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Borrowing on Bioarrayers

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On October 10th about a hundred bargain hunters pack into the small ballroom of the Durham, NC, Holiday Inn, to munch on Danishes, sip coffee, and find a steal. Xanthon, a local biochip company, had shut its doors a few weeks earlier and its debtors hired the technology equipment auction firm Cowan Alexander to sell its assets.

As the auctioneer chants off the bids offered by those in the room and several hundred others participating via Webcast, images of the items up for grab flash across a large screen behind him: a Waters HPLC system; a Packard biochip arrayer; two Axon microarray scanners; seven Zymark Microplate Stack and Twisters; several GeneAmp PCR machines; centrifuges; enterprise servers; PCs and random computer parts; lab benches, office cabinets, reception chairs; and a three-by- four-foot cheese board — to name just a few. Within a few hours, 624 lots would go under the hammer, each at a fraction of its retail cost.

For many, events like this are an opportunity to stretch their equipment budget by snagging a bargain. But for companies like Oxford Finance, which brokered a loan of $4 million to Xanthon, it highlights the risky business of lending money to an early stage biotech company, and represents perhaps the last chance to recoup some losses.

"It's part of the risk, of course," says Alden Philbrick IV, CEO and founder of Oxford Finance. "There wasn't anything glaring that we could look back now that would have been a red flag." Besides, equipment financing might not be as glorious, but it's nowhere near as risky as what venture capitalists do: "Their investments lose seven times out of 10," Philbrick notes. In the current dreary capital market, when many young companies are struggling to survive on funds raised in sunnier times, equipment financiers like Oxford are increasingly making their mark.

"You really want to conserve your cash as much as possible, probably now more than ever," says Orchid BioSciences CFO Donald Marvin. Just a few big-ticket items such as DNA sequencers and mass specs are enough to break even a well-funded company's bank. And with the IPO door slammed shut, and the prospect of raising additional venture funding bleak, companies are looking to squirrel away whatever cash they have left.

"It would just be bad business sense to use your valuable venture capital to buy equipment," says Stuart Collinson, member of Forward Ventures, chairman of startup GeneOhm Sciences, and former CEO of Aurora Biosciences. "You can actually extend the cash life of your company by financing your equipment."

Until recently, Oxford Finance was little more than a broker, with a contract to find clients for GE Capital. But in March it entered the big league, closing a private placement of $50 million with the help of Friedman Billings Ramsey. With matching debt, that translates to a $100 million purse reserved for loans to emerging life science companies. Oxford has already loaned or committed about $70 million to more than 30 customers, and Philbrick expects the entire amount will be out by the end of the first quarter of 2003. "We anticipate continually going to the equity markets to increase the capital size of the company," Philbrick says.

Oxford, founded in 1987 and named for one of Philbrick's favorite sailing destinations on the Chesapeake Bay, is headquartered in Alexandria, Va., in the 200-year-old former Bank of Alexandria building, with its original vault door still intact.

Like the Bank of Alexandria of yore, modern banks are not the best place to finance your new company's lab, says Philbrick. "The bank's main product is taking your money on deposit. They do loans but they heavily structure them with blanket liens across the company," he says. "The cash on deposit in the bank is actually one of the company's assets. So if there is a problem, they just offset the loan balance with the cash in the bank and you end up borrowing your own money."

Oxford, on the other hand, places liens only on your equipment. "It's purely an equipment-based loan and we give them lines of credit that they can draw from over a period of usually about a year for different equipment acquisitions." If a company defaults, the most it can lose is its equipment.

Until 1996, Oxford provided financing for all kinds of tech companies. Since then, it has narrowed its focus solely to life sciences, and that, Philbrick says, gives him an advantage over his competitors: Oxford is comfortable taking risks where others would shy away.

"They know the market, they know the companies, and more importantly they know the venture capitalists that invest in those companies," says Orchid's Marvin. "And that's where they derive their degree of comfort in making an equipment line available to a startup company: by looking at the pedigree of the VC investors in the company." In fact, Oxford will not provide a loan to a company that is not venture-backed.

Before committing to a loan, Philbrick or one of his 14 colleagues studies the borrower's business plan, visits the facility, and meets with the company's CEO and CFO. "We want to understand what they're all about," says Philbrick. "And with all that information we assess what our risk profile looks like."

To further balance its risk, Oxford usually requires really early stage companies to provide an equity kicker: warrants to buy stock in the company at its most recent convertible preferred price. "Their warrant coverage is quite reasonable," says Cellular Genomics VP of finance and operations Tom Gerson, whose company borrowed $400,000 from Oxford in 2000 and another $3 million this September to finance the equipment needed to transition from developing tools to discovering drugs. Part of the recent loan went for a Micromass QTOF and about $1.4 million for chemistry R&D equipment, including a Varian NMR. "They know the equipment, they understand the biotech and genomics business, and they're comfortable lending against it," Gerson says.

