Stuart R. Gallant, MD, PhD

PharmaTopo recently posted on the topic of founding a pharmaceutical startup.  Today’s post looks at pharmaceutical startups from the investor’s point of view.  There are many ways to invest in the pharmaceutical sector (pharma focused mutual funds, venture capital funds, angel investments).  This post looks at angel investing and friends and family rounds.

Deciding to Invest in Startup Pharmaceutical Companies

Everyone should think carefully about their personal investment strategy.  PharmaTopo likes The Financial Times Guide to Wealth Management [1] as a good general investment guide—though it is aimed at UK residents, so Americans must extrapolate from its recommendations at times.  The guide’s author offers this commentary on angel investing, “My advice is to view such investments as ‘fun’, like indulging a hobby, and to disregard them from your overall financial resources unless they become cash again.”  That thought can serve as a caveat for the remainder of this post.

The Pharmaceutical Startup Journey

The pharmaceutical startup journey is composed of many steps.  The following table focuses on the key steps for early drug development:

A way of thinking about this is that these are a series of questions that are asked—with each question more expensive than the last to answer.  The three questions underlying pre-clinical development are:

• Discovery:  Can a committed graduate student get this technology to work?
• Confirmatory:  Can an independent researcher repeat what the graduate student did and perhaps take it a little farther?
• IND:  Can a medical treatment be designed around this drug concept which is safe enough for trial in humans?

Funding Pharmaceutical Startups

The preceding photograph depicts three stork chicks in their nest with one of their parents.  Imagine that this photo portrays the first stage of preclinical development (the safe NSF/NIH funded university nest).  To become an independent drug development project, the stork chick has to grow and stretch its wings and eventually make the first perilous attempt at flight from the nest.  In many ways, the first flight from the nest is the most dangerous point for the chick and for the drug development project.  About 50% of drug development candidates fail in preclinical development [2].

Some fail for good scientific reasons:  1) poor efficacy in in vitro and in vivo models, 2) poor stability or difficult to deliver effectively, or 3) difficult to manufacture.  But, some drugs fail because the do not receive the needed funding.  Numerous factors affect whether it is easy to find investment capital or not.  Here are just a few of those factors:

Clearly, some drug concepts are going to be snapped up by venture capital and large pharmaceutical companies.  But, that does not mean that the other drugs might not make successful treatments someday.  Consider the case of Biomarin—a successful biotech company headquartered in San Rafael, California with six FDA approved medications on the market in 2023.  The initial research that started Biomarin came out of UCLA, but without $1M of funding from the Ryan Foundation [3] (a private fund dedicated to treatments for mucopolysaccharidosis 1 (MPS 1)), Biomarin might not have succeeded in raising $11M in its first year of operation and eventually going public in 1999.  That small investment of $1M was the critical capital for all that came afterward.

The Investing Process

Venture capital firms use three techniques to manage their funds in a way that will attract investors.  Small investors can learn from these techniques.  They include:

• VCs look at a lot of deals:  Venture capitalists discuss many deals with company founders to find a good fit for the VC firms interests and strategy.  A good way for an inexperienced small investor to both see a lot of deals and get advice from more experienced investors is to join an angel investing group (see “Resources” at the end of this post).
• VCs work hard to minimize risk:  Venture capitalist look for companies with a well-developed business plan that is likely to succeed, then they work closely with the founders in execution of the plan to maximize the chance of a successful exit.  Angels with experience in pharmaceutical development and in business management can also be helpful to startup founders.  The most valuable resource that a founder has is their own time—if an angel can help the founders work more efficiently and effectively, the risk of the project can be reduced as the founders devote more effort to the critical pharmaceutical development tasks.
• VCs look for investments in which their capital multiplies the value of the company:  Venture capitalist search for companies which lack the capital to make a big leap in value, often by increasing the number of customers they serve.  Small investors can help startup pharmaceutical companies undergo a similar transition.  If the investment capital is used to conduct critical experiments or other development tasks which reduce the overall risk of the project, the valuation of the project will increase proportionately to the decrease in risk.

