Risk Mitigation in Early Stage Biotech

Alex Efron is an Investor at Telegraph Hill Partners with over a decade of experience in healthcare, technology, and venture capital. He specializes in life science enabling technologies, managing all aspects of the investment process from sourcing and due diligence to deal negotiation and portfolio support. His background includes strategic consulting for Fortune 500 healthcare companies and biochemistry research. He holds an MBA from Columbia and an MSc from McGill University.

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Click here to download the sample risk matrix that Alex presents during his talk.

Please note this is a lightly edited transcript that may contain errors.

Alina: Hi everyone. thank you all for coming today. Just to give you a little context, use of Funds is a monthly series that focuses on sector specific fundraising questions. So this season in particular focuses on the life sciences and we're asking questions around traction, commercialization, risk mitigation, and many other things.

The series is run by the team at Weave Pitch, where we specialize in helping startups in the life sciences, health tech, climate and AI navigate their fundraising journey. So with that, I would love to have Alex Efron from Telegraph Hill Partners, introduce himself briefly, and then we'll kick off and to talk about our topic today, risk mitigation.

Alex: Thanks so much for having me today, Alina and Max. Hi everyone. I'm Alex Efron. I'm an investor at Telegraph Hill Partners, or THP for short in San Francisco. I joined about three and a half years ago. Prior to THPI spent time at investment firms, spring Mountain Capital and Windham Venture Partners focused on healthcare and life sciences in New York where I'm from originally.

Prior to that I had previous experience in healthcare investment banking at Goldman and management consulting, working across biopharma device diagnostics and payer and provider organizations. A little bit about my firm, THP we're a venture and growth equity investor focused exclusively on life science and healthcare technology, spanning across different sub-sectors with the big notable exception being therapeutics.

We were founded in 2001 and are currently investing out of our fifth fund. About $570 million of commitments. We take an active engaged approach and we focus, that means sort of focusing on a smaller set of portfolio companies as the lead or often sole institutional investor. And just to give a few more numbers, since our founding about 23 years ago, we've partnered with 49 companies.

Achieving 25 exits via strategic m and a three IPOs and have 21 current active portfolio companies. So very much looking forward to the conversation today, and hopefully we'll try to move very swiftly. So we've got plenty of room for Q and A.

Alina: Awesome. So thank you for that introduction. One of the reasons we were really excited about our conversation today is because we wanted to talk a little bit about risk and Alex you in particular have, I think a unique kind of strategy for thinking about risk and a unique process.

And so I'd love to talk to you broadly about how do you evaluate risk relative to early stage life sciences companies and also even have you share your kind of behind the scenes template for how you look at companies when you, when an early stage life science company comes your way.

Alex: Yeah. Great. So I'll share my screen in a minute just to kind of flash up and maybe quickly walk through this risk template. And you know, I should say too, this adjusts a little bit depending on the company, the space that we're looking at. And I'll also, you know, add the disclaimer that this is just a, you know, sort of an internal tool for my team but is not necessarily, I wouldn't claim, this is how every investor might approach, prioritize or consider you know, different risks.

You know, take that as it, as you will. So let me just share my screen here. Can you see this? Yes. And so I'm just gonna kind of quickly walk through this. As you can see, it's not exactly a, a high tech template. But I've got one or two of these populated and I'm happy to have the Pitch and Weave team circulate this afterwards if it would be helpful.

But this is just sort of an internal tool that often our teams will, populate relatively early in a, you know, diligence or evaluation process. And then we will, as we're progressing, we'll sort of update these as we think about areas that either we've learned a little bit more about and have identified more information that might help us lower the risk category or increase it.

And so this is kind of a nimble template here. Maybe it's not so nimble, but generally we try to think about risk in a couple different categories here and then. Think about specific sub areas and try to evaluate the risks between medium, low and high. And I should say none of these, even if they end up in the high category are necessarily impediments for us to do an investment.

But it's really just so we kind of know where to focus our diligence and also post close. Where we're really focused on, you know, what could come up to bite us and what areas should we be really focused on, to the degree that we can, given the market or business model to de-risk, you know, following the close of the investment.

