Entrepreneurs Confront VC Firms' Geographic Bias

by David E. Griffith, senior editor
Financing a start-up company in any field is never easy, but securing the funds to launch a neurotechnology or medical device firm is a truly herculean task. Entrepreneurs face a long road of research and development, prototyping, and testing with little guarantee of a pay off.

All of that research, testing, and staffing is expensive, way beyond the means of most individuals. So that leaves most biomedical entrepreneurs desperately seeking funding from venture capitalists at some point during the early development of their companies.

The good news for biomedical businesses is that venture funding is increasing. From 1995 to 2000 there was an unprecedented upswing in venture funding. The bad news is that much of that funding was geographically localized and that venture capitalists have a tendency to favor certain types of biomedical companies over others.

Leading Regions for Biomed Funding
Executive director of the Southern California Biomedical Council (SCBC) Ahmed Enany said it’s no secret that certain regions of the United States are blessed with biomedical venture funds and others go begging. According to Enany’s figures the L.A./Orange County area finishes a distant fifth in biomedical venture money behind Silicon Valley, New England, San Diego, and the Southeast.

Although the primary focus of Enany’s research is what he calls the "pathetic" state of venture funding for biomedical companies in Los Angeles, his findings also are of value to biomedical entrepreneurs in other geographically unfavorable regions of the country. The problem, according to Stephen O’Connor, president of the modular microfluidic componentry company Nanostream, is one of proximity. He argues that if you need venture funding for your business, it’s a good idea to start your company in an area where there are a lot of venture funds focusing on your field.

"VCs don’t like to drive to board meetings," O’Connor told a recent gathering of the SCBC. "It’s really as simple as that. They want to be able to drive 15 minutes to a board meeting, and that’s important because a start-up company has a board meeting once or twice a month." O’Connor’s assessment of the situation is blunt, "If you’re starting a biomedical business in Boise, it will be really hard to raise venture money."

Alan Kleinman, an analyst with the Encino, CA office of Pacific Venture Group, said that O’Connor’s argument is a bit simplistic and that VCs are looking for the right "opportunity," no matter the geographic distance from their home offices, but then he reluctantly adds that "all things being equal" between two opportunities, a VC is likely to invest in the opportunity closest to its offices.

Herd-Like Mentality
The issue of geographic distribution of biomedical venture funds is about much more than just the distance between a start-up company and the offices of the venture fund. "There’s a herd-like mentality among VCs," said Sidney Edwards, a principal with the Los Angeles office of TL Ventures, a Wayne, PA-based venture fund. "They tend to focus on specific regions like Boston and San Francisco and hot fields like pharmaceuticals and genomics where they have made money before."

According to Edwards and other VCs and biomedical executives, the key to bringing biomedical venture funding to a specific region of the country is a track record for the region and the entrepreneurs who operate within it. One of the things that venture capitalists look for before they fund a biomedical start-up is the presence of seasoned biomedical executives not just in the company they are considering but in the community as a whole. And what they really want is a CEO with a track record of making money for their fund. "Venture companies love to fund someone they funded successfully before," said Carolyn Siegal, senior vice president of Cell Matrix, an L.A.-based pharmaceutical development company.

Attracting VC Attention
The ready availability of proven biomedical executives is one of the reasons that San Diego has managed to attract so much VC funding. The other is the perception that San Diego is the place to be for biotech firms on the West Coast, a perception that San Diego boosters have helped perpetuate with marketing and public relations campaigns. "The perception is that [a Los Angeles biomedical company] could be more successful in San Diego," said Siegal.

But even if a biomedical entrepreneur is located in an area of the country that’s not thought of as a biomedical hotbed, he or she can still attract VC attention. It’s just the odds are against them. VCs say the best way to even the odds is by knowing how to play the game. Frustrated biomedical executives reply that they are very willing to learn how to play the game, but the rules of the game are constantly changing.

Matthew Hanson, vice president of business development at Integrated Medical Systems Inc., likens the experience of trying to please venture capitalists to Dorothy’s trials in the Land of Oz. "She spends the whole movie getting apples thrown at her by evil trees and running away from flying blue monkeys, and then when she finally defeats the Wicked Witch and takes her broomstick back to the Wizard, he says, ‘Nice job. Come back tomorrow.’ Each time you talk to the venture capitalists they tell you, ‘what you need to do is this.’ So, you do that. Then they say, ‘Oh, that’s fantastic. But what you really need is this,’" Hanson said.

The key to minimizing such frustration, according to both VCs and biomedical executives, is to find the right fund and the right principal from that fund. Of course, that’s easier said than done.

"It’s a numbers game," said Cell Matrix’s Siegal. "There are a lot of firms out there, but they don’t all fit with your company for one reason or another. It’s a relationship. It’s a little bit like dating. Why you don’t fit isn’t important. It’s more important to find a venture fund that will work with you as a partner."

Pacific Ventures’ Kleinman agrees, but adds the VC’s perspective. "We’re looking for a variety of pieces," he said. "It’s critical to find that right match, not just with a particular venture fund, but targeting a specific partner within that fund. Make sure you do your homework on the fund and the people involved."

TL Ventures’ Edwards advises entrepreneurs to be aware of the investment focus of the venture firm that they are courting. And even so, he says companies pursuing venture capital must be persistent. "It’s a business where you will end up with ‘no’ a lot of times before you hear ‘yes.’

Working with Angels
Executives of start-up companies that hear "no" from venture funds are likely to seek investment from individuals or groups of individuals, so-called "angel" investors. That can be tricky and it can result in difficulties in securing the additional financing to take a company from development to testing, or from testing to market.

O’Connor says Los Angeles is the "City of Angels" in more ways than one for biomedical companies. "We have a lot of rich people in Los Angeles," he explained. "So a lot of companies are funded by angels."

There are good and bad aspects of angel funding. O’Connor said the last company he was involved in was funded by angels and it ran smoothly and sold for $300 million. But O’Connor is also the first to say that angel financing for biomedical firms is problematic because of the amount of money involved to bring a product to market and the effects angels can have on subsequent financing. "Angel funded companies often have problems later when they pursue venture funding because of weird corporate heirarchies," he said.

Also, angel funding can be a very dynamic proposition, as many entrepreneurs have discovered in the wake of the recent stock market meltdown. "A year ago a lot of angel investors said they were in it for the ‘long haul.’ Then when the market tanked, they wanted their money back," said O’Connor.

Cell Matrix’s Siegal says another disadvantage to angel funding can be the restrictions that the investors place on how and when the money can be spent. "Angel funds are often on a convertible debt basis," she explained. "You have to ask the investors when you can spend money, and that’s a hard way to run a business."

Despite such disadvantages, neither VCs nor biomedical executives say that entrepreneurs should turn their nose up at angel funding. "Many companies are funded by a combination of angel and venture money," said Kleinman. "It all depends on the product." Edwards added, "Devices are less expensive to bring to market than drugs, so there are usually more angels involved in device companies."

Regardless of whether a start-up company is seeking funding from angels or VCs, it’s critical that its management understand the ways of the business community and adhere to them in their business practices. "Entrepreneurs need to be more discriminating," said Siegal. "They need to subject themselves to the same standards that the investment community is going to subject them to further down the road."