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Experts outline key survival strategies for university start-ups

This article appeared in the March 2013 issue of Technology Transfer Tactics. Click here for a free sample issue or click here to subscribe.

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While it is a fact of life in tech transfer that the majority of academic start-ups don’t make it, a panel of experts at a recent webinar sponsored by Technology Transfer Tactics recommended a range of strategies — from the earliest days through later stages — that can increase the odds of successfully entering the marketplace and sustaining a growing business. They also addressed when and how to pull the plug on start-ups that are not making the grade.

At the very outset, a start-up can make critical mistakes that can sink even the best technologies. “You’ve got to be able to anticipate and avoid conflicts and early warning signs,” said moderator Jack Brittain, Pierre Lassonde Presidential Chair in Entrepreneurship at the David Eccles School of Business at the University of Utah. “Do the right things by researchers and understand what may take them by surprise.”

“Our focus as academics is to advance our science and understanding — we do not necessarily have mastery of the critical areas of marketing,” noted Russell Medford, MD,PhD, co-founder, president and CEO of Salutria Pharmaceuticals, LLC, who was a tenured professor at Emory when he launched his first successful spinout. Given that fact, he noted, a key concern is educating faculty on their role beyond science and technology — obtaining capital, for example.

“Researcher engagement is absolutely critical — particularly in the early stage,” added Troy D’Ambrosio, director of the Pierre Lassonde Entrepreneurial Center. “Failures occur, for example, when a manager or CEO is dropped in the researcher’s lap without any introduction; they can lose the ability to learn from and understand each other.”

“In the early stages the scientific founder and business founder need to make each other happy,” agreed Kevin Lei, director of the Emory University Venture Lab. “Set clear expectations that include at least two key points: what they expect to get from each other, and what each of them expect to get from the company. The bottom line is that the business founder and the research founder have to work together or you will not have a company.”

The faculty founder, he continued, may be the first CEO, but as a company grows most of them step down — although some do leave the university and remain with the company. “If the faculty founder plans to stay with the university and be CEO, they should be aware of the commitment and sacrifice, and [the importance of] separating their two different roles,” Lei continued. Such a combination is rare, he noted, “but if they can do it you should encourage it.”

Medford did wear both hats successfully, “but it’s not the norm; it also means you have to have a certain amount of humility,” he emphasized. “The expertise I brought was not how to build a company or communicate with investors, although the keys to success are value creation and risk mitigation — central themes in raising money and building a company. So, one has to learn how to be a CEO and business manager.”

Often with scientist CEOs, however, ego gets in the way of success. “One of the dilemmas you face is when a faculty member is not the right person and they don’t recognize that,” added Brittain. One strategy the center has employed very effectively, he offered, is to have faculty mentors sit down with their colleagues and talk through what it will take for a launch. “Mentoring is extremely important,” he said. “It’s a hard message to deliver to faculty, but bringing in an external person like Russ who has been through the cycle is a good way of heading off problems before they occur.” Getting off track at this early stage, he declared, “is a significant failure point.”

Understanding the market

Another challenge for scientist founders, Medford continued, is whether they truly understand the market for their invention. “The entrepreneurial professor or scientist has a great deal of passion; that’s what drives entrepreneurship and it should be encouraged and cultivated — but not understanding what the market opportunities are is probably the most common reason [for failure].” Great science alone, he noted, is “not sufficient to justify investment. It is the [technology] that meets a critical need that has value, and/or a drug or device that has sufficient proprietary protections so that the investment being required has a significant chance of giving a return to investors. That requires market analysis.”

Market dynamics are a critical part of that analysis, said Brittain. “You may have potential buyers — but will they buy?” he posed. Brittain cited the real-life example of a company that provided help with household concerns (such as picking up dry cleaning). “They gave out free use certificates. I brought it to my wife and she said she’d never use the service because she did not trust they would do things right. I knew they were in trouble; they only lasted six months.”

Unfortunately, he added, the company had launched a big, expensive marketing campaign, “but they had never talked to someone in the market.” The bottom line, Brittain noted, is that analysis should go far beyond the size of the market, including factors like the buying cycle.

Time to market is another critical consideration, observed Medford. “It’s not the market today that’s being analyzed, but the market when your innovation will be commercialized,” he explained. “That takes into account competition, advancement in science and technology, the marketplace, ability to pay, and so forth. This is a non-trivial exercise for those of us in biotech.”

D’Ambrosio recalled a program he recently attended at Georgia Tech where participants had to go out and interview 100 potential customers over a six-month period. “Almost uniformly the comments came back that the people did not care about the technology, but about a problem that needed to be solved,” he said. “This was a rude awakening; you must see where the pain point is. The exercise of getting out and talking to potential customers has a great deal of value.”

