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Overcoming the bottlenecks in financing young biotech companies

Experiences from the Munich Cluster

Diplomarbeit 2007 77 Seiten

BWL - Investition und Finanzierung



1 Introduction

2 Definitions, Characteristics and Classifications
2.1 Biotech
2.1.1 Business Segments
2.1.2 Business Categories
2.1.3 Business Models
2.1.4 Business Framework
2.2 Young Companies
2.2.1 Company Formation
2.2.2 Growth and Challenges
2.2.3 Specific Characteristics of Young Biotech Companies
2.3 Financing
2.3.1 Models of Entrepreneurial Finance
2.3.2 Business Angels / Family Offices
2.3.3 Venture Capital
2.3.4 Subsidies
2.3.5 Other Financing Instruments and Sources
2.4 Munich Cluster
2.4.1 BioRegio Contest
2.4.2 Current State of the BioM Region

3 The Challenge of financing young biotech companies
3.1 Risks and Resultant Financial Implications
3.2 Biotech Financing Cycles
3.3 The Eminence of a Current Bottleneck

4 Experiences from the Munich Cluster – Interview Analysis
4.1 Scope, Sample and Sequence of Interviews
4.2 Financial Sector Activity
4.2.1 Specifications of the Bottlenecks
4.2.2 Drivers of the Bottlenecks
4.2.3 Starting-Points to Improve
4.3 Financial Cluster Activity
4.4 Financial Company Activity
4.4.1 Financing Strategy
4.4.2 Financing Status Quo
4.4.3 Financing Lessons Learned
4.5 Financial Investor Activity
4.5.1 Investment Peripherals
4.5.2 Investment Criteria
4.6 Interview Results and Evaluation

5 Tackling the bottlenecks
5.1 Elements of a Successful Financial Strategy
5.2 Endogenous Strategies - Avenues for Biotech Companies
5.2.1 Big Money Model I: Biotech Venture Capital
5.2.2 Big Money Model II: Co-operations and Alliances
5.2.3 Low Budget Model
5.3 Exogenous Strategies - Avenues for the Framework
5.3.1 Cluster and Regional Strategies
5.3.2 National Strategies
5.3.3 General Societal Strategies
5.4 A comprehensive Biotech Financing Cycle

6 Summary and Outlook


Figure 1: The financial biotech gap

Figure 2: Biotech Company Analysis: Usage of different financial sources for growth

Figure 3: Implications of the service level intensity

Figure 4: Suggestion of a comprehensive biotech financing cycle


Table 1: Process of (bio-pharmaceutical) drug development

Table 2: Forms of Company Formations

Table 3: Risks and Costs of (bio-pharmaceutical) drug development

Table 4: US Biotech VC Investments over time

Table 5: Summary and comparison of major interview findings


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Interview Questionnaire for biotech company executives

Interview Questionnaire for biotech venture capital investors

Interview Questionnaire for other biotech industry experts

Interview Protocols are not publicly disclosed

1 Introduction

We live in the so called “biotech century”[1]. Biotechnology has become an important part of our modern society. It plays a key role for medical and environmental improvements and by its commercialization “biotech” also has material economical impact. Thus, it is crucial to fully understand its drivers and processes - from both a socio-economic as well as an academic perspective. Within this scope, adequately financing the major players of this industry, the predominantly young and highly-innovative companies, is a major factor of success.[2]

Now then, why is it relevant to specifically look at these young biotech companies – as suggested by the title of this thesis? Precisely because financing young biotech companies might indeed be special: there are unique characteristics of the industry, the companies embedded, the people involved and the investors attracted, which at least justify a deeper look into the unique challenges of that very group of companies. This analysis is the first objective of this thesis.

Furthermore, empirical evidence shows that start-up firms play an important role for the advancement of the biotech industry, mainly due to their function of serving as a technology-transfer mechanism to bring research from the academia to the marketplace.[3] In so far, it could be justified to pick out this specific sample. Moreover, in this regard it is widely acknowledged that “since the year 2002 a financial gap for the young biotech industry [in Germany] is existent. … But the young biotech companies need financing for the very long-term R&D phases, before first returns can be achieved[4]. So, it may also be justified to reveal possible, typical and specific bottlenecks in financing young biotech companies. This advanced analysis is the second objective of this thesis – and leads to the formulation of the research question:

In the case of occurrence of specific bottlenecks in financing young biotech companies, where are these bottlenecks rooted in and how is it possible to overcome them?

Stating as well as answering this question has both academic and practical relevance. From a practical point of view the answers might be used to re-think and re-design the current processes: be it the affected company, be it the interested investor or be it the regional or national administration, this analysis may be a good starting point for developing hands-on improvements. From a theoretical point of view, the profound understanding of this specific situation is worthwhile for a well-defined reason: it is a virtually perfect example of the complex interaction of totally different disciplines: (natural) science, entrepreneurship and finance. Individually, these fields are extremely broad and extensively covered by researchers and academics around the world. Taken together and combined, the previous work and the resultant publications are manageable, though.

