Tag Archives: business environment

Interview with Dave Madden of Narrow River Management

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by Howard Johnson


Interview with Dave Madden of Narrow River Management

Dave Madden and I worked together at Paine Webber Development Corporation (PWDC) in the late 1980s. At PWDC, we both became excited about biotechnology, working on financing companies such as Genentech, Amgen, Centocor and Genzyme in innovative product development partnerships.  Since then, Dave has gone on to have a very successful career in bioscience as a chief executive and board member of several companies, and as an investor and entrepreneur.  Starting in 1992, he was CEO of Selectide, which was sold to Marion Merrell Dow (now Sanofi) in 1995.  He then was Co-CEO of Royalty Pharma , a leading investor in the biotech space. In 2005, Dave became acting CEO and Chairman of the Board of Adolor, which Cubist Pharma acquired in 2011.  He is now Chairman of Dicerna Pharmaceuticals and Founder and Principal of Narrow River Management, a NYC-based management firm focused on developing new biopharmaceuticals.


I recently asked Dave to answer a few questions of potential importance to NYC bioscience entrepreneurs.


1.       What’s the key to starting a successful biotech company?

I don’t think there is a single key to starting a successful company in the bioscience space.  For me, the key is to have an attractive molecule addressing a disease for which there are no or few treatment options.  In addition, I think it is critical to have a finite time frame and a well- circumscribed budget for answering a value-creating question.  In our case, this question needs to be a Phase 2 clinical trial.  Once these elements are in place, the key to success is execution; that is, performing the trial to get quality data on time and on budget.



2.       What type of drug development projects do you think appeal most to the venture capitalists right now?

This is a difficult question to answer, given the state of the life sciences venture business.  We are all aware that this financing sector is contracting, making it much more difficult to fund even high quality projects.  Having said that, we find there are distinct factions within the industry – for example, there are those that favor our approach of single product focus with short-term milestones and a finite budget.  Others favor a less binary strategy seeking to build a product portfolio or technology around a management team in which they have confidence.  As far as the hot sector of the moment – if there is one, I do not know what it is.


3.       What’s the best advice you can give a young scientist or entrepreneur about starting a biotech company?

I would say the best advice I could give is to critically assess the data in support of your product or technology and to do the experiments that will disprove your hypothesis as early as possible.  I think the worst thing that one can do in this business is to have an optimistic assessment of the data that defers making the difficult decisions and increases costs unnecessarily.


4.       What did it feel like to get your first product approved by the FDA?

In our case, the approved product was Entereg at Adolor.  Given the circumstances of the approval, in which the drug was given an unprecedented black box warning highlighting no known risk, the victory was bittersweet.  On the one hand, we were excited to have an approved product; on the other, we were convinced that the label given the drug was unfair.   This label continues to impact the use of what is an excellent drug.  In addition, we were developing Entereg for chronic use together with GSK and, given some results that we had in those clinical trials, the additional safety data that the FDA requested made this additional indication economically unfeasible to take forward.


5.       What are key issues that drive a sale of biotech company? Any negotiating advice you can provide to maximize price?

One obviously needs a product or technology that others might be interested in and a convincing data set that will enable them to bring it to commercialization in a straightforward fashion.  In the case of a product, most often this is a Phase 2 trial in the intended population of sufficient powering to be convincing.  In the case of a technology it is more variable.  We sold Selectide as a technology company (combinatorial chemistry) with a few preclinical programs that had resulted from the technology.  Today, the bar might be higher, but this tends to vary according to trends in the pharma industry.  Just a few years ago, SIRNA companies were sold for quite handsome prices, for instance.

The key to maximizing the price one can achieve is also obvious – and that is having alternatives.   I typically take that to mean the ability to fund the company and the project through the next value-creating milestone.


6.       What is Narrow River Management’s mission?

We started Narrow River with a few key premises.  The first is that for our particular skill set, the place where we can add the most value and create the most value for ourselves and our co-investors is in proving that a drug works in man – not discovery research, not preclinical development, but Phase 2 human clinical trials.   The second premise is that we should allow our co-investors to select the products in which they have an interest.  As a result, we fund each product we intend to develop separately in a special purpose corporation.  Thirdly, we only take on projects that can be completed within a 2-3 year time frame and for which the result will be a data package that is (if successful) saleable or sufficient to attract the capital needed to complete a pivotal set of studies and register the drug ourselves.  Finally, we decided to manage the businesses with very few of the best people and to outsource as much as possible.

Based on these premises, our mission is to find and develop interesting new drugs.


