Trends in Life Science Exits: How to Get Best Bang for Your Buck (Part 2)

Editor’s note: Matt Megaro was president and CEO of Quill Medical, Inc., a medical device company that he co-founded in 2000 in Research Triangle Park, N.C. The Company achieved profitability in 2006 following the successful commercialization of a series of minimally invasive cosmetic surgery devices. Quill was sold to Angiotech Pharmaceuticals in 2006 in a $200 million structured acquisition. This article is the latest in the Entrepreneurial Spirit series produced in partnership through the Council for Entrepreneurial Development and WRAL Local Tech Wire.

This is the second of a two-part article.

RESEARCH TRIANGLE PARK – One of the most important things on the mind of any entrepreneur in the late-stage developing their business is exit strategies. Exiting can be a very risky process and it is hard to know sometimes whether or not your company is ready for it. If so, how can you be sure you are following through with the best deal? Matt Megaro has extensive experience in starting and developing biotechnology and medical devices ventures and shared his thoughts with us on current trends in life science exits.

From your perspective, what makes a company attractive when looking to exit?

I’ll tell you, whenever we got “no’s” from a would-be acquirer or investor or a “not now’s” (which is the same to a “no” to an entrepreneur who takes these to heart) we learned to grow thick skin. I always used to describe the process as kissing a lot of frogs and hoping that you eventually find your Prince Charming. The process also teaches you not to be naïve. You have to look at yourself realistically and from the point of view of your would be Prince. Listen to their “no’s”. Listen to their reasons, and try to learn from that, saying, “Maybe we need to get more data; maybe we need to take a different approach – maybe that smudge on our face looks like a wart to them and we better clean it up so at least we aren’t looking less attractive then actually are.”

The other thing that makes you more attractive at times is simply to look rare. When we first tried to do deals at Trimeris and also later at Quill, it was always the same story, we were “interesting”, their scientists would always say “I love this”, and the businesspeople would always say, “It’s too early, or we have some more internal realigning to do but we’ll keep you in mind.” It was always the same menu selection of excuses and it doesn’t matter if its biotech or biomedical device, it’s always the same tipping point that you need to reach before a good deal can get done. Many of these people are going to say, “give me more data, give me more progress,” and they won’t ever act until something changes. And what I have found changes, and what makes you more attractive, has almost nothing to do with your actual progress but has to do with changes in the prospective partner or changes in the competitive environment. If you suddenly have a strategic value - something that helps them protect their current franchise, or helps them take away market from their main competitor then you will really see these guys get off the dime. Fear of loss - of your getting away - is a great way to stimulate action from the big fish.

You have to lay the groundwork for competition. When you are doing deals you have to try to talk to as many prospects as you can and keep those talks active, even if these are mostly parties who say they don’t want to act right now. Try to stay in active touch with everyone and cultivate their continuing interest, because something may change. Quill was a great example of this. Our relationship with and existing partner led to our acquisition. We made an effort to keep our partner advised or our other product applications; even though they indicated they could not pursue these at the moment. Then, after they were acquired, the relayed our information to their acquirer who turned around and bought Quill. They wanted to increase the value of our partner’s business buy adding Quill’s entire product pipeline to the equation. Also, we had an attractive 50/50 profit sharing deal with that partner and the acquirer wanted that deal to go away in the process. So, what happened? Our partner’s status changed dramatically and suddenly and we fell into the right exit opportunity. The point is that we stayed in close contact with our partner, even when they were saying no, and when their situation changed, they immediately relayed their excitement about our technology to their new owner.

At the time this was happening, we also had another party speaking with us; they had been talking about doing a deal for nearly four years but nothing ever got traction. They were a big medical device company with a lot of money but no real urgency to act. When they got wind that we were going to be acquired and that there was now a clear risk of losing our technology, they became very active, making numerous increasingly attractive acquisitions offers. The funny thing is that we never told them that we had another offer – the market just sends out these signals and they heard them loud and clear and fell over themselves to get a deal done. Again, we were the same company and we kept this company very current on our progress but what made us attractive to them was the fact that somebody else thought were pretty good looking too – sounds a bit like dating in high school, eh?

Is there an ideal timeframe, financial position or other milestone which signifies the best time for a company to exit?

There seem to be many different times when you can sell your company or be acquired, if you are looking for that exit strategy. The problem, however, is the price is only “right” once for the necessary majority of your investors. At first, a lot of my Quill investors would have rather we didn’t sell Quill when we did – they saw a shot at a much larger gain. There will always be some who feel that way no matter what is being offered. In the case of Quill, for example, we had an opportunity for the investors to get four-fold return of their investment and a reasonable shot at an additional 17-fold from future earn-out payments. Sure there was a chance for a lot more if we did not sell, but there was also a threat from another large medical device player who was signaling us that if we did not deal with them, then they would challenge us in the market and would challenge our patents as well. This was basically a hardball intimidation tactic – our patents were very strong, our weakness was a lack of the significant resources it would take to fight a siege battle against a determined and well-healed enemy whose intent was to drain our resolve and drag us back beaten to the negotiating table. These are the sorts of threats you can expect in our particular jungle and we did not want to risk losing a really good acquisition opportunity while trying to get an even better outcome only to end up with essentially nothing if all our plans unwound.

So the question of when to exit depends on a lot of factors and this it a gut-wrenching process. I learned from Trimeris that that company’s greatest value may actually be just before market launch of the main product. After that, reality set in and all of the investor exuberance turned into the sober realization that expectations had been too high and that the limitations of that product were always apparent but just not being appreciated. I’ve seen that often in biotechnology, the time to sell is often before sales start since actual sales are nearly always less than the optimistic forecast made during the emotional pre-launch era. Anyway, the value goes way up based on emotion and grand expectations – the reality part comes crashing in later.