The underlying topic, financing young biotech companies, was recently addressed by Thalmann’s doctoral thesis. Within that, he provides a good overview of the state-of-science of this general topic[5] and further gives first indications of a possible bottleneck. So he notes: “the (Venture Capital) investors … have tightened the requirements for financing [young biotech companies]. They are switched over to predominantly finance … late-stage biotech companies.”[6] Since then, several semi-academic articles[7] and very recently the enlightening but only financing-touching book “Science Business”[8] were published. The profound examination of the current bottlenecks, its drivers and solutions, however, are not yet comprehensively academically covered.

Moreover, the underlying structures are broad and complex and my discussion here is necessarily limited in scope. To deal with this challenge, I will focus my elaboration on a specific region: Munich. This approach on the one hand brings in a specific (and desired[9]) regional coloring, and on the other hand it allows conducting personal, qualitative interviews. Since the research question is under-stood as an open question, it is scientifically adequate to use qualitative interviews to generate insights and suggestions how to deal with the bottlenecks, using the wide knowledge of the respondents. Accordingly, three different groups of interviewees (biotech executives, biotech venture capitalists and external biotech industry experts) were chosen to obtain a comprehensive overview, to detect all important drivers and to deduct a preferably exhaustive roadmap. This analysis is consistently complemented with the results of an extensive literature inquiry.

To fulfill the objectives and to make it easier and more interesting to follow, I will structure the text according to a generic outline: first, major definitions and further specifications of the subject will be given and the underlying and complex structures will be described (chapter two). Second, the individual pillars will be combined (“financing”+”young”+”biotech”→”challenge”) and the basis for the elaboration of the research question will be provided (chapter three). Third, as a major part the qualitative interviews (“Experiences from the Munich Cluster”) will be structured, analyzed and evaluated, which provides empirical response to the research question (chapter four). Fourth, the hints, insights and impulses of the interview analysis will be taken on and will be combined with additional ideas to develop different strategies to overcome the bottlenecks (chapter five). Fifth and concluding, all findings will be shortly summarized (chapter six).

Accordingly, I will start with the theoretical background:

2 Definitions, Characteristics and Classifications

Taking the title “overcoming the bottlenecks in financing young biotech companies”, it becomes obvious that different aspects altogether create a challenge which can only jointly be met. However, as a first and necessary step it seems to be useful to deconstruct these different aspects and to individually unplug its drivers. For this reason, the thesis’ “pillars” “biotech”, “young companies", “financing” and supplementary “Munich cluster” will below be examined. Thus, I will begin with the first pillar of this thesis[10]:

2.1 Biotech

The primary aspect to be discussed is the biotech scene. I will start with introductory definitions, follow on with a description of general industry segments, categories and models and conclude with a look on the industry framework.

So, what is “biotech”? Since biotechnology, or short biotech, is a rather diffuse collective term, many different definitions can be found in the literature. The most common used definition of biotechnology in the European landscape is deliberately broad. It covers all modern bio-techniques but also many traditional or borderline activities and is published by the OECD: “[biotechnology is] the application of science and technology to living organisms, as well as parts, products and models thereof, to alter living or non-living materials for the production of knowledge, goods and services.”[11]

This definition stresses the fact that biotechnology is not only a field of research but an important economic enabler for growth by creating new and innovative goods and services. It is important to emphasize that products itself are not the biotechnologies’ defining characteristics. Paugh/Lafrance for example state: “biotechnology is not defined by its products but the technologies used to make these products. Biotechnology refers to a set of enabling technologies by a broad array of companies in their research, development and manufacturing activities”[12].

Link finally states that “in all likelihood, current definitions of biotechnology will increasingly be modified as what is now the biotechnology industry becomes embedded within other industries”[13]. In so far, the different definitions and its evolution simply show the dynamics of this economic sector.

Despite the multitude of definitions, the major basic characteristics of the biotech industry can be described: the biotech industry is, according to Zucker et al. a “preeminent example of an industry undergoing very rapid growth associated with radical technological change initiated in academe and based on basic science breakthroughs[14].

How does the picture look like in Germany? In 1995 there existed about 70 biotech companies, whereas today – dependent on the definition – 350 to 600 biotech companies can be counted, which marks the top position in Europe.[15] One of the major characteristics of Biotech companies is the high expense-rate for research and development (R&D), which comes along with a high rate of employment of highly skilled and highly paid researches. According to a study, conducted by Achleitner/Klöckner for the European Private Equity & Venture Capital Association, the average VC-backed biotech company has R&D expenses of €7.3m (which is more than the double amount of the study’s average company) and a ratio of 74% of R&D employees to total staff (which is far above the study’s average of 33%).[16]

Continuing and according to Heidenreich et al.[17] we can distinguish three main differentiating characteristics for biotech companies: the business segments, categories and models[18], which will be characterized as follows:

2.1.1 Business Segments

As one of the major characteristics the biotech industry can – generally speaking – be subdivided into “color” segments: the so called “red”, “green”, “grey” and sometimes “blue” biotechnology.[19] The terms refer to the products and processes the companies deal with and might differ remarkably in their economic conditions: market volume, social acceptance and – importantly for this thesis – financial requirements and options. One should mention, however, that this theoretical clear distinction cannot always be drawn in reality since companies may be engaged in different markets and might even develop products or offer services for more than one segment.

