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Published 29 November 2012 05:16, Updated 29 November 2012 06:54
David Whitfield wants to raise $5 million – soon. He had hoped the $650,000 he raised from family and friends in November 2011 would last until mid-2013 but his low energy LED lighting technology business, enLighten, is “already outgrowing its cash flow”. To fund domestic and international expansion, Whitfield reckons he will be “knocking on doors” for the next year. He is encouraged by the arrival of Southern Cross Venture Partners’ renewable energy fund but realistically reckons the likelihood of him raising funding from a local source is “low”. He has tried investor speed dating in the US with no luck and is now considering teaming up with partners in facilities management-type companies that can help with sales of his lighting products for large buildings.
“We’re an innovative company and we’ll innovate where we’ve got to and if that means innovating in the way we get finance then we will do that,” Whitfield says of his four-year-old venture.
Early stage companies operating outside hot sectors such as mobile, social media and software-as-a-service are working hard to get a look-in at early stage funding.
At the same time, some venture capital funds are investigating alternative modes of investment to ensure the equity capital market can also work for these companies.
There’s a few reasons that particular sectors dominate funds invested. Thanks to the “lean” start-up way of thinking, digital and internet-enabled companies are relatively cheap to build, which speeds up the time it takes to reach a market of paying customers. For an investor, this is attractive because hopefully, it also means a quicker exit. With the rise of local incubators and accelerators such as Startmate, Pollenizer and AngelCube, which focus on start-ups, deal flow is on the rise.
In comparison, start-ups dealing with hardware or operating in the clean technology and life sciences sector are expensive to develop and are slow to market. To illustrate, the chief investment officer of Octa Philip Bioscience Managers, Matt McNamara, discusses a drug development scenario: “From Eureka! to getting a prescription from your pharmacist might be 18 years,” he says. “Not even the early stage venture capital fund is looking to hang in for that time length.”
Octa Philip is on the fundraising trail, hoping to pump up the $55 million it has raised to hit a final close above $100 million. It will be the fund manager’s second bioscience fund. But as McNamara explains, the fund uses a slightly different strategy to ensure the venture capital model suits the life science sector.
“We don’t go shopping too early in the tech development timeline,” he says. “That doesn’t mean there is no risk, it’s just reduced risk. We look at technologies that are about to enter the clinic [clinical trials] or are currently in the clinic.”
McNamara concedes this does limit the upside but he reckons it’s a more sustainable approach to venture capital in the biotechnology and life sciences sector. “When I was at an early stage VC we were looking at everything as [having the possibility] of 10 times [return],” he says. “We don’t look at it like that. Most of what we invest in has the prospect of four times and so when we do achieve that we will exit, even if we leave money on the table.”
Going after a “less risky, less aspirational but more realistic four times return” means Octa Philip is generally investing in a series B or C round. But this doesn’t provide much solace for the earliest stage biotechnology companies.
“The period which is really dangerous for young life sciences companies is year one to year five,” the chief executive of peak body Ausbiotech, Anna Lavelle, says. “That’s when they’re most vulnerable and it’s harder for them to get support.”
For biotechnology start-ups, the traditional venture capital model might not be broken “but it’s certainly limping very badly”, Lavelle says.
With most venture capital funds working on a 10 to 12 year cycle, the time taken for many start-ups to get their technology to market is too slow.
As well, limited funds raised by the VCs mean low capital deals are easier to get over the line. App developers are cheap. Medical breakthroughs are not. To counter theis “what we’re seeing in life sciences is a much higher appetite for creative financing,” Lavelle says.
Creative financing might sound like a euphemism for cooking the books but in fact Lavelle says it’s actually about initiatives such as developing partnerships with large pharmaceutical companies. So, instead of a big company funding its own research, or owning a large stake in a start-up, it could fund a start-up’s research and clinical trials in return for first bids on the resulting product.
“Small biotechnology companies are very good at managing the risks and they’re also more nimble and faster than if they are pulled into the bureaucracy of a large pharmaceutical,” Lavelle says.
