The idea of using debt to support businesses in healthcare and life sciences tends to be viewed warily and with good reason. At MidAmerica Healthcare Venture Forum this week, GE Capital senior vice president in life sciences Joe Hammer offered up some helpful insights on the different kinds of debt available to biotech and medical device companies, from pre-revenue stage companies to more mature businesses.
Evolution of debt Debt for early stage companies has evolved from equipment based purchases which would incur debt. With the transition to more virtual companies with limited value, venture debt take the first lean on all assets, most likely carve out IP which allowed lenders to provide more cash runway. Currently there’s much more collaboration between lenders.
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Three levels of debt for life sciences Bank debt tends to come in at preclinical level from $200,00 to $10 million. Venture debt comes in after the safety profile has been established around the time of phase 2 trials or Series B financing round. Structured finance comes in post revenue after the clinical pathway has been de-risked. Companies that would tend to opt for this have raised $5 million, are looking at deals from $20 million to $100 million and have some revenue.
Why has debt financing increased in recent years? There’s been a significant decline in equity financing in the past 20 years. From 2003-2013, equity financing declined by 40 percent. In an environment where venture capital firms have less capital, private equity and other groups are moving into the asset class.
Debt financing stats In 2014, debt financing accounted for $2 billion of deals done. That was an increase of 53 percent by value over 2013. About 125 deals were done in that timeframe, a 34 percent rise. Average deal sizes increased 16 percent to $15 million.
It’s not so much a question of equity vs debt as how much of each Hammer said when it looks at evaluating deals, understanding the syndicate is really important. “What is [the management team] projecting out? In scenarios a, b, c, when do we think this company is going to run out of cash and at that point what liquidity options do they have? The number one thing we will look at are existing syndicate of equity investors. What are the reserves, what’s their investment thesis and how will that be stressed? Core of debt underwriting: what are the liquidity sources at what time and how much debt do you have outstanding?”
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The relationship amongst the lender and the equity is paramount How will the parties react in a downside case? If everything is going well, everyone is making money, the relationship is great. From a lender’s perspective you have to be able to diversify risk. Those relationships are going to build over time and you depend on them, because it is inevitable that projections will change and everyone knows it. There is inherent risk and it’s important that any lender is aligned not only with management, CEO and founders, but also the existing syndicate.
Debt isn’t a substitute for equity Debt is a vehicle to extend the cash runway. It is an important tool to give companies more time to meet clinical milestones to boost their valuation without diluting the current shareholders or founders. A good rule of thumb is $3 of equity for every $1 of debt.
