Pulse of the Canadian healthcare sector (Part 3): improving the funding for early stage companies
July 24, 2013
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Based on personal discussions and CVCA financing data (see Part 2 of this blog series), I conclude there has been insufficient funding available for the quality early stage Canadian healthcare companies and technologies for several years. I am going to outline my perspectives on three groups of options for improving the funding.
- Can some of the funding sources which have left the sector be enticed to come back?
- Can the funding level from some of the current sources be increased?
- Are there new sources or formats for funding?
1) Can some of the funding sources which have left the sector be enticed to come back?
- Major Canadian banks – the banks are interested in increased profitability and dividends in the short term. As an investor in Canadian financial stocks who is looking for yield to support my retirement, this is a strategy which I strongly encourage. In my opinion, it is unlikely that they would consider investing in a VC fund with considerable risk and no benefit from exits for 5 to 10 years – this is not their core business.
- Other limited partners for Canadian VC funds – limited partners for VC funds could include public and corporate pension funds, endowments, foundations, family funds and funds of funds. The major Canadian healthcare VCs have been approaching these potential LPs for more than five years with no success. Their intent was to find a lead LP willing to invest $50 million to $125 million in a preferably $200 million plus fund. Some of the pension plans might consider more risk after several more years of good returns and reduction of unfunded liabilities. If these potential LPs are not interested in the classical VC fund format, are there other fund formats which would appeal to their current risk appetite?
- Retail investors – the retail investors in the LSVC funds were drawn in by the immediate tax savings and later repelled by the poor performance. Beyond the tax savings, I do not know if many of those retail investors really understood the risk associated with these funds. With the tax savings either eliminated or reduced by governments in the short term, what would bring some retail investors back to the sector? As mentioned below, there may be some new formats potentially worth investigating.
2) Can the funding level from some of the current sources be increased?
- Governments – with the deficits being run by the federal and most provincial governments, it is difficult to ask ’please sir/madam, may I have some more’ and realistically expect that it will happen. The sector should at least be asking for transparency on the real number of dollars available and the rules. Any group asking for more funding should be very clear on what the governments wants in return, besides photo-ops. And I think it is very clear that government’s priority is new jobs.
- Industry – some pharma companies have become partners with Canadian VCs and healthcare institutions but the Canadian investments are small compared to the investments in early stage companies and in R&D agreements with academic institutions in the U.S. and E.U. My first question to all of the Canadian healthcare institutions, and governments – have all of these deals been examined to determine why those agreements were signed? Was it based on the lead researchers, existing IP on new targets, a team of chemists and biologists, an incubator facility, critical mass, co-funding, etc.? Assuming there is some kind of a pattern, is industry being offered what they want, or simply be asked to give?
- High net-worth individuals and families – In my previous blog, I wondered how these people became healthcare angels. These are not the individuals who donate $5 million or more and have their name placed on a building – those are philanthropists. These angels are investors and are looking for a monetary return. They are mostly accredited investors who have from $10,000 up to maybe $250,000 which they might invest in a new venture. Are there any formal and successful healthcare angel groups in Canada? Are these angel groups led by only one or two people with healthcare experience? Are they led by an individual impacted by a disease either personally or in a family member? Are they led by a former patient who is grateful for the care and attention or clinical outcome? Are some angels interested in high risk therapeutics and others in companies with revenues which need capital to grow? I do not know the answers but asking the questions might allow the sector and individual companies to understand how best to approach this funding group. Companies must also understand the limitations of angel investors in terms of total funding available and ability to lead subsequent funding rounds.
3) New sources or formats for funding
I am convinced that there is more funding available. I am also convinced that asking for funding from the same potential sources in the same way that has been unsuccessful in the last few years will also be unsuccessful for the next few years.
- Can philanthropists be turned into investors? Do the philanthropists know that if their donation results in a discovery with commercial potential, it may die because of the lack of early stage funding? Is there any way a group of philanthropists can create a fund or be on call to help in the first stages of commercialization? It might be as simple as holding 2% to 5% of a donation for commercialization activities.
- Can new angel networks be created, or existing ones expanded, to provide new healthcare funding?
- Retail investors do not understand biotech – genes, monoclonal antibodies, targets, the immune system, etc. Most probably have no interest in trying to understand biotech. However, most of them have heard of various diseases, and hear or read about new medical innovations at a local university or hospital. What formats can be used to get some of the retail investors back?
- The previous three points have been placed in descending order of funds available from an individual investor. If one or two philanthropist-level funders decide to create a fund or a funding network, can that then be cascaded down to include angel and retail investors? I am sure that there are legal hurdles and also time and cost hurdles – raising $2 million from one source and then the next $2 million in $25,000 pieces from 80 sources. What may be needed is a brainstorming session where all possible formats are put on the table, followed by a detailed analysis of the pros and cons of all the options.
- Can a fund be created which invests in a specific disease or technology which can be explained and sold to investors? Can this be done in a reasonably quick manner (months, not years)? How much needs to be raised so the fundraising and operating costs do not eat up too much of the capital? Can investments be done such that losses from write-offs flow through to investors?
A potential new drug to treat cancer grabs the headlines, as evidenced by the recent press coverage of a new drug targeting PLK4, CFI-400945, developed through the efforts of Toronto’s Tak Mak and UCLA’s Dennis Slamon. They have raised $40 million from grants and gifts to bring this drug to the clinic later this year. Angel and VC healthcare funding is generally focused on novel therapeutics, medical devices and diagnostics which have patent protection and large market potentials. Large potential returns are essential because the approval rate among novel cancer drugs entering clinical trials is about 5%.
I have been an angel investor in three companies – the investments in two diagnostics companies were profitable whereas the investment in a therapeutics company was a write-off. The diagnostics companies were not developing novel biomarkers or platform technologies – they were developing better versions of existing products for niche markets where annual sales could be in the several to tens of millions. The major risks for these companies were financial – raising money to reach profitability, and market – potential sales were not big enough to attract major VC funding. Both of these diagnostics companies were acquired by non-Canadian companies.
- There are many healthcare products which are commodities, for which little or no research is needed, there is no regulatory approval process (registration may be required) but quality and cost-effective manufacturing processes are critical. Provincial ministries of health probably spend billions of dollars annually on these commodities – is there any preference for Canadian suppliers (cost and quality being equal, and in compliance with international trade agreements)?
- The healthcare sector is a service sector. There are numerous private and public companies which provide healthcare services, including lab diagnostics, information technology, medical imaging, physiotherapy clinics and long term care. There are probably no ten-baggers here but I am sure there are opportunities for longer term regular cash flows, which many Canadians are looking for in this low interest-rate environment. This may not be an area for classical VC investing but perhaps one where private equity can apply its skills in consolidation and economies of scale.
There are no easy answers or simple solutions. However, repeating the same requests and complaints for the nth time is unlikely to change the result. Hopefully, some of these questions may help trigger some new thoughts on funding strategies or formats.
Note: I am on the Business Advisory Board for Bloom Burton. As a reminder, the comments in this and following blogs are my personal views and do not necessarily reflect the views of any of my current or former clients and employers.