First, the “red” biotechnology comprises all medical applications, drug development and additionally the generation of agents via genetically modified animals.[20] As a result of the time and capital intensive drug development process, companies of this segment typically show negative cash flows for many years after their foundation[21]. Hence, this segment and the pharmaceutical activities will be under special surveillance for this work, since its companies show the highest financial needs and bottlenecks due to the highest product development risk at hand. Second, the “green” biotechnology comprises all biotechnological applications in the agricultural sector. Third, under the term “grey” biotechnology (which is increasingly also referred to as “white” biotechnology) all applications and developments in environmental protection as well as bio-process-technology are subsumed. Lastly, the “blue” biotechnology comprises all applications of ocean biotechnology.

2.1.2 Business Categories

In separation from the named segments Heidenreich et al. further distinguished three major categories, based upon clusters of business purpose[22] and size.

The companies, subsumed under the category I, are called “Entrepreneurial Life Science Companies (ELISCOs)”[23] and are typically small and medium-sized companies, whose only purpose is to commercialize modern biotechnological applications. A major determining characteristic for all companies of this category is the reliance upon inventions and innovations, which can be proven by e.g. a high rate of patents and patent registrations. Moreover, a high employment rate of researchers, a clearly communicated growth strategy and high financing needs (“cash burn rate”) are important but not exclusive characteristics. Due to the extraordinary high finance needs, “category I companies” will be the focal research objects of this thesis and the conducted analyses and evaluations.

“Extended Core Companies” are small and medium-sized companies of the category II. In separation from category I, these companies do not fully fulfill the criteria described before, or do not generate more than 50% of sales with applications and processes of modern biotechnology. Finally, under the category III, all big companies of the life science industry (> 500 employees) are subsumed. Here, especially all pharmaceutical, chemical and nourishment companies, of which many are global or multinationals, can be listed. Due to the size and the typically high focus on market applications, these companies generate a major percentage of the global biotech products sales.[24]

One should add that, from an industry point of view, usually companies of all three categories are closely linked together. Typically, companies of the category I are highly focused on capital intensive research on innovative processes, technologies and products and tend to sell to, license to or co-operate with companies of the category III, which do have extensive market know-how. Companies of the category II are often supplier or sub-contractor for the other category companies or tend to develop products and offer services for niche markets.

2.1.3 Business Models

Besides the characteristics described before, many different classifications of biotech business models exist. However, in theory one can distinguish two main types of biotech models, as well as a hybrid model with characteristics of both types.[25]

The product business model aims to generate value in developing drugs and either taking them to the market itself or licensing them out to pharmaceutical and top-tier biotechnology companies.[26] Following this model offers the highest (financial) returns in case of a self-developed and approved blockbuster drug. On the other hand, it is the model associated with the highest risk within the biotech industry, since the uncertainty of drug approval and technical difficulties can only partly be mitigated throughout cooperation and diversification.[27] As 19 of the top 22 biotechnology companies in the world with market capitalization in excess of US$3bn are classed as product companies[28], the product business model is considered a proven model.

During the last years the “platform or tool business model” gained popularity especially among European biotech founders and venture capitalists[29], although it has been around in other high-tech industries for some time[30]. As a mean to reduce the risk of the classic business model, companies of the platform model focus on licensing, subscriptions and services and further biotech related activities like e.g. contract research, bio-informatics or consulting. This model allows generating early positive cash-flows and prevents the companies from the high risk of failure in drug development and approval. However, investors sometimes doubt the ability to generate sustainable value (i.e. margins and market size) with this model.[31]

The third model combines the two pure models and therefore it is often called “hybrid”, since it “generally constitutes a platform technology capable of generating a pipeline of products”[32]. In so far it often is an evolution and alteration of an existing pure business model, either used as adding value potential to a platform technology or used for spreading risk and minimizing costs compared to a straight product orientation.[33] Due to these advantages, Fisken and Rutherford argue that the hybrid biotech business models will become the dominant strategy for the future[34]. Besides the previous mentioned biotech business models, sometimes “supplier” are mentioned as a model as well.[35] However, for the scope of this work, suppliers of instruments and materials for biotech companies will not be considered since they only indirectly (via their customers) have to deal with the specific risks and financial gaps reviewed in this work.

Besides describing inward-looking biotech characteristics (segments, categories and models), one should also put attention to surrounding structures:

2.1.4 Business Framework

Due to the concurrence of cutting edge technology advancement and ubiquitous human (body) impact of its products and results, the biotechnology is highly regulated[36]. So on the one hand the general law aims at regulating the (gene) technology and on the other hand, food and pharmaceutical biotechnology are regulated by industry-specific prescriptions. Due to its relevance for this thesis, I will focus on the bio-pharmaceutical drug development process (table 1).

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Table 1: Process of (bio-pharmaceutical) drug development[37]

This process covers a complex, multistage pathway from discovery to approval of medicines for patients. Although clinical testing represents the greatest share of costs, each stage in the process is time consuming, expensive, and risky. Stage-specific activities include[38]:

In the first stage, the drug discovery, researchers identify a target for a new medicine, such as a molecule believed to affect a particular disease. Then they screen (using IT) or create (using biotechnology) thousands of compounds, identifying hundreds of potential final products. While most will never be approved for use in patients, each one will be evaluated to determine potential value compared to existing therapies, complexity of large-scale manufacturing, and other factors.

