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By Michael Greeley

MICHAEL GREELEY October 10, 2003 | The Q2 venture financing statistics have been compiled, and the news is not all that bad. The modest recovery in the general economic environment seems to be extending to the bio-IT sector. Both the number of companies being funded and the amount of capital raised are improving, although the figures may still mask some concerns.

Overall, the domestic venture capital industry invested approximately $4 billion in 442 companies in Q2, as tracked by VentureSource/Ernst & Young. Healthcare, which includes bio-IT, device, services, and bio/pharma firms, accounted for 105 of those companies and $1.2 billion. This is a healthy increase over the Q1 pace of 86 companies raising $0.8 billion, which, arguably, was the absolute bottom of the cycle. Bio-IT still represents a relatively small portion of this activity; only seven companies were able to raise just under $30 million.

Q2 by the VC Numbers 

$4 billion Invested in 442 companies overall

$1.2 billion Invested in 105 healthcare/bio-IT companies (vs. $0.8 billion and 86 companies in Q1)

$30 million Raised by seven bio-IT companies

$6 million Median investment amount per round

$18.2 million Average sale price of VC-backed firms

$21 million Average amount of capital invested in sold firms

Source: VentureSource/Ernst & Young LLC 
In general, these bio-IT companies tended to be infrastructure providers and vertical application developers, many of which were focused on solving data bottlenecks in the healthcare delivery system. Analytics and content aggregators struggled in Q2 to raise capital from venture investors.

The size of venture rounds reflects a much more prudent financing strategy. The median amount invested per round for all companies was $6 million (ranging from $0.8 million for seed rounds to $6.7 million for second rounds), at an average of $14.3 million pre-money valuations. This is a positive development for venture investors because it highlights that entrepreneurs are much more focused on capital-efficient strategies. Typically, early-stage companies should have a monthly burn rate that equates to $15,000+ per FTE (full-time equivalent) employee, which implies a monthly gross burn rate of $300,000. (Taking into account revenue, net burn rates of $200,000 to $250,000 are common.)

Venture investors also track the dynamics of the IPO and M&A markets. While there has not been an IPO market for nearly three years, and, arguably, there will not be another one for early-stage venture-backed companies for another two to four years, the M&A market is showing some signs of life. Although M&A activity is a good sign, these transactions are not always positive. This past quarter, the average sale price of venture-backed companies was $18.2 million, versus the average amount of invested capital: $21 million. Clearly not a great outcome for investors.


'We Saw Signs' 
Having said that, not all the news is bad. According to Jim McCord, CEO of Fast Track Systems, a provider of database solutions for clinical trial providers, "We saw signs of market improvement, as we raised $4 million from both financial and strategic investors." Though it can be a challenge just to get initial meetings with venture capitalists, McCord advises entrepreneurs to go to market with a number of milestones achieved and with a proven business model. For Fast Track, it was critical to have a strong pipeline of leads, paying customers, and a proprietary database that was not easily replicable. "Additionally, make sure you are raising enough capital, as many funds won't do small deals anymore," McCord observes.

A lot of capital has gone into the bio-IT sector lately — but not a lot has come out. McCord cautions fellow entrepreneurs to "really think through the exit scenarios, including mergers and acquisitions. A return to a strong IPO market is probably at least two years out, and extended exit time frames work against a VC's returns." McCord predicts a robust M&A market will develop because "there are just too many small companies."

Entrepreneurs often find themselves increasingly beholden to their existing investors. "We counted on strong internal support, and in order to accomplish that, we kept expectations realistic and our shareholder base simple," says Rick Salas, CEO of iLiant, a technology outsourcer to the healthcare industry. Salas successfully raised $4 million this past quarter from his existing investors to create a fully funded plan. "It was important to get as far down the path as possible before we raised additional capital," Salas says.

Working with existing investors is a balancing act. Of utmost importance is that the CEO get the company funded, recognizing the fiduciary obligation to do so at the most favorable terms and valuations for all investors. Terry Edwards, CEO of PerfectServe, a voice and data communications provider to the healthcare industry, warns that "you need potential outside investors to keep the process honest." In fact, to complete a follow-on investment, most funds require management to secure a new investor to set terms and price. Edwards says that "strategic investors are increasingly more important in later rounds as the value proposition is more clearly articulated."

So what should we conclude from the Q2 funding data? Clearly, investors are focused on firms that provide solutions to life science companies' immediate problems. Funding strategies are under enormous scrutiny, and funding "big picture" concepts will not be accepted. As signs of liquidity return to the market, and bio-IT companies can begin to show quarter-over-quarter growth, investor interest will improve. Right now, investors' appetites may be sated, but they'll be hungry again.

Michael A. Greeley is the managing general partner of IDG Ventures, a global family of venture capital funds operating in North America, Europe, and Asia, with approximately $600 million under management. He can be reached at mgreeley@idgventures.com. 



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