Is "more" always "better" for biotech start ups?

The data is mixed. So­lu­tion: have the lead in­vestor per­form like a lead in­vestor. Con­ven­tional wis­dom and good sense would argue that it is good news for an early stage biotech com­pany to an­nounce the back­ing by a large in­vestors syn­di­cate (4 or more).

In­deed, the fact that many smart peo­ple are in­de­pen­dently de­cid­ing to in­vest into a com­pany, con­tribut­ing their cu­mu­la­tive ex­per­tise, net­works, and cash, val­i­dates the po­ten­tial of the start- up, pow­er­ing it for suc­cess. This is all true, how­ever this bless­ing comes with some caveats, that en­tre­pre­neurs need to keep in mind.

Anec­dot­i­cal ob­ser­va­tion and analy­sis done on sam­ples of Eu­ro­pean and Amer­i­can start-up com­pa­nies backed by 4 or more in­vestors seem to show a dis­pro­por­tion­ally high num­ber of "prob­lem com­pa­nies", in com­par­i­son to the con­trol group, com­pris­ing com­pa­nies backed by only 2-3 in­vestors. What?? Re­ally?? Agreed, there is a pos­si­ble bias, play­ing against the ob­ser­va­tion: prob­lem com­pa­nies usu­ally go through more fi­nanc­ing rounds, end­ing up hav­ing more in­vestors around the table, so large syn­di­cates would be a me­chan­i­cal "con­se­quence" of the prob­lems. How­ever, the sam­ple can be ad­justed to in­clude only com­pa­nies that were backed by many in­vestors com­ing in at the SAME round, not over many sub­se­quent ones. The ob­ser­va­tion still holds true. Fewer suc­cess­ful com­pa­nies than in the con­trol group. Does this make sense? How can 4 smart peo­ple be more often wrong than 2 com­pa­ra­bly smart ones? Maybe a cou­ple of thoughts to break this ap­par­ent para­dox…

The first sim­ple ex­pla­na­tion is that the 4 back­ers are not re­ally de­cid­ing in­de­pen­dently of one an­other; maybe 1 or 2 have come to in­de­pen­dently val­i­date the up­side, but usu­ally the oth­ers have been de­ci­sively in­flu­enced by the lead in­vestors. So in re­al­ity the val­i­da­tion of the up­side is not war­ranted by 4 in­de­pen­dent brains. Ok then: but this doesn't ex­plain why this sam­ple should be worse off than the 2-in­vestors backed com­pa­nies: it should be at least com­pa­ra­ble.

Here a key that could ex­plain the "cost" of hav­ing 4 back­ers. Every ven­ture fund is like a liv­ing or­gan­ism, with a de­fined life­time (usu­ally 10 years). Dur­ing its life­time, the fund goes through highs and lows, pe­ri­ods of re­peated re­al­i­sa­tions and suc­cess­ful exits and pe­ri­ods of pro­longed droughts: this im­pacts re­serves man­age­ment and the fund's risk re­ward at­ti­tude to de­ci­sion mak­ing. Also, a fund in its first year of life will have a longer term at­ti­tude in re­spect of strate­gic de­ci­sions to be taken by the port­fo­lio com­pany, while a fund in its 5th or 6th year, for ex­am­ple, will start look­ing at paths to liq­uid­ity. All these con­sid­er­a­tions im­pact the spe­cific agenda of the in­vestor, in a way that can be largely seen as in­de­pen­dent from the per­for­mance of the port­fo­lio com­pany. At any point in time, there is a de­fined prob­a­bil­ity that any two funds may have di­verg­ing agen­das; when the funds around the table are 4 or more, it is math­e­mat­i­cally pre­dictable. This is when closely held port­fo­lio com­pa­nies hit the is­sues of share­hold­ers dis­agree­ing about the next strate­gic step, whether it is the next round of fi­nanc­ing or a trans­ac­tion with cor­po­rate part­ners. Hence de­lays, stress and wrong de­ci­sion mak­ing.

What do we make of this ob­ser­va­tion?

Whilst we don't think that 4 in­vestors is bad news for a com­pany, we do think that it should be much bet­ter news than it cur­rently is. The cash re­sources of 4 in­vestors are a strate­gic asset that com­pa­nies should not un­der­es­ti­mate. The good news is that the ob­ser­va­tion sam­ple in­cludes a group of com­pa­nies for which the 4 in­vestors-syn­di­cate seems to be work­ing well. This is due to the pres­ence of a clear lead in­vestor within the syn­di­cate, as demon­strated by a clearly higher eq­uity stake, or by a unique in­volve­ment in the ex­ec­u­tive man­age­ment of the com­pany, this func­tions as a cat­a­lyst in de­ci­sion mak­ing and pre­vents many of the "stall" sit­u­a­tions that can be ob­served oth­er­wise.

In ad­di­tion, em­pow­er­ing a lead in­vestor to play the lead in­vestor role de­creases the risk of del­e­ga­tion of re­spon­si­bil­i­ties and di­lu­tion of the sense of ac­count­abil­ity to­wards the en­tre­pre­neur, that can some­times be ob­served in large syn­di­cates made of equally heavy in­vestors.