Build a real team

When assembling your management team, noted Brittain, it’s important to ensure they truly are a team. “Is there an alignment of interest?” he challenged. “One of the first start-ups I did I got together with a friend — and it was a mistake.” It’s important, he explained, to see if people are engaged in the company for different reasons. For example, in his case the friend wanted to be CEO but not an employee.

Lei notedthat TTOs face significant challenges when filling the top spot for their start-ups. “It’s really hard to find start-up CEOs that have domain expertise and are willing to run a start-up with little compensation or equity; we often take who’s available — and that sows the seeds for failure,” he admitted. “Another common mistake is that the faculty entrepreneur wants to use friends and family — not because they have domain expertise but because they are accessible and less expensive; some of them learn the hard way.”

“Start-ups are always cash poor so you usually end up with non-optimal senior management,” Medford agreed. “So you need expert advice from colleagues who’ve done this before, from business professor colleagues, or via a mentoring program.”

The start-up’s board of directors, he adds, should be viewed as a key source of this expertise. Members should have skill sets that can help you advance your company as it grows. This could include, for example, clinical trial development, regulatory issues, or healthcare delivery systems. “Complement and augment the management skill set you have,” he advised.

There is also a tendency in start-ups to be informal in the early days, and Brittain said that is a mistake. “You want to be very formal, with clearly defined roles and responsibilities,” he advised. “You also should have legal documents to help you work out issues for unanticipated problems with the leaders — someone may become sick and can’t function, for example. The legal organizational document should specify how to replace them. Or, in a divorce, a former spouse could have claimant rights. If the company is run way too informally it really messes up the whole dynamics of the management team and it can totally knock you off the rails.”

By putting real effort into defining corporate structure and governance early on, Medford adds, many potential problems can be averted. “If you take board and corporate structure seriously you do not have to be intimidated by the experience. Understand that this is not a game or something to be taken lightly, and that the invested capital should have an equal seat at the table with the scientific founder. Once you take peoples’ money, that’s a serious commitment to respect the investor and be sure to get the maximum chance for a return on investment.”

Responding to ‘failure’

Another pitfall common to start-ups that fail is an inadequate response to bad news — which is virtually inevitable at some point in the growth process. “We’re in the business of risk, and as long as one is up front and explicit about the risks going forward, a failure in the program is part and parcel of the investment proposition,” said Medford. “If one of the initial assumptions turns out to be incorrect, you have to have a plan in place to be able deal with it and reposition the company — for example, use the technology for different or parallel purposes.”

Lei echoed the need for a back-up plan. “A lot of university start-ups are based on an initial discovery indicated by scientific results in the labs,” he says. “Of course that’s encouraging, but more often than not it is not sufficient.”

“We had recently seen a lot of success in mouse models [for a dermatological therapeutic], but it did not do well in pigs, and ultimately not well in humans — but we had a pivot point to go to corneal applications,” Brittain illustrated. “We had developed a healthy dose of skepticism out of the pig model and set aside funds for this.” Pivoting, he adds, “can keep you in the game.”

“Only one in 100,000 science ideas make it to the clinic,” noted Medford. He cited another example — he was one of the founding members of a company based on a technology out of the University of Texas that targeted bacterial adhesion molecules. “It went public, many millions of dollars were invested, and then we found as a public company we were not meeting the primary end points in the clinic,” he related. “The stock went to pennies per share, but we had a few million dollars still in the bank and had made a decision at the board level to change the management team … to gather new technology on a different platform.”

Through merger and acquisition of another company, the start-up pursued an antiviral therapeutic approach, and three years later the parent company was sold for $2.5 billion to Bristol Myers Squibb. “The primary science failed, the value proposition was gone, but the board’s internal investors and the street had sufficient confidence to puzzle our way through this and make a good approach to building value,” said Medford.

IP and patent strategy

Just as your management team must win the confidence of investors, “your valuation has to be accepted by investors or it will not be meaningful,” said Lei. Accordingly, he noted, from a tech transfer perspective “we need to understand what we really have. Do we have just an idea? A preclinical stage technology? Later clinical stage technology? You need to valuate it accordingly and reasonably.”

“The key thing to keep in mind is that technology is not a product, and a product is not a business,” added D’Ambrosio. “Exponential value creation between those steps is significant.”

“In my world IP is critical, but the IP is often embryonic in the university setting, so we must have a reasonable pathway forward,” said Medford. “While we may not have a patent immediately, we may need to get an opinion from an IP counsel that there is a pathway — although not assured. That’s important to investors. Then, what’s the competitive landscape? As a company that patent landscape will define what type of project we can advance with what kinds of technology; if you don’t understand what’s out there, you could ultimately be blocked.”

“If you’re not in a strong IP position, you can’t [stand up to] competitors,” added Lei. “Take your competitions’ patents seriously — even if you think their patents may be invalidated.” Lei said his team learned a valuable lesson when one of their start-ups was put out of business as the result of a patent infringement suit.

