Webinar Recap: Creative Financing & Investor Sentiment for Biotechs


WATCH WEBINAR REPLAY

The Biotech team at Gilmartin recently hosted a webinar with BTIG on Creative Financing and Investor Sentiment for Biotechs. The webinar featured a Q&A session that was joined by BTIG’s K.C. Stone (Managing Director, Head of Healthcare Investment Banking), Mikhail Keyserman (Managing Director, Healthcare Investment Banking) and Michael Karmiol (Managing Director & Head of Healthcare Equity Capital Markets). The webinar was moderated by Laurence Watts (Managing Director) and Stephen Jasper (Managing Director) of Gilmartin Group.

Here are our key takeaways from the Q&A discussion: 

1. Biotech Valuations, Rebuilding Balance Sheets and Bankruptcies
2022 has been a challenging year, particularly in the macro landscape. With around 200 companies trading at negative enterprise value, the capital markets have cooled off.

Costs of both clinical and pre-clinical studies have dramatically increased, resulting in a lot of companies exiting their clinical programs. As companies enter 2023, they need to streamline their focus on costs and rebuilding balance sheets while still being cautious of macro challenges. Bankruptcy continues to remain as the last option for biotechs even in the challenging market conditions. The ability to reduce burn without significant fixed expenses, quality programs, and valuable IP continues to play a vital role in avoiding bankruptcy in the biotech market.

2. Biotech Stock Price Recovery
Currently, investors continue to take a critical approach and emphasize selecting solid, de-risked stories with good management teams and science resulting in large caps and revenue generating companies to lead in 2023. As investors seek additional opportunities, the smaller caps will benefit, but the smaller micro-cap companies can expect to lag in the beginning of 2023.

3. Reopening of Capital Markets in 2023
Capital markets and M&A activity in the first quarter of 2022 was down 90% y/y, however the optimistic side of the story is that after the first quarter, equity capital markets in the healthcare sector have been up 50% each subsequent quarter. Building on the momentum, we can expect to enter a healthier M&A and capital markets in 2023 with maybe the small micro-cap companies lagging by a quarter.

4. Uptick in ATM Usage vs. Traditional Follow-Ons
The smaller cap companies can expect to start with ATMs as they have lacked the ability to finance using traditional methods. It is expected that biotechs with 3 key pillars (positive data, existing insider support, market cap) will continue to use more traditional financing and follow-ons. While ATM use is a great tool and good housekeeping for most biotechs, we will see a shift towards traditional financing and follow-ons as the capital markets start to improve, especially for the smaller-cap companies. Regardless of the type of financing, it is critical that biotechs get in front of the right institutional investors and build a syndicate.

5. Current Financing Options for Biotech
Traditional financing options remain available for biotechs with data and market cap. In the absence of traditional financing options, alternative financing such as debt funds that weren’t previously made available in the healthcare sector have seen an uptick in the sector and continue to receive several opportunities. The market has also seen an uptick in IP monetization and royalty partnering.

6. Big Pharma M&A Activity
Anti-trust and FTC risks are currently on top of the minds of big pharma. Big pharma’s are mindful of therapeutic overlap and crowdedness. It is expected that in 2023, big pharma will look at complementary therapeutic areas and different types of assets instead of going bigger in areas they already have natural commercial and pipeline presence.

7. Healthcare Conferences & Investor Meetings
While investors are continuing to take meetings with companies they have pre-existing relationships with, they are slow to take new meetings. Incredible numbers of investors return to academic conferences to meet with KOLs and management teams. Having a comprehensive strategy for KOLs and helping investors get educated on a particular target and program is going to become more critical. Having thought leaders and objective KOLs presenting stories will be accretive to investors’ investment process and will lead them to do a lot more diligence work. Overall, especially in a difficult market, biotechs need to make their fundraising approach ongoing, and utilize healthcare conferences whether in person or virtual.

Gilmartin Group has deep experience working with both private and public companies in the Biotech sector. For more information about how we strategically partner with our clients, contact our team today.

