How To Assess Your Firm’s Cash Needs and Access Growth Capital
“Growth capital is more than just cash. For life science companies, it is often what separates success and failure. ”
To grow in a highly regulated environment like life science requires an abundance of time—and time costs money. Identifying that your company needs outside cash to grow effectively is not as challenging as preparing your company to be investible and taking an unbiased approach to determine its value. In this blog, we discuss how your company can access growth capital and prepare you for the changes that accompany the cheque. This may be a scary time for your business and its executives, but preparing for the future—and managing expectations during the process—is crucial. As the famous quote goes, “Imperfect action is better than perfect inaction.”
Who Needs Capital?
Amid an economic shutdown, a pandemic, unprecedented levels of government stimuli and quantitative easing, a better question might be who doesn’t? If we are to focus our attention on the life science industry, there is a very obvious reliance on research & development to find new therapies, and a further reliance on these innovative therapies to create revenue growth up and down the value chain. Organizations focused on R&D, sales and marketing, manufacturing, ingredient supply, and distribution all rely on innovation, so investment dollars (albeit with a higher risk-return tradeoff) flow into innovation at the ground floor of the life science industry. If we dive deeper into R&D companies, we know that to develop a pharmaceutical product from an Investigational New Drug (IND) through to commercialization costs billions of US dollars. Yes, billions with an “s.”
For those that want to learn more about the drug development process including vaccine development and how the industry is tackling COVID-19, listen to our recent podcast on The Platform with Dr. Beatrice Setnik, CSO of Altasciences.
At any rate, if you are a bonafide R&D company, you likely don’t have billions of dollars lying around, and even if you did, you would likely want to find a way to reduce your risk. Typically, development risk is reduced through outside investment, partnerships, JVs, or licensing agreements—all common approaches in the life sciences. Small R&D firms that are pre-revenue and pre-commercialization are too small for growth capital by definition, and attract investors in venture capital and angel investing who have an appetite for higher risk ventures. For the small R&D companies reading this, fear not, we have an upcoming podcast on The Platform and an associated blog focused on venture capital and angel investment that will help navigate your unique funding landscape. On the opposite end of the spectrum, large Pharma & Biotech players have a plethora of options for cheap money including access to equity markets, creditors, rated debt, and big banks. Candidates for growth capital lie in between these two extremes.
Growth capital is reserved for operating companies seeking to grow while maintaining control. This type of investment typically attracts private equity dollars for a minority equity stake in return. In the life sciences, common uses of growth capital include the expansion of an operating business into a new facility, adding manufacturing capacity, adding manufacturing capabilities in new dosage forms, or gaining access to new markets. Contract Service Organizations (CSOs) like Contract Research Organizations (CROs), Contract Development and Manufacturing Organizations (CDMOs), or even Active Pharmaceutical Ingredient Suppliers (API Suppliers) fit the mould for growth capital investment. Often, these companies are privately held, high production volume, and low margin businesses. Interestingly, growth capital in CSOs has been very profitable, and therefore, demand has driven valuations upwards for the entire CSO segment. What used to be valued at 10x EBITDA 5 years ago, is now attracting investment at 15-20x multiples. Capital will flow from private equity firms and growth funds into businesses that show the most potential return, which we will discuss in the next section.
What are Investors Looking For?
Growth capital dollars are seeking a return on investment above all else. Let’s face it, it is the entire business model of PE firms to outperform public market dollars and other investment strategies, or they would invest there instead. But let’s dive deeper: according to Jim Gale, Managing Partner at Signet Healthcare Partners, growth capital seeks:
Revenue;
Validation of receptivity in market;
Positive economic trends or a positive industry outlook;
An exit (eventually)
This is not an exhaustive or exclusive list, but rather a wish list of items that can maximize deal value.
How to Prepare Your Company
So how does your growing company prepare for growth capital?
Institutionalize your company:
Have a board of directors
Strong corporate governance for accountability
Strong financial controls to rapidly produce reports and requested information
If you have a board, be prepared to offer board representation and inspect its composition from the perspective of an investor. On Episode 1 of Sosna’s podcast, The Platform, guest growth capital investor, Jim Gale, wants to be able to influence decisions in the companies he invests in. Investors don’t want their capital tied up with a board that is in decision-making paralysis. This happens most often with a multitude of strong personalities, lack of board experience, or representation from within the same industry. Jim provides us with an example of a poorly constructed board on The Platform.
Prepare 3-5 year financial forecasts; you can then be prepared to challenge aspects of an investors valuation of your company and its assets
Create a business plan; why do you need the money and how will you use it to grow top and bottom lines?
Find Net Present Value and define it; link to articles
Define comparable companies and do a comprehensive competitor review
Where are the Next Big Opportunities?
Orphan Drugs, and Steriles have shown resilience in their valuations: Orphan Drugs due to a lack of market competition, and steriles primarily due to the technical expertise and high startup costs required. Outside of these two segments, gene and cell therapies will be transformative and will continue to be large attractants of growth capital. The acquisition of Paragon Bioservices by Catalent or Brammer Bio by Thermo Fisher Scientific are examples of cell and gene therapy CDMOs capturing high valuation multiples due to the excitement surrounding these types of manufacturing technologies and the positive outlook for the future of these products.
If you’re seeking growth capital, we encourage to reach out to adam@sosnaco.com to discuss how our team can support your corporate and business development goals.
For more information on Growth Equity firm, Signet Healthcare Partners, visit: http://www.signethealthcarepartners.com/