Alina: So, we're gonna dive into specific sections more more closely in this talk, but I would also just at this high level, are there specific risk categories that you weigh more so than others? Are there specific categories or are all of these weighted evenly?

Alex: Yeah, that's a great question. I think it really depends on the company and in particular, the stage. To maybe a lesser degree, the sector. I think if there are areas where, this is, for example our firm has invested a lot in life science tools and instruments. And so there's a lot of comfort, there's a lot of knowledge on kind of the key value drivers there.

So for a lot of those we might not be as concerned about business models if we're very familiar with it. But I would say the focus, you know, let's say focused generally on earlier stage companies, we're really focused on business model team. And then I'd say these two kind of together product and technology and market.

So always really focused on what is the product, how differentiated is it, how early or advanced in development. Team is a little bit nebulous, but really wanna understand sort of what they've done. What are the backgrounds? Is this the team that can really build a substantive, you know, business and, you know, market as, as you all know, we wanna understand that either the current product or the vision is to expand into a large growing market that can support a high growth and eventually large and highly valued company for our exits.

We're not so focused, for example, on competition. If the product and technology is really compelling. And I'll just scroll down a little bit here because I couldn't show everything, but clinical factors, for example, a lot of companies we look at don't really have much in terms of clinical factors for a medical device or some more kind of regulated products, diagnostics.

This would be companies that require a clinical FDA pathway. This would be a higher consideration of what has been demonstrated so far in terms of efficacy or safety, if that's relevant. And then the last part here is really kind of around the actionability of the deal and whether or not this sort of meets our kind of risk and returns you know, aspects here.

Alina: What would disqualify a deal, for example?

Alex: In terms of this final section here? I would say, generally I think we're focused on, the more so than I'd say a lot of venture investors we're pretty focused valuation and how that relates to our, ownership, as well as what that means for a post-money and the kind of exit potential, whether we need a really premium exit, to achieve kind of our targeted returns. I would also add that our targeted returns depend a little bit on the stage of the company and the overall risk profile. More advanced companies that have more commercial adoption.

For example, a clearer path to profitability, I think we would underwrite for lower target return multiples than something a bit earlier stage. Hopefully that answers the question.

Alina: Absolutely. We could spend a lot of time on that, but I wanna dive into multiple parts of this. So I wanna scroll back up to business model, and I wanna just get a better understanding or what are some of the common risks you've seen when it comes to a business, a company's business model. So maybe reimbursement or. Recurring versus non-recurring business models or margins. Just what are some of the kind of ways in which you've seen this play out and what strategies have you also used to help companies overcome some of those risks?

Alex: Yeah, so I would say, again, it very much depends on the type of company and the stage, but I think if you look at sort of the examples populated here, this is a, this is an example of an instrument company.

That has a system, so like a capital purchase and some recurring revenue streams through consumables and reagents. And so not all companies we're looking at have that built out. But we're often, for example, concerned with a company that just has a single high cost piece of capital equipment, that generally has a very long sales cycle..

Then once you place it, the kind of recurring revenue is usually, lower margin service and maintenance revenue. Sometimes there's professional services associated with it, but I think the concern there is it's a lot of work to gain a new customer and then every year you're kind of starting from scratch to just build up, you know, from your pipeline to be able to grow your revenue year over year.

You actually have to make more sales than last year. If you contrast that with maybe one of the best business models out there. Enterprise software with a recurring license, you just have to maintain your customers from the prior year and then sell some new ones. On top of that, I think, you know, the consumables and reagent streams can, which are often higher margin, can be sort of, the razors and blades model can be a lot more kind of compelling, at least in this, instance, versus a very, a single, you know, high cost piece of capital equipment, which by the way, can also be really impacted by macro economic pressures like we're seeing today in the biopharma industry where budgets have been constrained and expensive. Capital equipment is just taking a lot longer to actually push through the channel. Maybe another, you touched on re reimbursement risk, which I don't think is relevant for this one.

I might touch on it a little bit in this one here, but, you know, sometimes we're, we're looking at companies that, not only need to go through clinical development, and approvals, but also need to secure new, reimbursement codes. Sometimes they have existing reimbursement codes which they can get to market on, and that allows us some more confidence in sort of forecasting how the business will grow. And often part of the strategy is upon developing more evidence to demonstrate, for example, greater efficacy than the existing sort of standard of care from which these existing reimbursement codes are that they might try to, longer term generate a new product specific reimbursement strategy that secures premium reimbursement.