The second stage is called pre-clinical testing. Candidate drugs from the Discovery stage then receive extensive testing in the laboratory and in animals to assess safety and show biological activity against a disease. In addition, chemistry tests establish a compound’s purity and stability, while manufacturing tests determine what will be involved in producing the medicine on a large scale, and pharmaceutical development studies explore dosing, packaging, and formulation.

If this phase was successful, the product candidates are approved for clinical trials. In three phases of clinical trials, teams of physicians test a new drug in patients to learn whether they are safe and effective. In Phase I, the medicine is tested for safety, safe dose range, and mechanism of action in 10 to 100 healthy volunteers. Phase II uses placebo-controlled trials, with 50 to 300 volunteers who have the disease being studied, to establish that the medicine effectively treats the disease. In Phase III, the medicine is finally tested in large trials with 1,000 to 5,000 patients to determine effectiveness and to identify side effects.

While Phase I to III studies are taking place, researchers are also conducting toxicity tests and other long-term safety evaluations, evaluating dosage forms, planning for full-scale production, designing packaging, and preparing the extensive application required for legal approval. Even with this complex process, only one out of five drugs that enter clinical testing is ever approved by the authorities. If all trials are successful, the application for the future biopharmaceutical drug is filed. External scientists and (sometimes) advisory committees review all clinical trial results and the company’s application and decide whether the data justify a new medicine’s approval for patient use. If so, the biotech-company can start marketing and producing its potential revenue generator.

Having broadly discussed the general technological and industrial background of “biotech”, I now direct the attention to the second pillar:

2.2 Young Companies

The second pillar of this thesis is the complex of young companies, entrepreneurship, venture creation and growth. So I will first define the major terms, follow on with basic models and conclude with derived challenges as well as a specification of young biotech ventures.

So, what are “young companies”? Many definitions in the area of entrepreneurship and young, high-growth companies exist and these are hardly nonoverlapping. According to Sharma/Chrisman, “there has been a striking lack of consistency in the manner in which these activities have been defined.”[39]

The term “young companies” is difficult to catch. In the common process-oriented definitions and descriptions[40] this is usually defined as “post-formation-phase” and it is generally considered to be of high importance for the survival of any kind of recently formed company[41]. Now the question should be raised, up to which age this term has merits and accordingly is commonly applied. According to Fallgatter, the exact point of time where a company can be defined as “established” (and by that isn’t “young” any more) cannot be marked-off exactly for all kinds.[42] However, in general one might say, this resembles the point when a company resolves - in the sense of Stinchcombe - its “liability of newness”[43]. Another approach would be the separation according to specific criteria[44] and determinants like industry structures, products, strategic resources or customers, which can have very different specifications.[45] Hence, usually three to five year after formal formation are referred to as the lower bound whereas the upper bound of being “young” is estimated as eight to twelve years.[46] Now the broad time frame for being a “young company” is set up. But how does it start to be a company at all?

2.2.1 Company Formation

The formation of a company is comprehensively defined by Unterkofler as a “multi-staged, interactive and interdisciplinary process, which essentially comprises all activities (planning and preparation), necessary to use an idea (of forming a company) to create a viable (in the sense of marketable) company.”[47] In so far, it is evident that the formation of a company is not simply a point of time, neither just a legal or financial act but a process. Nevertheless it is one of the first clear circumscribable milestones of a young company and often referred to as “point of no return”[48].

Founding activities can be structured and distinguished according to several dimensions and criteria. In the German literature the structure of company formation forms[49] by Nathusius serves as reference in the majority of cases. Accordingly, I will use it as a starting point, too. The dimensions are as follows:

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Table 2: Forms of Company Formations[50]

As a general note one should bear in mind that the dichotomy of each of the characteristics is referring to the very ends of the spectrum. Certainly in reality different forms in between will be found and could be described. However, as a first step the structure above can help to identify the important specifics of founding companies, particularly in the biotech sector.

The criterion structural existence distinguishes company formations which are set-up as complete new start-up, called ‘primary’ foundations, from rather re-formations, building upon a more or less existing structure. The latter are called ‘derivative’ foundations. In this category fall the different forms of company succession, the founding of holdings and joint ventures as well as company formations in the context of mergers and acquisitions (M&A).[51] Now, in the case of biotech formations typically new structures are created, concurrently often using umbrellas of technology breeding centers and technology transfer institutions.[52] So university spin-offs are typical.

The second criterion is the degree of innovation. It aims at the company concept which forms the basis of the company formation. ‘Innovative’ formations are – according to Schumpeter – the “combinations of new factors”[53]. Since material as well as immaterial input-factors are included, for the biotech industry especially the knowledge based factors (research, development, networks etc.) are meaningful examples. On the other hand, ‘imitative’ foundations typically follow existing concepts, structures and ideas or they multiply the new factor combinations in follow-up formations (e.g. in franchise systems).[54] These are not in the spotlight of this paper and can, due to the importance of a unique technology base, only hardly be adopted for the biotech scene in reality.

