Financing Alternatives for Biotech Companies
By Tod Edgecomb, Partner, Advisory Services
We’ve all heard about the traditional financing options for biotech companies – initial public offerings (IPOs), crossover rounds, bridge loans, licenses, partnerships, grants, etc. Prior to going public, biotech companies will typically raise funds through private equity raises including preferred stock, warrants, convertible debt, or some combination thereof. In this article, we’ll discuss some less common options for biotech companies during the pre-IPO and post-IPO phases.
Prior to going public, there may be some alternative sources of financing such as crowdfunding and a simple agreement for future equity (SAFE).
The simplest and most well-known form of crowdfunding is GoFundMe, which is an example of donation-based crowdfunding. This tends to be used by individuals and non-profit entities for charitable activities.
There are other forms of crowdfunding, such as debt-based and equity-based crowdfunding. In an equity-based crowdfunding program, the participants receive shares of the business in exchange for the cash provided.
If a technology/product has appeal for the general public, the founders could consider an equity crowd funding campaign. Equity crowdfunding lets biotech startups raise money by attracting a big pool of small investors. Things to consider before pursuing this avenue are the relevance of the product/technology to the public and the company’s ability to generate a message that could easily be understood by the general public. Although it might increase brand awareness and provide free marketing, it could also be a large investment of time and effort and not provide the kind of funds the company may need.
This approach may not be the ideal way to raise substantial funding. However, it could be a useful tool for smaller biotechs or startups to acquire the necessary funding needed during the earlier stages.
A SAFE is a way for a startup or early stage company to receive committed funding without issuing actual shares of equity, which won’t occur until the Company does a capital raise down the road. The concept was introduced in 2013 when founders of pre-revenue companies were having difficulty raising their first round of funding. It’s difficult to value a pre-revenue company. SAFE agreements are a good workaround by allowing you to delay valuation until a future date while still having the ability to raise capital. The SAFE agreement converts into company shares at a later time when new investors come in and do priced rounds. It offers companies quicker access to financing relative to equity financings, as they don’t require lengthy negotiations, documentation or require agreement on the company’s valuation. In addition, since they do not come with shareholder voting rights or other control mechanisms, the owners will have less investor interference.
The entity receives cash now in exchange for the commitment to issue shares to the holder upon a triggering event, such as the next capital raise by the entity, an outright sale of the company, or an IPO. If the entity never needs to raise more capital and is never sold, the SAFE may never be converted.
This differs from convertible debt as it doesn’t accrue interest and has no maturity date. The SAFE investment could be held by the company indefinitely.
It’s a very quick and easy form of raising funds as there’s a standard form that can be used with very little editing. It also doesn’t require the entity to have a valuation, as the valuation will be determined later when an actual fundraising round occurs.
Although it represents neither debt nor equity, it is typically classified as a liability on the balance sheet as it represents an obligation by the entity to issue an unknown number of shares to the investor in the future at an unknown price.
A SAFE can include a valuation cap or a discount. The valuation cap, as it implies, puts a cap on the valuation of the entity the holder will have to pay for its shares at the next capital raise, which puts a floor on the holder’s pre-money % ownership. Alternatively, the investor may receive a discount on the price per share paid. For example, if the new investors pay $10.00 per share, the SAFE investor may pay only $8.00, receiving a 20% discount. Alternatively, the SAFE can be structured so there is no valuation cap or discount. Instead, the SAFE holder receives what’s referred to as “most favored nation status”, which means the SAFE is converted at the most favorable terms offered to investors in the next priced equity round.
If an acquisition occurs before the next capital round, the SAFE holder will have the option to either 1) receive back the money invested, or 2) convert the SAFE into shares of common stock based on the valuation cap and sell the shares as part of the acquisition. Option 2 will be more favorable if the acquisition price is more than the valuation cap.
There are some drawbacks. For example, the founder(s) may offer valuation caps that are too low and cause themselves significant dilution down the road. They may also be tempted to negotiate additional terms by using side letters, which sort of defeats the purpose of a SAFE. In addition, not using a consistent SAFE with different investors can cause problems in the future. Founder(s) should also be sure to properly factor the SAFE conversion into the capitalization table and should be very careful not to underestimate the level of dilution that may occur upon conversion. In addition, they should avoid the mistake of agreeing to a low valuation cap to in order close the SAFE quickly without considering the impact on conversion.
Once a company has completed its IPO and is registered with the SEC, some additional financing alternatives also become available. A traditional follow-on offering is always a possibility. Here are some additional options.
Private Investment in Public Equity (PIPE)
A PIPE is a private placement of securities of an already-public company that is made to selected accredited investors. This usually requires the issuer to file a resale registration statement covering the resale from time to time of the securities the investors purchased in the private placement.
PIPE transactions may involve the sale of common stock, convertible preferred stock, convertible debentures, warrants, or other equity or equity-like securities of an already-public company. Usually the issuer cannot issue more than 20% of outstanding stock in the transaction without shareholder approval and prior notification to exchanges.
