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Sunday, 30 October 2016 17:06

As Michigan life sciences industry awaits exits, focus shifts to later-stage funds, talent

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Joining MiBiz for a life sciences roundtable were (top left to right) David Esposito of Armune Bioscience Inc., Dr. Tim Fischell of Ablative Solutions and Dale Grogan of Charter Capital Partners; (bottom left to right) Jim Medsker of Keystone Solutions Group, Stephen Rapundalo of MichBio and Phil Torrence of Honigman Miller Schwartz and Cohn LLP.  Joining MiBiz for a life sciences roundtable were (top left to right) David Esposito of Armune Bioscience Inc., Dr. Tim Fischell of Ablative Solutions and Dale Grogan of Charter Capital Partners; (bottom left to right) Jim Medsker of Keystone Solutions Group, Stephen Rapundalo of MichBio and Phil Torrence of Honigman Miller Schwartz and Cohn LLP. Photos by John Lacko

The availability of scientific and executive management talent and the access to later-stage investment capital remain major issues for Michigan’s life sciences industry.

That capital gap is worst when it comes to securing large financing rounds from in-state sources for life sciences companies that were seeded years ago and have moved down the product development pathway, according to industry professionals MiBiz gathered this month for an executive roundtable discussion.

The discussion — held at the downtown Kalamazoo office of law firm Honigman Miller Schwartz and Cohn LLP, which sponsored the roundtable — included:

  • David Esposito, president and CEO of Kalamazoo-based Armune Bioscience Inc.
  • Dr. Tim Fischell, CEO and chief medical officer at Ablative Solutions Inc. in Kalamazoo
  • Dale Grogan, a managing partner at Charter Capital Partners in Grand Rapids and Michigan Accelerator Fund I
  • Jim Medsker, president of Keystone Solutions Group in Kalamazoo, a product development firm and contract manufacturer of medical devices
  • Stephen Rapundalo, CEO of the Ann Arbor-based trade association MichBio
  • Phil Torrence, a partner at Honigman in Kalamazoo whose practice specializes in life sciences.

Here are some highlights from the discussion. 

To start out, how do each of you view the state of the life sciences industry in Michigan?

Medsker: From Keystone’s perspective, it’s been a frenzy. We’ve been very, very busy. We’ve experienced last year about 120-percent growth in that area. We see a lot of early-stage startup activity going on and it’s been great, both in the Class I and Class II medical devices, and in particular we see a lot of activity in the health care market.

Esposito: My focus certainly has been on diagnostics. The interactions with university support, other entrepreneurs and physician groups in our sector have been alive and well. It’s a very collaborative environment to support early-stage businesses like ours. That’s been very productive.

Fischell: We started Ablative Solutions about five years ago and have worked very closely with Phil Torrence and Honigman. In terms of resources in Michigan, for us the excellence in corporate management legal counsel has been key and one of the reasons we sort of started up things here. The other resources have been some early funding from groups like Michigan Accelerator and BioStar (Ventures, a VC fund in Petoskey) and others that have been very productive in launching our efforts.

For a variety of reasons, we have not necessarily found the depth and breadth of talent for sophisticated medical devices and the depth and breadth of deep-pocket funding resources in this state that would really make it a primary place. Our primary place now we’re going is California … but I’d love to be able to do this kind of endeavor full scale in Michigan and cut my burn rate in half or less.

Rapundalo: The industry has grown very nicely here in Michigan in the last few years and the numbers bear that out. Across the board, there’s been a 6-percent increase in employment and the number of companies. Pharma in particular saw 11-percent growth and has rebounded from the Pfizer shutdown in Kalamazoo and Ann Arbor, which is real encouraging to see. The med device sector, if you believe some of these rankings out there, has become the 10th largest in the country. People now recognize (Michigan) as having a concentration and strength in med devices. (There’s been) a lot of notable, almost explosive growth in startup companies … in the medtech space. Therapeutics and such lag for natural reasons. It’s just a tough business to be in.

