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Fits & Startups: Investment Capital for Early-stage Biotech Companies

Randy Scott
Randy Scott's funding structure kept the company operating long enough to be bought by GlaxoSmithKline in 2009 for $135 million.
[Photo: Jon M. Fletcher]
In 2003, Randy Scott, president of USBiomaterials, decided to take the firm's tooth remineralization formula and spin it off into a company called NovaMin Technology. NovaMin's ingredients had proven effective at strengthening teeth, eliminating tooth sensitivity and fighting cavities, and Scott and the company's other founders thought they had a winner.

Scott, starting with just $350,000, began combing through a list of potential investors, calling as many as he could every day. "I was constantly pinging on people," he says.

Scott got a nibble from a venture capital firm, Durham, N.C.-based Intersouth Investors. The firm had the kind of resources Scott was looking for, but it told him it would consider writing a check only after Scott met a list of objectives.

To keep the company going in the meantime, Scott turned to a group of friends, acquaintances and previous investors in USBiomaterials and raised $600,000. He lumped those creditors into a limited liability company, which held a convertible note that would later turn into equity in the company.

That structure enabled his investors, as shareholders of the LLC, to elect a managing member who would speak for the group — a move that proved beneficial for both sides. "From our perspective, we got a single point of contact, and from the individual investors' perspective, they now had a little bit of leverage and clout."

As NovaMin began to ramp up production and generate sales, Scott needed another round of short-term funding. This time, he turned to his board of directors, company employees and other insiders and pulled together $760,000.

Scott structured the debt differently this time around, turning the debt into bridge notes — intended to take NovaMin to the point of profitability — that came with an interest rate and a repayment plan structured as a percentage of revenue.

Tying the payback plan to the company's revenue stream was important, Scott says. With revenue still unpredictable, he needed to avoid running out of operating funds. "If revenues are low, the payments will be low and the company will be OK, but if revenues are high, then the payment will be higher and we'll be able to afford it."

By 2005, NovaMin had accomplished the goals that InterSouth had laid out. The VC firm stepped up with the first round of what was ultimately $10 million in financing. In 2008, Harbert Venture Partners of Birmingham, Ala., kicked in another $2.5 million.

The happy ending? A year later, drug giant GlaxoSmithKline bought NovaMin for $135 million.

Funding Tips

Randy Scott, an entrepreneur with a background in brand management at Procter & Gamble and marketing for LensCrafters and Nine West, offers five tips for biotech entrepreneurs looking for startup financing.

1) Pick the right investors
Entrepreneurs often make the mistake of taking the first money that becomes available or of choosing investors who agree to take the least amount of equity in the business. Since very few biotechs survive on one round of financing, Scott advises entrepreneurs to look for patient investors with enough resources to provide funds at more than one stage. It will be hard to raise money from new investors "if the original investor isn't continuing to be committed to the deal."

2) Consider venture debt
Square 1 Bank, Silicon Valley Bank and Comerica Bank are among the few banks in the country that provide financial services to entrepreneurs and venture capitalists. "They can put together financing packages that will reduce your need to raise as much equity capital, which means you don't have to give away as much of the company," says Scott, who saved NovaMin shareholders about $1.5 million by securing debt financing from Square 1 Bank.

3) Communicate bad news and good news
Investors "are trying to do a job too, which is to invest their investors' money. They have to make decisions all the time about how bullish or bearish to be about the individual companies in their portfolio, and it's important that they know what the status is in a real candid way. I never got punished, if you will, for delivering bad news."

4) Anticipate future funding
Scott originally thought he could get by with around $2 million to $4 million but ultimately needed well over $10 million. "Start raising money or planning and acting based almost on a worst-case scenario as opposed to a best-case scenario." It's much easier to postpone an investment round than it is to pull one out of thin air.

5) Eyes wide open
Plan for negative events — slower-than-expected sales, for example — and be honest about how they may play out. "Taking a slightly negative view is much less likely to hurt you than taking a slightly overly optimistic view of things."