There are some of advantages for PIPE transactions. They typically have lower transaction expenses and require disclosure to the public only after definitive purchase commitments are received from investors. Information required by investors is very streamlined information. The transaction can close and fund within seven to ten days of receiving definitive purchase commitments.
There are two types of PIPE transactions – traditional and non-traditional.
A traditional PIPE transaction is a private placement of either newly issued shares of common stock or shares of common stock held by selling stockholders (or a combination of primary and secondary shares) of an already-public company that is made through a placement agent to accredited investors. Investors in a traditional PIPE transaction commit to purchase a specified number of shares at a fixed price, with the closing conditioned upon, among other things, a resale registration statement ready to be declared effective by the SEC. In a traditional PIPE transaction, the investor bears the price risk from the time of pricing until the time of closing. The issuer is not obligated to deliver additional securities to the PIPE investors in the event of fluctuations in stock price or otherwise. Investors enter into a definitive purchase agreement with the company in which they commit to purchase securities at a fixed purchase price. However, funding does not occur at the time of entering into the purchase agreement. The company first needs to file a resale registration statement covering the resale from time to time of those securities by the PIPE investors.
Non-traditional PIPE transactions generally are structured as private placements with follow-on (or trailing) registration rights. Once investors enter into a definitive purchase agreement, a closing is scheduled where Investors will fund the transaction. After the closing, the company has an obligation to file a resale registration statement and use its best efforts to have it declared effective. Typically, the purchase agreement or a separate registration rights agreement outlines specific deadlines for the resale registration statement. Some PIPE transactions provide for the company to make penalty payments if the company fails to meet the deadlines set for filing or effectiveness of the resale registration statement. In the case of a PIPE structured as a private placement with follow-on registration rights, the investor will not have the benefit of a registration statement right away – this will usually go effective 60 to 90 days following the closing.
At-the-Market (ATM) Facilities
At-the-market (ATM) offerings have become very popular for publicly traded biotech companies. These offerings are more flexible and cheaper than traditional secondary stock offerings, and they can allow companies to raise money by leveraging company milestones, planned news releases, as well as upward trends in company’s share price or a broader bull market. In an ATM equity offering, a company can sell any number of just-issued shares or ones already owned at current market prices through a broker-dealer. However, this method of financing is typically not available to companies until one year after the IPO date.
ATM offerings tend to be smaller and more spaced out than more traditional follow-on offerings, where a set number of shares are sold at a set price in one lot. Shares can be sold as needed and aren’t locked into a batch and companies are not obligated to sell if prices aren’t favorable. The company sells newly issued shares through a broker-dealer at market value in small, multiple lots. They can be vulnerable to price volatility as the price at which shares are sold is not locked at any point. Shares are sold at the market value in effect at each point in time.
The utilization of an ATM is only disclosable after the closing (in the next 10-Q filing). The company must have a public float of at least $75M, unless certain criteria are met. It may be a good option for a Company ahead of major data events (awaiting results which could be positive or negative). If results are negative, the Company has already raised some funds to survive the other side. It’s faster, cheaper and more flexible than follow-on (secondary) offerings and can help avoid the actual commitment to sell stock (i.e. can avoid selling at lower prices).
Companies wanting to do an ATM need to file a shelf registration statement on Form S-3, or use a previously filed one. The Company must have been an SEC registrant with timely filing of reports required by SEC for at least 12 months prior to the filing of Form S-3. Otherwise, the Company will be forced to use a Form S-1 instead.
- No requirement to announce it; disclosure required only after the closing.
- Allows the issuer the flexibility to act according to market movement, taking advantage of rising stock prices, and alternatively setting a floor price under which sales won’t be made.
- Sales made under an ATM offering are executed immediately.
- Lower commissions than with underwritten offerings.
- Require continuous costs to keep running.
- Not preferable during a bear market or a period of stock price declines.
- Total funds raised will be smaller than a traditional follow-on offering and may not be the best choice for companies that need a lot of capital very quickly.
- Generally, only available to companies able to do a shelf filing using Form S-3 (Form F-3 for foreign private issuers) and usually not available to companies with low trading volume.
Equity Line of Credit
An equity line of credit can be a great tool for companies that want the option of raising equity capital as needed over a period of time, usually 2-3 years. Some are completed using a shelf registration statement and others are completed as private placements with an obligation to register the resale of the securities sold under the equity line.
The equity line of credit facility is entered into between a public company and an institutional purchaser, whereby the purchaser commits to purchase up to a pre-established dollar amount of the company’s shares in a series of “draw downs”, at the option of the issuer. During the term of the equity line, the purchaser is committed to buying the securities at the option of the buyer, who has the ability, but not the obligation, to sell the shares during this period. The company elects to draw down under the facility, by providing a notice to the investor. The investor pays the market price of the shares less an agreed-upon discount, usually subject to a minimum price below which no shares may be sold.
There are many financing options out there. Evaluation of the alternatives and execution require extensive planning and analysis. Be sure to give it the time and effort it deserves. For more information, please contact a Marcum professional today.