Torrence: We’ve had a tremendous amount of growth over the years and at any given time, we’re involved with five to 10 … life science or med device companies that are at one round of funding or another. 

I’d echo some of Tim’s comments — you know, be careful what you ask for. We set out 20 years ago to really put an effort into making Michigan a place to grow and incubate and hopefully keep life science and med device companies. We’ve done a good job of that. However, it is challenging. Where you can get these companies launched with $1 million, $2 million, even $10 million rounds of financing, both med device and life science companies are very, very expensive to fund. The ability of our investor base in this state to finance all the way through without getting help from the coasts is damn near impossible.

We have a number of very exciting companies and their capital needs to get to that next milestone are not $3 million or $4 million. It’s in the $10, $20, $30 million range.

Grogan: I think we have a robust ecosystem here. There has been tremendous investment for early-stage companies and, of course, we know the brand names at the other end of the spectrum. But what we have is this dumbbell effect where you have a lot of really great companies like Gemphire (Therapeutics) or Ablative and some of these smaller companies that have been able to get launched, but there’s no middle ground because we don’t have the path of hyper-growth to get from starting into the first $100 million, $300 million, $500 million of revenue. There’s an absence of that market, then you drop to the big end. We don’t have all phases of that business continuum in Michigan, so these scrappy startups can’t continue their growth and development.

We’ve seen a lot of companies have to go outside of the state for large financings. Do you see a day when those large capital rounds are more readily available within Michigan?

Grogan: I don’t know if it will be exclusive. I think it’s syndication and leads here, but what we have not had is a 20-year history of running the investment cycle from early stage to exit. We’ve seen some, but really this is the top of the second inning for venture capital in Michigan. 

But that said, those funds that have been around sort of post-recession are maturing and starting to see some exits. If things go according to Hoyle, you’ll see sort of a whole disgorgement of these positive exits, which will hopefully recycle cash and create investor confidence.

Torrence: That creates partnerships, too, with the syndicates. In addition to IRR, the way a lot of funds are measured on performance is how many dollars can they get to follow their one dollar. So the more deals that Michigan-based funds do with funds that are not tied to Michigan, the more overlap and connections and, hopefully, that leads to a good exit, and then over time you start to build those relationships. 

The key word to all of this is patience. This is not something that is going to get major traction in one, two or three election cycles. (It’ll take) multiple, multiple decades to get this thing to really mature.

Rapundalo: I would add that in addition to these young companies maturing and going through their entire business life cycles, for the established companies they’ve been starkly ignored, forgotten in terms of the capital markets understanding them and this industry and being able to support them. Part of that is education. I don’t think the capital markets understand our industry, at least not here in Michigan, and so convincing them that our long-established $100 million-, $500 million-type companies are worth investment for expansion, new product lines and what have you is still a major area of need.

Esposito: We’re raising a $25 million round now and part of the interest on the coasts is not just money, (you have) to mention talent. Beyond the scientific talent, the leadership talent that has turned a few companies typically has come from money sources on the coasts, too. So if somebody is really stepping up to lead a good-sized round, chances are they have a suite of leadership that they want to do it with again. It takes a good 10- to 15-year cycle to probably have a lot more of those just fundamental leadership baskets on the coasts that’s following the money, too.

Fischell: In the end, if … you’d like to see Michigan competing with California and maybe Texas and Boston and … the basic talent, regulatory talent, clinical talent, executive talent and funding, … it’s going to take a lot more nurturing in terms of keeping undergraduates, training bioengineers, keeping them here and retaining them, and then having executive teams that are trusted by big, deep-pocket venture groups. Or, it’s creating those venture groups that can collaborate outside Michigan to create syndicates. It’s a very complex process and to do that all in the state of Michigan, it would be helpful if the state itself maybe did more to incentivize people.

Torrence: In New Jersey, you can actually sell within the state your net operating losses (NOLs). For example, one of our clients every year sells their NOLs at a discount to a profitable company and gets, I don’t know, 85 cents on the dollar.