Alina: Outside of devices, where you're potentially helping them think about is whether there is a consumable revenue source or some other strategy, are there other kind of life sciences business types that you've seen that have had specific kinds of business models struggles?

Alex: Yeah. I mean, I think one of the things which we didn't touch on too much here is gross margins. that's always obviously a tricky one to really nail down. And a lot of times too, companies sort of start when they start selling the product. A they don't have as much validation and, and brands, so they really, it's tough to sell at a premium, for example, it's replacing a, an existing product.

So you're a little bit capped on your average sales price and your manufacturing, for example, in small volumes. So your cogs are pretty high. And so I think we often see companies that don't start with great margins, but we love to see, founders who have done the work, you know, more than just a slide, but can show us, you know, upon sort of further diligence, evidence that, that, you know, they're able to increase their, average sales price, but also working with contract manufacturers or, they have plans for product design improvements to improve manufacturability or to reduce the bill of materials, or automate aspects of quality control and testing that helps paint a picture to what the gross margin profile might be like at scale in a, a few years down the road.

Alina:Awesome. That's really very helpful.

Alex: Maybe the the last part too, which is sort of related to business model, but also uh, commercial is sometimes there are different, go to market commercial strategies that can be sort of creative and more capital efficient, avenues that can support the business model.

For example, partnerships, distribution channels. Those can be great value drivers. However, we generally try to advise, especially, you know, companies that are early and early or pre-commercialization to not overly rely on third parties to sort of control their their destiny. I think that's, that's also sort of a pitfall we often see, which is, hey, this strategic is really interested in selling our pro product.

We don't need to build any sales or BV team and they're just gonna push it through their channels. Um. Being overly reliant on that. We've found historically it's sort of a recipe for disappointment.

Interesting. Okay. I wanna move on, because you mentioned one of the other areas, that's obviously of importance is the product and technology and, I'm kind of curious when it comes to how, , how companies really talk about their differentiation, either in terms of their IP and their product, in their product or technology or in terms of potentially their competitive landscape or go to market.

What are some of the red flags that you've seen or, examples that you've seen in terms of how they're communicating their differentiation? Sure. And by the way, Alina, should I keep sharing my screen? Is that helpful or is that too much right now?

Alina: I think it's very helpful actually.

Alex: Okay, okay. I'll keep it up. So, you know, red flags, I think there's a couple here. I think especially when you're talking to investors, maybe don't assume that your innovation is such an obvious improvement to them over the sort of current status quo. I think the the better you're able to really, you know, communicate that, and to the degree you can quantify sort of those level areas. So, maybe a couple areas here. One is around IP, you know, see a lot of pitches that just talk about the number of filed or a, you know, granted patents. And while that's good to sort of show, the focus on IP. IP is created equal and the number of patents does not necessarily translate to the strength of a company's IP estate.

And so when we're kind of digging in there, we really wanna see is the IP specific, is it novel? Is it non-obvious, which points to sort of. Defensibility, in the courts and also broad enough that it can defend against possible workarounds, design arounds of the underlying technology. We generally assume that once patents have been filed, or certainly once, really innovative products are announced and launched to market, that the com competitors, the incumbents are gonna immediately start working, to catch up as soon as you publish.

So, you know, that's both for IP, but also, just sort of an understanding that, there's, you have a bit of a head start. And also just to know that, to keep in mind that just because you have really strong IP and it maybe it's bulletproof, doesn't mean that a big bully strategic might not sue you anyway and tie you up and, you know, try to sap your resources and so kind of always assume, the worst and plan accordingly. I think, generally, in terms of advice on this point, try to stay humble, especially if you don't have an IP background. I certainly don't. And, be thoughtful about who you select as counsel for IP. Ideally someone with, specific domain experience and who's really familiar with the landscape and, relevant, cases in, in this area.