The main thing is that you and your investors try to take a very sober look at the realistic value of your venture with full appreciation of the downside risk of remaining a small independent company in a risky world. Hindsight shows time and again that unrealistic expectations like these have often killed the better exit opportunities.

The right timing has always got to be looked at in the context of the alternatives to grow. At Quill, we were already profitable. Our first product was selling well, but the big products, the ones that were just launched this year by Angiotech, those we believe are the main value drivers. They were approved, but not yet marketed. Did we have to wait for them to be marketed before exiting? Probably not, because we structured a deal that basically said, “Look, we are going get rid of all of our small company risks like lack of size and resources and let someone bigger and more capable get the maximum market penetration form these products. And, if the sales go up, then we receive significant additional payment.

We did have the option to raise a lot of capital – several parties were interested in investing large sums. This would have increased our chances of surviving the threats out there and to achieve greater value from our products. But it also meant that we had to achieve a lot more value on a future exit to cover these new investors. This chance to remain independent and maybe generate a better exit value later did represent a better deal for our investors then selling now on good terms.

So, you can look to certain milestones or events as possible future exit opportunities – this is ok for planning purposes. But, you must constantly look at your immediate circumstances and make sober decisions that are not overly driven by the fear or the greed instinct. It is just like gambling. I don’t care what anyone calls it, it’s gambling and the odds are best calculated by cool heads.

How does a company ensure the best “bang for the buck” post-exit?

There are a couple of ways you do that. The second way, and I mention it in this order for a reason, is to put very creative and detailed diligence terms into your contract. If the acquirer must perform in the future in order to deliver your future payments, then you have got to have a couple of things: an assurance that they are going to apply themselves for this purpose and a clear remedy if they don’t.

What we did at Quill was we set up a holding company, and we gave it a lot of money because we had a lot of cash leftover. Thus, we had the capital to assert our rights and defend the contract if need be. So, you create a good contract, you make it pretty definitive, and you give yourselves the means to enforce it. These are essential things needed to get a structured acquisition deal to work.

But the most important thing you do, more than all the contracts you want to write and all the money you want to put behind them to enforce them, is to set your deal up with a party who clearly needs and wants the products to succeed. We had offers from significantly larger companies, but our feeling was that there was a tremendous risk, and I had a very experienced Board of Directors warning me of this, that a big company might just stick our products on a shelf. These are companies that seem to reorganize themselves every 18 months, and when they do, the project “du jour” is no longer in favor, and gets sidelined. It no longer has a champion, and you get to sit there and watch it waste away, because it just doesn’t quite “fit” with the new strategic vision of the current regime in power. This may not seem to make sense, but think about it, these are the same big capable companies that could not come up with innovative products like these in the first place. In simpler terms, these big machines can hide a lot of wasted effort among all their moving parts.

So, pick the right partner. I am so pleased with our acquirer Angiotech, because they have made Quill’s products a driving priority in their organization and are building and excellent marketing force to promote them. Many of these hires are excellent people from industry who come out of the very big companies we have been referring to. These are people saying, “Hey, I really want to be part of these products, and I can’t believe my guys didn’t pick this up, they should have bought this thing.” Those are the kinds of people and the winning attitudes you want - ones focused on succeeding in a big way.

So, your partner may not need to be the biggest and most dominant player, but it should be one that is smart, one who is nimble and has both the means, and more importantly, the drive to pull make things succeed. So I think how you prepare for the most “bang for your buck” post-exit under a structured acquisition, is by what you do pre-exit - get the right contract protections put in place and do your deal with a partner who has a core reason to focus on the success of your products.

What are some key characteristics of successful serial entrepreneurs?

The successful ones seem to be good at appraising themselves honestly and being willing to change their minds. The start-up environment does not forgive many mistakes so at least avoid the ones due to the ego.

Creativity is also important – a good imagination for what might be. After all, your venture is, by its nature, about what has never been done before so there is no cook book approach to your business planning. It is a game – one with lots of unknowns and the successful entrepreneurs are constantly evaluating options, risks, and opportunities – all in search for the best path forward. I suppose you can call this constant worry – I just used to brood a lot.

Intelligence also matters but not the sort that generally comes to mind. Few of us are smart enough to put together a winning plan for a venture from the start. But the successful entrepreneurs seem to understand that tenacious follow-through is what gets these ventures to the finish line. I can’t tell you how much that has mattered. For me, I think it is not much more than low-browed stubbornness. Sure, none of us wants to fail in our goals and failure can happen for a lot of different reasons. Sometimes the drug Gods forsake us and there is not much you can do about that. But, the last thing an entrepreneur wants is to look back on a failed venture and know it would have worked “if only we filed the patent correctly, or designed the study differently or put that contract term in place”. The good entrepreneurs seem to let these things haunt them before they happen and they work furiously to avoid their ever becoming reality.

I will tell you one other belief I have always kept to myself; I don’t believe that success in entrepreneurship is a function of working yourself to death. It’s not about working 80-100 hours a week. I know this goes against most of the entrepreneurial mantras out there, but I believe that success depends mostly on focused efforts on a well conceived plan. I worked too much in my early startups and I’m glad to have gotten that out of my system before I became married and had a family. A successful entrepreneur seems hardly that it means burying a good marriage or become estranged from your kids in the process.