The third criterion, the independence of company founders refers to the personal status of the initiator and main person in charge. Here one can distinguish ‘independent’ from ‘dependent’ founders. Since the founders might still be employees of e.g. a university or research institute at the beginning of the formation process, this criterion – following the definition of Nathusius[55] - aims at the desired or planned final status rather than the current state. The class of dependent founders consists either of founders of derivative ventures (e.g. already employed by the mother company) or supporters (e.g. employed by a business development company), who perform their job by founding companies, while “independent” founders do not have such structural links. One should further add that in the case of biotech companies formations are mostly performed by a group or team of founders[56]. So, the criterion should either be applied to the dominant founder or should be taken as a description of the team composition.

Besides this description of company formation forms, Nathusius furthermore distinguished different basic company formation models[57], as alternative possibility to structure the universe of formations:

The imitating start-up is the generally dominating, basic company formation model, even though the transition to other models can occur at a later point of stage. It is characterized by a short phase of founding activity and a brief phase until the aspired size is reached. This fast development is made possible by a relative simple and lean structure as well as the low level of (product) complexity and the broad base of data and experience of similar foundations. Hence, the central aim of this undertaking is to realize the self-employment of the founder or team of founders to secure a long-term income, which strongly ties the founder(s) to its company. The imitating start-up is finally characterized by a rather short loss phase and following conservative growth rates. In other words: the precaution- and risk-prevention-principle is a major characteristic.

The high-tech start-up is typically the underlying biotech formation model. According to the criteria already discussed, it is a classic example of an innovative high-growth company formation, rather than a mean to secure a stable income basis. This model is to a far lesser extent characterized by personal ties of individual founders but instead by technology-oriented team founders.[58] To facilitate this aim high-tech start-ups are commonly set-up as legal entities which can exist and succeed without engagement of its founder(s) and its structure is more complex and alike traditional company set-ups. Further characteristics are higher market-entry barriers and a long phase of losses – which is supposed to be compensated through high growth and high yields afterwards. In other words: the risk-taking-principle is a major characteristic.

The Management Buy-Out (MBO) is the third formation model[59], which usually occurs at later stages of the company development. This is the reason why it isn’t in the main focus of this thesis and won’t be discussed further.

2.2.2 Growth and Challenges

Lippitt/Schmidt open their paper in the Harvard Business Review with the line "As a business organization goes through the stages of birth, youth and maturity, it faces a predictable series of organizational crises"[60]. They continue: "like people and plants, organizations have lifecycles". Since then, extended and controversial literature evolved on the topic of company life cycles and growth models.[61] So, after the elementary work of Penrose[62] several models were described, reaching from pure life-cycles over stage-descriptions to lastly evolution models.[63] For the scope of this thesis it is adequate to review the common idea:

The life-cycle can be described by different milestones a company reaches or is supposed to reach within its aging process, which are differentiated by changing importance of structural and functional characteristics (e.g. financials, HR, business systems, owner's personal goals, product developments).[64] Generally speaking the life-cycle theorists distinguish the phases: start-up, growth, maturity and decline/turnaround, which are used to describe different challenges the companies face. The term “young companies” will be interpreted in this thesis as the time-frame from the start-up and its proceedings’ over a phase of initial growth. Since financing is the central issue of this thesis, the point in time, when classic corporate finance instruments will be in place, is used as the time-frames concluding upper borderline.[65] The early phases all together determine a specific but comprehensive array of challenges, which often are summarized as liabilities of ‘newness’ and ‘smallness’.[66] Biotech companies, as a typical representative of high-tech ventures, additionally face ‘technology’ related challenges. Correspondingly, I will continue with challenges, determined by the very characteristics of biotech ventures:

2.2.3 Specific Characteristics of Young Biotech Companies

According to the results of the empirical study of 88 public US Biotechnology companies by Freier, these are dominantly founded by “interdisciplinary teams of scientists … and experienced managers”[67]. Another US survey reveals that “biotech companies are usually founded by members of academic institutions and/or venture capitalists”[68]. Distinct characteristics are: team formations, multidisciplinarity and a high degree of professionalism. A comparable survey for the German or European Markets is still missing; notwithstanding, the interviews conducted for this thesis confirm these findings. An important aspect is, however, that being public coinstantaneous shows a certain level of success. So this study’s list could in return be not only a description of young (US) biotech companies but of young and successful companies. This success is not always acknowledged for Germany, though. Accordingly not all desirable descriptions (i.e. professionalism, multidisciplinarity) can simply be conferred. So for instance in contrast to its US counterparts, a dominance of formations by sole scientists can be detected among the young Munich based biotech companies, as reviewed in this thesis.[69]

Another general characteristic is the companies’ “extreme dependency on its (often single) market-product or its lead product pipeline candidate respectively”[70]. Furthermore, young biotechnology companies often start and grow in clusters. The empirical study of US biotechs by Kollmer accordingly reveals that “more than two third of the companies [evaluated] come from the established biotechnology clusters”[71]. For this reason, this complex will later on more extensively be discussed in chapter 2.4.