Authored by:  Rachna Udasi, Analyst, Gilmartin Group

Mid-Year 2022 Private Market Review (VC) and Fundraising Refresher

The past few years have been ones of immense strength and record activity for venture capital (VC). Following a monstrous and record-setting 2021, the first half of 2022 has been different of sorts. VC has not been sheltered from the barrage of uncertainty felt in broader markets due to macro concerns. The private market has begun to show signs of weakness despite many data points remaining historically high. As we enter the second half of the year, it is important to review how the landscape has changed over the past six months.

Mid-Year 2022 Review: Venture Capital  

Deal Volume Stumbles 

The onslaught of adverse economic headlines—inflation, rising interest rates, geopolitical turmoil, etc.—has contributed to the surge in volatility and slowdown in VC deals in 2022. During the first half of the year, global venture deal volume and average deal size (Seed through Series E) declined by ~6% YoY and ~12% YoY, respectively. While volume continued to grow during Q1 (albeit at a considerably slower pace), Q2 marked an inflection point as volume experienced a significant pullback, falling ~17% YoY.

U.S. Healthcare deal volume and average deal size (Seed though Series E) during the first half of the year declined ~37% YoY and ~0.5% YoY, respectively. The outsized pullback in volume has shown no signs of abating as volume in Q2 fell ~42% YoY (vs. -32% in 1Q22) and ~20% sequentially (vs. -30% in 1Q22). The weakness in volume has also been widespread, spanning across both early stage and later stage deals. Average deal size, however, has been relatively consistent ($42.7M in 1H2022 vs. $42.9M in 1H2021), but current data indicates that it may be trending lower moving into Q3.

Source: Preqin (as of July 2022)

The Silver Lining: An Unprecedented Level of Dry Powder 

Although deal activity has cooled, VC has continued to attract capital this year despite negative market volatility. Globally, VC firms have raised more than $100 billion through the first half of the year, down ~10% YoY but still elevated compared to pre-pandemic levels (average of ~$75B in the 1H from 2017-2019). The influx of capital and reduced level of deal activity has led to unprecedented amounts of dry powder waiting to be deployed. As of June 2022, VC dry powder globally was more than $500 billion, which is more than double the amount exiting 2019.

Preqin defines “dry powder” as the amount of capital that has been committed to funds minus the amount that has been called by general partners for investments.      

U.S.-based VC firms have also fared slightly better coming off the launch ramp of 2021. During the first half of the year, U.S. VC firms raised ~$79 billion, down only 0.2% YoY. As of June 2022, U.S. VC firms had more than $280B in dry powder waiting to be deployed. This marks a record high as investors continue to sit on the sidelines.

Source: Preqin (as of July 2022)

What can we expect for the rest of the year?

It remains to be seen whether the drop in activity marks an adjustment from 2021’s record-breaking venture activity or the beginning of a more sustained downturn. Economic uncertainty due to the inflation, rising rates, supply-chain problems, and lingering COVID-related headwinds may continue to impact VC and public markets. On the other hand, record-setting amounts of dry powder have been amassed by VC funds and may continue to be deployed as investors gain more confidence and clarity.

For a company looking to raise capital during this turbulent time, it is important that you continue to meet with potential investors. Although there is a heightened sense of scrutiny with new investments, the relationship building process is as important as ever. VC firms are continuing to explore investments and meet with management teams given the seismic amount of capital on the sidelines.

Recap: Natural Progression of Venture Fundraising

In our previous dive into the basics of venture capital (VC) and private equity (PE), we wrote about the general structure and process of how both VC and PE firms invest. Here we take a deeper look into the natural progression of how the venture fundraising process works.

There are five key stages of venture capital, starting from the seed round and ending with the mezzanine/crossover round. As a company develops and matures, each succeeding fundraising round represents a milestone for a company. Each round, investors will evaluate the merits of a company and how successful it has been in achieving its targeted goals. The amount of money a company can demand usually also increases as a company begins to reduce risk. Here’s an overview of each major round during the venture fundraising process.

1. Seed Funding 

  • Seed funding is the first “official” equity funding stage.
  • Seed funding is the vehicle for a company to continue the progress made in the pre-seed stage by iterating on an idea or minimally viable product/service using funds from accredited investors.
  • Investors may continue to be owners and/or family and friends, but angel investors, incubators, and accelerators may also participate.