Rapundalo: The talent is critical, especially C-suite, and that’s really where we have a huge challenge — convincing folks to come here. Once they get here, it’s good. They see the value of being here, but getting them here is the tough nut to crack. To grow the entire industry, it’s going to take partnerships within industries, with the financial markets and with government. Everybody has a role to play, and I think that’s where Michigan probably still has a ways to go. And as a result, because (the state) has kind of stepped away from these things over time, we’re no longer in that top 15 we probably were 15 years ago. It’s a different mentality in Lansing.

Michigan lacks both an angel investment and an R&D tax credit. Has that affected decisions on business investment?

Rapundalo: Michigan is one of only four states that no longer have an R&D tax credit. These things add up and they play into how competitive we can or cannot be. … When people ranked things like talent, access to capital, business incentives and commercialization of IP, business incentives usually came in fourth or fifth. It was talent and capital that was always at the top. 

But certainly when people are looking from the outside, if nothing else, on paper it’s noticed. If it’s there, it may not be the determining factor, but if it’s not there it’s noticed. You have to have an economic development toolbox that you can pick and choose what is going to be appropriate for your company. There’s no one size fits all.

Esposito: I think it’s more of a helpful add. Raw talent and access to capital and ideas are probably the biggest ones. I think all of the other stuff is just nice to have it.

Fischell: There’s a real appeal to having it, if you could really create a (life sciences) business and do it in Michigan.

How does Michigan stack up against some of the other states who are leaders in the industry?

Fischell: To grow a company in the Bay Area (San Francisco) is unbelievably expensive, so you’re paying people 50 percent more than they’d be paid here because of housing. The lease rates are triple than what they would be here, if not four X, for commercial space. Then you have higher insurance costs, infrastructure costs, and a whole bunch of other things. California obviously has the talent pool and the capital pool, and you can see it with those huge disadvantages of the burn rate of creating and running a company that they have. To run a company in California is almost prohibitive today. It just goes to show the opportunity we could have (in Michigan).

Torrence: (California) is a higher tax state, too. One of the highest tax states is Minnesota and it is probably just below Silicon Valley and Boston as one of the most robust medical device hubs in the entire country, if not the world. … We have a number of clients up there that we work with that are publicly traded, small-cap companies. There’s a whole subsector of companies that are in the service of contract manufacturing. They have the talent there that we would love to have.

Rapundalo: The other feature that they have, much like the Bay Area or wherever, is it’s concentrated. Pretty much the entire medtech sector in Minnesota is within an hour’s drive of Minneapolis instead of being spread out.

What’s one public policy change each of you would like to see in Lansing that would help the industry?

Grogan: It’s the Venture Michigan Fund. This was a grand economic gardening experiment that was started by the 21st Century Jobs Fund years ago — three administrations ago — and it was sustained through both the Engler and the Granholm administrations, and here we are now and for whatever reason this governor — which is curious as a former venture capitalist — (said) for the MEDC, that’s not the highest and best use and way to invest. That is exactly wrong. It is the highest and best use.

If you want to create infrastructure — and we’ve all agreed that infrastructure is where this starts — you have to have money, which attracts the capital, which creates the businesses, which creates all of these new opportunities. That is what is necessary because any entrepreneur in Michigan in the life sciences business will tell you there is not enough capital out there. So that means the state needs to seed this. It’s done a very nice job historically, but then all of a sudden it just stopped watering the plants. To me, that’s a dumb way to tend to your crops.

Torrence: I agree completely. If I look back early in my career, almost every startup or venture deal we did had 21st Century Jobs Fund loans or investments. Then that seemed to switch to instead of putting state money into startup companies, it seemed to invest directly in funds, and over time that has even dwindled quite a bit. If you had to pick one thing, Dale’s right, it’s capital.

