One of the toughest questions facing bioentre-preneurs is where to get the financing to buildtheir businesses. For bioentrepreneurs, cash istheir companie’s lifeblood, and biotechnologycompanies require constant transfusions.What differentiates successful bioentrepre-neurs from unsuccessful ones, however, is notonly their appreciation of the value of cash,but also a clear sense of when to raise howmuch cash from whom. Understanding theseissues allows the bioentrepreneur to develop arational financing plan that reduces risk, min-imizes equity dilution, and increases theopportunity for success.

When to hit the fund-raising trailMost budding bioentrepreneurs are unsure ofwhen they should be asking for what. It hasbeen my experience that the easiest way toanswer this question is to recognize whichstage your company is presently in (see Table1). The launch of Hybritech—a diagnosticscompany based on monoclonal antibodytechnology that I co-founded in 1978—illus-trates this approach.

When we set out to launch the company,we only had an idea about how we coulddevelop a product. I benevolently call this the“early-technical” phase of the companybecause we had no proprietary technology,and really wanted the money to demonstrateproof of principle through basic feasibilitystudies. With hat in hand, we went out askingfor $178,000 and came back with $300,000 inseed-round financing.

Based on our success in proving the prin-ciple of the business, six months later we wereat the “second-stage-technical” phase. Weneeded money to resolve technical challenges.We collected $3.5 million in our first round offinancing so that we could lease lab space, hirescientists, and begin making the antibodiesthat we would use in our diagnostics. Themost convincing argument we made with theventure capital teams participating in thisround was that we would use this money tobuild a sustainable company. To accomplishthis, we needed to prove that we could makeour technology work in an industrial set-ting—outside of the academic lab. The mile-

stone that demonstrated this to our investorswas our creation of antibodies against thehepatitis B surface antigen during this phase.

With the creation of this potential prod-uct, the company began to come to life as abusiness. At that stage, we needed to refine

our business plan so that it clearly articulatedhow we could build a sustainable and prof-itable business based on our experience todate. A key element in this formulation wasthe fact that our efforts had enabled us to filefor our first proprietary patent. This patentprovided much of the credibility and confi-dence our investors required to more thandouble the previous round’s investment dur-ing our second round of financing. Thisenabled us to enter the “execution” phase ofHybritech’s development, by allowing us toenter the early phases of our product-devel-opment process.

How much to ask forAll business activities involve risk, but not allrisk is equal. Earlier stage financing partnersabsorb the greatest risk because they areimpacted not only by the risk associated withthe current stage of the company, but also byall subsequent stages of risk. For example, theinvestor who puts in seed money is likely tohave to wait until the company goes publicbefore seeing a return. In exchange for accept-ing this risk, earlier-stage financing partnersdeserve a greater opportunity for upsidereturn. What this means to the bioentrepre-neur is often equity dilution by exchanging apercentage of the company for cash. Theremay also be other forms of exchanged value,such as product distribution rights for cashthat may be bartered for later-stage risk.

Clearly it is in the interest of the bioentre-preneur to minimize this dilution. The chal-lenge is to assess how much time and invest-ment is required to transition from one riskstage to the next. While there is no textbookformula to calculate either the timing or theinvestment required, I have developed a ruleof thumb that the early-technical phase

NATURE BIOTECHNOLOGY VOL 17 SUPPLEMENT 1999 http://biotech.nature.com BE33

should take no more than six months andcost less than $600,000.

This high-risk seed money can often com-mand as much as 40–60% of the company.During the next year, a biotechnology com-pany will need between $1–5 million to devel-op its prototypes based on first-round financ-ing. These investors generally receive 40–60%of the company, while earlier equity positionsare diluted. From there, as the companyenters the execution stage, it is likely to needan additional $5–15 million over the courseof the next 18 months to do early productdevelopment. Investors will expect 20–30%of the company in exchange. As the product isrefined and prepared for market an addition-al 2–3 years are required, and here anywherefrom $20–50 million may be spent. Despitethe vast sums involved, these investors arecloser to seeing a return on the investment, sothey will be likely to ask for 25–35% of thecompany.

The dilution dilemmaThe natural tendency is to ask for as littlemoney as possible at the stages of the compa-ny at which investors can demand a relativelylarge equity position for a modest investment.While the entrepreneur clearly does not wantto “over-dilute” by raising too much cash tooearly in the company life cycle, I recommenderring slightly on the side of overestimatingcash needs. Industry and economic develop-ments beyond the company’s control can cre-ate unforeseen difficulty in raising futurerounds, while unexpected technical chal-lenges can drain cash reserves and lengthenthe time needed to reach the next stage.Entering a financing round in a position ofweakness is a clear opening for dilution. Inaddition, I have never heard of companygoing out of business because it had too muchcash in reserve.

Examples abound of companies eitherover-diluting or underestimating require-ments. It is important that less-experiencedbioentrepreneurs leverage the learning ofthose who have managed businesses at eachstage of the funding life cycle in order to avoidthe pitfalls of over-diluting or underestimat-ing requirements.

At Hybritech, we demonstrated ournaivete when raising the seed round and werefortunate to have selected experiencedinvestors who understood and corrected our

FINANCE

Rational financingIn an otherwise crazy market, a successful strategy can be based on knowing when, how much, and from whom to raise cash.

Howard C. Birndorf

Howard C. Birndorf is chairman and CEO ofNanogen, 10398 Pacific Center Court, SanDiego CA 92121 (hbirndorf@nanogen.com).

All business activitiesinvolve risk, but not all riskis equal.

© 1999 Nature America Inc. • http://biotech.nature.com©

199

9 N

atu

re A

mer

ica

Inc.

