These alternative funding sources can even be a better fit for some startups.
Most biotech and medtech startups are familiar with venture capital (VC) and government grants—the traditional modes of life sciences funding. However, there are a number of other ways for these startups to acquire the capital they need.
From Labiotech: “The VC model often fits drug development companies, where the outcome is either the drug gets approval and makes a big return, or it fails. Companies offering services, selling tools or developing diagnostics might start making revenues earlier, but it will take longer for them to make the 10-fol return that most VCs seek. In these cases, the VC model may not give the company a chance to reach its full potential.”
Thus, unconventional funding sources can be the right choice for some startups. Read on to learn about four different methods of startup funding besides VCs and government grants, and the pros and cons of each.
Groups like the American Heart Association and others advocate for patients with specific diseases and disorders. These groups generally work to increase funding for treatments and support legislation that is friendly to patients. Startups who focus on treating or curing one or a handful of diseases can potentially benefit from relationships with these groups and may even gain investment from them.
Large patient advocacy groups sometimes have internal research foundations. These foundations often focus on academic research, providing grants to postdocs and faculty, but some do fund industry research and development (R&D). Groups such as the Juvenile Diabetes Research Foundation (JDRF) even have their own venture philanthropy fund that focuses primarily on investing in startups with high clinical potential to aid type 1 diabetes patients. Importantly, their investment strategy includes funding companies that are focused on associated diseases and platform technologies that may be applicable.
The process for gaining access to these funds varies. JDRF for example does not have an “apply here” link or similar on its site. Rather, visitors are instructed to email for additional information. In terms of the strategy for a startup to win funding from these groups, it’s a bit different than from traditional venture capital. Traditional VC’s are more interested in the return on investment than anything else, whereas patient advocacy groups are looking for the biggest benefits to those who suffer from the disease. Of course those benefits will only come from successful companies, but understanding this nuance can help startups craft a successful pitch. Patient advocacy means that these folks want to hear first how a technology is going to help the people they serve, and then how it’s going to make money.
Pros: For companies who are focused on one or just a few diseases, working with a patient advocacy group can result in more than just funding. These groups often have connections to experts in the field that can help the startup.
Cons: The pool of potential funders is smaller since there are only so many patient advocacy groups per disease, and funding processes are not necessarily streamlined. Additionally, working closely with a patient advocacy group can make it difficult for a startup to pivot and focus on a different disease if the market or technology calls for such a change.
Sometimes grouped in with angel investors, family offices are private wealth management firms that serve one or a few ultra-high-net-worth customers. These firms provide advice on investments and philanthropy as well as legacy planning and management.
Because family offices manage the finances of ultra-high-net-worth investors, the approach can be similar to that a startup would use with an angel investor. However, the difference lies within the family office’s focus on legacy building. High net worth individuals may have an interest in financing projects that they believe will “outlive” them. While angel investors may invest to make more money or because they enjoy it, family offices frequently invest in companies as an alternative to donating to non-profit organizations. Therefore, the startups that they fund have to be well-aligned with the high net worth individual’s interests. Often, family offices will prefer to invest in biotech or medtech companies that focus on health concerns relevant to their clients.
These factors that influence family offices mean that startups have some research to do prior to seeking investment. Discovering family offices and finding out what individual high net worth individuals are interested in can be challenging, but there are ways. First, some websites list family offices and either have the list or the details of each office behind a paywall. Finding the interests of these high net worth individuals is trickier, but one method is to look at what types of causes and organizations they donate to (if they already invest, even better). If a startup matches the high net worth individual’s interests and the family office is identified, then the next step is to make contact.
Just like with a traditional VC or angel investor, warm introductions are by far the best. Second to that is any formal application or contact process that may be listed on the family office’s website. See this previous post to learn more tips on making initial contact with an investor. As noted in that post, the final and least promising method of reaching out is a cold email. However, as family offices are less-frequently contacted by startups, one might be more likely to get a response to a well-crafted email.
If a startup can get a family office’s attention, the conversations that follow need to peak the interest of the high net worth individual whose money the office manages. For a startup to successfully pitch to family offices, they must focus on these investors’ unique motivations. Storytelling is great way to do this, especially if the startup focuses on a specific disease that the investor cares about.