Rapundalo: I’d like to see an overall life sciences initiative. Obviously, that would be made up of a lot of pieces, some of which in terms of what you guys are describing is almost industry-agnostic. It’s not just specific to our industry, but there should be pieces that are, as some other states have done. And make it visible again, even if it is just carve out a piece of that 21st Century Jobs Fund pie or whatever. But at least tell people out there that it exists and that we exist, and that we have a tremendously strong industry that is growing and that you can start a company here and have high value. Or if you are a home-grown company, there is support to make it continue for another 50 or 100 years.

Fischell: I like the concept of an angel tax credit. We’ve raised $21 million in angel money in our company, and we probably could raise more if I could say to guys, ‘You know, you also get a 10 or 15 percent or whatever tax credit back.’ … There are a lot of very smart and thoughtful investors that are willing to support companies in our community, and I think that could be promoted more. 

Medsker: Focus and visibility for these startups because for one, what resources are out there? They don’t even know. So having an initiative like that will at least bring it to the surface so that they have access to it.

Torrence: You can’t look at this in a vacuum. There are some Michigan-specific, unique issues or wants that I’m sure we all have. But when you look at the state of the life science industry and how institutional money even on the coasts is viewing risk/reward, the point at which a lot of major investors come in for the big, big rounds keeps getting pushed further and further out. What happens as a consequence of that is that more and more of that expensive funding — not just the seed funding, but the tens of millions of dollars in each of these companies — is really thrust upon the backs of these angel investors. So you really need to look at the whole kind of continuum within that sector.

What is limiting the availability of capital for the industry? 

Torrence: I don’t know if it’s just one day a lot of these institutional funds woke up and said, ‘You know, we don’t like medical devices and life sciences anymore.’ I think part of it is a lot of these unicorns have sucked up tons of money from the industry and people are looking at getting one thousand times return on their money. As a result, you have many, many, many more life sciences companies competing for a shrinking pool of capital that’s out there.

Did you ever think 15 years ago that you’d be talking about how we need more large venture funds in the state for the later capital rounds? 

Rapundalo: In all fairness, Michigan has certainly seen a lot of growth in the early-stage capital. … We’ve done some things that are right. We just need to do more of it and make sure the whole ecosystem of the funds and the talent is there. And that takes time.

Isn’t that a good problem to have because it’s been created by success?

Rapundalo: Yeah, but there’s a still a mentality in Lansing that made it difficult to get those funds reauthorized. When you’re having to constantly battle that, that tells you the sentiment up there, let alone the understanding, isn’t there. It is puzzling given the governor’s background.

Torrence: It’s a good problem to have, but it’s really dangerous because as a consequence of not being able to raise additional funds, a bunch of these companies have to have a fire sale or shut down. How hard do you think it’s going to be for Tim or Dale to raise that next round or fund that next company when a bunch of their investors got stung?

Is there still the fear that if companies are going to the coasts for funding that they will eventually follow the money and relocate there?

Rapundalo: A lot of the investors have realized the value that is here and what they can get for their buck.

Esposito: That’s something that can’t be overstated — the cost structure to run a business here. You can scrap by a lot longer here than you can on the coasts without burning through a ton, and there’s enough talent to get the thing going. But it is that next-level round where I think you wander. My whole executive team is a bit scattered. It’s virtual, for sure, but having still that core flag in a state is important.

Rapundalo: Twelve, 15 years ago, you did see young companies leave and get pulled by their investors to go wherever. I think that has diminished a lot. You do hear a bit … but you don’t hear that in the news as much. It’s not quite the exception, but it’s certainly not the rule.

Fischell: To me, the bigger issue is getting the talent pool to move here from California. … I hate to say it, but people are not going to move from Palo Alto. You just can’t pay them enough. You have to pay them their Palo Alto salary.

Rapundalo: We have seen an uptick in folks moving back for family or whatever kinds of reasons. They were from here or they went to school here.

Fischell: If they were from here, you have a chance. They have connections here. If they have no connections here and you’re dealing with the climate — winter’s kind of tough here — the Californians who’ve been there 10 to 20 years and have gotten used to that. (They’ll say), ‘I’ll go take another job. I have three job offers in the Bay Area.’