7.       Tell us a bit about your current development project.

The first product we are developing is a protein that we are testing in a disease called Thyroid Eye Disease, or TED (also called Graves’ Orbitopathy).  TED is a disease, associated with Graves’ Disease, that causes the eyeball to protrude from the socket.  It is an orphan disease that affects mostly women and the morbidity associated with the disease can be quite severe. We are starting a clinical study in TED patients that is commencing presently and for which we hope to have the topline data in about 18 months.



photo credit: St Stev



Apr 16, 2013

The “Money” Slide for a Diagnostic Company Pitch Deck

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The “Money” Slide for a Diagnostic Company Pitch Deck

If there were only one slide I could have to present to an investor about a diagnostic company I was trying to get funded it would be this:  For diagnostics, the most important thing is to show how your test changes the course of the treatment.  Does the doctor do something different based on what information they receive from the test? A classic example of not doing this is the diagnostic for STREP.  We all know people who have gone to the doctor for a sore throat.  The doctor took a swab for a STREP test for which they would get a result a few days later.  In the mean time, they sent the patient home with a prescription for antibiotics that they were to start taking.  So, there was no point to the STREP test, as the physician had already acted on a course of treatment.  Insurance companies hate to pay for tests like that, as well they should.

The “money” slide starts by showing the current diagnostic work up in a decision tree format. You help the potential investor visualize the current course of treatment.  For example, the patient presents with chronic chest pain.  The doctor does a physical exam and oral family medical history. Then, based on that, decides to have the patients cholesterol checked. That is the first fork in the decision tree.  Based on those results, the doctor may decide to do a stress echo test.  That is another fork. After that, they may do an EKG or body scan.  There is a cost to every fork the physician goes down.  The key pieces of information you need to show are, 1) where does your test comes in to this work up and 2) how will the physician go down a different path due to the new data?  At what fork does your diagnostic intervene?  You have now achieved goal number one – showing how your test changes the decision.

For first time entrepreneurs, coming up with market size is often a struggle. If you put numbers by each of the decisions (e.g. the stress test- the number done a year and cost to perform the test) you can fairly easily start to show market size as well as savings for going down the path with your information instead of their regular procedure. In one simple step, you have now shown market size to the investor and savings to payers, which will help with the reimbursement discussion.  (See my earlier blog Reimbursement for more on that topic).

If by going down your path the treatment plan now cuts out X tests at a cost of $Y then you also have information for how you would value price the test.  Physician adoption is always a big question with any new technology.  This slide will also show if you are taking revenue out of the doctor’s pocket.  For example, if they get paid for performing the procedure that your test is making irrelevant.  By having this information, you can craft a better sales strategy to address this potential concern.

The diagnostic money slide that I have described shows:

  • what problem you are solving
  • the market size for that problem
  • the change in physician decision making, and therefore
  • what price you could potentially charge (for which you may get to be reimbursed)
  • and potential hurdles to adoption.

That’s a lot of important information in one slide.  Hopefully it will help you get money from investors.

Jan 14, 2013

When Should Your Biosciences Startup Use an NDA?

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Founders of startup companies often face a difficult situation: They want to talk about their company, their business plans and their ideas with potential investors, friends and family, and anyone else who innocently asks them what they are working on, yet at the same time, they fear that sharing sensitive information about their company at its fledgling stages may lead to this information being “stolen,” copied, or widely disseminated by a competitor.

A Non-Disclosure Agreement, or NDA is at its core an agreement that says that when one party discloses information that is confidential (what falls into the bucket of “confidential information” is defined in the agreement), the receiving party is not permitted, legally, to disclose that information to anyone, with certain very limited exceptions. In addition, the receiving party is not permitted, legally, to use the information that is disclosed to it, except for the purposes specifically set forth in the agreement.

It’s no wonder that an NDA can seem like such a panacea to startup founders: You can have your cake and eat it, too!  As a founder, you believe that with an NDA, you don’t have to worry that someone else is going to make the same cake you’ve shown people and get it to market sooner than you, with better functionality.

And although an NDA is sometimes a great tool for minimizing the risk that your company’s confidential information will fall into the wrong hands, or be used improperly, it is not always the best tool.

So: When should you use an NDA?

1. When your talks with a third party are about to begin.

If you are going to share confidential information with a third party, you should have an NDA in place before starting the process of disclosure. Do not wait until after talks have begun to try to get a confidentiality agreement signed.

However, if you have any doubts as to the trustworthiness of a potential acquirer, investor or collaborator, or any other party with whom you want to discuss non-public aspects of your business (e.g. data from clinical trials, the subject of a patent application, a trade secret, etc.), you should NOT share any information that you would not want to become public.  Even if such a third party signs an NDA, although you have legal protection under the terms of the contract, it may be “too late” to fix the damage to your business once the genie is out of the bottle and they violate the contract.  If they break their word (and violate the contract) and share, use or copy your confidential information, suing them for breach of contract (which can be both expensive and time-consuming) may not undo the damage that has already been done.  Especially for the founders of early-stage companies, or any company that does not have the resources to litigate at length, it is a far better strategy to be careful about your disclosure than to rely on an NDA to keep untrustworthy confidantes honest.