2. Series A

  • Series A funding revolves around a company’s revenue growth (i.e., proof of concept). At this stage, management teams will have to figure out how the company’s products and/or service will appeal to the targeted market.
  • Mostly, funding from this round helps a company conduct extensive market research, pay employees, launch the product/service, and develop a marketing strategy.
  • Investors involved come from more traditional and well-known VCs.
  • By this stage, it is also common for investors to take part in a somewhat more political process. Commonly, a single investor or a group of a few investors may serve as the lead in the round. Once a company has secured a lead, it may be easier to attract additional investors as well.

3. Series B 

  • Series B funding is about expansion, taking the company to the next level, past the development stage.
  • Series B funding becomes possible only when a company proves its market viability and is ready to expand on growth paths that have shown initial success.
  • Typically, before Series B funding rounds occurs, the company has to have shown strong achievements after its Series A round. Therefore, Series B is the ammunition for growth with a larger investment round.
  • Funding from this round is mostly used for business development, sales, advertising, technology, and talent acquisition. These investments provide the foundation for expanding market reach and meeting investor heightened levels of demand.
  • Investors involved continue to be mostly VCs.
  • Series B investors include many of the same participants in previous rounds.
  • However, a Series B round also opens the door to a new wave of additional investors (e.g., VCs specializing in later-stage investing).

4. Series C 

  • Series C funding centers on long-term growth, focusing on a company that has already proven its business model but needs more capital for expansion.
  • The proceeds from this financing round are most commonly used for entering new markets, research and development, or acquisitions of other companies.
  • Although not formally the last stage of the funding lifecycle, most companies will end their external equity fundraising with a Series C round.
  • Many investors from  previous financing rounds tend to participate, but this round of financing often attracts new investors as well.
  • Unlike the previous stages of financing in which most investors are VCs and angel investors, large financial institutions such as investment banks, hedge funds, and PE firms will begin to participate.
  • Participation from a wider range of investors is due to proven strengths of the business model and opportunity, and the perception that the company has been materially de-risked.

5. Mezzanine/Crossover

  • The mezzanine and/or crossover round is the final stage before a company goes public, typically occurring within 12 months prior to an IPO.
  • Mezzanine financing is typically known as bridge financing because it finances the growth of expanding companies prior to an IPO.
    • A crossover round is traditionally defined as a venture financing in which there is significant participation from investors that typically buy into publicly traded companies or IPOs, usually within the 12 months prior to their IPO.
  • Investors from previous financing rounds may continue to participate, but interest is more widely spread as investors are looking to benefit from the lower valuation than the IPO valuation.

Gilmartin Group partners with many healthcare innovators, both public and private, to build nuanced communications strategies and develop sustainable messaging that sets companies up to build credibility over time while clearly conveying the differentiated value they provide. To learn more about Gilmartin and how we strategically partner with our clients, contact our team today.

Stephen Yeung, Associate

 

Valuable Lessons from WeWork and Other Unicorns

Recent scandals among tech’s unicorns have turned investor attention to hypergiant funding and blitzscaling: Outcome Health faced an investor lawsuit regarding misleading claims; John Carreyou’s NYTimes bestseller “Bad Blood: Secrets and Lies in a Silicon Valley startup” centers around fraud charges faced by Theranos; and, most recently, WeWork has faced negative publicity for its IPO plans. But what is “hypergiant” funding and “blitzscaling,” and how can companies avoid becoming cautionary tales?

The dangers of conflating “hypergiant” funding with “blitzscaling”

Due to unprecedented amounts of global dry powder, “hypergiant” funding rounds have become more prevalent among venture capital (VC) and growth equity investors. Global funds held as dry powder, or kept in reserve, have increased from $400 million in 2003 to $2 trillion in 2018. Many top global VC funds, such as Sequoia Capital, Andreessen Horowitz, and NEA, have raised later-stage venture funds of $1 billion or more since 2018. As a result, “hypergiant” rounds of $250 million or more steadily increased from 38 over the course of 2014 to 35 per quarter in 2018.

Increases in hypergiant rounds have coincided with the rising popularity of a strategy known as “blitzscaling.” Reid Hoffman began teaching a class called “Technology-Enabled Blitzscaling” at Stanford University in 2015; according to Hoffman, the term can be described as “what you do when you need to grow really, really quickly.” He elaborated, “It’s the science of rapidly building out a company to serve a large and usually growing market, with the goal of becoming a first mover at scale… Google revolutionized how we find information – it has over 60,000 employees and has created many more jobs at its AdWords and AdSense partners.”

