Biotechs seek venture debt but lenders are tight

BOSTON (Reuters) - As cries of anguish from biotech companies seeking funding grow louder, and the capital markets remain firmly closed, many are turning to a non-traditional form of debt.

General Electric Co's (GE.N) GE Capital, SVB Financial Group's (SIVB.O) Silicon Valley Bank, Hercules Technology Growth Capital Inc (HTGC.O) and other specialty financing companies offer a type of borrowing known as venture debt that is becoming increasingly popular with cash-strapped biotech companies.

Venture lenders provide secured loans with warrants to venture capital-backed companies. The loans are not necessarily based on hard assets such as factories and equipment, as bank loans are, but on intangibles such as intellectual property.

"The way we look at it is we provide investors with a lower-volatility way to get exposure to great venture-backed companies," said David Fischer, a partner at Gold Hill Capital, which specializes in technology and biotech venture lending.

Venture debt funds are often structured like venture capital funds, with the money put up by institutional investors and wealthy individuals. Returns are generated in part by the return of capital, interest and fees, and in part through appreciation of the equity portion of the loan.

Should a company fail, the debt-holders are reimbursed before the venture capitalists, who rely for their returns on the sale of their protege companies.

"A debt fund is less risky than an equity fund," said Parag Shah, senior managing director, life sciences, at Hercules Technology. "We are not wholly reliant on exits to make our returns. We make an interest rate regardless of whether the company makes a stellar exit."

While debt funds may be less attractive than equity funds when stock prices are rising, they can cushion the blow during down times. And for small biotech companies which are typically shown the door by traditional banks, the loans can be life-saving and protect them from dilution.

Last month Poniard Pharmaceuticals Inc (PARD.O), which is developing a cancer drug, raised $27.6 million in debt from GE Healthcare Financial Services and Silicon Valley Bank.

Caroline Loewy, the company's chief financial officer, said that even though the company could have issued more stock, it would have been very costly and dilutive.

In April 2007 the company raised $75 million at $6.33 a share. Now the stock is trading at $4.30 a share.

"For us to go back to the equity market just wasn't attractive," she said.

As financing options for biotechs shrink, venture debt lenders gain a greater pool of potential investments; but they also have to screen their investments more tightly.

"We are being a lot more picky in terms of who we lend to," Shah said.

At Silicon Valley Bank, which focuses on technology, life sciences and wine, opportunities from the current credit and banking crisis abound. The bank offers venture debt and will continue offering it, though more cautiously.

"We are still actively in this business, but it is more difficult to lend into companies whose next round of financing would typically be an IPO," said Michael Hanewich, head of the bank's life sciences unit.

That's because part of the safety of venture debt lending is knowing that top-tier venture capitalists will continue to fund their companies, enabling the debt to be repaid. Once a company goes public, the availability of funds becomes more uncertain, especially in a volatile market.

Silicon Valley Bank, which also acts as a commercial bank, managing the deposits of biotech and technology companies, has so far been able to weather the crisis in the banking industry because its focus has always been capital preservation.

"There is a flight to safety," Hanewich said. "We have no real estate exposure; we advised clients not to invest in auction rate securities; we have no exposure to Fannie or Freddie; so we don't have many of the issues facing others."

"We are opening accounts as we speak, he said. "This is a very exciting time for us."

(Editing by Gerald E. McCormick)