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BayBio Entrepreneur & Investor Roundtables event puts industry changes into relief

Last night, as a BayBio partner, I attended the Ninth Annual Entrepreneur & Investor Roundtables event in Palo Alto. This BayBio event gives entrepreneurs in start-up life sciences companies an opportunity to meet and present to investors, both VCs and angel groups. The format is a speed dating arrangement that gives them about eight minutes to pitch.

I’ve attended this event for the last six years, and it’s an interesting reflection of how the industry has changed over time. In the early days, there was more interest in funding and more resources. Now the sources of funding are fewer, the dollars are more scarce—and the bar of approval is higher.

Investors, both VCs and angels, are more specific in their focus and they need to see higher levels of meeting milestones before approving additional or initial funding. There is more emphasis on demonstrating proof of concept before they fund the next level.

Also, the funding requirements to grow these companies are always going to be higher than many of their entrepreneurial counterparts in the tech industry. This is also different from entrepreneurs in the social media or software space, where an investment of $500K can keep you going for more than a year.

Although the funding climate is difficult and takes patience, the passion among entrepreneurs is still strong. Also, I’ve noticed over the last few years that these scientist-entrepreneurs are more business savvy than in the early years, and they have practiced and refined their presentations and their understanding of business forecasting and strategy.

The virtual company approach is almost universal in one form or another, with everything outsourced except for core competencies. Hiring fewer employees but using more consultants and developing collaborations is the norm. And overseas clinical trials are growing more common, in part because of the difficulty and expense of dealing with the FDA.

I have to say that I am always very impressed with the courage, stamina and determination of the entrepreneurs that I have met in life sciences. They are definitely not doing this for the money, but rather they truly believe that their efforts are helping humankind and/or the environment.

The other recurring fact is that I continue to meet people from all over the world at these events, which demonstrates that the Bay Area is still the global magnet for this type of talent and passion.

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The JOBS Act: Who are they kidding?

The JOBS Act (Jumpstart Our Business Startups Act) purports to foster the growth of small businesses, allowing them easier access to funding by lowering bureaucratic hurdles and thus enabling the growth of their business and their ability to hire more people.

In reality, the bill—passed overwhelmingly by the House last week and now awaiting President Obama’s signature—allows small companies to avoid scrutiny of their financial statements for the first five years because compliance is too costly. What is “small”? Companies with revenues of less than $1 billion. Yep—that’s most of Silicon Valley.

These small companies need access to funding. VC funding (with astute financial inquiries) isn’t readily available, so they go to the public market where we, the investors, have only the financial statements, press releases, website content and other information the company produces. We have to trust that it is accurate, but the JOBS Act says the internal controls and third-party independent oversight mandated by SOX legislation is “too costly.” Too costly for whom?

A well-designed SOX program is not too expensive—it’s too expensive not to have those controls. Any idea how expensive a restatement is? (Think audit fees, legal fees, the army of accountants crunching through your books, regulatory inquiries, shareholder litigation, the list goes on.) Nearly one-third of companies that have had IPOs since 2004 have had to issue financial restatements—that’s a staggeringly high number.

Why do small companies get it wrong?

For starters, finance isn’t viewed as a strategic business function—it’s viewed as overhead. That means it’s often not properly funded, so there’s not enough horsepower to make sure the books are accurate, not enough access to expertise to understand complex accounting regulations and not enough rigor in the close process. Bottom line: the financial statements are not accurate. They do not serve as a basis for understanding the financial position of the business—either for making investment decisions or making management decisions about running the business.

JOBS Act advocates say that most companies will be fine without the discipline of solid internal controls. Really? Did you see the latest from Groupon? First it stumbled with its IPO, and now it has stumbled with its first 10-K. See any patterns? In this last trip-up, the company identified a material weakness in internal controls related to the financial close process and cited three contributing factors: 1) an inadequate close process, resulting in a number of manual post-close adjustments; 2) account reconciliations not performed and/or reviewed; and 3) inadequate policies for timely, adequate review of estimates and assumptions. These are pretty basic controls that every company should perform as part of its normal close process—nothing fancy or tricky here—yet Groupon doesn’t seem embarrassed about missing these controls. (And it certainly isn’t embarrassed to be taking investor money.) While Groupon wouldn’t benefit from the JOBS Act because it has revenues of $1.6 billion, it’s a great example of what often happens with young, newly public companies and the challenges they face in providing accurate financial information to the investor community.

In the wake of the massive frauds perpetrated by Enron, WorldCom, Adelphia, and others, we got SOX. In the wake of the massive frauds perpetrated by Wall Street—which drove us into the deepest recession since the Great Depression—we got Dodd-Frank. Who are we kidding with the JOBS Act? Get ready: we’ve paved the way for a lot more fraud and financial misstatements.

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Survey benchmarking Bay Area start-up environment reflects RoseRyan client experience

The Bay Area Council Economic Institute has just released the results of its survey that benchmarks the Bay Area environment for young companies and entrepreneur-led start-ups. The Council’s 300+ members are a “who’s who” of Silicon Valley; I was pleased to be selected as one of the partners who contributed to the study.

Although there has been improvement in the local economy over the previous year, the survey shows there are still challenges. This is consistent with RoseRyan’s experience in the marketplace. Our clients are still having a tough time raising capital, regulations are still difficult to navigate, and other geographic areas are competing for business, but I am still optimistic in this region’s ability to adapt and innovate at a great pace.

I’ve compared some of the key findings to RoseRyan’s experiences:

Listing regulations and requirements do not discourage companies from seeking public listings: Only 16 percent of respondents agree. This is key as clients usually are not prepared to handle all of the main components of preparing their S-1s and SOX requirements after an IPO.

The government has developed tax incentives to increase the amount of research and development. 36 percent disagree and 28 percent are neutral. Tax incentives play a smaller role here than other parts of the world. Most companies, like most of our clients, do not rely on government subsidies but are certainly aware of available grants and tax incentives.

Compliance with government regulations does not unfairly burden new and growing firms: 31% disagree, which is much lower than other parts of the world. This is consistent with many of our clients’ experience. They still have to deal with a labyrinth of regulations in California which are slowly getting less cumbersome.

Government programs provide high-quality services to new and growing firms: 12% agree. Unfortunately, there does not appear to be any faith in government programs. Many of my clients feel that government support is a bonus.

Most entrepreneurs personally know one or more private individual investors (i.e., “angels”): 43% agree. Most of RoseRyan’s clients are cognizant of the “start up” ecosystem of investors.  They understand the ebb and flow of the markets based on the overall economy.

Stock options are considered a positive source of compensation. 84 percent agree.  This is consistent with our business, and we expect stock options to be a strong motivator for attracting and retaining employees.

Benchmarking the Bay Area’s Environment for Entrepreneur-Led Start-ups provides many other interesting insights. You can learn more about the Bay Area Council on their website.

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