Learning from the mistakes of WeWorks and others 

WeWork’s failed IPO demonstrates the dangers of conflating large funding with rapid scaling. Not all companies with large funding possess the same fundamentals to be successful at rapidly scaling.

The classic venture capital playbook is to jointly fund startups through a series of gate-staged rounds (i.e., Series A, Series B). Each round’s purpose and size are intended to reflect a startup’s needs at that specific stage. This strategy reduces risk for venture capital firms, as nearly 2/3 of startups stall and fail to exit or raise follow-on funding.

Masoyohi Son, CEO of Softbank and its Vision Fund, was said to have launched the Vision Fund to transform VC’s typical playbook of gate-staged investments. Softbank typically decides on its own if a venture is worthy of funding that is significantly greater than its ask. In 2018, while the median size of late-stage VC investments was $35 million, Softbank led or sourced 18 funding rounds of $350 million or more.

These days, if a startup needs to raise capital, it is easier than ever to tap into private markets. Therefore, it comes as no surprise that the median gestation period from seed to IPO has lengthened from 3.2 years in 2000 to almost a decade in 2019.

However, with WeWork’s recent failed IPO, it makes sense to examine sound hypergiant funding principles. Specifically, some entrepreneurs mistakenly believe that massive capital investments alone can be used to achieve a sustainable competitive advantage. While blitzscaling encourages rapid expansion in order to take advantage of network effects, it does not urge companies to ignore lean methodologies or standard investing concepts.

Valuable lessons from WeWork’s recent IPO failure

Hypergiant funding is not the inherent reason for WeWork’s failure, or Outcome Health’s recent lawsuits for that matter; rather, company executives ignored many basic principles. Notably, after WeWork’s failure, the NYSE tweeted the following:

“Before you take your company public ask yourself these four questions:

  • Is there a compelling business case for going public?
  • Is there a clear, strategic roadmap for the long term?
  • Is your company’s financial house in order?
  • Is the right executive team in place?”

While these questions may seem basic, they summarize many enduring considerations as companies scale and tap private or public markets for additional funding. Below are some guiding principles to keep in mind:

