An innovative financing tool at your fingertips

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By: Shawn Lawrence

The Canadian biotech landscape has been hit hard by one of the most severe market downturns in recent decades. Those that have survived have needed to turn to non-traditional mechanisms to raise additional funds and to be on the lookout for new methods to complement their financing strategies.

One such instrument gaining popularity is the Standby Equity Distribution Agreements or “SEDA.” SEDA’s are a vehicle that was pioneered in 2001 by Yorkville Advisors LLC, an investment manager to a family of funds headquartered in the U.S. The SEDA enables a company to raise cash by selling newly issued equity, but allows it to do so in tranches so that the company can draw down funds as and when needed.

Dr. Michael J. Nowak, managing director at Yorkville Advisors explains that SEDA’s are akin to having another tool in the armoury of a biotech company’s CFO and senior management.

There are many reasons a company may consider the SEDA equity line as a complement to their financing strategy, including its flexible and simple nature. He adds they are a cost-effective way for publicly traded companies to optimize their capital structure to pursue their growth strategies.

“It’s a very simple mechanism, all a company has to do once they’ve established a SEDA with us is call or email us with an advance noticeup to a certain tranche limit or maximum weekly allotment whether it’s $500,000 or $1,000,000, depending on the agreement, then they can sells us those shares at a price determined by the marketplace over a period of the next five or ten days.”

Moreover, companies that take out a SEDA have the right or option to sell Yorkville shares throughout the duration of the instrument without obligation. In fact, the only obligation is for Yorkville to buy the shares, in good times as well as bad on the insistence of the company doing the selling.

“The companies are not obligated to sell shares to Yorkville at any time, so the control is completely in their hands. Especially during times when the share price is unattractive or the company doesn’t need cash, the instrument can lie dormant,” says Nowak.

And if a company wishes to extend the SEDA beyond the three years, that option is also available. And if a company wishes to cancel the SEDA option, they can do so at any time and at no cost.

In addition to flexibility SEDA’s also recognize urgency and can provide certainty to companies making use of the vehicle.

Nowak states there are four pillars to the SEDA tool, the first of which is opportunistic fund raising on good news reporting. The SEDA also gives companies a real competitive edge in raising capital both quickly and on a company's own terms.

“It’s useful for companies experiencing increased market volatility and trading volumes. In the right hands it can be effective in other ways as well. Say a company has reached a significant milestone, or had some other significant news, the SEDA allows the company to take advantage of an increase in share price or trading volume, essentially it allows the company to react quickly to favourable circumstances, such as a rising share price or potential acquisition,” he said.

The SEDA can also enhance the liquidity of stock in a controlled and measured way; while at the same time broaden a company’s investor base. Additionally, the flexibility to raise funds in incremental amounts provides a mechanism for the company to effectively cost –average down its cost of capital, minimizing dilution to its shareholders.

The third pillar of a SEDA is that it provides additional leverage in strategic negotiations with pharma companies or other partners.

“The key here is having the additional funding of the SEDA at your disposal, by having it there in your back pocket, you can improve you’re bargaining position in talks.”

Perhaps the most important bonus of having a SEDA is that it can provide companies with a safety net in downturn scenarios.

“It’s hard to go out and do a private placement and difficult to execute some equity based financing on the heels of negative news for obvious reasons. So as long as there’s liquidity in your stock, you could raise money via a SEDA. The key here though is to still use the product strategically, like any equity based financing, dilution is something that investors are concerned about so its best to make sure in such instances to explore all options,” states Nowak.

Already, five Canadian biotech companies have established SEDA agreements with Yorkville Advisors including: Labopharm Inc. ($25,000,000), Allon Therapeutics ($10,000,000), Resverlogix Corporation ($25,000,000), Medicago ($10,000,000) and Patient Home Monitoring Corp. ($5,000,000) on the Venture Exchange.

Numerous other biotech’s from both Europe and the U.S. have also used the vehicle.

According to Nowak, some companies have used it to fund additional trials; others have used it to retire financial debts that they might have. Others have even used it to hire additional sales people to drive revenue. However a company chooses to use a SEDA, the key he says is that they have the option to use the instrument at any time they want.

“So, they don’t need to do a road show, they don’t need to do anything else to raise capital. All they need to do is call us up and say look I’m going to be doing this and they have that right for three years,” said Nowak.

Count Labopharm Inc., a specialty pharmaceutical company focused in the pain and depression marketplace, as one of the organizations that sees the benefits in the SEDA vehicle.

Labopharm has had the facility in place since late 2009, at a dollar amount of $25,000,000.

“I think it definitely served its purpose,” says Labopharm Global head of corporate development Jason Hogan. “I think at the time that we put it in, it was a good tool for us to provide some financial flexibility, some additional liquidity at a time when we weren’t prepared to undertake a large equity offering.”