She adds that there is also evidence of smaller companies “looking for revenue streams that are not their main goal”, such as a developer of technology around trans-dermal drug delivery realising their intellectual property has uses in skin care. “People are getting very clever at how they manage their small business to keep it sustainable and alive.”
Lavelle says a few venture capital funds, particularly GBS, have been supporters of the sector but laments the general lack of available capital. However, according to the Australian Private Equity and Venture Capital Association, the life sciences sector received about $96 million of new funds in 2011-12, which equated to 40 per cent of the total funds handed out by venture capital funds.
Angel investor and business development director at Sydney start-up incubator ATP InnovationsAndrew Stead is always keeping an eye on early stage investment activity. His “gut feeling” on that number is that most of the money going into life sciences, reported by AVCAL, would come from follow-on investment in portfolio companies. “Right now in the life science space, we’re at the end of a lot of funds,” he says. This means funds are into follow-on and divestment, rather than bringing in new portfolio companies.
Looking specifically at first round deals, Stead can count only three deals in companies outside the mobile, social and web sectors in 2012. Nexvet, an animal drug developer, raised $2.5 million from the Trans Tasman Commercialisation Fund, a collaboration between a number of universities. Q-Sera raised $900,000 from the Medical Research Commercialisation Fund and Uniseed to develop its serum based on the blood clotting properties of snake venom. And One Ventures made its first investment in clean technology company in January, Peak3, which is a Queensland company that measures and manages diesel engine emissions, with a focus on the mining industry.
Stead says the preference for early stage investors, angels and venture capital funds, is to back companies in sectors in which they have experience. He says there are fewer local investors with experience in the life science, clean technology and hardware sectors. He also notes the growth in accelerators and incubators has buoyed the capital raising success of the “on-trend” companies.
“In the accelerator and incubator space there’s only Ignition Labs and ATP Innvoations looking outside the mobile and web space,” Andrew Stead says.
Ignition Labs was ATP Innovations’ first attempt at an accelerator program. It chose five web and software-based companies operating in clean technology to undertake a three-month intensive program. The companies received seed funding of $25,000 in exchange for a 7.5 per cent stake. Of the five companies, one is in discussions to raise capital and another plans to raise funds on a crowdfunding platform. Compared with the most successful accelerator, Startmate, which has seen six of 13 companies raise angel or venture capital, this hit rate might seem low but Stead says that if the two Ignition Labs companies can close, he will be “extremely happy”.
For clean technology companies, the fundraising environment is “slightly more healthy at the moment” due to the creation of Ignition Labs at the bottom of the funding pyramid, followed by the GE “ecomagination challenge”, which is a $10 million joint venture between a number of funds giving out five lots of $100,000 to clean tech ideas, Stead says. Southern Cross Renewable Energy Fund offers access to larger funds. “So there’s people with an intent,” he says.
Mark Bonnar is the investment director for Southern Cross’ new $200 million fund, which has been jointly funded by the federal government and Softbank China. The fund closed its first call in September 2012, co-investing $5 million with US fund New Venture Partners, in Brisbane Materials, a spin-off company that started life at the University of Queensland. Brisbane Materials enhances the efficiency of solar panels. Bonnar says the fund will look at companies at a range of stages, so long as revenue is less than $20 million. Brisbane Materials was pre-revenue.
One of the reasons that more money is not raised by renewable energy companies, especially companies that require large infrastructure plays, is what Bonnar calls the “double valley of death”. The first valley to leap is raising money to get technology out of a research institution or the inventor’s brain and into a prototype. But the second valley, which is the more capital intensive one, is raising enough money to show the technology works on a large scale.
“Nobody wants to invest these days in something that’s not proven and de-risked,” Bonnar says. “We’ve got to take these technologies through to their scale up [phase] but then that’s the really hard bit because we don’t have the money [to fund that phase]. That’s not venture capital. That becomes first in field project finance.”
Whitfield of enLighten says the reluctance to fund outside the “lean” sectors is cultural. “Although Australians are early adopters of new technology, the finance industry does not like to invest in what they perceive as a high risk marketplace.”