What investors look for in bioscience startups: part 2

VCs take on significant risk by investing in early stage companies. It is critical they do as much due diligence on potential investment opportunities as possible.

It would take volumes to discuss in detail what VCs look for but generally, they will assess at least seven critical factors very closely. The better positioned a company relative to these factors, the higher the probability of raising capital. They include:

Unique Product or Service: VCs will assess how a product or service differentiates from competing products or services. Does it solve a real problem or need? How is it protected from competitors? VCs are very sensitive to intellectual property (IP) – the more the better. Product IP creates barriers to entry.

Large and Growing Target Market: Does the product or service target a large and growing market? A good rule of thumb: Is the market at least $1 billion in annual sales? A VC might assume that at best, a company will capture 10% market share – $100 million in annual revenue which is a good benchmark revenue goal for an early stage company, particularly for a $5 – $10 million investment.

Scalable Revenue Model: Scalability refers to the ability to increase revenue at decreasing costs to derive that revenue. Also, is it a recurring revenue model? An example of a scalable and recurring revenue model is a telecommunication service provider. Once the infrastructure is in place, the business easily can add new customers onto the platform and customers pay recurring monthly fees for service.

Solid Business Plan: This is much more than just having a well written business plan. It is about the content of that plan. Does the company have a thorough, well crafted strategy? What is the vision of the founders? How will management execute the plan? Is it feasible?

Significant Gross Margins: High gross margins leave residual income to not only meet fixed costs but also provide wiggle room for errors in forecasting and downturns. Also important is how defendable are the margins. Is the business in an industry with low barriers to entry which invites competitors and squeeze margins. Commodity products and services such as building materials usually do not have high gross margins because of competition which erodes pricing and with little control over the cost of goods, margins are thin. Software on the other hand, tends to have high gross margins.

Clear Exit Strategy: As indicated previously, funds need to liquidate portfolio holdings in order to wind down the fund and return investors their money plus gains on investments. Private equity investments have a very limited secondary market; unlike the public stock markets. VCs rely on portfolio companies being acquired or going public (IPO) to provide a liquidity event.

At the center of the diagram, connecting all of the factors is Management. The management team is the glue holding all the pieces together and making them work. A strong, seasoned management team is often the most critical element to raising venture capital. VCs will pay particular attention to management’s experience, track record of success (not necessarily entrepreneur success), education, ability to work as a team, leadership skills, etc.

In the diagram area surrounding boxes – within the circle of the diagram, there are two additional concepts that are critical to all of the factors are two concepts that are applicable to all factors:

Adaptability: An emerging growth business must be adaptable – the management team must be able to recognize challenges, embrace and change with new information, evolve the product, change the business plan and direction, adapt the revenue model and adjust to ever changing regulatory environments.

Focus: Aspiring entrepreneurs often want to set the world on fire. However, it is important to stay focused. For example, if your business is ready to roll out a product or service in the United States, focus on that goal – not trying to roll out the produce in multiple countries throughout the world. Focus on the most critical applications of your product or service first, prove that model then go after other applications.

Funding bioscience ventures challenges the most experienced team, particularly in difficult economic times. Putting yourself in the shoes of investors at each stage of development will help you identify those most likely to show interest in your project and help you craft a pitch that fits their criteria for investment.
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Categories: Company Perspectives, Finance