“It may not matter if a competing patent is invalid; you have to spend millions to prove it,” he warned. “For that you need a lot of money in the bank — and start-ups rarely have it. Be aware you may have unfair players out there who just want to block you.”

Raise capital carefully

Raising capital is obviously critical to a start-up, but D’Ambrosio noted that doesn’t mean you should take money wherever — or however — you can find it. “As you bring on early-stage management, you may get too much equity in the hands of the wrong people. Or, when people come in later, the early founders will lose out — that becomes a very difficult negotiation,” he warned.

“A lot of start-ups try to get whatever money’s available — from friends and family, or angels,” Lei observed. “If your company is funded by non-VC investors, make sure the capital structure is VC-friendly for later financing. Once the initial capital structure is established, it’s hard to fix.”

Of course, having too little capital is also a big risk, added Brittain. “One company here expanded locally; in the first iteration things were booming and they way over-expanded — but they had no working capital,” he recalled. “They couldn’t fulfill orders to meet all the retail demand. Things can go so well people do not pay attention to capital availability — and that can literally put you out of business.”

“Each stage of investment is a function of time and the probability of increased value at subsequent investment rounds,” said Medford. “The goal for early investors is to have minimal equity dilution and for the program to go on, reducing their risk as the company incurs success. As you reduce risk, you can raise the necessary capital with minimal dilution — but you will get diluted, and founders at the academic level need to understand that. Your idea is 100% yours, but when you bring investors in it is theirs as well, and they rightly expect to be part of that dream of yours.”

Ultimately, he continued, you will own a smaller portion of a growing pie — but that’s not necessarily a bad thing. “Would you prefer 10% of a multi-billion-dollar product that cures cancer or 100% of an academic idea that never got its first dollar?” he challenged.

Nonetheless, D’Ambrosio added, he has “seen deals stall” because the scientific founder felt he was giving too much equity away.

It should never be your financial goal to go public, added Medford. “The goal is to create value,” he said. “The whole trick here is to ensure you have sufficient capital to advance your plan, absorb inevitable delays as you go forward, and at the end of the day to have the potential of a product line many, many times higher in value than what the first investors started.”

Though it may be a difficult pill for faculty inventors to swallow, Medford stresses that good science goes nowhere without good capital. “If you do not value capital as equal to science and technology, you’ll be doomed to failure.”

Keep that focus

Another error common to start-ups that fail, noted Brittain, is that they lose focus. “There was one company, for example, that started chasing target after target; their technology looked really promising, but they tried to do six different things and accomplished none of them.”

Medford agreed. “Focus is absolutely key,” he asserted. “If you can’t present a disciplined plan that recognizes your value proposition, you won’t get investors — or you’ll lose the confidence of the investors you do have.”

The interests of a VC, he continued, are not the same as those of your company. “VCs distribute risk over several companies, but they want you to focus on one product,” at least initially, he observed. “As a company you have to step back and recognize that for all your shareholders you have to have a diversified strategy that recognizes some things are going to fail.” Ultimately, he says, discipline is one of your most important considerations. “You have to identify and stick to specific milestones and goals, so you’ll raise more money with each tranche.”

“A common mistake is an imbalance between your first product and your future pipeline,” added Lei. “You may try to impress investors that your company is not a one-product company, but investors want to see whether your first product can achieve the milestones they’re looking for.”

When should you pull the plug?

Recognizing that a start-up is not going to make it and “pulling the plug” can be a difficult decision, but it is certainly an important one. How do you make that decision? “Do you have a value proposition for further growth for shareholders and investors?” posed Medford. “If the answer is yes, continue to move forward. If the answer is no — if there are clinical trial failures, political issues, and so on — you have to say it does not justify investment and risk. Also, do you have a plan in place that over time does develop value and is acceptable to investors? If you have neither of the two, it does not matter if the founder or CEO wants to continue — it is the fiduciary responsibility of the board to shut the company down.”

At such a point, added D’Ambrosio, “youhope you have a great board member who says, ‘Hey, it’s no good to chase this anymore.”

Such a move is also difficult for TTOs, Lei noted. “We’re the good guys; we spend the first dollar to protect the IP that becomes the basis of the company,” he noted. “But we universities do not have deep pockets. If we do not disrupt the life of the company, our own life support is threatened. Still, we try to pull the plug only after we give the founders plenty of time, and we make sure they understand our issues.”

Contact Brittain at 801-581-8791 or brittain@business.utah.edu; D’Ambrosio at 801-585-3844 or troy.dambrosio@business.utah.edu; Lei at 404-727-2211 or klei@emory.edu; and Medford at 678-330-2500.

The webinar this article was based on, “When Good Start Ups Go Bad: Worst-Case Scenario Management Strategies,” is available in full on DVD, on-demand video, and print transcript, including all handout materials. For details and to order, click here.  


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