Also, if some subset of information about your company is truly “the secret sauce,” even with an NDA in place, you should be careful about when to reveal that information.  If your company is going through the diligence process with a potential acquirer, investor or collaborator (including any party with whom you’re evaluating a potential licensing, distribution or manufacturing relationship), you should wait until you are really comfortable with the other party and the terms of the deal to share the juiciest details. “Staging” the process of disclosure, such that you do not disclose the most important information to a third party until you determine that the third party is serious about completing a transaction with you (on what you believe will likely be reasonable terms in general), is a good practice.  Although an NDA is typically executed prior to the start of the diligence process, it makes more sense to wait to disclose the really sensitive information until the deal is close to completion than to share early on in the process and then kick yourself when an ill-suited potential acquirer, investor or collaborator walks away with knowledge about your company that you would much rather he or she did not have—NDA or not.

2. When your patent filing strategy is implicated.

The laws surrounding patents are very sensitive to public disclosure of information.  For example, if you discuss an invention with third parties and you provide printed materials or if a transcript of your discussion was made, without any understanding that the printed materials or transcript should remain confidential, the printed materials and/or transcript may be treated as a “publication” of that invention.  Under current U.S. patent laws, inventors are entitled to a one-year grace period that runs from the first publication of an invention, and under the new America Invents Act, which will come into full effect on March 16, 2013, the one-year grace period may be triggered by purely oral disclosure as well.  Once that one-year clock runs without you having filed a patent application, the disclosed invention may be considered “prior art,” and thus not eligible to be the subject of a new patent filing.  If your company is concerned about global patent strategy, it is worth noting that many foreign jurisdictions are even more sensitive to public disclosure of information, and many do not offer the one-year grace period offered in the U.S.  While an NDA is not a guarantee that no public disclosure has been made, it does indicate your intent to keep confidential any disclosure you made of your invention, and suggests that the invention should not be considered prior art.

3. When you’re dealing with employees, consultants and other service providers of your company.

Employees, consultants and other service providers who have access to confidential information of the company should always sign an NDA at the time of commencement of their service relationship with the company; this should be a condition of employment and should be signed before any access to confidential information is granted. For employees, consultants and other service providers, an NDA is often combined with an assignment of inventions agreement, which states that any intellectual property developed by the employee, consultant or service provider in the course of rendering services to the company is assigned to the company and is the company’s property, in addition to being kept confidential.

And now the other side of the coin: When might it be acceptable for you to skip the NDA?

1. When you’re meeting with potential venture capital (VC) or professional angel investors.

Innumerable websites and blogs written by VC and angel investors have set out reasons why they won’t sign NDAs.  In summary:  These investors state that they meet with so many companies (many of which are in the same field, or are working on similar products/services as companies that the investors have already invested in) that signing an NDA creates liability for them.  Their concern is that if they sign an NDA in respect of confidential information of Company X,  Company X can sue them for breach of the NDA and allege that their confidential information was passed on by the investor to Company Y, a competitor of Company X that the investor ultimately decides to fund or has already funded.  Although there is no guarantee that Company X would prevail in such a suit, investors usually prefer not to open themselves up to that possibility (and avoid the headache of dealing with lawsuits). So, while it is nice to get a potential investor to sign an NDA, if possible, if you are talking to a financial investor (a VC), rather than a strategic investor (a company in your industry that might invest), you can often get comfortable that you do not need an NDA because as a general matter, financial investors like VCs are not in the business of taking ideas, starting companies and running those companies—they invest in companies started by you. Not to mention the reputational harm a VC would suffer if it were to violate the expectation of confidentiality and share or improperly use the confidential information of a company it had considered funding.

In the end, the best way to play it safe when there is no NDA in place is to play your cards close to the chest and delay sharing any sensitive information until you have a good working relationship and trust your potential investor. It’s also a good idea to conduct diligence on your potential investor—sharing information with a VC who knows your space generally, but has not already invested in a direct competitor of yours, can also provide you with some comfort.

To sum up: When it comes to your company’s confidential information, an NDA is a useful tool, but your common sense is more useful still.  Whether or not you have an executed NDA, you should not disclose sensitive, “secret sauce” information to anyone you don’t trust, or at the very start of assessing a potential business relationship with another party.  This should go without saying, but social interactions are no exception to the rule of common sense; a piece of information you let slip at a party is as likely to end up on the web or in the hands of a competitor as information revealed at a meeting with an investor (if not more so!).  In those situations where you decide that an NDA is the right tool, consider what is appropriate given your specific context (e.g. if the recipient is a company, who at the company will have access to your information; what should be the duration of the NDA; does the NDA need to be mutual, etc.).  And of course, when in doubt: ask a lawyer.

Jennifer Berrent is a partner in WilmerHale’s Corporate and Emerging Company Practices. She can be reached at +1 212 937 7513 or jennifer.berrent@wilmerhale.com.

Joshua Fox is a partner in WilmerHale’s Corporate and Emerging Company Practices and Life Sciences Group. He can be reached at +1 781 966 2007 or joshua.fox@wilmerhale.com.

Inga Goldbard is an associate in WilmerHale’s Corporate Practice. She can be reached at +1 212 295 6306 or inga.goldbard@wilmerhale.com.

Nov 13, 2012

Trust but Verify

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By Melinda Thomas, EIR for NYC.