  1. A great vision and business plan are fundamental. As the proverb goes, “Vision without action is a daydream. Action without vision is a nightmare.” A company’s vision should be clear, concise, and inspiring. An example is Microsoft’s vision at its founding, “A computer on every desk and in every home.” In order to execute a vision, companies should have a comprehensive business plan that lays out objectives, actions to obtain them, and the timeframe to accomplish these actions.
  2. Business models are paramount. Capital-intensive, low-margin businesses cannot sustain a competitive advantage with new technology and massive funding alone. Total addressable market (TAM), barriers to entry, customer satisfaction, and sustainable free cash flow (or a feasible, well-conceived path towards one) are enduring investment concepts. Alibaba raised only $50 million venture capital before becoming cash-flow positive in its third year of operation, and Facebook was generating over $1.5 billion in operating cash flow prior to going public.
  3. The core business is foundational. Investors often heavily discount new, additional products and growth avenues. Yet, some companies begin rapid expansion into new areas without fixing the fundamental issues in their core business first. An example is WeWork’s launch of its elementary school product area known as WeGrow.
  4. Scale at the right time, rather than as a result of access to capital. It makes more sense to scale when there is data available on the competitive landscape and the degree to which a product satisfies a strong market demand, such as a sizeable serviceable addressable market (SAM), strong user growth, and/or requisite proof-of-concept data (i.e., clinical studies). Scale too quickly and the company might stall; mistakes can become compounded. On the other hand, scaling too slowly might not be aggressive enough.
  5. Internal controls should not be sacrificed for profit. WeWork was forced to react to investor concerns regarding related-party transactions, such as Mr. Neimann’s personal ownership positions in buildings leased by WeWork and We Co’s $6 million purchase of the trademark of the word “We” from a company controlled by Mr. Neimann. Internal controls such as audits and expenditure review triggers for items over $1,000 can pay dividends later on.
  6. Accounting principles exist for a reason. Overly complex spreadsheets can generate accounting mistakes if they become too cumbersome to operate and update. A lack of financial standardization can result in inappropriate revenue recognition and theft. Finally, separation of bookkeeping and auditing becomes crucial as companies scale. Investors value independent audits, and strategic investors are known to request Quality of Earnings (QoE) reports for larger scale acquisitions.
  7. Governance matters. Companies should implement written codes of conduct and implement structures that avoid bias and conflicts in decision making. Elizabeth Holmes of Theranos prevented subsequent board efforts to replace her by multiplying the voting rights of her shares to give her 99% of total voting rights. At WeWork, Neumann’s voting shares and the stipulation that significant power passes to his wife, the company’s Chief Brand and Impact Officer, in the event of his death raised significant concerns. A newer investment strategy – Environmental Social & Governance (ESG) – has emerged in recent years, and it emphasizes some of these concepts. ESG and sustainable investing focus on relations with employees, customers, and stakeholders, as well as proper corporate governance – leadership, pay, voting rights, and history with the SEC and regulatory bodies.
  8. Accountability fosters growth. As companies scale, specialization becomes more important. Key performance indicators (KPIs) and accompanying analytics are critical to the deployment of a significant amount of capital. Additionally, intermediate milestones allow companies to course-correct early in the journey at significantly less expense.
  9. Cultures that cultivate fear can be dangerous. At Theranos, for example, would-be whistleblowers were threatened with lawsuits, and some employees were fired and marginalized over criticism of company practices. As a company quickly grows, executives should manage and measure their cultures to ensure they are addressing employee concerns and encouraging trust.
  10. Reliability prevails in relationships with customers and investors. There are serious repercussions for presenting false information to healthcare providers, patients, and investors. Following Wall Street Journal allegations that Outcome Health misled advertisers by overcharging clients and manipulating campaign results, key investors decided to sue Outcome Health for committing fraud, and the company is being forced to reinvest $159 million in the company while the co-founders step aside from daily management. In the case of Theranos, the SEC charged CEO Elizabeth Holmes with “massive fraud.” As part of the settlement, Holmes must return millions of shares to the privately held company, pay a $500,000 fine, and she cannot serve as an officer or director of a public company for 10 years.

Conclusion

Modern scandals among notable unicorns in healthcare and technology have caused entrepreneurs and investors to reflect on recent events. While global dry powder remains high and the number of unicorns has multiplied, hype does prevail over math in a world that relies on ratios such as Return on Invested Capital (ROIC). Sooner or later, sophisticated investors penalize dysfunctional business models. That said, with the appropriate framework and culture, companies can easily avoid becoming yet another cautionary tale.

To learn more about Gilmartin and how we strategically partner with our clients, contact our team today.

Caroline Paul, Principal

Follow-On Offerings

In previous blogs we have covered some of the basics of IPOs, the Importance of ATM Financing for Biotechs and Shelf Registrations. Today we look at a few basics of a marketed follow-on offering.

Marketed Follow-On

A marketed follow-on is a publicly announced offering that may include a short roadshow. Unlike an IPO roadshow which can take around two weeks, we typically see marketed deals that take just a few days from announcement to pricing. For example, earlier this month a company filed their S-1 and announced their deal on a Monday and priced four days later on Thursday afternoon. With a few days available, there are options for marketing the offering:

  • Quick Roadshow. With just a few days, there is a chance to go to New York, Boston and possibly the Midwest.
  • Conference Calls. With limited time and difficult logistics, it may make more sense to host a series of conference calls with investors.

The bookrunner(s) will best be able to recommend one of the strategies, or a combination of the two. The best use of your time will be based on factors such as: most recent conferences attended and 1-1 meetings; recent non-deal roadshows; and other meetings or calls with investors. The bookrunner(s) will also look at the recent trading activity to understand which investors may be the most interested in the offering.

