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In Capital Freeze, Some Life-Sci Startups Look for Warmth from SBIR, STTR Grants

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PHILADELPHIA — The ongoing financial meltdown is drying up traditional sources of financing for early-stage life-science companies, leading them to pursue alternatives they may not have otherwise considered, a panel of professionals agreed during a conference here last week.
 
With the IPO window shut and venture capital scarce, some early-stage companies in this region are considering pursuing federal grants under the US Small Business Administration’s Small Business Innovation Research and Small Business Technology Transfer programs.
 
“This is a value question that I think some biotech companies can start thinking of taking advantage of,” said Mel Billingsley, president and CEO of the Life Sciences Greenhouse of Central Pennsylvania, located in the capital Harrisburg. “From the entrepreneur’s standpoint, [SBIR and STTR] is non-dilutive funding. It preserves an equity stake, such as it is. … It gives you some third-party validation for your technology.”
 
Walter Greenblatt, managing director of Walter Greenblatt & Associates, a Princeton, NJ, financing services firm, said “there are more life-science deals out there competing for less capital” because investors “feel it’s really hard to justify investing in risky early-stage biotech when every blue chip stock is on sale.
 
“Even the optimists have to be concerned about how much they can put into early-stage biotech right now,” added Greenblatt, who, along with Billingsley, spoke during “The Evolution of Capital: Traditional and Non-Traditional Funding,” a panel session held Nov. 11 as part of Biotech 2008, the annual conference of Pennsylvania Bio and New Jersey’s biotechnology industry group, BioNJ.
 
Panelist Zev Scherl, general partner in NewSpring Capital, agreed, saying “the recession will eventually have a dramatic impact on healthcare and pharma and medical technology spending. I don’t think it has had one yet.”
 
Radnor, Pa.,-based NewSpring, which also has offices in Short Hills, NJ, manages more than $500 million in separate funds focused on providing mezzanine capital and equity capital to growth- and expansion-stage businesses in the life sciences and other tech- and business-service specialties.
 
That goes for private equity firms, which has hindered their ability to raise funds and forced them to limit their financing to existing portfolio companies rather than expanding their life-sci portfolios, Scherl said.
 
“I would venture to say private equity will go by the wayside because there’s no debt available to private-equity firms to do life-science deals or medical device deals unless [companies] are generating cash,” Scherl said.
 
“If you’re not cash-flow positive, you’re in a tough spot right now. If you haven’t figured out your business model yet, you’re in real trouble. It’s going to be hard to get another round done,” Scherl added. “You’re not going to get a second chance this time.”
 
Billingsley of the Life Sciences Greenhouse of Central Pennsylvanian said the squeeze on traditional financing has prompted more early-stage companies to consider pursuing SBIR and STTR grants.
 
Under SBIR, 11 federal agencies award life-sci and other tech startups first-phase funding of up to $100,000 and second-phase funding at higher maximums that vary depending on the agency.
 
STTR enables five of the 11 agencies to award tech-transfer grants of similar amounts. According to Billingsley, it is possible in some cases for entrepreneurs to gain up to $3 million in Phase II funding by matching the grant amount with their own capital.
 
Companies that are majority-owned by venture-capital firms have been excluded until now from receiving SBIR and STTR grants — a circumstance Billingsley said could change if the programs are renewed as expected next year by Congress.
 
The change is expected since the US Senate Small Business Committee approved compromise legislation in August that allowed the National Institutes of Health to award up to 18 percent of its SBIR dollars to VC-owned firms, while the other 10 agencies in the SBIR program could fund up to 8 percent. In addition, the size of SBIR and STTR awards would increase, to $150,000 in the first phase and to $1 million for second-phase grants.
 
‘Tougher, Longer, Harder’
 
“You have to look at what’s in front of you right now, but also you have to find, for five years and beyond, what your value proposition is,” Billingsley said during the panel talk. “It’s going to be tougher, longer, harder to try to work with the VC community.”
 
Recent statistics by two VC market-tracking firms appear to bear this out. During the third quarter, the amount of venture capital invested in biotech and pharmaceutical companies in the Philadelphia Metro region slid 35 percent year to year to $56 million from $86.3 million, though the number of deals rose during the period to three from two, according to Dow Jones VentureSource.
 

“It’s going to be tougher, longer, harder to try to work with the VC community.”

Dow Jones VentureSource said investment in regional medical-device companies has fallen even further during the period to nothing from $116.8 million year over year.
 
By comparison, the quarterly MoneyTree Report, released by the National Venture Capital Association and PricewaterhouseCoopers and based on data by Thomson Reuters, showed that metro Philadelphia fared much better for biotech investment, which showed the region racking up $110.3 million in seven VC deals in Q3 ’08 versus $56.8 million in five Q3 ’07 deals.
 
On the medical-device side, investment slipped to $16.6 million in two deals during the third quarter of this year from $180 million in five deals in the year-ago quarter, according to MoneyTree.
 
Companies already drawn to the region’s greenhouses, Billingsley added, may wish to finance their companies quickly through debt that can be converted into equity at a later date. He acknowledged that while the extra debt scares off many business owners, the resulting convertible debt has the advantage of not requiring an immediate valuation of the startup company — a potential boon given the drop in valuations in recent years — and typically rewards investors with a bonus or discount on shares when the debt is ready to be converted.
 
‘Tough All Over’
 
Speaking with BioRegion News after the discussion, Billingsley said the market upheaval has made the task of raising capital “tough all over,” though entrepreneurs in Philadelphia have one advantage: the presence of several groups designed to support life-sci entrepreneurs.
 
They range, he said, from state-created “greenhouse” incubators like his, to the two-decade-old Ben Franklin Technology Partners, which provides financial and entrepreneurial support to a variety of tech startups.
 
“It varies according to stage. Certainly if you are an earlier-stage company with a year’s worth of cash on hand, the goal is to be frugal with your investing, focus on building value,” Billingsley said. “But it’s perhaps a little more difficult if you are a mid- or later-stage clinical company, where the cost of clinical development may require another significant fund-raise.
 
“For the time being, as long as the VCs that have invested in these companies continue to address capital needs in a very dry period, there will be companies that will survive and get past this particular drought,” he added.
 
That could change, he said, if the capital markets stay unstable, preventing exits by going public. “You’d have a system with an awful lot [of companies] in the pipeline trying to move forward, and no way they can manage,” said Billingsley. “That would ultimately, over time, start to impact all the way back in the pipeline.”
 
That has already started to happen, he said. “Think of it as a funnel with a very small hole open right now: The only hole that’s really open to the mid- and later-stage companies are mergers and acquisitions,” Billingsley told BRN.
 
Billingsley’s greenhouse supports a portfolio of 13 companies ranging from Azevan Pharmaceuticals, a Bethlehem-based drug developer focused on the central nervous and cardiovascular systems; to InRange Systems, an Altoona-based developer of a remote drug therapy-compliance systems; to SoftGenetics, a maker of software analysis tools for genetic researchers and diagnosticians located in State College.

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