time chief executive officers and management teams. If there is an opportunity for an introductory meeting, the company can go back to the investor at the time of financing and show that they have done what they have said they were going to do.
Lack of Compelling Intellectual Property (IP)
For a company seeking to commercialize a drug, IP is likely to be its most important asset. A failure to have a clear IP strategy that is well protected with the requisite freedom to operate and that will not infringe on the IP of others, is likely to be a non-starter for investors.
Lack of a Clear Regulatory Pathway
The regulatory pathway needs to be known and achievable. If the path to regulatory approval is not clearly identified or realistic and the company does not have a clear plan for the type of preclinical and clinical trials that will be required, investors will not be willing to put in the time to consider the investment opportunity.
Use of Proceeds Not Commensurate with a Value Inflection Point
The presentation needs to be clear as to how the funds being sought will be deployed and result in the drug program reaching some milestone, such as the filing of an Investigational New Drug (IND) Application. This will result in the company being able to raise the next “Series” of financing at a higher valuation and not be dilutive to the existing investors.
Lack of a Clear Exit Strategy
The proposed milestones, fundraising, and timelines to achieve them need to be realistic and align with the strategy for exiting the business, whether through an IPO, an M&A transaction, or a licensing transaction to Big Pharma. In the end, the investors need to be able to discern how they will obtain a return on their investment and when.
An Inexperienced Team
While an early-stage biotech company is not likely to have a complete management team with the requisite expertise needed to develop a drug, it can ameliorate the situation to some extent by having advisors to fill some of the gaps. However, investors will take the qualifications of the team into account in deciding on an investment.
Lack of Appreciation of the Size of the Investment Needed for a Successful Product
There is a difference in producing enough product for a clinical trial and producing commercial-scale drugs. The capital required may represent such a substantial investment as may make the development of the drug uneconomical.
Risk Aversion
Investors approach an investment opportunity with a degree of skepticism, exhibiting risk aversion. They look for flaws in the investment being presented with a disposition to avoid funding it. This is a high hurdle to overcome, especially given that investors are bombarded with a huge volume of pitch decks and tend to make only a limited number of investments.
Lacking an Institutional VC Investor
Not having an existing institutional VC investor may make it more difficult to attract future investors. A highly regarded VC firm adds an amount of validation for the program for which additional funding is being sought. Some of this can be overcome if there is another investor who can be perceived as being “smart money” like a CRO or a potential manufacturer of the drug (CMO).
Insufficient Supporting Documentation
If an investor expresses some interest in considering an investment, they will start to do some preliminary diligence (documentation such as correspondence with the Food and Drug Administration (FDA), material contracts). If there is an inconsistency between the documentation with what has been presented, the company will lose credibility that will likely end the investment discussion.
A Poor Pitch Deck or Presentation
A critical step in obtaining financing for drug development is preparing a compelling pitch deck that distills complex scientific information into a presentation that will resonate with potential investors. While a well-prepared pitch deck does not translate into getting an investment, a poor one can be detrimental to having the financing even being considered. Likewise, a poor presentation to an investor can be the death knell to obtaining funding.
Final Fundraising Advice
As noted above, even in the best of times, some impediments to raising capital for a biotech company are out of its control. However, companies seeking funding for drug development can avoid a self-inflected wound by taking note of the many ways in which raising capital can go awry and consider ways to ameliorate the situation. This may entail hiring an executive with the requisite experience in raising capital. Such a person is more likely to recognize the pitfalls and steer clear of them. Alternatively, it might behoove a company to consider retaining an advisory firm to assist in the capital raise and thus mitigate the issues that will render fundraising dead on arrival.