Underwriters

Over a year ago we looked at Considerations for Choosing Investment Bank Partners. With a new offering, there is an opportunity to look at the banks from the original deal and possibly make some changes. A few things to consider:

  • Evaluate the Bookrunner(s). While your bookrunner(s) may have done a good job on the IPO, it may be time to look at their recent performance and decide whether they are the right fit for the next offering. Do they continue to be a leader in the space? Have they continued to work with you as a partner since the time of your IPO? Will this transaction be important to them? A lot can happen between an IPO and a follow-on offering, so this is a good time to evaluate the relationship and figure out what is best for you and the company.
  • Evaluate the Co-Managers. Just like you evaluate the bookrunner(s) from your IPO, this is also a chance to look at the performance of the co-managers. Keep in mind, that just because a bank participated in the IPO doesn’t mean they should automatically be involved in the follow-on.
  • Add New Bank or Banks. A follow-on offering will typically be larger than an IPO providing the opportunity to add new banks to the deal. If you worked with a smaller bank during your IPO, now may be the chance to work with a bank that has shown consistent leadership in your company’s space. It may also be a good chance to broaden your relationships with new banks.

All of the decisions listed above are important and should not be taken lightly. As with the IPO where there may have been disappointed parties who did not get to participate, be prepared for the same when it comes time to raise additional capital.

Pricing

Whereas an IPO has a price range on the prospectus to give investors a starting point to where the deal may price, a follow-on already has an actively traded stock. The S-1 will list the last reported sales price of the company stock before it filed, but it will be the next few days trading and demand that will determine the price. From here, there are several scenarios including:

  • Strong Demand from Investors. If there is strong demand (which hopefully was anticipated), there is a chance that the stock does not move drastically from the last trade listed on the S-1. In this event, many investors may end up putting in orders at the market, meaning the underwriters may price the deal at the closing bid on the night of pricing, or at a slight discount (say pricing at $10 even despite the closing bid being $10.12).
  • Weak Demand/Price Sensitive. Investors may also be more price sensitive. This can end up being reflected in the stock trading down from filing, or investors putting in limit orders. Using the $10.12 closing mentioned above, an investor may put in an order such as this:
    • 500,000 shares at 9.50
    • 250,000 shares at 9.75
    • 100,000 shares at market

It will then be up to the bookrunner(s) to figure out the appropriate price with the most demand that will allow the stock to trade successfully in the aftermarket. If there is sufficient demand at the $10 level and includes the well-known investors in the space, then the orders that come in at the $9.50 level can be ignored. On the other hand, if the demand is price sensitive then the investors may have more leverage to force a pricing at a discount to the closing bid.

One interesting scenario is where a large, existing investor chooses not to participate in the follow-on offering. It may be that they already have a full position and are unable to buy any more shares. There is also a possibility that they will be a seller after the deal prices in anticipation of increased liquidity, especially in the first few days after the deal prices.

The above are just a few things when it comes to follow-on offerings. A deal itself is a great opportunity for a company to raise money and/or for original investors to gain liquidity. When thinking about the factors and metrics for a marketed follow-on versus other fundraising means, contact us to review the options.

Tom Brennan, CFO

Engaging Hedge Funds

Hedge funds represent a substantial pool of potential capital to biotech management teams, but engaging with them can offer many challenges due to their varying structures and motivations.   Understanding the drivers of the decisions within this class of investors should aid in increasing management teams’ comfort level in dealing with them.  Two of the more common frustrations regarding hedge funds are that they tend to be overly focused on short-term events and that they may be short a stock.

Mutual funds vs. hedge funds: Risk tolerance and the difference between absolute and relative performance.

The first distinction one must make amongst investors is between mutual funds and hedge funds. Mutual funds are highly regulated pooled assets that must be sold to investors under a prospectus. The prospectus sets forth stringent guidelines regarding investments that may be included. The mutual fund was designed to reduce the risk for unsophisticated investors and allow broader participation in markets.

The second most common identifying feature of a mutual fund is that its performance is generally measured relative to both a peer group of similar funds and a benchmark index. The S&P 500, the Nasdaq composite and the Russell 2000 are three of the most common. Mutual fund managers express their performance in terms of their percentile performance relative to their peer group and whether they out or underperformed their benchmark, e.g. “over the past 3 years our fund outperformed the S&P 500 by 6%, placing it in the 86% percentile of our peer group.” Though greatly enhancing market participation, mutual funds, by their very design and regulation, have shortcomings. Most notable is the fact that mutual funds offer little defense when markets are weak.

