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Is Your Life Sciences Company Ready for Financing?

By David Lin and Jodi Hansell
[March 2003]

For venture capitalists, Life Science companies have become all the rage. In 2002, even amidst the continual economic downturn, investments in the Life Science industry grew significantly as a percentage of total venture capital investments. Last year, the Life Sciences sector was notably one of the few fund-raising bright spots. This bulletin examines the strength of the Life Science industry relative to the current climate of venture capital investing and provides an overview of basic issues for a Life Science company to consider before seeking venture financing.

What is the current state of venture capital investing?

Overall, venture capital financing in 2002 remained weak, following its steady decline since reaching record-setting levels in 2000, as shown in the chart below produced by Venture Economics.

Source: Venture Economics

Despite low overall commitment levels from venture capitalists in 2002, investments in Life Science companies as a percentage of overall venture capital investments remained resilient and grew steadily. According to the PricewaterhouseCoopers Money Tree Survey, last year, the Life Science sector (Biotechnology and Medical Devices combined) captured $4.7 billion and claimed 22 percent of all venture capital invested, the highest proportion of total venture capital in seven years. The attraction toward Life Science Companies continues to grow, despite the fact that the markets have not rebounded from recent events.

The 2002 breakdown of investments per industry sector is as follows:

Life Sciences investments, broken down by industry

What can I do to get my Life Science company ready for VC financing?

To get the attention of investors, it is extremely important that you put your best foot forward. You will almost always only get one shot with a venture capitalist, and seldom are there second chances to make a good first impression. Venture capitalists expect entrepreneurs to have the basics covered before they meet with VC's. Although by no means complete, the following list provides a few ideas to start thinking about when forming your company and preparing to look for financing.

1. Hire legal counsel and an accountant with industry knowledge.

You need to retain the services of a lawyer and an accountant knowledgeable about new technology businesses and, specifically, the Life Sciences industry. Numerous key decisions unique to Life Science companies must be made both before and shortly after a Life Science company is formed. Investors expect new companies to retain competent, experienced counsel with industry knowledge. Trying to cut costs by avoiding getting sound, immediate professional advice does not pay off long-term.

2. Give careful consideration to your choice of entity.

It is imperative that your choice of business entity suits your company's business needs. The choice of Subchapter S corporations, Subchapter C corporations, limited liability companies and partnerships all have different consequences for your business.

Eye-opening example:

A company was formed as a limited liability company and received millions of dollars in investments. Just before its initial public offering, the company discovered that as a limited liability company, it could not go public and that it needed to convert to a corporation. The conversion alone cost over $25,000 and took several weeks. The conversion process also revealed that earlier decisions made by the company, not anticipating its conversion into a corporation, caused it to incur huge tax liabilities. Over the course of several months, the company's problems were resolved. By that time, however, the markets had changed, rendering its initial public offering unsuccessful.

3. Protect your intellectual property immediately (ALL of it - not just patents).

In the Life Science industry, it is essential to get an early start in securing IP rights to protect innovations and to limit effective competition. In addition to filing patent applications, it is critical that all persons who come into contact with your copyrights, trademarks and trade secrets sign appropriate agreements. These can be in the form of non-disclosure, confidentiality and proprietary rights agreements.

Eye-opening example:

A software company hired independent contractors to add art and graphics to its software product and to assist with writing the business plan. Before the product hit the market, the independent contractors claimed they had rights to the technology and should be allocated part of the profits. Since the Company did not have the time or capital to dispute the claims, and there was no agreement in place to protect the Company, the management decided to allocate some of the profits to the independent contractors rather than entering into litigation or a lengthy dispute. Essentially, they gave away their own profits because they did not take the right steps to protect themselves in the first place.

4. Choose strong management.

Industry analysts have noted that venture capitalists invest in management teams, not just technology. In fact, for many VCs, management is the number one issue when considering an investment. If you are not able to afford full-time management, you should consider assembling a high level board of advisors that believe in your business, are willing to support and promote your business and who are willing to accept equity in lieu of cash.

5. Write an Intelligent Business Plan.

Venture capitalists expect to see that entrepreneurs have thoroughly thought out the details of their business plan. One section often overlooked is the section on competition. Although no one may have a product identical to yours, it is critical that you define your space as closely and accurately as possible. You should describe the related markets generally and name several specific companies. You should distinguish yourself from your competition in an intelligent manner, but you must show investors that you know what you are up against.

A more detailed description of the elements of a business plan can be founded in the publication Cracking the New E-conomy, published by the Washington Software Alliance in cooperation with Davis Wright Tremaine and other partners. A copy of the book may be purchased from DWT's online Bookstore.

6. Develop a Product Prototype.

It is important that you have a demonstrable product before you go in front investors. Nothing captures the hearts and minds of investors better than seeing how a product will be built and how it will work upon completion. Help them picture what they are buying and help them picture the end product. In addition, a well thought out sales and marketing plan is essential which gives a clear understanding of initial market focus and potential diversity of technology applications.

For further guidance or to seek specific information, please contact DWT's Life Science attorneys. With offices from coast to coast, DWT Life Science attorneys combine their experience in diverse practice areas with industry knowledge to help you reach your business goals.

FOR FURTHER INFORMATION, PLEASE CONTACT THE AUTHORS:

Jodi Hansell, 212-603-6416, jodihansell@dwt.com
David Lin, 206-903-3963, davidlin@dwt.com

This Life Sciences Advisory Bulletin is a publication of the Life Sciences Group of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory Bulletin is to inform our clients and friends of developments in life sciences law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

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