I think maybe one other area just to talk about here for differentiation is, you know, often we see really exciting technologies that are looking for applications and companies.Especially early stage can really blast us with all the different applications of their technology. And it's tougher to sort of cut through the weeds to say, how are you gonna launch? Who are you gonna target? What is that killer app? And so I always recommend folks really try to paint a clear picture of what is that killer app, that has a demonstrable value proposition, an ROI, something that's really going to help resonate with the market and those sort of end users. So, I assume that this level of differentiation piece, that's something you can do at any stage.

Alina: I'm curious, there are really early stage companies that haven't as many patents yet, or who are at different stages of how do they prove, that their IP isn't a risk to you as you're doing your due diligence?

Alex: Yeah, it's a good question. I don't think there's any way to really prove it. We'll, often, if we advance in diligence, we'll certainly look at the IP and sometimes we'll actually get on a call with their council just to understand the overarching strategy and what are the key claims.

And so, you know, it's a little bit of a process, but I think to the degree that you can explain the fundamentals of the IP, you know, estate or portfolio versus just. Number of patents and current status. That's really helpful for us to understand sort of the relevance and what is the, you know, key innovation or innovations that sort of drives the product or the platform.

Alina: Absolutely. Okay. I know we have so much to cover and so little time, and I want a few minutes for questions. So in these three minutes before we turn to questions, can you just talk a little bit also about how you assess clinical, risks? So, you know, either if a company is very early in their FDA clearance path or they require additional manufacturing certifications or et cetera, how do you help advise companies on overcoming those risks?

Alex: Yeah. It's a great question and unfortunately this isn't one that I think we have a systematic approach. I think from my perspective though, first we're really just trying to understand what is the stage of clinical development and that the two important kind of questions there are, what have they done so far and what is sort of the evidence generated that some product is likely to be effective and safe. Let's say, we'll just paint broad strokes here. That might inform sort of the remainder of the clinical development, and then what are the next steps in terms of clinical trials, in terms of, you know, toxicity studies or manufacturability type work. And then what are the associated timelines and costs for that.

And so to the degree that companies can be sort of forthright in these are the studies that we've done, whether published or otherwise, that really indicate hey, it's great if we have some human data, for example. But also what's the size of the trial we need and how long is, and who are the patients.

For example, is that gonna be really tough to recruit for given a rare population or tight inclusion, exclusion criteria? And similarly just, you know, broadly, what are the sort of costs there and have they thought through what are the other risks?

Alina: Absolutely. And I know that at Telegraph Health Partners, you're not doing as much pre-seed, but I assume that this is a particularly challenging and tricky situation when you're talking at very early stage.

Alex: Yeah. I will say clinical risk is one of the risk areas that my team is least comfortable taking. And it's a big part of why, as I mentioned in the opening, we don't invest in therapeutics businesses because I understand there's platform businesses and a lot, but ultimately that sort of comes down to individual assets going through the clinical development process and getting FDA approval, which is, you know, long.

A lot of time, a lot of expense, and often sort of a binary outcome of approval or denial or, you know, deprioritizing a program. And so for us, when we're looking at companies with clinical development risks, we're really trying to focus on companies that have generated significant, relevant, human data. Or there's something, you know, there's been a few exceptions otherwise that make us feel a lot less concerned about the likelihood of clinical trial failure there.

Alina: Absolutely. So I wanna turn to questions. I think Aaron, feel free to hop on if you want or I can read your question.

Audience: No, that's fine. You can read it, I guess, if you want to. I, yeah, I guess I really liked your model. I think it's really interesting the way that you're viewing and analyzing these kinds of companies. I was curious how you weigh these different categories depending on the stage of the business that you're looking at, whether they're earlier stage, later stage. I mean, obviously. Early stage patents might be very valuable. Um, later stages you're saying you start to see a lot of numbers. Same thing with data for some of these pre-seed companies that may not have data versus the data packets that they're expected to achieve over the course of their time as they get to Seed and Series A. So I'm kind of curious bit about that thinking.

Alex: Yeah, I think that's a great question, Aaron. I would say, for earlier stage companies. We're not as concerned about some of the aspects of business model, for example, like gross margins. There might not be enough data. Hopefully we can think about comparables in the market to say, oh, yeah, similar sort of companies at scale are able to achieve that.

