5 ways biotech startups can mitigate risk to grow sustainably in the long run

Santé

5 ways biotech startups can mitigate risk to grow sustainably in the long run

October 28, 2022

Omar Khalil@okhalil / 10:30 AM EDT•October 28, 2022

Omar Khalil is a partner at Santé Ventures, where he focuses primarily on biotechnology and medical technology companies.

The unprecedented explosion of investment in life sciences over the past decade has resulted in incredible new therapies for patients, strong financial returns for companies and an overall increase in translational research, which is critical to advancing the next generation of therapies. It has also led to eye-popping levels of capital raised by early-stage companies, some of which were years away from entering the clinic with their first product.

Naturally, a generous flow of financing generates excitement for everyone involved. Capital is the fuel that advances scientific and technological innovation, and it means a life science startup can create products that benefit the world at large.

But what happens when the funding suddenly dries up?

In the world of biotech, for example, it’s extremely capital intensive to develop multiple products that are all going through clinical trials simultaneously. The infrastructure needed to maintain these different programs can be too unwieldy to weather a financial drought.

A better approach would be to focus on a lead program — a single product that they can take through various stages of development, ultimately leading to FDA approval. In fact, lead programs validate the value of an underlying platform, enabling companies to raise capital through licensing and partnerships.

Founders shouldn’t let peer pressure or investor check size mandates dictate their financing strategy.

There will always be ebbs and flows in funding, so here are five ways life science startups can optimize for success regardless of the economic climate.

Don’t confuse successful fundraising with a successful company

At the end of the day, fundraising is a means to an end. The mission for most life science startups is to improve patient outcomes. However, science is hard, and cash in the bank does not overcome the complexities of human biology. Plenty of companies have successfully raised significant amounts of capital but were never successful in developing a beneficial product, therapy or technology.

While not a perfect proxy, the value at which a venture-backed company exits (through M&A or IPO) can be an indication of its success in developing a new product. However, there is practically no correlation between the amount of capital a company raises and its ultimate exit value.

Since 2010, the R-squared between exit value and total invested capital — a measure of how correlated the two variables are — for all healthcare exits is a paltry 0.34. When you drill down to a correlation between the exit value and the amount of capital raised in a company’s Series A financing, it drops to a practically negligible value of 0.05, according to PitchBook.

These statistics support the notion that just because a company raises significant amounts of capital (especially early on), there is no guarantee of a successful investment outcome.

Founders shouldn’t let peer pressure or investor check size mandates dictate their financing strategy. Instead, focus on advancing your program through the key stages of technical and clinical development.

This enables more capital to be raised over time and, ultimately, more value to be created for shareholders.

Maintain strategic focus over optionality

While management teams and investors like to have “multiple shots on goal” to increase their chances of success, the lack of a singular focus can lead to heavy cash burn. Too many resources are needed to run multiple programs in parallel. Instead, it’s important to remember that the vast majority of a biotech company’s value is driven by its lead program. Especially early in a company’s lifecycle, the strength and progress of the lead product often drives both investor and strategic (i.e., Big Pharma) interest.

Don’t spread your limited capital across several programs too early. Instead, avoid distractions and direct the flow of resources to your company’s most valuable priority.

In my own portfolio, I’ve seen startups make the mistake of taking on too much, too quickly. Eager to demonstrate the broad potential of their technology, CEOs will quickly ramp up hiring and development activities for multiple programs. However, these companies were later unable to raise subsequent rounds due to both market- and company-specific factors. This led to drastic cuts, including employee layoffs and project cancellations with key vendors.

Such cuts can be devastating for company culture and morale, and when managed ineffectively, can cause a downward spiral that doesn’t end well. Thankfully, our companies have had the strong leadership necessary to get through the challenges successfully, but they didn’t get through that without significant scarring.

Validate your platform

Of course, a company launching with option value and the potential for generating multiple clinical programs presents an attractive profile. However, that optionality should not come at the expense of putting the lead program at risk.

Any new platform technology should be validated, and it’s only truly validated when a program derived from that platform demonstrates a clinically meaningful effect.

The success of a lead program justifies increased investment in other programs. Few companies can overcome the failure of a lead program to successfully advance other products.

New technology platforms are typically more capital intensive to scale, due to the novelty of the development and manufacturing processes. Key to success here is to ensure the technology has been validated and sufficient value has been demonstrated to lower the company’s cost of capital for building and scaling up manufacturing operations. The increased scale can then help advance subsequent programs at an even faster rate than if they were pursued from the beginning.

Identify true value inflection milestones

A detailed and realistic development plan is foundational for any life science startup. It’s also vital to integrate that development plan with a thoughtful financing strategy.

Founders should identify and externally validate meaningful milestones that will lead to technical validation or risk mitigation of the program to provide the guideposts for their company’s capital needs.

While it’s important to have contingency funds (typically six-12 months of additional runway), raising substantially more capital can lead to unhealthy growth. Conversely, raising too little capital means there will be more rounds of fundraising.

Figuring out the sweet spot of how much capital the company needs to increase the likelihood of success while avoiding the challenges of overcapitalization is among the most important exercises for a new venture. Management teams should validate those milestones through conversations with their investors, advisers and industry partners.

One of the most critical mistakes I’ve made when working with an emerging life sciences tech company was believing “if you build it, they will come.” Despite customer skepticism about the space, our team convinced ourselves that clinical proof-of-concept data would be sufficient to generate market interest.

Deeper exploration would have identified at least two additional milestones related to manufacturing and regulatory development that were critical for driving interest. While our team was able to raise the capital to achieve the additional milestones, greater validation upfront would have led to a stronger, more comprehensive development plan.

Stay disciplined

It’s often said that life science startups can be incredibly successful while never generating a profit (and often, never even generating any revenue). That means they will always be reliant on external financing for everyday operations — capital that can be very expensive for existing shareholders.

Founders must remember to stay disciplined about expense management, even when capital availability is high. You need a cushion if and when capital becomes more limited in the future.

Even for companies who are awash in cash, prioritize the program’s critical path while limiting the temptation to allocate resources against “pet projects” or purely academic exercises.

The life science venture ecosystem is adjusting to a significant slowdown in financing volume and velocity after several record-breaking years. It’s still too early to know whether this is a short-term correction, or if it’s a new normal that will be maintained for the foreseeable future. However, by following the five strategies above, entrepreneurs can be better prepared for whatever comes next.