Hedge funds first sprang to popularity in the 1970s as investors saw very few opportunities to profit from owning stocks during this period and were searching for alternatives. Far less regulated than mutual funds, hedge funds were only to be sold to “qualified investors” under Regulation D of the Securities Act of 1934. Hedge funds were designed to give more affluent, sophisticated investors who could tolerate more significant potential losses, the opportunity to pursue higher returns that could come about in more varied market conditions. For more on hedge funds, see our introductory piece here.

Portfolio concentration and leverage: why hedge funds managers always seem to be more focused on the short term.

In order to offer higher rates of return and to manage market volatility, hedge funds, by necessity, must run more concentrated portfolios and sell stocks short. Short selling necessitates the use of leverage as one must borrow shares to sell them into the marketplace with the hope of buying, and covering the short position, at a lower price level. In addition, managers often use leverage to amplify their returns on the long side as well, feeling that their shorts will protect them from any sudden downturns. Concentrated portfolios and leverage conspire to rob the hedge fund manager of the luxury of time and patience as each position contributes far more to overall portfolio performance than in a mutual fund. Leverage only amplifies this risk. These attributes increase the nervousness of the managers driving far more portfolio turnover as it is far worse for a fund to incur losses from bad trades than miss out on the profits from successful trades as the losses are much harder to make up. For example, a $1 million position that loses 50% must then rise by 100% to recoup the loss. As a result, hedge funds are far more likely to “shoot first and ask questions later.” This explains why interactions with hedge fund managers are dominated by intense discussions of near-term milestones, often to the consternation of management teams and the mutual fund investors who may be sharing the same meeting.

Short sellers: It’s not personal. Don’t shut them out.

Having a dialogue with hedge funds will require management to have discussions with individuals who may have sold shares short. It is possible to have productive interactions with an information flow that can be beneficial to both sides. Frequently, management will attempt to reduce their interactions with people who may be short their stock, assuming that restricting access and information will dissuade short sellers. Unfortunately, the opposite tends to be true. Management truculence only serves to encourage and attract shorts as their conviction grows that “management is hiding something.” As discussed above, understanding the motivations of short sellers can increase managements’ confidence in dealing with them.

A hedge fund can short a stock for a myriad of reasons. Their reasons can be central to the future of the company, “the drug isn’t likely to work,” or they can be utterly irrelevant in the long term, “I think the stock is too expensive,” or “I am short a basket of stocks because I think the market is due to pull back.” Understanding the underlying motivation of the short is very important and can only come about through dialogue. Finally, management should also be aware of any credible short thesis that has emerged from information sources outside of their control — for example, doctors or patients who are making negative comments. A short seller is very unlikely to reveal their sources, but the tone of their questions may help to uncover their thesis.

Ultimately the job of a biotech management team is to develop a drug and not to understand why any given investor is making a particular decision. Therefore, too much focus on the activities of investors is likely counterproductive to the central corporate mission. Regardless, it is beneficial for management to have access to a broad pool of investors as the back and forth of the marketplace can reveal useful pieces of information. Within that context, a basic understanding of the hedge fund should allow management the ability to create far more productive interactions with them.

Matt Lane, Managing Director

 

 

The Importance of ATM Financing for Biotechs

The story of a development-stage biotech company is one of almost continuous fund-raising. Why, you may ask? Well, in the absence of revenue, the expense of progressing a drug candidate through preclinical and then clinical studies falls squarely on a company’s shareholders and supporters.

Once a biotech company is public however, the number of funding options that are available become more plentiful and rewarding – that is the benefit of going through the IPO process. Typically, such companies are also much further along in the development of their assets, which further increases financing options.

Private, early-stage biotechs typically survive on seed funding, early round financing from venture capitalists, and non-dilutive grants from government, industry, or charitable organizations. Once they are publicly listed, however, their increased fundraising options include follow-ons, a variety of secured or unsecured debt financing, convertibles, partnership or licensing agreements (in which the company typically sells off foreign markets for its drug that is has no plan to commercialize itself), and at-the-market (ATM) facilities.

In the biotech world, ATM facilities have become so popular that it’s almost unheard of for companies to NOT put one in place on the first anniversary of their IPO, which is the first available date that such an undertaking is typically possible. ATM financing used to get a bad rap, but over the past decade they have come to be seen as a logical and necessary part of a biotech’s financial arsenal.

