Angel Investing in FDA-Regulated Start-Ups

The U.S. Food and Drug Administration ensures patients and providers have timely and continued access to safe, effective and high-quality drugs and medical devices. It digs through hundreds of pages of clinical trial data to determine if a new drug or medical device effectively reaches its treatment goal without outweighing the risks associated with taking or using it. The agency has done this for more than a century.

The FDA typically approves somewhere between one and two dozen novel drugs a year, and data show that just one out of every 5,000 experimental drugs that enter preclinical testing will make it to pharmacy shelves. Medical devices can have a shorter regulatory review with typical annual clearances and approvals of between two and three dozen.

How does the regulatory process affect decision-making around the funding of medical innovations? And how can angel investors proceed on this uncertain and foggy path without much opportunity for foresight?

These are fundamental questions. Medical innovators’ ability to gain and sustain market share is deeply shaped by the context of market entry, yet the pathway to that entry — even the possibility of entry itself — is clouded by many regulatory unknowns. Regulatory outcomes can propel the direction of a young business down a cliff or up the heights of success, and the journey can be arduous, elaborate, time-consuming and expensive.

But, successfully navigating regulatory passage can lead to higher valuations, deep competitive advantage and enhanced acquisition potential both during and upon approval.

The regulatory risks angel investors need to know

The effect of novelty on early innovators’ market entry is ambiguous, yet the boldest medical discoveries are among the most impactful and rewarding. As trailblazers and early-stage investors, we face:

• Delayed, reduced, or prohibited entry, determined along a road of many binary decisions;
• Uncertainty about anticipated costs between innovation and commercialization;
• A potential “first-mover penalty” due to technological uncertainty;
• The real possibility of large up-front fixed costs to establish regulatory precedent, including the content and format of information required and evaluation criteria in cases without formal objective regulatory guidance;
• Vulnerability to competition, alternative solutions and health care delivery changes that can occur during a regulatory route taking years to complete;
• Lack of immediate clarity surrounding the overall regulatory regime in large quickly-evolving technological categories, in the area of digital health for example; and
• The impact of any new leadership on the FDA’s priorities and initiatives.

Navigating the regulatory risks

We can be smart by asking the right questions when evaluating young biomedical and device companies for investment. The foggy bridge of regulation does not have to be completely dark. Rather, we can illuminate it by seeing regulation in a broader context and recognizing that the path needs constant investor attention at every major step.

In more than a decade of investing in health care and life science companies, Golden Seeds and its members have found that although fears about the regulatory process, cost and time are valid, from an angel investor’s standpoint it is important to recognize that companies rarely move all the way through the regulatory process before experiencing liquidity events and that the vast majority of obstructions are revealed early.

Pharmaceutical and device companies look to acquisitions and partnerships to fill their pipeline gaps as part of their innovation strategy, so early investors often exit after a successful pivotal clinical trial or regulatory hurdle. The large capital requirements that may be necessary for the FDA green light at the end of a very long journey are rarely seen by angels who have moved on well before.

Products fail even in the best of circumstances, but early-stage investors can mitigate regulatory risk by asking key questions when they evaluate a company in its earliest stages of development:

• Do the founders have someone in or advising their company who understands the regulatory process, its rules, best practices and evolving government policies? Has that individual talked with the FDA to assess the regulatory field in connection with the company?
• Have the founders outlined a regulatory strategy and plan of action, benchmarked and with reasonable metrics, coordinated with their fundraising projections? And is that timeline supported by precedent or other similar examples?
• Has the company been intentional about crafting a regulatory strategy with an eye toward exit opportunities along the way?
• Is this a pioneer or novel technology? Will there likely be any lack of FDA familiarity with the primary technology? Are objective regulatory guidance and product evaluation criteria in place?
• What early measures and countermeasures related to regulatory approval have been considered in the design of the product or technology?
• Are there regulatory political factors at play in approval priorities? Studies show that patient advocacy, public interest demands, potential market size, the entry order of prior products, and the marginal value for consumers may affect the duration and nature of the regulatory approval process.
• Has the company connected with possible acquirers, partners or experienced collaborators who can offer their expertise or share the regulatory risk?

The biomedical industry is especially sensitive to the broader trends and flows of capital in the global financial markets. The regulatory bridge that adds uncertainty does not end with an investment decision. Investors need to manage risks after they make the financial commitment, through reinforcing connections in the form of consistent interaction with company leadership and the company’s consistent interaction with the FDA. Continued communication and vigilance can illuminate the regulatory bridge and help direct the company toward a rewarding destination.

Learn more about the Golden Seeds Investor angel network.