He adds that about a month after the company put the vehicle in place, Labopharm drew down a million dollars to take the facility for what he called “a bit of a test drive.” The funding worked much better than he had anticipated.

“We wanted to see how it worked and when we did our first draw down, our stock performed well during the pricing period. Then did an equity offering in early 2010, and just based on those events we haven’t needed to use it again. But just knowing that we have this facility and ready access to capital should we need to utilize it is great. I would say our experiences with the SEDA have been positive and it’s a very cost-effective vehicle to put in place, relative to other financings and certainly compared to debt, the cost of actually putting the facility in place was very reasonable on a relative basis.”

When asked if it has fulfilled its four promises, he believes it has. However he stresses not to put too much dependence on it, but rather use the vehicle strategically.

“For example, I don’t know if I’d use the term safety net in association with a SEDA. You don’t want there to be the perception that there’s never ending dilution for your shareholders. I think we look at it a little more strategically than that, and again I think that’s another really good reason to have it in place, perhaps when you don’t need it, because you can then use the facility more strategically then putting something like this in place when your funds are completely depleted. Other than that, for sure it fulfills those four promises. For us it didn’t increase our liquidity as we were a very liquid stock prior to having the vehicle and I wouldn’t say it did much to broaden our investor base, but certainly it has given us leverage in partnership discussions,” he said.

Like Labopharm, Calgary based Resverlogix set up a $25,000,000 SEDA. They did so according to Resverlogix president and CEO Don McCaffery based on the fluctuating economy and talks of double dips permeating throughout the industry.

“So far, we’ve only drawn $200,000 just to initiate it and we may not use any, but the option to draw from it is there, depending on what market conditions are. It gives us a safety valve in case of equity markets drying up or anything else, we have a way of self funding going forward,” he said.
McCaffery believes it is an important vehicle for any non-cash flowing research company to actually put in place for many of the same reasons that Hogan described. But McCaffery also subscribes to the theory that one can never be too safe in this industry where funding is concerned.

“We can actually self finance using the SEDA, so it’s definitely a plus and it also saves time in that we don’t have to go out looking for cash. It’s a good fund to have in your back pocket in both good and bad times. We would draw on it in either situation, but selectively. During good times you’d be drawing on it based on liquidity and you can take larger amounts. In bad times, if you need to draw on it because there is no other equity available, such as when the equity market dried up in 2008 and companies had no place to get cash, its probably one of your better options.”
As for what Yorkville does with the shares they purchase, Michael Nowak explains that Yorkville can hold onto them and try to capture equity upside, or they can sell them into the market and other investors. And if the company wants Yorkville to sell the shares back, they will.

“It’s really whatever the company wants from the SEDA, we’re still a shareholder like every other shareholder, but we’re probably a bit more passive.”

The question one might ask then is what’s in it for Yorkville?

“Before fall 2008 it was a different world,” says Nowak. “Our fund was doing equity investments or convertible debt, when the financial crisis started two years ago, we found the SEDA an instrument that a lot of companies were interested in, but it was also very interesting for us because it’s a more conservative way to buy equity in good companies. In the old days as a fund we would write $5 million, $10 million checks, a large bet at one time at one place and at one price. The SEDA represents a way to not only buy significant amounts of equity but over a longer period of time. As the share price will jump around, we as the equity investor have got a much finer control of the risk that you’re buying. And hopefully for the company, the equity price will go up over that time, and so the company is able to sell equity at a lower and lower cost of capital.”

Essentially, it’s a risk managed way to invest but most importantly it’s still a way to invest and buy equity in good companies.

“Obviously what we’re really interested in is the equity upside in these companies because the slight discount to market, the five per cent we get covers costs, covers trading costs and currency risks, but it’s not where you’re going to make a significant profit. So what we’re looking for is the equity upside,” he explains.

Nowak was himself, once a general partner in a large venture fund, and not surprisingly he takes the same approach when assessing the opportunities to invest with good companies via the SEDA vehicle.

“We really want to find companies with good strong growth potential. Usually that means a good management team and a product or technology that addresses a large market. On top of that we have some financial metrics that we believe the SEDA works best for, so we do like to see companies with market caps of roughly $50 million or more, and with trading volumes of $50,000 a day or more. We’ve made some exceptions along the way when we think there’s a compelling case, for example, Medicago. We started SEDA discussions with them when they were much smaller, but we saw a lot of potential in that company. The same goes with Allon Therapeutics. Liquidity is a challenge for Canadian biotech companies, but we think there are a lot of strong fundamentals there from a business perspective and that’s why we’re so active in Canada.”

His biggest success story to date with the fund is Achillion Pharmaceuticals, a New Haven based company focused on Hepatitas C that had positive proof of concept data last December.

“Their stock went up 80 per cent on that good news, and so we were able to capture the equity upside with the shares we owned in the company because the trial was successful. It’s pretty much what a traditional investment approach would be; our goal is to capture that reward or investment result.”