Warrant coverage, however, isn't a strict requirement. US Genomics, for example, struck a deal for a $1.5 million line of credit with no equity upside for Oxford. "Our equity is very valuable to us, and so that was something we were looking to avoid," says US Genomics controller Matthew Hashem. Oxford obliged by hedging its bets through other terms of the loan.

General Options

One of Oxford's biggest competitors is a company that it introduced to the life sciences market: GE Capital, which has more than $400 million out to more than 300 firms in the space.

"The advantage with GE is the other added products we have throughout the company," says Anthony Storino, managing director of the strategic initiatives group at GE Capital Funding. "So it allows the customer to go the full cycle with us. They can start with us when they're small, maybe pre-revenue, and just move through the whole life cycle, staying with one financing company the whole time."

Oxford, on the other hand, argues that because it's small, focused, and flexible, it can provide more customized and personal service. "We certainly can be more responsive than a very large corporation can. We don't have departments that specialize in different aspects of the relationship down the road. Asset swaps, billing or collecting, or new contracts are handled by the same people as opposed to having it handed off to someone that doesn't know you," says Philbrick. "And we can do things in days that the big corporations take weeks or months to do."

US Genomics' Hashem says that the best thing to do is diversify your debt. "We have utilized GE Capital to some extent too," he says. "It's nice to keep your options open. Let's say one of the companies decides, 'Hey, we don't want to be in that space anymore.' You could be cut off immediately and that would be disastrous."

And while Oxford has the advantage of being more attentive to the customer, "with GE Capital you're establishing a relationship. Maybe they're going to participate in a future round through GE Equity," he adds.

Sometimes the best terms on equipment financing are directly through the large vendors. "It's like Ford or GMC," says Gerson. "They may make the decision to provide attractive financing so they can move product." For this reason, Cellular Genomics recently financed a MALDI-TOF Voyager and a DNA sequencer through ABI. Even with a line of credit in the waiting, sometimes vendors' offers are too sweet to refuse. Agilent's life science and chemical analysis division had a promotional program called "Divide by 12" for equipment purchased by Oct. 31, in which buyers could spread their payments over 12 months, interest free. Another program called "Advantage24" offered a 24-month lease with a buyout for 15 percent of the original cost.

Agilent also provides aggressive incentives to its sales staff for moving customers into Agilent Financial Services for financing. "The percentage of our sales we financed doubled this year and next year we expect it to double again," says Joseph Pinto, who heads rental and financing for Agilent's life science and chemical analysis group.

There are other things to consider, though, such as the administrative costs associated with sending out dozens of checks for equipment financing. "And also, clearly, the more business we give a company like Oxford, the more benefits we get in terms of rate, flexibility, or ability to expand the credit line," says Gerson. "So we would only [take vendor financing] for significant, big-ticket items where the vendor has a particularly good program."

A Borrower Be

Before heading out to get that financing to stock your new lab, take some advice from those with some experience.

Shop around. "Have discussions with at least two or three organizations. But you don't have to shop around too much to find out what's available," says Gerson.

Negotiate. "A lot of times startup companies are in such a hurry to get the financing, they'll take the initial term sheets without having a reasonable discussion about the terms," says Gerson. "These organizations are flexible. Maybe the interest rate is more important to them, but they'll flex on the warrants. Or maybe they're willing to give you 48 months instead of 36."

When a financing organization gives you a line of credit, you will be charged a commitment fee even if you don't touch a cent of it. Companies vary on what these fees are. And, yes, this too can be negotiated.

Finance rates are usually based on the three-year T-bill. The initial term sheet will often say that if interest rates rise, the borrower will have to pay a higher rate. "You should argue that if rates go down that you as the borrower should get the benefits," says Gerson. "It's a reasonable thing to request."

Always choose financing over digging into cash reserves. "The most expensive capital you can find is VC funding, because the venture capitalists are looking for a high rate of return to offset the risk of making the investment," says Collinson. "That cash should be used for things that are going to be worth a great deal in the future: hiring people and filing IP. Equipment is a means of getting there, but its residual value is typically very low and not a good use of valuable VC money."

Choose carefully. Probably most import of all, says Hashem, "are the qualitative things that are not easily measured. Like in any relationship that is critical to your business, pick your partner wisely. It could be a disaster for your business down the road if that relationship doesn't work out."

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