Gowlings' Bob Ford. (Darren Brown, OBJ)

Despite some big VC wins for local firms, funding remains problematic, experts say

While a couple of recent big dollar venture capital wins for Ottawa biotech companies can't hurt the city's life sciences sector, it might not be wise to read too much into the deals.

Biotech companies face particular challenges when looking for money, essentially because they typically need significantly more of it for a longer period of time, making them a much less attractive target for many investors.

"They are still having a rough ride, and like all companies out there trying to raise money, they are finding it difficult because we don't have a lot of accessible capital in the market right now," said Michelle Scarborough, Ottawa Centre for Research and Innovation director of investment and commercialization.

"And that's particularly important in the life sciences sector because they need a broader depth of capital over a longer period of time to see an exit. We've seen some big deals, but it's still a struggle."

Ms. Scarborough works with life sciences companies and investors to try to make matches for deals.

A couple of life sciences companies topped the charts in the past two years – Epocal raised $35.5 million in April and Variation attracted $41.6 million in late 2006, with most of the cash flowing into these firms coming from the U.S. sources.

The size of these two deals emphasizes the shortcomings of Canadian biotech funds. Two of the largest – CTI Life Sciences Fund is about $100 million, while Genesys Capital Partners is roughly $75 million – would use almost half their money to capitalize a potential homerun biotech company.

In today's climate of tight-fisted venture capitalists, the general lack of funds means that Canadian life sciences outfits continue to look more and more to the U.S. for the wads of cash they need to bring their products to market. That reality has some worried.

"There's just no big money in venture capital in Canada anymore. There are really very few funds that are doing well at all, and although there are exceptions, overall it's pretty tough right now," said Bob Ford, a partner in Gowlings' business law department working from its Kanata technology law office.

"A lot of labour-sponsored money that went into the market between 1998 and 2005 when the tax rules changed is really stranded and the returns have been very bad, so there's not that many life science funds in Canada, and the ones that are here haven't done very well."

That creates a vicious circle where companies can't find money in Canada, so they look to the U.S. for investment, which often means they move their headquarters – or at least regulatory functions – south to be closer to the cash source. This limits both the companies that stay in Canada and pool of talent available.

But a C.D. Howe study found that a huge part of the problem is Canada's unfriendly stance toward foreign investors, and it urged the government to unblock barriers that hamper the flow of critical capital from outside the country.

"Given the size of Canada's gross domestic product and population relative to those of the United States, Canadian venture capital firms should be receiving about 10 per cent of the total funds invested in the two countries' venture capital firms. Their share, however, is far short of that amount and falling," wrote authors Stephen A. Hurwitz and Louis J. Marett in the February 2007 study Financing Canadian Innovation.

"Without change, capital-starved Canadian companies will fail to commercialize much of the nation's R&D investment, raising the risk of Canada squandering a significant share of its intellectual capital, and needlessly imperilling its future economic growth."

And biotech outfits take a hit on both sides of the equation because they are almost always in a situation that has an early stage company looking for substantial seed financing that also requires several follow-on round.

"The earlier the stage, the harder it is," said Ms. Scarborough. "Generally, what we are seeing is that they may get the first funding from angels or an early stage fund to take them to the first clinical trials, but then they need to take the drug or medical device to the next level, and they are running into trouble getting into that follow-on financing."

In the end, companies look for cash wherever they can find it, with some choosing to close the gap through a listing on public markets.

Unfortunately, taking a biotech company to the markets too early can cause huge headaches.

"When they go public that early, they have to disclose everything – if they have a bit of a hiccup as a private company, the company just goes on, but in a public company it's a big deal and people sell it off and the shares drop and they have a tough time recovering," Mr. Ford said.

Liponex is a good example of this problem. When it had some less than terrific results from its clinical trials in March, there was nowhere to hide and it hasn't been able to recover.

A day after announcing that its "good cholesterol" drug candidate failed to generate statistically significant results in its first human trial, its shares dropped almost 80 per cent from $2.46 to 53 cents. It has been hovering in the 25-cent region since mid August.

Being public also makes raising further money difficult once things have gone wrong, because it is usually done through a share offering, which may find the company forced to accept less than optimum terms after its stock takes a huge hit.

On the other side of the equation, many Canadian companies simply don't get to the stage where they can be attractive to U.S. venture capitalists because they are not funded well from the start.

"And the companies have to be even better than their U.S. counterparts to get the big money because there are tax rules and structuring that make investing in Canadian companies a little harder," Mr. Ford said. "There's more cost and time involved in those deals."

A quick look at the Toronto Stock Exchange shows only about 90 life sciences companies trading, with more than 60 per cent having a market cap of less than $100 million. Only three have a market cap in excess of one billion, and only 12 are above the $500-million mark.

The good news is that outfits such as Epocal and Variation seem to be emerging anchors that can launch Ottawa's life sciences sector into the big leagues.

"I think a strong biotech industry in Canada is important for the country and for Ottawa because it helps diversify away from some of the telecom," Mr. Ford said.

"There is some great science, particularly in the universities that, if commercialized, would really do well to put us on the map – if we can find enough money."

By Jeff Pappone

Special to the Ottawa Business Journal