My husband is a retired Detective with the NYPD and one of his favorite phrases is “Trust but verify.”  My corollary would be trust, but get it in writing. Contracts have two main purposes: one, as a tool for communication and expectation setting.  The conversations that need to happen to develop and execute a contract are very important. They can actually build trust (or destroy it). Two, contracts serve to clean up messes at the end of a transaction.  When everything falls apart, people scramble for the contract to figure out how to unwind the deal as cleanly as possible. That said, in between the start and the end, contracts have very little value as day to day operating documents.

This last point about how you interact with the other party to the contract on an ongoing basis is important because in the last few weeks I have met with 3 different founders who really didn’t trust one of their partners, whether that was a co-founder, business partner, or service provider. In each case they believed that if they just made sure to cover their concerns in the contract, all would be well.  They said things like “If he doesn’t do what I want I will just terminate the contract.”  For context, they didn’t trust that the person would do what they wanted so they told themselves it would be okay because they could always bring down the hammer of terminating the contract.  This will only work a few times before the operating relationship becomes untenable.

Do not override your gut, but verify the feeling by having a frank conversation with the other party about what concerns you. For example, if you think they might steal your idea, ask them how they think you should protect your intellectual property rights.  Then listen to your gut again about the answer you get (and verify with an attorney).  If you don’t believe you can have a candid, professional, conversation about potential pitfalls in the relationship, you already have your answer as to whether you can trust that this collaboration is going to work. It’s not.

Sep 18, 2012

I Want to Be a Biotech Rock Star

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Guest blogger: Carl Berke

Hospitals and universities create technology but they don’t make products. And an invention is not an innovation until it reaches the market. It is only through the intermediacy of a company that a technology is transformed into a product that can reach patients. That company may be an incumbent player in the healthcare industry or it could be a venture backed startup – either way, the intellectual parent of that technology is entering into a complex commercial relationship with their employer and the company who is pledging to turn their brainchild into a star.

Research scientists who work in the private sector (e.g., pharma industry), know well that the fruits of their labors, just like a coal miner or a studio script writer, belong to their patron and employer. The deal is that they are paid to invent and their creations are pre-pledged by terms of employment as the property of those that pay them. For my own first patent, Polaroid Corporation thanked me with a princely sum of $1 paid as full consideration for assignment of my invention rights to the company.

Academic policy towards patent ownership is different from industry and academic medicine even more so. Physicians have been raised in a legacy culture of humanitarian mission and independence from higher authority. That ethos separates physicians from institutional hierarchy and control which is the norm for the private sector.

So you can see we are headed for trouble. What happens when, let’s say you, a biomedical faculty member, aspires to follow in the footsteps of other colleagues you heard about who profited handsomely from their research discoveries and inventions? Maybe for years, your lab has been elucidating a cellular pathway associated with a disease state and has gotten to the point where it looks like you have way to modulate a targeted enzyme with a small molecule inhibitor. The compound has a favorable drug profile and it shows promise to fulfill a substantial unmet medical need.

So you want to start a company – a new venture, an excellent adventure, formed to bring your invention from the benchside to the bedside. Maybe you do well by doing some good for patients and the public? Drug therapies typically require astronomical sums of money to prove safety and efficacy to the satisfaction of regulatory approval authorities. No one is going to make that investment without strong assurances of monopoly for a long enough time to recoup the investment and multiply that into profits. So you file an invention disclosure with your institution in the hopes of a patent to establish your intellectual property position.

Most institutions of a certain scale maintain a tech transfer function with staff trained in the complexities of patent procurement and licensing. The licensing group must make a judicious decision to invest in the patent prosecution. While all parents think their babies are beautiful, bear in mind that when your institution commits to supporting a patent filing, the cost to support prosecution from filing with the USPTO and then through the international phase can exceed that of a college education. So the institution will be looking to realize a return on that investment as soon as possible by finding a licensee to purchase the product development rights. Thanks to the Bayh-Dole Act, institutions have revenue sharing formulas that make the inventors their partners. They are incentivized along with the inventors to be active in promoting the technology to potential licensees whether it be a start-up or an existing industry player.

The reality is that a very small fraction of patent filings are truly useful enough to ever generate any product revenue at all. Typical cost to prepare a US patent submission is $30,000 and that multiplies for international filing. What happens if your institution does not share your high opinion of the value of your invention? Then you must make the case yourself for the business value it can generate. For that, you may want to enlist the help of someone with more business experience – could be a personal connection or perhaps a business school class who needs a project. If you can’t convince your institution to invest, but you remain a true believer, you can ask them to waiver their rights back to you and pursue the patent on your own account.

Let’s stipulate for this discussion that the patent has “value” – then the question becomes how to monetize it. Who will want to invest the substantial capital investment to transform the idea into product profit? Many investigators seek the adventure and excitement of a startup – a romantic contrast to the monastic life of a lab researcher. But what if there is already exists a company who is ready to plunk down cash up front for a license to the pending patent? Newco vs. Oldco? Bread today versus bread-and-butter tomorrow? A conundrum yes, but in the real world, that choice seldom arises. Pharma and device incumbents generally don’t bid for technologies until they are substantially “de-risked”, e.g. compounds with clinical proof-of-principle data or approved devices. The exception is when the technology represents an “improvement” to a product they already sell. In these economic times, the endgame of a startup is no longer IPO (initial public offering); it is acquisition by one of those big players.

