Growing life science companies seeking to raise capital face a wide range of options, structures, and considerations.
Friends and family, angel investors, and even some venture capital firms typically finance early-stage needs, as investors obtain equity ownership interests in exchange for potentially rewarding upside return propositions.
As companies continue to grow from a technological and clinical perspective, they may consider venture debt as a non-dilutive funding source to extend cash runway and reach key value milestones.
Over the last 15 years, the market for venture debt has grown significantly, with many different players and structures available to companies today. The current landscape offers companies significant flexibility in terms of deal size, repayment (duration, interest-only period), and cost structures (coupon, fees). Largely due to advances in technology and R&D, valuations for emerging life sciences companies have increased, while the runway to value inflection points may have decreased.
Deal Terms and Financing Partner
When evaluating a potential financing, borrowers should carefully consider the deal terms as well as their financing partner. An ideal lender will have a deep understanding of the company’s needs and timing, as well as broader market dynamics. The growth trajectory of an early-stage company is likely unpredictable, and it is important to find a financial partner who will work with the management team and other investors to manage the ongoing financial needs of the company as the business emerges.
Potential partners should also be evaluated based upon their expertise in and understanding of emerging life science and healthcare companies – specifically, the industry-specific financial, commercial and scientific challenges.
Benefits of Venture Debt
The key benefits of venture debt include:
- The least dilutive financing option – preserves control and economic upside for existing employees and investors
- Extends the cash runway of the company – supports the achievement of upcoming value milestones
- May “bridge” between equity rounds – instead of issuing equity to finance upcoming growth, the company may be able to raise equity at a higher valuation after a key milestone has been achieved (thus further minimizing dilution)
- Venture debt may used to supplement an existing equity round, allowing venture capital investors to not only leverage their investment, but preserve dry powder for future needs of the company
Traditionally, only companies who had already received FDA / CE Mark approval or were in pivotal trial stages could take advantage of venture debt. However, lenders are increasingly financing companies with early-stage technologies (Phase I or II), ongoing negative cash flows, and little or no hard collateral. To do so, these specialized lenders evaluate the following credit factors:
- Key clinical, developmental, and strategic milestones – significant value inflection points to grow the value of the company
- Quality of intellectual property – platform technology and core value proposition
- Current cash runway of company – it is recommended that companies maintain 6 to 12 months of cash runway on the balance sheet at all times
- Clinical results to date / regulatory positioning and timing
- Product pipeline – diversification and “multiple shots on goal” help to mitigate risk
The typical venture loan will have the following characteristics:
- Par amount – up to $50MM, or potentially greater with specific lenders and/or syndicates
- Total duration – up to 60 months
- Amortization structure – initial interest-only period up to 36 months, with level amortization thereafter
- Coupon, facility fee, and final payment fee – cost should be evaluated on an all-in basis
- Warrants or success fee – 2 to 4%
- Security – typically a lien on all assets, other than intellectual property; negative pledge on intellectual property (there may be other company-specific structures or carve-outs)
- Additionally, companies may be able to arrange lines of credit secured by accounts receivable, inventory, or PP&E
Fitting Debt Into the Capital Structure
When evaluating financing options, it is important to consider how venture debt can benefit the company, and how a loan facility can fit into the company’s broader operational and financial plans. Equity will always serve as the backbone of a company’s capitalization structure, but when thoughtfully deployed, venture debt can be a valuable complement, allowing companies to support ongoing growth objectives, cushion its balance sheet, and minimize dilution as the company strives to achieve its longer-term goals.