Helping unlock financial potential: exploring five strategic financing alternatives for biotech companies

In the face of economic headwinds, biotech companies are reevaluating their financial strategies. The once-booming Initial Public Offering (IPO) market has cooled, and many biotechs are grappling with lower valuations, likely influenced by the broader macroeconomic environment. As we enter 2024 amid unprecedented economic uncertainty, emerging growth biotechs (non-public entities) lacking access to capital markets can explore alternative avenues to help propel their drug program pipelines. Five strategic financing alternatives for biotechs include: 

1. Equity instruments: preferred stock and warrants  Biotechs commonly obtain capital through the sale of preferred stock. This avenue allows flexibility in payment, with investors having the option to pay some or all cash upon closing. Commitments or options for future share purchases may be tied to time, program progress, or specific milestones. Warrants, offered alongside preferred stock sales or independently, provide investors with a future opportunity to purchase stock at a predetermined price, offering a potential upside in the event of increased stock value. 

Benefits: 

• Access to capital: Equity financing can help provide significant capital at a lower cost. 

• Flexibility: Companies enjoy flexibility in fund utilization without stringent restrictions. 

• Future financing opportunities: With committed options for additional preferred stock, biotechs can help anticipate future financing and cash. 

Drawbacks:  

• Opportunity challenges: Global economic headwinds slow funding for early-stage biotechs, which can make obtaining funds more challenging. 

• Dilution concerns: Selling additional shares, especially at a lower price, may lead to substantial dilution for existing investors. 

• Loss of control: Preferred stock provisions, benefiting certain large investors, can include a guaranteed board seat or the power to halt fundamental transactions like a company sale. 

2. Strategic alliances 

Amid patent cliffs and economic challenges, many pharmaceutical companies are seeking to expand their pipelines, offering biotechs a chance for non-dilutive funding and industry-leading knowledge through strategic alliances, such as license and collaboration agreements. These strategic alliances provide varied funding structures, including upfront payments, cost reimbursement, milestone-based funding, and future royalties. 

Benefits: 

• Accelerated development timeline: Cash infusion generally accelerates clinical trials, helping prevent delays and allowing for larger trials or faster FDA approvals. 

• Enhanced knowledge: Pharmaceutical companies bring valuable insights on regulatory affairs, trial design, manufacturing capabilities and market access, benefiting the biotech’s management team. 

• Program endorsement: Working with reputable companies can serve as an assessment of a company’s technology, especially for platform companies. 

• Cost and risk sharing: Strategic alliances can help mitigate operational and financial risks, reduce costs and offer flexibility for additional drug program development. 

Drawbacks: 

• Intellectual property risks: Protecting proprietary information is often crucial for biotechs reliant on a successful drug pipeline. Contracts should be structured to safeguard assets, considering complexities upon exiting the agreement. 

• Less control over development: Joint steering committees in strategic alliances can hinder decision-making and progress due to conflicting opinions and timelines. 

• Loss of future earning potential: In commercial success, biotechs may not receive 100% of revenues, as collaborating pharmaceutical companies may sell or co-promote, which can result in royalties or profit shares based on contract terms. 

• Acquisition limitation: Alliances can hinder future merger & acquisition activity because the company who a biotech has the strategic alliance with may need to approve the transaction. 

3. Grants 

Government grants, accessible through local or national programs, can offer low-cost funding without diluting equity. Identifying programs aligning with development goals and meeting eligibility criteria is often essential. 

Benefits: 

• Low cost: Grants offer funding without the expense of equity dilution, high interest costs, or restrictive debt covenants. 

• Confirmation of science: Obtaining a grant from a reputable organization can serve as the external recognition needed to enhance attractiveness to investors. 

Drawbacks: 

• Application challenges: Grant applications can be burdensome, highly competitive, and time-consuming, with no guarantee of success. 

• Reporting requirements: Funding agencies often mandate reporting, posing an administrative burden with added efforts for record maintenance. Additionally, there may be audit requirements incurring associated costs. 

• Limited funding: Funding might not be sufficient to cover the costs of the trial, and as a result, the level of effort necessary to obtain and maintain the grant may not be worthwhile. 

4. Debt 

Biotechs can secure non-dilutive capital via debt agreements, featuring fixed repayment schedules or balloon payments. Certain agreements may also offer borrowing options tied to future milestones. 

Benefits: 

• Predictable terms: Payment schedules and upfront interest metrics are established in advance. Companies can gain clarity on the debt agreement's cost, enabling effective long-term planning. 

• Non-dilutive: Debt can allow early investors to maintain ownership share, avoiding substantial dilution from multiple equity funding rounds. 

Drawbacks: 

• Payment terms: Biotechs lacking revenue sources may defer financing needs, merely delaying the requirement for funding. 

• Interest rates and fees: Current higher interest rates and additional fees (e.g., exit fees, prepayment penalties) can elevate the overall cost of debt. 

• Stringent requirements: Lenders may decline loans due to default risk, imposing strict financial criteria that can impact business decisions like maintaining cash balances or specific financial ratios. 

• Repayment risk due to a material adverse event: Clauses designed to protect lenders can force loan repayment at an inopportune time in the event of changes to the business. 

5. Convertible debt  Convertible debt, widely embraced by biotechs, involves borrowing cash that can be converted into equity, often at the company's discretion and, more commonly, at the lender's discretion. The structure of convertible debt is similar to both equity and debt, which can offer a nuanced blend of benefits and drawbacks. 

Benefits: 

• Attractive to lenders: Convertible debt allows lenders to potentially gain future ownership without committing to a fixed equity valuation at the start. Lenders can assess the biotech's progress and enterprise value before deciding to invest. 

• Speed: Convertible debt offers a faster financing option compared to an equity round, serving as a bridge to future equity funding. This can be beneficial when a biotech requires additional capital to complete research and development, reaching a crucial point for future equity financing. 

Drawbacks: 

• Debt repayment: Debt repayment without conversion can cause financial hardship for the company. 

• Dilution: Conversion to equity dilutes existing investors, and potential dilution at a lower valuation than expected can compound this effect. 

Selecting funding alternatives 

Biotechs, in their pursuit of additional funds for vital operations and research, should carefully select their funding method based on their stage, risk tolerance, and existing capital structure. Proper diligence and legal advice are essential steps before considering any financing option.