With the basic knowledge of young companies, their characteristics and challenges, in mind, I now turn to the third major pillar:

2.3 Financing

The third pillar to be discussed is venture financing. As already used in the previous chapters, I will follow the line: definitions - general models – biotech applications.

So, what is “financing”? In this thesis different finance related terms are used: corporate finance is the basic umbrella and entrepreneurial finance the core of further evaluation. According to the Encyclopaedia Britannica corporate finance can be defined as: “the acquisition and allocation of a corporation’s funds, or resources”, whereas “the first function of corporate finance, resource acquisition, refers to the generation of funds from both internal and external sources at the lowest possible cost to the corporation”[72].

Besides the cost aspect, other factors gain relative importance if “young companies” are the matter of investigation. So Sahlman states that: „if ‘entrepreneurship’ is about relentless pursuit of opportunity without regard to the resources currently controlled and ‘finance’ is about cash, risk and value, then ‘entrepreneurial finance’ is about the pursuit of opportunities to create value”[73].

In the scientific literature and the curricula of renowned business schools, ‘entrepreneurial finance’ gained growing importance over the last 15 years.[74] It should be helpful to review the current structuring of the field:

2.3.1 Models of Entrepreneurial Finance

In the fundamental work of Nathusius different models of entrepreneurial finance are described. I will follow its underlying assumption that two different basic models can be distinguished: the ‘low budget’ and the ‘big money’ model.[75]

The first entrepreneurial finance model, the low-budget model, is based on the idea of ‘strategy follows finance’. In this case the (scarce) financing is the main bottleneck in the strategy development - and in so far limits the possibilities of the business formation. This model follows the rule “start small and either stay small or grow”. Instruments of this model can be of importance for biotech ventures as well – which will later be discussed – but usually the “start small” is difficult for research and technology oriented, capital-intensive biotech business models.

The second entrepreneurial finance model, the big-money-model, is based on the idea of ‘finance follows strategy’ and accordingly it is exactly opposite to the previous described. In this case the financing is – among other determining factors – a means to the realization of the desired or demanded greater business model and not its limitation. This is usually realized by following a top-down approach: beginning with a vision, building a concept and finally deriving the necessary funds and resources. The finance instruments vary from bootstrap financing instruments[76] over seed and venture capital to mezzanine capital and IPOs.

Due to the structure and its used instruments, this model resembles the corporate culture of established industrial companies and financial institutions. According to Nathusius this is the reason why it is preferred by experienced founder-teams and that it is furthermore a factor for the failure of inexperienced teams who might even neglect this “start big and grow” approach.[77] To conclude, this model is the basis for many biotech ventures.

As described earlier, one of the major functions of finance is the resource acquisition. Over the time, in the field of corporate finance, theory and practice developed a plentitude of financial instruments to fulfill this very purpose.[78] However, for the case of financing young companies and in particular young biotech companies, only a special set of selected financial sources and instruments play a role. Starting with classic corporate finance, all potential instruments of financing can in general either be equity or debt related. However, the (high) risk profile of the business, the short corporate history and little adequate collateral clearly favors equity instruments.[79] So in the following paragraphs in particular these instruments and their sources are shortly defined, characterized and evaluated.[80]

2.3.2 Business Angels / Family Offices

A “popular source of [outside] equity”[81] is the investment by “business angels” or “family offices”. Business angels in this context are private investors, who directly invest in their target (biotech) company without using a financial intermediary.[82] These investors may range from family and friends to extremely wealthy individuals, managing their own money. If this management is done for a whole family, the newer literature talks about family offices.[83]

It is difficult to obtain data on the size of the angel financing universe. Depending on the definition of “business angels” the empirical results vary from 25.000 € to “typically below 500.000 € per [average financing] case”[84]. This shows - whatever number is taken - the almost exclusive appropriateness for relative early stages of development or a contribution in a finance syndicate. Nevertheless exceptions exist and the impact of wealthy individuals and families for the biotech industry can be substantial: for instance Dietmar Hopp, one of the founders of the software company SAP, is said to have personally invested more than EUR 200m in the German biotech industry over the last two years.[85]

2.3.3 Venture Capital

Stevenson/Roberts broadly define venture capital as “a pool of equity capital which is professionally managed”[86]. Within the German tradition of being interested in sophisticated and analytical definitions e.g. Nathusius distinguishes three different notations: fhe first definition resembles the previous definition by Stevenson/Roberts, but excluding investments into public companies[87], and eventually leading to the umbrella term “private equity”. Second, “venture capital - in a broad sense” comprises all kind of equity investments for non-public companies, in which the investors takes a minority stake and, besides providing mere financial funds, actively adds value to their investment. Third and finally “venture capital - in a narrow sense”, only comprises venture capital investments into small, early stage companies.[88]

An important tool to reduce the risk inherited with the investment in early stage technology companies is the use of staged financing. Gompers/Lerner note: “to ensure that entrepreneurs are making the proper investment choices, venture capitalists might stage their investment rounds at critical points in the firm’s development, such as … reaching Phase III clinical trials[89].

