Finding fixes for the early-stage funding gap

There’s one thing everyone is agreed on: it’s hard to get early-stage funding from venture companies. What is less clear is how to fix the problem. So when Imperial Innovations brought together 18 angel investors and venture capitalists investing in healthcare companies, at the Royal Society in London in December, there was plenty to talk about.

It was the first in a planned series of roundtables of investors held by Imperial Innovations, and in itself somewhat unusual: it is not often that a mixed group of investors get together to discuss their mutual problems. Equally, as its CEO, Susan Searle, explained, Imperial Innovations is an unusual university commercialisation and venture company – it creates, builds and invests in spin-outs. “We are a very early-stage venture builder with the capital to follow through in subsequent rounds,” she said.

More than meets the eye?

How bad is the problem of early-stage funding? “There may be more going on than in it appears,” said Andy Richards, a serial biotech entrepreneur and angel investor based in Cambridge. Just because we are not seeing, as in the past, several rounds of open fundraising, with at the end of it companies going public, doesn’t mean nothing is happening, he said. Many companies have no intention of going public.

“I think there are many more funders and sources of funders than everyone realises,” said Richards. “But what has changed is that the funders don’t act in the same ecosystems any more.” And with investors becoming more and more specialised, that leads to problems of alignment of interests when investors from different niches come together to fund a company.

But this fragmentation is welcomed by others. “I actually think it’s a good thing,” said Louis Nisbet from Kurma Biofund. “There are horses for courses – as investors you have to decide what you want to do and who your end customer is. For us this is pharma and biopharma companies that want to acquire products and technologies in asset sales; they don’t want to acquire infrastructure.”

Where are the big funds?

From the perspective of Imperial Innovations, the environment is “pretty good”, said Searle, with “lots of entrepreneurs buzzing around”. All the same, she said, it is really difficult to get venture firms to invest in early-stage companies. Imperial Innovations, she said, works across the spectrum of investors with angels, venture capital funds and seed funds like the Royal Society Enterprise Fund – described by its CEO, Andrew Mackintosh, as “a wealthy and well connected business angel, not a big fund”.

“It’s not clear to me why venture funds don’t invest at the beginning,” said Mackintosh, “because the continuity is very important.” The answer, according to Kate Bingham from SV Life Sciences: it depends on the business – if it takes ten years before the company can be sold, venture firms will stay away. “Our average holding period is about five or six years,” she said.

For Richards, one of the key issues is how to put together syndicates of investors who will take a company right through from the early stage through to an eventual sale. “Our approach is to build the syndicate from the start, not go to market, and have pockets round the table that can fund through to exit,” said Bingham. And that, she said, means being very careful about your partners.

Imperial Innovations is one of those so-called “evergreen” funds that put money into a company at inception and then inject capital at subsequent stages. “We have shareholdings in public companies and can remain in them,” said Searle. Being evergreen is an asset, said Andrew Lane from Unilever Ventures, allowing you to follow businesses through from the seed stage.

Aligning the corporates

As Richards pointed out, almost all the corporate venture funds are evergreens. “There used to be an enormous degree of scepticism about the alignment of a pure finance investor and a corporate,” he said. “That seems to have gone.” Deborah Harland from GSK’s venturing arm, SR One, stressed that her venture company does not take instructions from the parent company. “We don’t get told, we think about it,” she said. “We work very like a traditional VC.”

But the scepticism has not gone completely. For Stephen Parker from private equity firm Celtic Pharma, there is a problem if you are seen to be in pharma’s “back pocket”, because other investors may assume that the pharma company behind the corporate venture fund may have some kind of option to acquire the company. “You have to make it absolutely explicit that the corporate fund has no rights whatsoever beyond all enjoyed by all investors in the fund.”

Longbow Capital’s Edward Beckett said that while mainstream institutional venture funds look to use their financial strength to acquire preferred terms of investment compared with earlier investors, the corporate venturing funds look more to developing the business with a stronger sense of alignment to share in the value upside, with earlier-stage investors. Longbow works with business angels, corporate venturing funds and mainstream VCs as co-investors but recognises it can be challenging when larger VCs are reluctant to align themselves and seek to impose penal measures, which risks them being seen as the “funder of last resort”.  “With better alignment among different investor groups the equity gap could be bridged if not closed,” said Beckett.

Mind the gap

But there can be big problems if it turns out that the syndicate cannot find the money required, said Dean Slagel from Esperante. If you find you have a gap of £1 million or £2 million that you cannot close, he said, it can introduce a delay of six months while a new investor goes through due diligence – or longer, if the deal falls through.

Esperante is an evergreen fund, but Slagel was flexible about what to do when problems arise, such as insufficient new data to support an increased valuation and limited availability of further funding from existing investors. “If something falls over in the clinic and you think it’s worth continuing, then if you have a larger investor coming in you take the dilution [of shareholding] and you accept it.”  Esperante, he said, has co-invested with angels and big VCs, and “it’s not a problem either way”.

For some, the solution to having to find new investors is to build your own investment community. “We decided to build our own ecosystem rather than fight about who gets transitioned to what,” said Jim Torina from the US venture capitalist firm The University Funds. His company now has 15 major corporations signed on to taking up innovations from its 20 partner institutions, he said.