Seeking funding from emerging markets: Creative financing for startups
According to the National Venture Capital Association, venture capital funds in the United States have decreased from $25.6 billion in 2008 to $20.6 billion in 2012. And according to a CapitalFM News article from July 2012, overseas investment from Chinese companies will see “explosive growth” over the next decade, as the government has reaffirmed a strategy to encourage enterprises to invest overseas.
Do you see where I’m heading?
I love Canada, but when it comes to startup financing, I advocate seeking funding from emerging markets throughout the world. Not only are economists singing the praises of emerging markets, but nowadays more and more startups are actually turning to these markets to find the funding they need.
Here’s a story about a Canadian startup that found seed funding and in-kind services for their technology and business development overseas.
Toronto-based startup and MaRS client ScarX Therapeutics is a pre-clinical stage biotechnology company that has developed a novel therapeutic (MI-001) medication that prevents or reduces dermal scars.
By partnering with NovoTek, a Beijing-based pharmaceutical company, ScarX received some seed funding and 18 months of in-kind services to allow them to perform regulatory studies in North America. This 18-month period is also a technology evaluation period for NovoTek to license ScarX’s technology in China for a licensing fee plus royalties.
ScarX’s chief development officer, Ivan Waissbluth, answered some questions that startups might have about seeking funding and services overseas.
Why should startups seek funding from emerging markets?
Given the resources available, ScarX can only focus on Canada and the United States, and maybe Europe at a stretch. China, however, is out of our reach, or at least without help. By partnering with a Chinese group, we can perform studies that we have to do regardless. More than that, if NovoTek decides to license the technology after 18 months, they will pay ScarX licensing fees every time they achieve a milestone, such as Clinical Phase I, II and III, for example. This would help bring in multiple millions of dollars to ScarX even before sales have begun. Eventually, when the Chinese company reaches market, ScarX can still capture 5% of the net revenue in the massive Chinese market.
The nice thing for startup companies, given how difficult it is to get venture capital right now, is that partnering with overseas players offers financial support for product development in the North America market. There probably won’t be enough funding, but every dollar does count, especially undiluted dollars. Every dollar you earn this way means one less dollar you need to take from venture capitalists and one less share of the company you’ll lose.
I know it sounds like we’re giving away a huge market like China (since we’ll only capture 5% of sales), but it would be very difficult for a startup to tap into that market on its own anyway. So why not partner? Why not get some cash? North America, Europe and Russia still represent a lot of the market, and the money you can get from China will enable you to reach your target market or whatever you want to do.
Did you have intellectual property concerns when you began co-operating with China?
No, because we have intellectual property (IP) filed in China. Are we worried that somebody in China may ignore our patent position? There is no doubt that if someone is knowledgeable in the space and can fully appreciate what you are up to based on your patent, it could happen.
However, firstly, most startups coming from universities would choose not to file a patent in China, so that is never a concern, because they have never even had a commercialization opportunity. The fact that we filed a patent there is progressive compared to those tech transfer institutions.
The second point is about protecting yourself from somebody infringing your patent. Startups don’t have the resources to prevent someone in China from infringing. However, if you can partner with a group that has more resources than you do and that has business associated with your technology, an infringement will mean a business loss on their part. Hopefully, they will fight that battle on your behalf. So, in many ways, partnering in China makes a lot of sense for startups. Of course, if you are a large company and have deep pockets, then you’ll have a totally different strategy.
What are some ways of protecting intellectual property in China?
- Start with a strong IP position in China.
- Keep unique and highly confidential technical information to yourself.
- Only let potential partners deal with the technologies that have IP patented already.
- Structure the deal well.
For more information, check out “IP in China: What to know before you go.”
The China IPR SME HelpDesk was established by the European Commission to offer free IP strategy information in China.
What motivates Chinese companies to invest in overseas startups?
They are looking for cutting-edge technologies. Many companies in emerging markets have made tremendous amounts of money in global outsourcing, which has been heating up over the past five to 10 years. It doesn’t take long for a company to start thinking about moving up in the value chain. The Chinese pharmaceutical company we are dealing with will keep shopping for innovative technologies overseas as they can. I think we are going to see more and more of this type of deal.
How can startups seek funding from emerging markets?
It has to be part of your strategy from Day 1. Unfortunately, a lot of startups are established with a really narrow focus. If you can imagine how China (the emerging market) will look in 10 years, you might regret not filing a patent there now.
ScarX found the Chinese pharmaceutical companies through people who have connections in China. However, having connections is not the only way to proceed, especially given that more and more conferences and tradeshows are happening in China today.
The other thing to consider is that you have to be progressive in marketing your technology to China-based companies. These companies are not coming only to Canada—they go all over the world shopping for technologies, so it’s still a difficult process to get their attention.
The good news for Canadian startups is that Chinese venture capital firms and industrial companies have already reached out to Canada. For example, one of the biggest Chinese venture capital firms, Zhongguancun Development Group, has built a partnership with Invest Ottawa for an accelerator to invest $10 million in Canadian startups and will help these companies gain access to the Chinese market.