The BIA recently published a report, Money, Momentum and Maturity, with Evaluate and the London Stock Exchange, which indicated a drop in reported seed funding in the sector in 2015. On the blog today, BIA member Midven take a look at biotech seed investment and the important role it plays in the ecosystem.

Biotech seed investment can be a difficult space to invest but it’s the foundation of bioscience innovation, spring boarding new companies into the ecosystem. Yet biology is hugely unpredictable and despite attempts to apply models from other industries, notably software development and the rise of biology accelerators, the sector remains stubbornly risky, slow and potentially extremely costly to market.

It is not all doom and gloom. Drug development is seeing deep pocketed evergreen investors back some programmes straight out of university research and fund through to phase II. Sadly, many more companies fall outside this model. Not all drugs originate in academic groups with rich translational funding and good proof of principle data pre-spin out. Diagnostic and drug biomanufacturing often fails to raise similar levels of research funding and innovations may reach investors very early. Seed investment is crucial to overcome the ‘evidence hurdle’ and avoid funding rejection.

Different biotech companies present different risks and funding requirements over their life cycle but all face a reality in which private venture finance is principally for later stage investment. The BVCA reports that between 2012 and 2014 (latest figures available) all stage healthcare investment in the UK dropped from around 21% of the total venture investment to 9%. A recent report published by the BIA and Evaluate found a 71% increase in venture financing of healthcare 2014 vs 2013. Healthcare funding is growing slower than other technologies and the BIA headlined ‘better seed financing required’, noting that 70% of the UK biologics are phase II and later. The funding shortfall is at the start of the pipeline.

How can we spur seed investment in biotech? With appropriate investment staging and inventive investment structures. Seed investors back less developed technology and may be investing without any real opportunity for technology diligence. The seed investment is the technology diligence for the richer funds that follow or for the company management reaching out to new investors at the next round. Either way there are always key points at which a technology is better validated and more attractive to less risk-averse investors. The challenge is capital efficient funding to that point.

In drug development the risk points are well tested; there are fewer for diagnostics and they may be less clear in bio manufacturing technologies. Perversely it is easier to judge risk in the sector with the greatest technology failure rate. Greater clarity on risk points helps and the lower cost in some fields encourages different types of seed investors. Ultimately seed investment is crucial and whilst the quantum varies dramatically and what is seed to some looks like a far larger investment to others, the outcome is the same: more evidence.

What’s the reward for seed stage risk appetite? If the evidence increases valuation much of the seed stage dilution challenge is managed. Even so, for some sectors the funding requirement is so great that equity alone may never offer decent multiples. Other strategies may be mixed into the term sheet to protect against dilution such as royalties or leveraging public funding. Royalties have no impact on the subsequent investors yet are familiar to industry partners. Public financing is hugely helpful. The UK govt. provides very strong support for biosciences including a variety of grants as well as seed funds such as the Rainbow Seed Fund. Imaginatively combined these offer an extremely capital efficient way of reaching those key risk points. Innovative strategies will encourage seed investors and expand the number of de-risked bioscience companies developing better medicine.