• h

ttp

://b

iote

ch.n

atu

re.c

om

BE34 NATURE BIOTECHNOLOGY VOL 17 SUPPLEMENT 1999 http://biotech.nature.com

FINANCE

miscalculations before any damage was done.My co-founder and I believed that we neededonly $178,000 to meet our initial commit-ments and survive until the first round. Theexperienced financing sources immediatelyrecognized the shortfall and provided$300,000 in seed capital as opposed to the$178,000 requested. As a result, we were ableto meet all of our commitments and success-fully raise our first round six months later.

Whom to askCash may be king, but whom you get yourmoney from can be equally important to thedollar amount. Bioentrepreneurs must thinkof financing rounds as an opportunity toalign their companies with value-addedinvestors. The earlier the stage of the compa-ny, the more critical the selection. I teamwith well-known, well-entrenched venturecapitalists in the early rounds, add institu-tional investors and strategic industry part-ners in the second-stage-technical-riskrounds, and go to the public markets in thefinal rounds. This strategy encourages differ-ent types of investors to participate in laterrounds. For example, venture capitalists willoften participate in both seed and mezzaninefinancing.

Selection of value-added investors isoften situation-dependent, but I have experi-enced certain constants by using this strate-gy. By working with a large, well-establishedventure firm during early financing stages, Ihave found that you not only get a well-funded source of investment capital but aninvaluable source of experience and contacts.The larger firms can provide insights into thesuccessful and not so successful businessstrategies taken by other technology-basedcompanies in their investment portfolio. It isnot only this network of information aboutwhat is working in the current market, butalso the network of contacts that they canbring to the table.

When we move on to later rounds offunding, I frequently use strategic partner-ships with industry participants as a methodto gain additional value from a financingevent. Since every company has limitedresources with which to accomplish their

long-term goals, a partner’s non-financialassets—whether technical, commercial oroperational—can be used to create opportu-nities that might otherwise be unobtainable.

For example, at Nanogen we recognizedthat an enormous opportunity for our plat-form technology was the infectious diseasediagnostic market. In order to successfullyserve this market, any company would needan in-depth knowledge of the customers’needs and buying patterns, as well as cost-effective access to the purchasing and deliv-ery channel. The cost of internally develop-ing these competencies would be prohibitive.

Nanogen’s response? Develop a joint ven-ture with the world’s leading infectious dis-ease diagnostics firm, Becton-Dickinson(Franklin Lakes, NJ) to co-develop and dis-tribute next-generation products to servethis market. By creating this business rela-tionship with Becton-Dickinson, we turneda potentially difficult business situation intoan opportunity to access market and productexpertise while securing cash funding in theform of both equity and cost-sharing. Inaddition, Nanogen was provided access to anovel technology that can be used both with-in and outside the scope of the joint ventureto extend our technology’s reach. This com-bination has generated even greater valuefrom this “financing event.”

Strategic considerationsRaising funds is hard work that distractssenior management from the primary mis-sion of running the company and conse-quently moving from one risk stage to thenext. This is where creative financing strate-gies can most often save precious time—andsometimes even save the company.

For example, at Gensia we used the“Byers Two-Step” financing strategy namedfor Brook Byers (Kleiner, Perkins, Caufield &Byers, Menlo Park, CA) to fund both the firstand second rounds. This financing “tango”depends on setting obtainable milestones forthe company during the first round offinancing. When the company successfullymeets a milestone, it automatically triggersadditional funding for the second roundfunding at prenegotiated prices. By using the

Two-Step, we were able to focus all of ourefforts on meeting our development mile-stones without the distraction of raising thenext round or the risk of over-diluting thestock.

Perhaps the greatest challenge for abioentrepreneur is to access capital duringdifficult financial times. It is in these situa-tions that one really appreciates the value ofyour investment partners. For example,when I was on the board of directors ofLigand Pharmaceutical (San Diego, CA), wewere approaching the phase of the businesswhere we would consider an initial publicoffering to move the company into finalproduct development. At the time, however,the IPO market was closed—almost no dealswere getting done. Not accessing significantfunds would have been disastrous for thefirm. It was here that Fred Frank (LehmanBrothers, New York) stepped up to the platewith a strategy that yanked the investmentwindow open for us. We guaranteedinvestors in this IPO a two-year, 20% annualinternal rate of return, the discount rate atwhich the present value of the future cashflows of an investment equals cost of theinvestment. It was a bold move on our part,but it allowed the company to raise $45 mil-lion of badly needed capital in an otherwiseclosed market.

ConclusionsRecognizing when to initiate funding willhelp an entrepreneur match risk categorieswith appropriate financing rounds.Determining how much funding to raiseduring any given round will help minimizeequity dilution while allowing the businessto fulfill its business plan. And finally, select-ing who to accept financing from can pro-vide significant benefit well beyond the sim-ple value of cash.

But perhaps the most important take-home message for bioentrepreneurs is to notlimit the company’s finances by what othercompanies have experienced. If you stayfocused on growing your business and asso-ciate with true value-added partners, it islikely that an answer will emerge to get youto the next stage. ///

Table 1. Matching risk level with appropriate financing and partners.

Risk type Characteristics Financing Timing / Investment Additional Partners % Ownership

Early technical Proof of principle Seed financing $300–600K Venture capital & 40–603 to 6 months burn entrepreneurs

Second-stage Prototypes, resolving First-round financing $1–5 million Institutional investors 40–60technical technical challenges 1-year burn

Execution Early product Early mezzanine $5–15 million Strategic partners 20–30development 1–1.5 years burn

Market Final product development Later-stage mezzanine $20–50 million Public markets 25–35and commercial launch and public offering 2 to 3 years burn

© 1999 Nature America Inc. • http://biotech.nature.com©

199

9 N

atu

re A

mer

ica

Inc.

• h

ttp

://b

iote

ch.n

atu

re.c

om