Venture investors expect to get paid for the risk they take and they do that by investing in a portfolio of start-ups – the few winners have to pay for the majority of losers. As the IP owner or inventor, keep in mind that the odds are against any individual project paying off at all. So if you (the inventor and the institution) can get a license deal up front, it is generally far more attractive than suffering through the effort, angst and capital risk involved in a startup.

And what if your work attracts the attention of venture capitalists and they paint you a picture of an exciting future with your intellectual baby as the star of the show? Before you get too far, you need to reconnect with the tech transfer authorities in your host institution. In addition to licensing, they are also responsible for enforcing institutional policy and compliance with funding agency and government regulations. They have legal and contractual obligations and requirements that come with acceptance of government agency grant support or non-profit tax status. Over the years, the institution has evolved a set of policy guidelines designed to comply with regulation as well as maintain their brand integrity by avoiding ugly allegations of selfish motives considered contrary to their public mission. Clinical conflict is gnarly especially when you consider that the academic hospitals and their investigators are simultaneously in the business of clinical technology development as well as providing patient care. They do not want to be found in a position where their clinical judgment could be influenced in the slightest way by a related commercial interest.

So how does that affect you? Harvard-affiliated hospitals, my world, are among the most stringent in avoidance of conflict and so they can serve as a good case example. Inventors may not be involved with clinical studies (e.g., drug trials or supply of specimens), if they have any ownership connection to the prototype being tested. That applies to the institution as well if they have taken equity in consideration for licensing the technology to the company. Investigators may not accept research sponsorship from companies in which they hold equity. Our staff are allowed to enter into consulting contracts with companies developing their technology and they can serve on the board of directors but they may not hold operating positions at the company.

That all sounds quite restrictive so what happens if you disagree with your institution over the perception of conflict? The reality is that, with some compromise, you should be able to find ways to participate in continuing development of the technology as it moves into the company realm. One way to resolve disputes is to ask the institution to appoint an “overseer” to review any project-related activities that could trigger conflict.

Alternatively, your dispute may be over business terms. Institutions with less commercialization experience are usually the most difficult to deal with – they tend to overvalue their IP and be more inflexible on terms of business. The same goes for inventors. Inventors are usually best served by connecting with an entrepreneur they trust and who has worked with academic centers before. Starting up a company not something a faculty member can do casually on the side. Finding the right business partner is like finding the right fiancé – there are many considerations beyond the emotional. (see Not All Business People Are Created Equal). One of the most contentious points is the initial allocation of founders equity in a startup (i.e., dividing up the pie before initial funding). It is a somewhat of a free-for-all and inventors may be well served to consult with a venture lawyer (that you pay yourself), or a well-experienced entrepreneur-friend, to gauge whether you have a fair deal that is “at market”. (See Avoiding Founder’s Dilemmas) They should also advise you on all of the arcane legalities of company formation. But in any event, the inventor-founder should avoid the awkward position where you sit between the competing interests of your institutional employer and the investors.

Entrepreneurship is the pursuit of dreams and dreams are unbounded. Institutions frequently take equity in lieu of cash as consideration for license to startups or for their assistance in founding the company. That equity also helps to align the institution’s interest with that of the company and the inventors. So when reality bites, it is wise to remember that you, the investigator, will sit at the same table with your institutional employer and your dreamy startup. Which side are you sitting on? My answer is: it’s a round table and sometimes you sit closer to one party and then closer to the other but you are all pursuing the same dream.


This week’s blog was written by Carl Berke. The unifying theme of Carl Berke’s career might be called “management of innovation” plying his trade as a scientist, inventor, consultant, licensing manager and entrepreneur mostly in that order but sometimes all at once. He is currently a partner with Partners HealthCare Innovation Fund with the mission to spawn new ventures based on technology arising in the academic research community of Massachusetts General Hospital and Brigham and Women’s Hospital. He is also active as a founding director of Mass Medical Angels, an organized group of private individuals interested in aggregating their funds and expertise for seed stage investing in the very fertile Boston innovation ecology.”

Aug 15, 2012

The Glass is Half Full

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By Melinda Thomas, Entrepreneur-in-Residence for NYC.

Scientists and engineers like to solve problems. Because they like to solve problems, they tend to focus on problems. When you are presenting your business, you need to present the positives as well. To a scientist this may seem like you are trying to “cover up” the problems or be all “salesy”. I am not suggesting that. I am suggesting you provide a balanced view of how well your company is doing. Both sides. Good and bad. For team business meetings, as opposed to a pure R&D meeting, which I wouldn’t presume to tell you how to run, you want to start with what you have accomplished as a team since the last meeting. The discipline of this is to make sure you are acknowledging that you have made progress before diving into all the work you still need to do. It helps to keep the team motivated. It also helps to communicate to all team members what is going well. They have probably heard about all the things that may not be going so well. Making sure to highlight the accomplishments makes sure your team is also seeing the whole picture. My hope is that you at least get to the point that the glass is seen as at least neutrally full, if that is even a term. Someday you might even get to thinking of it as half full at which time you can think of yourself as a real entrepreneur as that is one of the common attributes of successful entrepreneurs, optimism.

