Due Diligence primer, part 1.
The PhD/Postdoc blog series features scientists at different stages of career development as they explore and plan for their next steps. Over the course of six months, Yeonwoo Lebovitz, Anthony Franchini, Megan Duffy, and Celia Fernandez will give monthly updates on their progress. Check back every Wednesday for new posts.
Current position: Postdoctoral Research Fellow studying Microbial Disease, Immunology, and Toxicology; Fellow at Kerafast, Lead Consultant @CBETHNK
Program start date: July 2014
Institution: University of Rochester
Well, everyone, the streak is over. After quite a productive October, November and the beginning of December have reminded me just how much of a grind science is on a day to day basis, and how easily it is for career plans to start coming off the rails. So December 2016 finds me at a crossroads, and not in the most spirited of moods. I don’t want to distract from my main topic here, but I was passed over for one fellowship which would have facilitated my return to the clinical lab (only partially blowing up my IDP…door not fully closed, but sure feels less likely now), my latest manuscript has a few glaring holes I need to fix about it, we lost TWO valuable team members at CBETHNK to thesis work, and just for good measure, I’ve been sick as a dog the past week.
But enough about sad little me, there is a lot going on and plenty of things to talk about. If you haven’t heard, UC Berkeley and the Broad Institute are in court over CRISPR patents. Those of us with an interest in Intellectual Property law and life science have been buzzing about it for some time. McKinsey and Co just published an interview with Bruce Booth, on Unleashing the Power of Entrepreneurship in Science. Bruce is a partner at Atlas Venture, sits on a long list of biotech company boards, and runs the Life Sci VC blog (you might recall that blog from my last post on resources). The interview is a good read, and echoes some themes I had scheduled to touch on this month: how to look at a company, understand its value, and break it down in order to recommend it to early stage investors. There are whole books written on this topic, mind you. So I won’t be getting to everything here. I just want to share my insights from the few projects we’ve worked on at CBETHNK. It’s relevant to the current project we’re working on, for some of our new group members, and hopefully, the NIHBEST readership as well.
To start off, internally, I find it easiest to assign a +/- value to each category during the due diligence process, then aggregate it all in the final summary. This month, lets touch upon the following topics: The Product itself, the Team, the Business Model, and Sales. Next month I’ll tackle more aspects.
The Product: Top of the list of for any due diligence for a life sciences company is whether or not the science/product is exciting. Investors can easily understand that the drugs or biological you are producing will cure disease. High-impact and far-reaching platforms are always the easiest to pitch. If you’re pitching a new plastic for use in test tubes or a streamlined coding scheme to reduce billing errors in medicare? SNOOZE. Not saying those things aren’t important, and couldn’t make a company profitable. But they aren’t exciting for investors. The Innovation has to be there, and be somewhat ahead of where the market currently is (trying to raise money by following and not leading is never good). One also has to take into account if this product fits into current use, or will it transform/alter practice? A good idea is great, but if secondary factors also have fall into place for it to have impact, it’s less valuable (think a smartphone but no cellular network to use on). It has to address a real problem, and real people need to be willing to pay for it as a customer base. Our take: Is there a clear niche for the product? Plus. Potential breakthrough? Plus. Prevalent disease state? Big plus. Is the team/lead investors itself excited about it? Plus. Furthermore, when you break down the product/technology down, see what else could be done with it. Can be of use beyond what the current scope of the company? big plus. Is it really easy to produce? Plus.
The Team: Do they have the training and skills required to make the product reliably? Do they have the drive? Does the company have anyone noteworthy on the board? Are they mature people who are focused on this or is there time divided? If a company is started by an Ivy league or Stanford drop-out, it doesn’t mean it will become the next Microsoft, Apple, or Facebook. It could very well be Theranos. There is a lesson for everyone in the VC world from that debacle. Just because Henry Kissinger, a former Marine General (James Mattis), a former banking CEO (Kovacevich), ex-senators and Secretaries of Defense are on the board, doesn’t mean the company can’t fail or is above board when it comes to its claims. What investors should have been noting is that this board had very little if any experience with the FDA regulatory environment and any scientific and tech voices to help guide it. This should have prevented Theranos from rising so high so quickly in people’s valuation. On a smaller scale (because not every company hits the $9B USD valuation), you also have to ask how well the team works together, what their track record is (success doesn’t always breed success, but learning from mistake does), and what their attitude is. You don’t have to like someone to bet on their success, but if you as a VC/potential investor doesn’t enjoy talking to or working with them, it is much harder to pitch it to other investors. This is the part of the position where you have to judge people, which I know is uncomfortable for some. This isn’t just about a good first impression. Would you be OK giving $10,000 and not seeing it again? Do you trust them to do whats best for you and their company? Or just themselves? Our take: Be honest and objective. The Resume speaks for a lot, but it isn’t the whole story. How the CEO/board of a start-up treats you does matter. Degree/Pedigree from big name school/program? Plus. Not their first company? Plus. Already done something in this field? Plus. Board has the business experience to back up growth claims/projections? Plus.
Business Model: Every start-up needs to have one. A huge red-flag if they have nothing. Of those I’ve been privy too, I can say you won’t agree with a few of the claims the company makes in these. They tend to be very rosy and optimistic. But you’d be too if you were putting your best foot forward for investors, right? On my side, these are great for fact-checking and making sure the team isn’t coming up with numbers out of nowhere. Like a well referenced science article, you want to see references you can follow-up on, new data sources, and plenty of new information the company is providing about itself. It can also tell you about the CEO or boards ambition. How far-reaching is their plan? Is their plan to take over market share realistic? Do they have partnerships in place that will help them? Something big on the horizon? Are they placing all their eggs in one basket in any way? Our take: Business plan present? A non-starter if absent , actually. Believable timeline? Plus. Rational goals? Plus. Claiming to overtake Humira in two years but still in pre-clinical stage is not a good sign. Maybe they will unseat goliath. But being far from market and not realizing it speaks to an immature company.
Sales: As I’ve previously stated, one great benefit to working as a fellow at Kerafast has been access to some really great and knowledgeable people. It is also first hand experience working with a company with investors to answer to. First and foremost, hitting sales projections as a sign of continued progress are critical. This isn’t necessarily feasible for early-stage companies, of course. You have to have a product first or IP to market. Licensing deals, even preliminary ones, go a long way in showcasing external faith in a product or service. One also has to ask who are the customers? Are they selling to hospitals directly? Patients? Researchers like myself? Clinicians? What is their general income level? Does it have a health insurance component? If possible, current and potential customers are great resources for betting gauging the companies likelihood of success. You want to hear positive things about the cost, delivery, and product usage from people who have no financial stake in its success. Our take: Current revenue stream/in talks with a buyer? Plus. Soon (1-3 years?)? Ok. Ten years away? Bad, the market will be vastly different then. This also segues nicely with talking about exit strategies next month. Sales projections and real revenue matter a lot for what the ultimate goal is. But lets get into that in 2017!
Next month we can focus on analyzing Market Size, Deal Terms, Intellectual Property, and Exit Strategies.
P.S. Shout out to Amy Spinelli, starting an internship with the UPenn TTO soon! Happy to see my friends and readers take advantage of new opportunities and branch out!