From "where is the money?" to "where is the money from?": Understanding capital sources and added value in early-stage biotech investing

If I had to vote on the most abused term in the VC industry, it would probably be "smart money", followed closely by calling everything "disruptive" for no reason. However, the concept of smart money is here to stay, so we should try to demystify its actual meaning, both from company and investor POVs. In this quick write-up, I’d like to offer a few perspectives on the added value of liquidity in biotech.?

Where is the money from??

Many would argue biotech and life sciences are generally some of the most conservative industries for innovation, transaction, and company building. The reasons are plentiful – there is a long history built around a steady and sometimes technologically innovation-lagging establishment. The patient-centric nature of the industry means heightened sensitivity concerning privacy, data, and regulation, as well as extremely high costs and, to be frank, increased probabilities of failure. These factors restrict rapid innovation and the creation of overnight unicorns, following a well-tested “better safe than sorry” strategy trying to minimize all possible risks throughout growth trajectories. This is where the “origin of funds” component comes in.?

VC perspective?

For VCs investing in biotech, entering promising deal allocations means having a chance to perform. The opposite, not diving into deals, is detrimental. One of the main factors in whether or not a fund secures a participation invitation is its reputation. While MP's track record is essential, the central area of evaluation is the source of the fund’s capital – mainly the origin of its LPs – as well as geography and the investors’ industry backgrounds. Some geographies have become toxic (think of Russia, Iran, etc.), and some industries are considered risky sources for raising capital (e.g., arms trade, corrupt government or corporation-related funds, etc.)

Given that the most desired rounds in life sciences are usually oversubscribed, a startup’s founders would rarely accept liquidity from VCs with questionable and potentially toxic capital origins. It’s also essential to note sources of VC capital also come in a clear hierarchical structure, with the lowest being toxic geographies and risky funding sources and the highest being institutional investors such as pension funds and large corporates. The higher up on the ladder, the more attractive the fund is to raising companies.?

Company perspective

Onboarding potentially toxic funds can hinder your subsequent fundraising in any given industry, especially one as risk-averse as biotech. In this industry, most early pre-clinical rounds (and sometimes even senior clinical ones) are raised despite uncertainty about clinical outcomes, regulatory response, efficacy, and the probability of an eventual M&A. While more “risky” VCs might tolerate these unknowns, an early toxic capital intake can kill a company’s chances to fundraise and, most importantly, get ultimately acquired by a large pharma player.

What is the value of “added value?”

VC perspective?

Being a financial investor is easy, but being a value-add investor is not. With the amount of free liquidity currently in the market, funds need more than the possession of capital to differentiate from other similar vehicles. However, the capacity for an intangible contribution in other areas can make a significant difference. To simplify, standing out beyond available capital can be boiled down to several factors being present: managing partners’ track record in investing and building biotech companies, deep industry-specific focus (think, for example, longevity in the overall biotech basket, or immuno-oncology in the general cancer treatment pool), as well as an extensive KOL and advisory network. When designing LongeVC we did so with these factors in mind. Today, our network of longevity and biotech connections and our team’s experience in biotech research and company development has proven to be valuable additions to our portfolio companies.?

Company perspective

Building a biotech or therapeutic company is notoriously difficult from an operational standpoint. Everything is challenging – accessing the best pre-clinical and clinical facilities, securing introductions to leading FDA consultants and regulatory guidance resources, contracting GMP manufacturing, attracting high-profile advisory board members – the list is endless. Sometimes, obtaining all this information can be impossible for founders to accomplish alone. Early-stage biotech VCs are viewed as partners who can provide more than capital deployment: access to their network of KOLs and infrastructure and general advisory on how to navigate various types of partnerships while venture building, where most relationships are often a costly hit-or-miss. A smart biotech founder should thus be on the lookout for “smart money” – a VC that understands the landscape, has intangible resources to deploy, and, as a team of managing partners, has preferably built something on its own.??

Finally, what is the holding strategy??

While the question seems straightforward, it has proven to be a walkaway factor in myriads of VC deals. With the source of funds being transparent, how long should the investor intend to stay??

In this case, both the VC and company perspectives align – honesty is paramount. The fund should, in all scenarios, clearly communicate its preferred exit strategy and holding period to the founders. In biotech, too short holding periods (e.g., 1-1,5 years) usually fall into the category of wishful thinking and will be perceived as very problematic in the founder’s eyes. Nobody wants a partner willing to leave the company before anything has been built. Periods that could be considered “too long” are less problematic as long as they match the nature and amount of capital invested. For example, a PE fund coming into a clinical-stage company would be perfectly comfortable staying until a liquidity event comes along (potentially 7-10 years). In contrast, an early seed fund willing to stay for a decade would be considered absurd.?

Apart from the purely financial and risk/reward profile differences, a lot has to do with the value different stage investors can provide to the company. A proper seed fund will navigate founders through the early dark waters of pre-clinical work, first infrastructural complexities, fundraising, and identifying credible advisory board members. In contrast, a senior institutional investor brings a deep understanding of M&A, managing unicorn-priced assets, and negotiating multi-billion industrial collaborations. Both are crucial in different stages, and skillsets rarely combine.??

While I hope the arguments above inspire you to dig into more detail, the overall picture is clear. In biotech, wiring money does not bring significant change. It is the intangible component of investment that makes all the difference.?

P.S. if you made it all the way to the end of the piece, treat yourself to a meme.