How do you overcome that?

Grogan: I wonder if we can do better marketing that we have opportunities here. If there’s one thing the state ought to do maybe it’s consider bringing back the boomerangs. Getting them in and creating that opportunity for them.

Rapundalo: And that’s been sort of a roller-coaster ride. They start programs like that. We participated in something called MichAgain and they would go to a major community like Cambridge and have events and try to reach out to former Michiganders. … We need something like that, but the state starts things and then pulls back. Sometimes they ride the wave between administrations and other times it’s actually within an administration.

What about the universities? Can they do a better job outside than what the state’s doing?

Rapundalo: I think they are, but they’re siloed. They’re not integrated. You need an integrated, coordinated thing so that the collective energy is pushing a lot of this.

It seems that Michigan isn’t unique in its problems. How are other regions of the country trying to solve the same challenges?

Rapundalo: Tennessee has put a lot of effort in the device and tech space and has tried to build infrastructure and ecosystems to try to support that. Colorado is another example. Different states have tried to figure out what they’re good at and not put all their eggs in one basket. They have certain intrinsic strengths and try to build around that.

Then you have to have a game plan. You have to have a long-term vision and you have to sell it to all of the stakeholders, not the least of which is the policy makers. That’s in short supply when you talk about politicians anywhere, let alone in Michigan and an industry that’s very, very difficult for them to comprehend.

Fischell: They started (focusing on) bioengineering at the University of Maryland 10 years ago. Before they got into all of this, they had 70 undergraduate students and 10 graduate students in bioengineering. This year there are 425 undergraduate students and 83 Ph.D.s being given in bioengineering, and the state of Maryland is building a $130 million (facility) for the Department of Bioengineering to try to increase this to 500 to 600 undergraduate students. The state funded this construction.

This is an amazing way to incubate talent, to create bioengineering at Western Michigan University. Take these young minds, keep them here or put them here so that they become Michiganders, teach them, and then create a talent pool and incubate talent in bioengineering. These guys have great ideas and they start companies.

Rapundalo: We’re sixth in the country for the number of scientists and engineers that we spit out. It’s not that we’re short on talent. It’s the retaining. I’ll hear constantly from the likes of Stryker and others who say, ‘Well, we can’t find good talent.’ Wait a minute. There’s this huge pool. Part of it is the schools aren’t producing what the industry needs. There’s a disconnect. There’s no shortage of areas where this state needs to put resources of one kind or another.

Look ahead for three to five years. What do you think we’ll be talking about if we get together again?

Torrence: Hopefully some big exits.

Medsker: We see a significant amount of growth in smart devices for collecting patient data and transmitting data and dealing with that huge database. We have numerous projects now — and this just started in the last 18 months, probably — (with) smart device stuff. Wearable technology is becoming prolific.

Grogan: Wearable, big data, and fintech as it relates to health care. Where those areas converge — and I’m not sure where they are, and what those companies look like — to me that’s where the opportunities are. If we have done our business well, there should be the resources available because we should have reached some of this harvest that we’ve been working so hard at for years. I’m very bullish on that area. What Michigan does very well is we build stuff, and we’re going from the knowledge economy to a knowledge-plus-wearable economy. We’ll build those things.

Rapundalo: I don’t know if we’re going to be driving it. I would argue we’re already behind the curve. There are other areas in the country where they’re already trying to put their stamp on the digital health space. We’re not one of them.

Fischell: There’s going to be a lot of growth in that space. The problem’s going to be keeping the manufacturing here and not having it move to China because that stuff’s pretty easy to build and it’s built at one-quarter of the cost or one-tenth of the cost in China. The technology can be innovated here, but my guess is it’s going to be hard to manufacture it in the United States because we have to pay our workers.

Esposito: We see it in a lot of industries, the whole digitization of everything. 

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Mark Sanchez

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msanchez@mibiz.com

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