Pros: Family offices are often overlooked as sources of funding, so there may be less competition for investment. Good storytellers are more likely to do well here.
Cons: Finding the right family offices to reach out to can be challenging, and they tend to have less formalized processes for pitching so the startup won’t know what to expect.
Depending on the technology and business model, different biotech and medtech startups can have different ways to generate early revenue that can help fund their R&D. This is certainly not a quick-fix type of funding, but for startups who are able to get that first bit of initial capital and now need income to sustain their operations, early revenue-generation can be a great method. There are a couple of ways for startups to generate revenue, one depending on their equipment and the other on their proprietary technology. Depending on the company they might use one or both of these.
Some startups have to gain access to or purchase a piece of expensive equipment just to begin their product development process. However, they often don’t need to use the full capacity of that instrument. One way to help pay for R&D expenses is to sell the excess instrument capacity in the form of fee-for-service work. University core facilities do this by charging independent companies a fee to use their equipment when faculty are not using it. There can be some initial costs related to this method of revenue generation, such as marketing, contract management, and accounting. Plus, running samples for customers will require a time investment. Luckily there are online platforms where companies can advertise their research services, such as Scientist.com and Science Exchange. Additionally, startups within incubators may find that their neighboring companies can become customers.
The second type of startup that can consider generating early revenue is the one that must create a product as part of their R&D. For example, if a startup has to purify a specific protein in order to test their technology, they may be able to generate extra protein and sell it. There has to be a market for this product that is relatively easy to break into, and similar to fee-for-service work the startup will have to spend some time and money on marketing and administration. If the startup can manufacture large enough quantities, they may even be able to partner with a distributor that can handle the sales, marketing, and shipping side of the business.
Pros: This method of funding uses resources the startup already has and does not cost any equity. If a startup is well-aligned with this method of revenue generation it can be relatively painless. There are online platforms for fee-for-service work and distributors for products that can assist the startups to find customers.
Cons: The biggest downfall of this method of startup funding is that revenue generating activities can easily become the company’s focus if the leadership isn’t careful. For a startup that also has equity investors, activities that slow progress toward their R&D milestones can be a problem. Additionally, for services and products that have a low profit margin, pursuing this revenue stream can cost the company too much money in the short term.
Although the cost of starting a biotech or medtech company is high, it is becoming cheaper over time. Therefore, debt financing is becoming more of a viable funding option for life sciences startups. Even with limited credit history, young companies may be able to get small business loans that can cover significant costs. However, “young company” is a relative term when it comes to applying for loans. Even with a government guarantee in case of default, Small Business Association (SBA) loans primarily fund companies that have been in business for at least two years.
There are different types of debt financing, but what they tend to have in common is requiring that the startup demonstrates high likelihood of being able to repay the loan, line of credit, etc., and requiring some type of guarantee. Other than for SBA loans, a guarantee can mean using business assets or even personal assets as collateral. This level of risk may be too high for some founders. One type of debt financing that may be particularly appealing is an equipment loan. This utilizes the equipment itself as collateral, and allows the company to pay for the item over time. Some equipment manufacturers and sellers offer financing for their more expensive instruments.
If a startup chooses to pursue debt financing, it is relatively simple to access. Banks, credit unions, and other lenders advertise their business loans and have structured application processes. After researching available loans, their terms, and their requirements to qualify, it’s mainly a matter of paperwork.
Pros: Debt financing allows startups to access capital without sacrificing equity, the process is relatively straightforward, and it builds business credit. Good business credit is important for a growing company.
Cons: This form of funding is expensive because of interest payments (though those can be tax deductible). It may be difficult or impossible for a very young company to secure debt financing and may require personal guarantees by the company’s officers. Also, monthly loan payments may become a burden for a company if they are low on cash.
Unconventional funding sources can be great options for biotech and medtech companies, especially those that don’t fit the traditional VC model. Each of these sources requires a different approach and has unique pros and cons associated with it. Startups should look at these options alongside grants and VCs in order to maximize their funding potential.
Revised 11/19/2020
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