What investors look for in bioscience startups

Funding bioscience companies is more like a relay race than a marathon. During each stage of development, from the invention or discovery phase, to the development and testing phase to the commercialization and launch phase, entrepreneurs typically look to different kinds of funding sources and investors. Likewise, investors at the various phases expect to “pass the baton” to the next kind of investor as the project progresses.

The first phase, the discovery of invention phase, is usually funding by government research grants that are designed to fund basic science or discovery. The next phase, the development phase, is a difficult time to raise money. Being in this “valley of death” challenges the innovation team and they usually turn to friends and family, SBIR/STTR grants, private investors, proof-of-concept sources, early stage technology funds and angels for money. During the testing and commercialization phase, larger amounts of money are needed to do clinical trials, prototype design, fabrication and testing. At this stage, venture capitalists provide the dollars to finance the venture.

Founders of early stage companies considering raising venture capital to fund development and growth, often find themselves wondering what venture capitalists look for when assessing an investment opportunity. The answer is not simple nor is it exact. Nonetheless, there are a few factors that every venture capital fund will assess when looking to invest in an early stage company.

First, it is important to review the basics of how venture capital works. Typically, a venture capital fund is set up as a limited partnership. The investors in the fund are Limited Partners (LPs) while the fund managers are General Partners (GPs). LPs are often large institutions such as pension funds, endowments but also may include very wealthy individuals. The GPs establish the fund, determine the fund strategy, its structure, the target returns and establishes the type of investments it will make and the investment criteria for investing in portfolio companies.

Once established and funded (by LPs), the GPs seek investment opportunities in companies that fit the investment criteria of the fund. GPs have a fiduciary responsibility to the LPs thus they will take extreme care in vetting investment opportunities.

Not only are fundamentals important but size matters. Over the years, venture funds have become very large and with limited personnel to tend to portfolio companies, they invest in a limited number of companies. Hence, the investment size for each investment is often largely driven by the size of the fund and today, is much larger than years past. For example, a $250 million venture fund may only want to invest in 20 companies with an initial investment of $5 million per company and holding back another $7.5 million in reserve for further investment in each company.

LPs invest with the expectation of a return of capital plus gains, in a few years. To provide this return, the fund must liquidate portfolio holdings. Most venture funds seek to fully liquidate in 5 – 7 years and disburse the funds to investors. To liquidate holdings, they must sell the companies or take them public. GPs obviously seek the highest return possible but target returns are usually 30 to 40 percent, although few funds actually achieve these results.
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