Jun 19, 2012

Founders Stock, Part 1

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Guest bloggers: Jennifer Berrent, Joshua Fox, and Inga Goldbard.

What Terms are Typical for Stock Held by a Founder of a Bioscience Startup?

Once you have incorporated your bioscience startup and decided on the allocation of ownership among the members of the founding team, the board of directors of your newly formed company will need to approve the issuance of stock to the founders. Typically, founders receive “restricted stock” of the company, subject to vesting over some period of time—usually over a total of four years, although a portion may be vested up-front based upon the founder’s time or intellectual property contributions to the company at inception.

What is “Restricted Stock”?

Restricted stock simply refers to common stock of the company that is subject to certain restrictions. These restrictions typically include restrictions on transfer of the shares by a founder; a right of first refusal in favor of the company if the founder proposes to sell her shares to a third party; and a lock-up agreement, which restricts sales of shares by the founder in connection with an IPO. However, the restriction that is most often the focus of founders’ stock, and the primary reason why it is referred to as “restricted stock,” is the right of the company to repurchase unvested shares of stock from the founder upon termination of the founder’s service with the company.

As a general note, although shares of restricted stock are subject to vesting and other restrictions, the holder of shares is otherwise entitled to all other rights associated with being a stockholder, including the right to vote, with respect to such shares.

What is “Vesting”?

Restricted stock “vests” when it ceases to be subject to the company’s repurchase option. Typically, vesting occurs over a period of time and is contingent upon the founder remaining employed by, or otherwise in the service of, the company. The date upon which vesting commences is called (unsurprisingly) the “vesting commencement date,” which can be the date of issuance of the stock, or some earlier date in order to give the founder “credit” for service to the company prior to the date of issuance. Vesting can happen at any rate, but monthly or quarterly vesting is the most common.

In addition, there is typically a “cliff” prior to the start of monthly or quarterly vesting. If a founder’s vesting is subject to a one-year cliff, then no vesting occurs prior to the one-year anniversary of the vesting commencement date. On the one-year anniversary of the vesting commencement date (the cliff), a large portion of the shares vest. A 25% cliff is common for restricted stock, though a smaller percentage of shares may vest at the cliff in cases where the founders have received some up-front vesting or “credit” for services previously provided.

Why Don’t Founders Typically Receive Their Stock Outright?

There are a couple of reasons why restricted stock, which is subject to vesting, is typically issued to founders as opposed to common stock that is not subject to vesting: 1) it protects the interests of the company and the other co-founders in the situation where a founder leaves the company early on, and 2) venture capital firms (VCs) and other sophisticated investors require founders’ shares to be subject to vesting in connection with a financing.

The benefit to the company and to the founders of granting restricted stock is easy to illustrate with a series of hypotheticals:

Scenario 1: Let’s say Company X was founded by a group of three people: Founder A (A), Founder B (B) and Founder C (C).  After the founders incorporated the company, the board of directors of Company X issued 1,000,000 shares of unrestricted common stock to each of A, B and C.  After six months, A can no longer work with one or both of the other founders (irreconcilable differences) and leaves the company. Since A’s stock was not subject to vesting, A walks away owning one-third of the company and controlling one-third of the stockholder vote. If B and C ever disagree on a matter to be voted upon by the stockholders, A is the tiebreaker. A’s vote could be the deciding factor in matters such as elections of directors, amendments to the company’s charter to authorize a series of preferred stock to complete a financing, or a sale of the business (among other things). It is not good for the company or the remaining founders when a person who is no longer employed by or in the service of the company can exercise that sort of power.  Also, why should A enjoy the benefits of the equity when B and C are doing all the work?

Although the company’s board of directors may issue additional shares to another person, including to B and/or C, it must have a proper business purpose for doing so, and even when it does, the large number of shares held by A can make taking significant corporate actions more difficult.

Scenario 2: In this case, the shares granted to A, B and C are subject to four-year vesting on a monthly basis (no cliff). When A leaves after six months, he has only vested as to one-eighth of his 1,000,000 shares, or 125,000 shares. Once his service to Company X is terminated, Company X can elect to repurchase the remaining 875,000 shares from A, typically at the original purchase price paid by A for the shares (which for a startup immediately following incorporation is a nominal amount) and A no longer represents the tiebreaker in a stockholder vote.

Vesting also prevents A from getting an economic windfall when he leaves the company (i.e. vesting into all of his shares for only six months of service while B and C have to work for four years to vest into 100% of their shares).

Scenario 3: In this case, the shares granted to A, B and C are subject to four-year vesting with a one-year “cliff” of 25%. This is the best outcome for Company X and founders B and C, because when A walks away after six months, Company X can elect to repurchase all of A’s shares.