As an angel investor, you will meet with many companies to discuss their business plans.  A small number of these companies will be ones that you seriously consider investing in.  At that time, you will want to review the details of their business under a nondisclosure agreement (NDA).  This process is due diligence.  Key topics to consider are:

• Product:  What makes the product unique and how the benefit to the patient can be described.
• Program:  Status of key studies (in vitro, in vivo, toxicology etc.) and chemistry, manufacturing and controls (CMC) work, including a project timeline.
• Exit:  Strategies for sale of the company or bringing the product to market.
• Investment:  The type and size of investment, terms, and how the capital is to be spent.

A more expansive due diligence checklist is attached below:

If a startup continues to look like a good investment following due diligence, an angel may invest between $10,000 and $500,000.  When larger amounts of capital are required, a group of angel investors (a syndicate) can invest up to $5M which puts them into the lower end of the venture capital range.

Friends and Family

Many of us have a cousin at a research university or a pickleball partner who owns a small analytical laboratory business.  These folks may approach you with an idea for a pharmaceutical startup.  These situations are different than run of the mill angel investments—they are colloquially known as “friends and family” investments.  Here are a few suggestions:

• You have a personal relationship, but it still helps to complete due diligence.  You may be the first or one of the first possible investors that this founder has talked to.  Your feedback can be helpful to them.  Even if you are the 100^th person they have talked to, you can still help them by honestly telling them what you do or do not find investible about their idea.
• Think about how this investment will affect your relationship.  If it might sour the relationship to see the money disappear, then consider not making the investment.
• If you cannot make the investment, you may still help them in other ways.  Make suggests regarding their plan.  Perhaps, offer them assistance (office space or a loan of equipment) that are free to you but might help them get started.

Resources

There’s a scene in Martin Scorsese’s film The Departed in which Frank Costello accosts Billy Costigan in a bar:

Frank Costello:  What they are going to do is come back with some guys and kill you—which sure as you are born they will do, unless I stop them.  Do you want me to stop them?

Billy Costigan:  Is this something I can’t do personally?

One important question of investing is:  what can you do personally versus what do you need someone else to do for you?  When you need some help in angel investing, here are some resources:

• Books:  In PharmaTopo’s last post, Gordon Daugherty’s excellent book Startup Success and Antonio Garcia Martinez’s juicy book Chaos Monkeys were discussed.  Two other books to consider reading are:  1) Brian Cohen and John Kador’s enjoyable read What Every Angel Investor Wants You to Know and 2) Andrew Metrick and Ayako Yasuda’s fairly technical text Venture Capital and the Finance of Innovation.
• Angel Groups:  Angel groups provide regular meetings where investments are pitched, offer template documents that are “neutral” (neither favoring investor nor founder) which can be helpful in negotiating an investment, mentorship, and other services.  As an example, Tech Coast Angels (www.techcoastangels.com) is a well regarding group.  Their membership fee was $1800/year (not sure if it went up).  And, they have a no-fee investment fund with a $10,000 investment minimum—this allows new angels to participate in investments which have already had due diligence—a great way to get started.
• The Lead Investor:  Every pharmaceutical investment should have a “lead investor,” someone with a lot of experience in pharma and perhaps a decade of experience specifically in investing.  For a cardiac drug, this could be a former development scientist in cardiological therapies who has retired and now makes angel investments.  He or she can explain the investment to other potential investors—particularly inexperienced ones.  If you are unsure about an investment, you can always ask the founders if they have a lead investor, and will they connect you to the lead investor?
• Your Lawyer and Your Accountant:  If you are not a CPA or a lawyer, you may need their counsel and assistance.  Remember a little advice now can help avoid sorrow later.

[1] Butler, J.  The Financial Times Guide to Wealth Management, 2^nd Edition.

[2] Gallant, S.R.  “Pharmaceutical Decision Making and Fundraising,” Pharmatopo, August 6 (2022).  pharmatopo.com/index.php/2022/08/06/pharmaceutical-decision-making-and-fundraising/

[3] Kohn, D.  “Saving Ryan,” 60 Minutes, April 24 (2001).  www.cbsnews.com/news/saving-ryan-24-04-2001/

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