Team is really important, but not the whole team, for example, or at least not. Certainly the whole team is important, but not all. Competencies. So at the earlier stage, we're not necessarily saying, Hey, does this team have commercial and go to market expertise? 'cause we know this is a really technical team and when the stage is right, when we're gearing up for launch, maybe we will supplement that with, commercial experience, commercial leadership that has launched similar sort of products or has, you know, established connections, etcetera, and can really define that strategy. So, maybe to flip it to the positives of what we are focused on, it's really the product, you know. Is this technology really exciting and how do that product relate to the market? So if it's early stage, there's no signs of product market fit, but what is sort of the val, what is the development of the product and what can we validate in terms of the performance features of that product?

That, in terms of the testing that's been done, that would. Indicate, you know, this is gonna be 10 times cheaper or 10 times faster than the current solutions, the market is gonna pull it. Versus us having to build a giant sales force and really, try to pull teeth to, to commercialize, and I think related to that too, we're very focused.

If it's not a fully developed product, what are the remaining technical development risks out there? , and are those risks that we can get comfortable with? Certainly at the pre-seed stage, and I'm sure there's often a lot more sort of technical development to be done. , and so in a deeper diligence, we're really trying to figure out sort of like, is it just, you know, engineering of solved technical challenges, or are there still, key aspects of the technology that we need to scale and prove out? And it could ultimately, not work, for example, in the, you know, market scale that we need.

Audience: Sure. So I guess what I'm hearing is early stage you're focused a lot more on technical risk rather than necessarily full on product market fit because there may not be any connection between those things at those early stages.

Alex: Yeah, I would say technical risk, but also like signs that if the product does work, there's enough evidence that it would be successful in this market. And sometimes we talk to, prospective customers, you know, different industry experts to say, Hey, if I were to sell you, if I were to tell you there's a product that does this, it costs this, this is sort of the, the performance, et cetera, would that be something you're interested in

Audience: And so, so I'm hearing part of your due diligence process actually involves going out to speaking to potential customers of these kinds of organizations and actually getting a sense of what they think as well.

We like to talk to them. We also like to try to identify individuals that are totally independent, completely naive, just to understand what their response would be like to, something they've never heard of, but they're pretty familiar with, you know, their market. And we generally try to also be sensitive and share with our, perspective with founders.

You know that we are talking to other folks, but we wouldn't share any, sensitive IP or anything confidential. Certainly not without, you know, prior permission.

Alina: So sorry to cut you guys off. I know we're at time and I would love to finish those, these questions. But before everyone leaves, I do also wanna just really quickly give Alex the opportunity to. Provide any closing thoughts, , and, , then we'll just close it out and maybe we can stay a few minutes after and finish off the questions, after that.

Alex: Yeah, I'm happy to stay over, just a few minutes. I know I was doing a lot of talking here and we didn't get to address too many questions. And to answer Lauren's question yep, definitely open to sharing my email. Um, I think, you know, if, if interested, we can, we can send around this, you know, this template document for folks. Definitely, you know, looking forward to connecting with a lot of folks.

Can't promise I can take phone calls with everyone, but, certainly would love to kind of network with the folks, uh, involved in this community. Alina, I think I forgot like part of your question, but I'm not sure if there were other areas that we missed or

Alina: No, just, any other closing thoughts that you have?

Alex: Yeah. I think. Maybe just to sort of wrap up this, I, I hope I, I wasn't too per prescriptive here to say there is a one size fits all approach that is applicable to all companies. Just trying to imbue a little bit of perspective of what someone in my seat is looking at and trying to sort of assess.

You know I'm certainly not pulling up a template like this in our first pitch call, but afterwards, I'm trying to think through like, what are the key focus area, you know, what am I really excited about here and like what are the risks that we would need to really prioritize? And so, , I would just, you know try to empathize with the other person across there, across the table or the zoom, and try to, you know, walk them through it. Don't assume anybody's an expert. I would be a little skeptical if they act like they're an expert or knows more about the area than you. And just try to be a little bit humble and transparent about, you know, Hey, here's how much work we've done and here are the key questions we still need to answer.

And by the way, that's part of where we want to use, one of the milestones of our. Series X financing is to hire this person who's got that expertise. Great. If you already have someone identified or a certain profile or we're gonna do these experiments to then generate this evidence, which is gonna de-risk that question in particular.