VCs also do not want a significant percentage of the company they invest in to be owned by an ex-founder who is no longer involved with the business. However, their main reason for wanting founders to have restricted stock subject to vesting is to create an incentive for the founders to remain with the company for a long period of time and to build a successful business, thereby creating value in the equity of the company.

Is “Acceleration” of Vesting of a Founder’s Shares Advisable?

“Acceleration” of vesting is exactly what it sounds like—a way to speed up the vesting of restricted stock. There are three common scenarios in which acceleration of vesting of a founder’s shares may be considered (although it is not always advisable to provide for acceleration in each scenario, for the reasons mentioned below).

Change of Control. A change of control usually refers to a sale of the company. This type of acceleration is also often referred to as “single-trigger” acceleration, since there is only one event—the change of control of the company—that triggers the acceleration. The amount of stock that accelerates (becomes vested) upon a change of control can vary. Full (100%) acceleration upon a change of control could work against the interests of the company and its stockholders, as it can make the company less attractive to potential acquirers. If all (or a large percentage) of a founder’s shares vest upon a sale of the company, the founder has less incentive to remain with the company following the sale. An acquirer who wants to retain one or more of the founders in connection with the acquisition may have to grant additional equity or other retention benefits to the founder(s) to provide incentives to remain with the company after the sale, which may in turn result in greater acquisition costs to the acquirer or, more likely, a reduced purchase price for the company.

An alternative to full acceleration upon a change of control is partial acceleration: some percentage—but not all—of the founder’s shares accelerate upon a change of control. Industry custom on partial acceleration upon a change of control varies, but generally, leaving some meaningful amount of the founder’s shares subject to vesting after the change of control is advisable, as it gives the new owners of the company comfort that they are not going to lose their talent immediately after the acquisition.

Termination Without Cause. This is also a form of single-trigger acceleration. Giving a founder full (or significant) acceleration of vesting upon termination without cause is not advisable because it is uncommon in practice to terminate a founder for cause, given that the definition of “cause” is negotiated and is often a high threshold to meet—being terminated for cause often requires that the terminated employee commit a crime or significant misconduct that has a material adverse effect on the company. Because of the complexity in establishing “cause,” full (or significant) acceleration of vesting solely upon termination without cause can nullify the main purpose of granting restricted stock, as a founder whose employment is terminated by the company relatively early on can still walk away with a significant equity stake in the company.

VCs will likely be concerned by significant acceleration of vesting under either of these two scenarios for the reasons mentioned above.

Termination Without Cause Following a Change of Control. This form of acceleration of vesting is often referred to as “double-trigger” acceleration because two things need to happen before the vesting of the founder’s shares accelerates: a change of control and then a termination of the founder’s employment without cause or for “good reason.” “Good reason,” like cause, is a negotiated term, but usually includes reasons such as a material reduction in salary or responsibility. Full (or significant) acceleration of vesting under this double trigger is fair to potential acquirers because it does not eliminate the founders’ incentive to remain with the company following a sale (the acquirer is in control of whether to terminate the founders’ employment post-sale). It is also fair to the founders because they will receive the benefit of acceleration if they are terminated after the sale (when the acquirer is their new employer), which sometimes happens following an acquisition where, for example, the acquirer bought the company more for its technology than its talent.

Jennifer Berrent is a partner in WilmerHale’s Corporate and Emerging Company Practices. She can be reached at +1 212 937 7513 or jennifer.berrent@wilmerhale.com.

Joshua Fox is a partner in the WilmerHale Venture Group and Corporate Practice. He can be reached at +1 781 966 2007 or joshua.fox@wilmerhale.com.

Inga Goldbard is an associate in WilmerHale’s Corporate Practice. She can be reached at +1 212 295 6306 or inga.goldbard@wilmerhale.com.

Jun 5, 2012

What Does It Mean to Be a Founder?

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Who should be called a founder? At the end of the day there are really only two reasons why it matters: 1) founders stock, and 2) the perception of the importance of the person to the company if she has that title. The title Founder can be given to anyone at anytime. It doesn’t necessarily mean that the person gets founders stock, although it’s customary. A legal agreement has to be written up to award founders stock. I’ll reserve a deeper discussion about that to the next two blogs on founders stock and the tax implications.

Let’s move on to the perception of what founder means. You may fight for the title because you think it gives you more control over the company. That kind of control really has more to do with equity position than title. Also, control in any given situation depends more on your ability to convince others of the correctness of your decision rather than any legal hammer you can bring down. Don’t get me wrong, when things get really contentious, you want to have an agreement in place, but it isn’t a good tool for working out day-to-day issues in a company. That said, having the title founder may mean others will give your view more weight in a given discussion. It may also mean that the employees of the company will pay more attention to how you are treated. That’s assuming they even know that you are a founder. In one company I know, there were so many founders that by the end of the first year, most of the 25 employees could’t determine who all the founders were or that the first couple of employees were not founders. In another company the one person who had that title only had a limited advisory role after helping with the initial idea generation. Maybe only two people in the company even knew that he had the title. He had negotiated for the title because it was important to him. He liked being able to say he was a founder of a company. It gave him some street cred.