An ATM allows a biotech to selectively and confidentially sell blocks of new shares to known, would-be buyers. Such transactions take place through, and in active dialogue with, the company’s ATM manager, with Cantor Fitzgerald and Cowen typically winning the lion’s share of such biotech business.

Although the number of shares that can be covered and issued by an ATM is limited by a company’s size (shares outstanding) and liquidity (trading volume), such facilities help smooth a biotech’s fundraising profile, which might otherwise be characterized by large, one-off follow-ons. These follow-ons typically only occur in the aftermath of major beneficial development milestones.

Aside from the flexibility and optionality, a key attribute of ATMs is that their utilization is disclosable only after the event. In fact, even funds using ATMs to buy stock are often unaware of the shares’ source. Instead, disclosure of ATM utilization is made after the event in the company’s 10-Q filing with the Securities and Exchange Commission (SEC).

This arrangement therefore enables a biotech to “hedge its bets” ahead of major data announcements, ensuring the company’s survival (and some residual value) in the event that such data turns out to be negative. Let’s walk you through a hypothetical example.

Without an ATM in place, Awesome Therapeutics, our example biotech company, is approaching the announcement of pivotal Phase 3 data for its potential cure for the common cold. It does not have the funds necessary to fully commercialize its drug, but plans to complete a follow-on offering in the event that the Phase 3 data is positive. Management are obviously confident that their drug works, and have lined up a syndicate of supportive banks who are standing by.

One of two scenarios now unfold:

Scenario 1: The Phase 3 data is positive, Awesome Therapeutics’ stock soars on the back of the news, and its banks leap into action and raise hundreds of millions of dollars for the company through a follow-on, enough to fund the company through the commercialization of its drug. Everyone is happy.

Scenario 2: If the Phase 3 data is negative, Awesome Therapeutics’ stock might tank by perhaps 50-70%, the banks will quietly move on to their next deal, and Awesome Therapeutics will be left with a diminished development pipeline and insufficient cash-on-hand to fully develop its remaining assets (if any).

Now, let’s replay the above scenario with an ATM facility in the mix:

In the six months leading up to the announcement of Phase 3 data, Awesome Therapeutics’ stock price is pushed up, perhaps driven by retail investors, in anticipation of the announcement of pivotal clinical trial results. In the last few months before data, Awesome Therapeutics, in dialogue with its ATM manager, sells shares into this demand. This results in tens of millions of dollars in new funding (perhaps even more) that it doesn’t have to disclose until its next 10-Q filing.

Once again, one of two scenarios now unfolds:

Scenario 1: If the Phase 3 data is positive, Awesome Therapeutics’ stock soars on the back of the news, and its banks still leap into action and raise hundreds of millions of dollars for the company through a follow-on. The company now has enough resources to fund through the commercialization of its drug. Shareholder ownership and upside has been partially diluted by the pre-data ATM offering, which the company eventually discloses, but everyone has nevertheless made money and therefore should be happy.

Scenario 2: If the Phase 3 data is negative however, Awesome Therapeutics’ stock will still tank (and the banks will still quietly move on to their next deal), but Awesome Therapeutics now has sufficient cash-on-hand (thanks to its ATM proceeds) to regroup and refocus on the development of its remaining assets. It will have survived a major (and unexpected) negative data event, and its management will have second chance to rebuild shareholder value.

Hopefully, the Awesome Therapeutics example helps you visualize how ATMs represent a valuable addition to a biotech’s fundraising options. While they were once associated with companies who couldn’t raise money any other way – especially through a formal follow-on process – they are now almost universally accepted as necessary to smooth the otherwise “lumpy” and uncertain landscape of biotech financing.

Inflexion points like data aside, an ATM–which, by the way, typically incurs half the banking fees associated with follow-ons and IPOs raising equivalent amounts–can also be used in the course of normal financing, side by side with a strategic investor relations program that seeks to raise awareness of a company’s investment thesis and prospects. Managed properly, biotechs can actually raise just as much through an ATM facility over several months as they can via a fully-fledged secondary market offering. For more on ATMs and other financing options, contact us.

Laurence Watts, Managing Director