Alina: Those are very great points and also gives a little more grounding into kind of the feeling of being on the other side and feeling like you're going through a rigorous test. All right. So I really, really appreciate, I know we blazed through a lot of topics, but I really appreciate you taking the time, Alex, to share kind of your approach with us.

For anyone on the, yeah, for anyone on the call. We are doing these, on a monthly basis. So if you sign up at Luma slash use of funds, you will get to see both upcoming events and also past recordings, which we share. Our next session is going to be with Scott Shively, who is a serial biotech founder and CEO and a commercialization expert.

It will be focused a little more on the therapeutic side. So we're extremely excited about that as well. Yeah, if we have a few more, if you have a few more minutes, Alex, just to answer those final questions, that would be wonderful. But, if not, thank you for anyone who has to leave. Thanks for attending as well.

Alex: Sounds good. Happy to stay on just for a few more minutes.

Alina: Okay. So we had a question actually, from Steve around how do you, and I don't know if Steve is still on here, but how do you value potential strategic partnerships when evaluating a company for investment?

Alex: Uh, okay. So I think, you know, it's sort of a case by case basis. I think we love to see it, founders that are thinking about strategic partnerships, where their product might fit really well into an existing system or workflow. I mean, there's a lot of different types of partnerships.

We love to see folks who are creative to say, Hey, this partner has great distribution in Europe or Asia, and like. That's something where we can focus on the US and they can, they can, you know, take us elsewhere. Sometimes folks are in early conversations or they just say, we think they would be a great partner.

And, sometimes folks actually have, terms, et cetera. And so I'd say, like I mentioned earlier, love the creativity. It leans towards folks who can really focus on what they're good at and. Try to kind of cut out the noise. With the exception being, I don't want to see a company whose whole plan relies on a strategic partnership, right?

Putting all your eggs in one basket rarely works out. And when it doesn't, there's a lot of strategic partners out there, whether through malice or incompetence, just don't end up delivering. And so, I always just advocate to make sure you're in charge of your own destiny.

And Steve, I would say too, I, I see you've got a, a TX in your name there on the therapeutic side, which again, not, don't actively invest it, but I'm also a co-founder of a therapeutics company. I would say like strategic partnerships there I think can often be really interesting as like a way to facilitate funding in some of your therapeutic platform or some of your programs, for example, can be great to say, Hey. We've partnered either our lead or our second program and you know, we've got that kind of covered and therefore we're raising, or we're gonna be able to focus more resources on our lead. You know, just kind of an avenue to have multiple shots on goal and show that you're not overly reliant just on the venture markets, or sometimes it's not even a strategic partner. Sometimes it's NIH or something like that.

Alina: All right. I think we have another question from Sean. In areas of medium or high risk, how do you balance using money as a tool to de-risk those areas against the ownership and exit potential?

Alex: I think I'm interpreting that as like the company using the money and the proceeds of the financing to sort of de-risk these areas. Yeah, I mean, I kind of see it holistically. We wanna understand that if there's a risk area that is a significant risk, that either if this is the final financing, that this is something that can be addressed or. If in our kind of forecast and operating plan that the right kind of either experiments or work or hires, let's say, can be accomplished within that timeframe with that budget to meaningfully de-risk it.

And so, we're always thinking about kind of ownership and exit potential, but we're generally thinking about ownership. Our ownership. Following the close of this investment and then any future dilution that is expected. And we do a lot of work there. Exit potential. Our view is that great companies get bought, not sold.

And so I. The eventual acquirer, and we generally prefer exits through strategic m and a for a number of reasons, but they're gonna be thinking about these same risk areas and also how is it gonna fit within our organization. So some of their areas of risks might not be concerns because they've got a global sales force, or they've got experts in X, Y, and Z. But similarly as you're de-risking areas, most of those are going to accrete value to your eventual exit potential.

Alina: All right. With that, I think we've wrapped it up. Thank you all for staying a little bit over. And thank you, Alex, for all of your time. You've shared so much in such a short period of time. So thank you again.

Alex: Thanks for having me, and appreciate everyone joining and sharing these questions.