Besides being staged, typically venture capital investments are:[90]

- limited: the investment is typically limited for a medium time frame (3-7 years);
- exit oriented: the venture capitalist aims at realizing a substantial capital gain with the final exit (sale) of “his” investment share;
- syndicated: syndication means that the entrepreneurial company receives financing from more than one firm to share the investment and oversight;
- restrictive: venture capitalists selectively use covenants and restrictions in critical (strategic) areas to limit the potential conflicts that could arise;
- overseen: usually the venture capitalist seeks membership in the company’s board to provide oversight and strategic advice;
- incentivized: usually the company’s senior management receives (or keeps) equity ownership and incentive compensation to directly link the interest of the VC investor and the entrepreneur.

A further note should be made on the special situation for venture capital financing in Germany and in particular the Munich area. Associated with the relatively late development of the German venture capital market, its legal and structural environment was long time underdeveloped.[91] In order to promote high-technology and new venture formation, the national and state government tried to adjust the framework actively, the most since the late 1990s. Eventually Munich developed as the national capital of venture capital: in terms of offices as well as of money raised and invested.[92] However, the legal and fiscal restrictions of (biotech) venture capital, compared to UK or US law, are still eminent and subject to ongoing discussions.[93] Due to its importance, this topic will be further discussed in chapter 5.2.1.

Venture capital investments are generally speaking worthwhile for the entrepreneur for two reasons. Besides the relative high inflow of liquid funds for the foundation and growth of the corporation, the investors offer the entrepreneurs a network and know-how pool.[94] The history has shown that the VC industry has created a platform for many high-tech innovations that would otherwise have taken longer to develop or that would not have been developed at all.[95] According to the biotech industry’s complexity and its high future (revenue) potential it is well suited and interesting for VC investments.

Concluding one should also mention the new and increasingly important public-private venture partnerships, like the High-Tech Gründerfonds (HTGF). Here “the Federal German government, the KfW banking group and the industrial enterprises BASF, Deutsche Telekom and Siemens have joined together under the "Partners for Innovation" initiative and started High-Tech Gründerfonds [which] invests venture capital in young, high-opportunity technological companies.”[96] Since this pro-rate-public financed fund is not simply return-driven but specifically aims at supporting new ventures, this can partly be counted as public promotion policy. Due to its importance, I will further elaborate on this source of financing:


[1] Rifkin (1999), p. 1.

[2] Cf. Rammer (2006), pp. 32-33.

[3] Cf. Giesecke (2000), p. 210.

[4] BMBF (2005), p. 3. Compare also Ernst & Young (2006a), pp. 2-3.

[5] Cf. Thalmann (2004), pp. 15-18.

[6] Thalmann (2004), p. 258.

[7] See e.g. the GoingPublic Magazin with its special annual editions on biotechnology.

[8] Cf. Pisano (2006).

[9] This will be more precisely discussed in chapter 2.4.

[10] The terms “thesis“, “paper“, “work” and “review“ are synonymously used.

[11] OECD (2006).

[12] Paugh/Lafrance (1997), p. 21.

[13] Link (2005), p. 5.

[14] Zucker et al. (2002), p. 143.

[15] Cf. BMBF (2005), pp. 3-4 and Europa Bio (2006), p.7.

[16] Cf. EVCA (2005), pp. 24-25.

[17] If not expressed and stated explicitly, the information given in the following paragraphs 2.1.1, 2.1.2 and 2.1.3 are based upon the compilation of Heidenreich et al. (2002), pp. 4-8.

[18] The terms are hardly itself mutually exclusive or comprehensively exhaustive. However, the facts subsumized under these terms are widely agreed in the literature as being of major importance. So the author followed the terms used by Heidenreich et al. (2002).

[19] Cf. Heidenreich et al. (2002), p. 4.

[20] Cf. Heidenreich et al. (2002), p. 5.

[21] Cf. Heckemüller (2004), pp. 20-21.

[22] According to the German term „Geschäftszweck“.

[23] Compare also Ernst & Young (2002), pp. 54-55 for the classification of this term.

[24] Cf. Heidenreich et al. (2002), p. 7.

[25] Cf. Fisken/Rutherford (2002), pp. 192-194. In contrast to this holistic approach e.g. Freier (2000), pp 91-92 distinguishes 8 different “ideal biotechnology business models”.

[26] Cf. Fisken/Rutherford (2002), p. 192.

[27] Cf. Kollmer (2003), pp. 66-70.

[28] Cf. Anonymous Author (2001), p. A1.

[29] Cf. Fisken/Rutherford (2002), p. 193.

[30] Cf. Scarlet (1999), p. BE13.

[31] Schühsler (2006), p. 122 and Fisken/Rutherford (2002), p. 193 e.g. stress the success while Scheibehenne et al. (2003), p. 674 didn’t find any empirical evidence that the business model as such has high importance for the decision. This discussion will be continued in chapter 4.4.

[32] Fisken/Rutherford (2002), p. 193.

[33] Cf. Mühlenbeck (2004), p. 109.

[34] Cf. Fisken/Rutherford (2002), pp 193-199.

[35] Cf. Sal. Oppenheim (2001), pp. 6-8.

