I think few things could be more rewarding than investing in a company that develops a cure or effective treatment for any of the hundreds of conditions that affect millions of people with no effective treatment. But finding the right company can be fraught with risk. That’s one reason why angel and venture investors have been allocating funds to later stage companies that carry less risk.
Luke Timmerman of Xconomy and David Sable, the portfolio manager for the Special Situations Funds, each compiled a handy list of red flags that should make prospective investors in startup life science companies pause. Here are six of them.
Results that can’t be reproduced This is one of the biggest problems with biotechnology companies in the early stages. A recent report published by Science drew attention to the issue. It said reproducibility and quality issues have been widely cited as barriers to drug development, according to the report. Timmerman refers to a study published in Nature, in which only 11 percent of results from 53 published biology papers could be reproduced. Other publications and reports have called attention to the issue (here, here and here).
Denial isn’t just a river in Egypt Competition, reimbursement question need to be addressed by management. It’s a good sign if they can identify how many other companies are targeting the same indication and what their drug will add to it. If the CEO says something to the effect that it has no real competition, it bears closer examination. Also, it may seem a little early to address reimbursement concerns, but it’s a source of increasing concern especially when the dust settles from the changes underway as part of healthcare reform. Ashley Dombkowski, a managing director with San Francisco-based Bay City Capital told Timmerman:
“In an increasingly consumer-driven system, price transparency for patients and caregivers will be ubiquitous, outcomes will be measured with unforgiving precision, and comparative assessments of value will be the rule not the exception. The company’s product better be able to stand up.”
What’s the focus? Timmerman makes a good point that it’s better to invest in a company that is developing a drug for an unmet need such as pancreatic cancer rather than try to compete with many other companies for a non-essential medication with a big patient population.
Who are the investors and who is associated with the company? This can be something of a double-edged sword. Is it attracting investment from some notable angel investors or venture capital firms? That’s a good thing, obviously. But on the other hand, VCs can also hurt a company. Vinod Khosla noted at the Tech Disrupt conference in September that most venture investors can add negative value in the advice they give to startups and counted himself among them. “I give them advice, but I tell them what I’m uncertain about. I’m confident that I screwed up more often than most people in this room. Hopefully, I can advise entrepreneurs to avoid mistakes. But you can never be sure if you’re trying something new and unreasonable.” Early stage companies are getting more and more support from big pharma, so that can be a great vote of confidence.
CEO gets rattled by questions Sable points out it’s a bad sign when questions from investors that force the company to drop the sales script provoke a bad reaction. It’s not pretty to witness either.
When CEO can’t answer basic questions If he or she can’t answer what should be basic, and important questions such as the company’s expected cash burn with a direct answer that can be a big red flag, Sable notes. “You are asking for millions or tens of millions of my investor’s money — give me a straight answer.”