As I mentioned in my blog you need to use the resources the company has to get what the company needs. In this case, the company wanted a relationship with this advisor so they gave him a title that cost them nothing. It was a chip in their negotiating kitty. This is important to remember as you try to hire the first one or two critical hires. Giving them this title and being clear about whether stock is tied to it may be enough to tip the hiring decision in the company’s favor.

One other thing to consider in terms of how the founder title is perceived is how the VCs look at it. When they see founder, they will assume that this person is critical to the company and actually had something to do with founding it, whether by coming up with the idea or marshaling the initial resources. So you do want to give some thought to how the company uses the title and how it’s presented to the investors.

At the end of the day, one thing that being called a founder means to almost anyone who hears the title is that the person was there very early in the life of the company. Beyond that it’s an open field in terms of its correlation to equity, control, and perceived importance to the company. If you want a more in-depth look at the how to make decisions about founders and founders stock splits, I suggest you read The Founder’s Dilemmas by Noam Wasserman, which I mentioned in an earlier blog.

May 30, 2012

Scientist As CEO

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By Melinda Thomas, EIR.

You’ve got this great scientific technology. You’ve been working on it for years. No one knows it better than you or has more passion for it. You want to start a company. The question is, should you be the CEO?

There are two main things to consider when making this decision:

  1. What does the company need in a CEO?
  2. Do you have those skills?

I was asked to speak on this topic at a recent Idea to IPO class session at the New York Academy of Sciences. I did an exercise of asking the class full of scientists to tell me what they thought a CEO’s job was. As they shouted out ideas, I wrote them on the whiteboard. I then asked the scientists to tell me what skills were necessary to fulfill each of those responsibilities (e.g., fund raising, strategic thinking). I wrote these on the whiteboard as well. Lastly, I asked what skills were typical of a scientist. Wherever there was an overlap with the skills needed to be CEO I circled it. In the end, about half the skills were circled, suggesting that scientists in general may not have everything needed to be a CEO. If you’re thinking about this for yourself, try the exercise and see what results you get.

This is not a static question. There are phases to a company. What it needs in one phase may be very different than another. For example, in the beginning, if the major challenge is that most of the company resources will be focused on further developing the technology, then perhaps a scientist who has led major research efforts can lead this team as well. But if the major challenge is finding customers for your technology and developing commercial contracts, then perhaps not. Steve Hochman of Ascent Biomedical Ventures, a local VC firm, said recently at a NYC Health Business Leaders event that “Marketing a scientist right out of academia as the CEO is a big mistake.” If you’re going to do it, you need to demonstrate that you have credible entrepreneurial expertise and a strong business advisory board.

You may say that you’re a really smart and driven person so you can develop the skills needed. Plus you would be saving the company money. That may be true, but do your investors want you to learn on their dime especially if you will transition out of the role in the future? And do the mistakes you will make and your lack of efficiency early on at those new skills, really save the company money? The best use of you as a resource to the company may be in moving the science forward more quickly toward the eventual product, and not being distracted by the other things that a CEO does.

Let’s say that you think you’re the right person to be the CEO for at least the first 12-18 months of the company’s life, what do you do when it’s time to transition? There are several options: 1) You can become the Chief Scientific Officer (CSO). This is the most common transition; 2) You can leave the company. This is the second most common transition; 3) You could leave the company but stay on the Scientific Advisory Board (SAB). The CSO or SAB roles are also ones you could take on at the beginning instead of being the CEO.

If you do take on the roll of CEO, some common mistakes to avoid are: 1) Being so enamored of the technology that you fail to focus on the market (i.e., it’s so cool everyone will want it); 2) Coming up with new and different applications for the technology every month. This is a corollary to #1 in that you can’t focus on the market if you keep changing who you think your target market is; and 3) Failing to deal with the people issues efficiently and effectively. In an academic lab, there’s often no rigor around holding people accountable for their work, getting rid of non-performers, or dealing with tensions within the team. Most people are usually working in parallel on their own research and transition out of the lab with regularity so dealing with these types of issues has less importance. In a start-up culture, in particular, these are the most important problems to deal with (see last week’s post on founder’s dilemma).

Apr 25, 2012

Avoiding Founder’s Dilemmas

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I attended a recent event at NYU where Noam Wasserman spoke about his research on what makes startups fail. It all began with a statistic he read where VCs in a study attributed 65% of the startup failures to issues within the management team. Not failed strategy. Not failed technology. Not failed market acceptance. Team issues. Specifically the founding team. Wasserman set out to study this phenomenon and has written a wonderful book – The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. What makes this a great book is that it has DATA! As scientists you not only like data but need it. Many entrepreneurs have thought that the bad things that happen to other startups won’t happen to them. The data suggest otherwise and will speak to your logical core and help you make the best decisions for your startup. It’s a must read before you have even one more discussion with anyone about starting a company with them.

Apr 17, 2012


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