[36] See e.g. Cantley, M. (1995) for a good description of the different actors, interests and resultant restrictions in the (food) biotechnology.

[37] Own illustration, based on the idea of Freier (1998), p. 95.

[38] The following paragraph about drug development is based on Freier (1998), pp. 93-95 and Thalmann (2004), pp. 130-137.

[39] Sharma/Chrisman (1999), p.11.

[40] Cf. e.g. Bygrave (1989), p. 8.

[41] Cf. Gartner (1988), p. 26.

[42] Cf. Fallgatter (2002), p. 28.

[43] Cf. Stinchcombe (1965), p. 142.

[44] Cf. Szyperski/Klandt (1983), pp. 57-60.

[45] Cf. Hayn (2000), p. 16.

[46] Cf. Chrisman et al. (1998), p. 6.

[47] Unterkofler (1989), p. 35.

[48] Nathusius (1986), p. 19. See also pp. 16-19 for a delimitation of the term “company formation”.

[49] Cf. Nathusius (2001), p. 4.

[50] Cf. Nathusius (2001), p. 4.

[51] Cf. Nathusius (2001), p. 4.

[52] Cf. Freier (2000), p. 114.

[53] Schumpeter (2006), p. 123.

[54] Cf. Nathusius (2001), p. 5.

[55] Cf. Nathusius (2001), p. 5.

[56] Cf. Heckemüller (2004), p. 20.

[57] See Nathusius (2001), pp. 6-10 as reference and for further literature on this topic. There one can additionally find the term “innovative start-up” which serves as intermediary model, which was not further explained in this thesis due to the intended conciseness.

[58] Cf. Dodge/Robbins (1992), pp. 31-32.

[59] Formally one can distinguish between a Buy-Out and a Buy-In. For further references see Achleitner/Fingerle (2003), pp. 3-19.

[60] Lippitt/Schmidt (1967), p. 102.

[61] Good summaries of models can be found e.g. in Cameron/Whetten (1983), Hanks et al. (1993), Levie/Hay (1998), McMahon (1998) and Quinn/Cameron (1983). These provide evidence of a set of common assumptions, but also conflicting conceptualizations of life cycles and stages.

[62] Cf. Penrose (1995).

[63] Cf. Gruber et al. (2003), pp. 29-31.

[64] Cf. Churchill/Lewis (1981), pp. 32-33.

[65] Compare Thalmann (2004), pp. 33-35 for a similar approach.

[66] See Singh/Lumsen (1999) for a comprehensive overview and compilation of organizational theory findings, in particular liabilities of newness and smallness.

[67] Freier (2000), p. 114.

[68] Kenney (1986), p. 68.

[69] In chapter 4 further insights will be given.

[70] Freier (2000), p. 141.

[71] Kollmer (2003), p. 153.

[72] Encyclopaedia Britannica (2007).

[73] Sahlman (1997), p. 4.

[74] See Achleitner (2001) as a German primer on the topic and a comparison of US-German similarities and differences in entrepreneurial finance and education.

[75] Cf. Nathusius (2001), pp. 27-48. It is worth mentioning however that this description is of theoretical nature. In practice the models often aren’t clearly disjunctive.

[76] Cf. e.g. Neeley (2003) for a definition and overview of instruments.

[77] Cf. Nathusius (2001), p. 33

[78] See Brealey et al. (2006), pp. 331-410 for an omnibus description of corp. financial instruments.

[79] Cf. Nathusius (2001), pp. 17-26.

[80] This assessment follows the idea and descriptions of the paper by Stevenson/Roberts (2006). In contrast, Nathusius (2001) goes much deeper into the topic and uses a more analytic approach to structure, cluster and describe the full array of entrepreneurial finance and its instruments.

[81] Stevenson/Roberts (2006), p 3.

[82] Cf. Nathusius (2001), p. 64.

[83] Cf. Lenzner/McCormack (1998), pp. 46-48. See Kühne (2000), p. 177-190 for a more detailed review on family offices.

[84] Stedler/Peters (2003), p. 272. Compare also Roberts et al. (2000), p. 5.

[85] Cf. Hoffritz (2006), p. 1.

[86] Stevenson/Roberts (2006), p. 4.

[87] The 2006 investment of the renowned private equity company “The Blackstone Group” in the publicly traded DAX company “Deutsche Telekom” would in so far be contradictory to this definition.

[88] Cf. Nathusius (2001), p. 54. Compare also Schefczyk (2004), pp. 17-22, for a comprehensive historical overview of different definitions and a comparison of US-German definitions.

[89] Gompers/Lerner (2001), pp. 50-51.

[90] Cf. Gompers/Lerner (2001), pp. 41-59 and Nathusius (2001), pp. 53-56. See Gompers/Lerner (2000), pp. 127-202 for additional insight and empirical backings.

[91] Cf. Betsch et al. (2000), pp. 78-79.

[92] Cf. BSWVT (2006), p. 6.

[93] Cf. BioD (2006), pp. 1-5.

[94] Cf. Balzer (2000), pp. 55-57.

[95] Cf. Lerner (1994), p. 2.

[96] HTGF (2006), p. 1.


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Titel: Overcoming the bottlenecks in financing young biotech companies