Industry: The heath care sector is dominated by few big firms that are highly profitable and with

stable free cash flow and returns on capital. Despite of the sectors high profitability is hard for new companies to come into the sector, which is due to high barriers of entry. One of the barriers is the long timeframe of the drug development (see appendix) and the amount of money that is necessary to be spent in order to get through with the project. As mentioned in our case, the cardio surgeons are the cowboys that fast adopts new technologies and cardiac devices, which are due to lower switching costs, as a result the product cycle can be very short and the firms must spent a lot of time and money in R&D in order to keep up with the development. Companys overview: Conor Medsystems, LLC develops controlled vascular drug delivery technologies. The company focuses on the development of unique drug-eluting stents for the treatment of restenosis. Its products include stents specifically designed for multi-drug delivery. The main competitive advantage of their stents is that their device includes hundreds of small reversion drilled into the stent, and each of this tiny holes could be packed with different drugs. Also they create new cobalt chromium stent that would be thinner and stronger. So approximately for further 2-3 years Conor wont have the rivals in this area of business. The question that faces the management on this stage is what appropriate scheme and amount of financing future activities of the company they should choose. From the one side it is possible to raise $10 million (12 month of funding at current burn rate) to be able to finish trails in Europe and then use this results to raise money at higher valuation after the trial to finish US trials. However it is not look like the best decision because despite that trials in Europe take less time and you can launch your product in the market faster and cheaper than in USA, the European countries provides state-funded universal health care and stents prices in Europe is two times lower than in US market and the company could face funds shortage and will need to seek for investors again. So it is obviously better to stick to the $30 million investment alternative (2 years at higher burn rate) that provide funding to finish the trials both in Europe and USA and also file the product application with FDA. Furthermore, company needs to find leading investor to have better opportunities in the future to be acquired by big medical device company such as J&J or Medtronic at the high price. This funding decision would have an impact on the companys exit options and ultimate valuation and can be viewed as one of constrains for the choice of financing. Also it is important for the company that new financing would not cause delution of existing shares of equity. Other constrained factor is time-limit, because it is left only 3 month before company will run out of cash. Angels (wealthy individuals): The benefits of obtaining capital from angels are that they have some entrepreneurial experience and useful contacts within the industry. They are very tolerant to risk and prefer to invest, usually small amounts 500 000$ or less, in companies that are in their start-up or in their early stage of their

development that have great growth potential. Due to the risk associated with the investment in startups or early stage firms, angels expect higher return on investment and tend to prefer equity-related securities or partnership interests. As we can see from our case, Conor were in no need of additional experience in the field, they needed only cash. They would be able to raise some money from angels but not much because, as mentioned before angels prefer to invest small amounts and they also were worried about the signal it would give. Angels are more focused on the opportunity rather than the valuation of the project and that would maybe signal high risk for the project and as a result giving the firm a low valuation and make tougher it to raise the additional amount of money at a reasonable prise. Hedge Funds: possibility to raise at least $7 million from Texas-based hedge fund and other smaller hedge funds. The main advantage of this source is that hedge fund gives more flexibility for Conor Medsystem management and it is less sensitive to ongoing trials and risks connected to this, so they can be sure that they will have ability to finish trials even if it will be with some issues in the process. However, hedge fund financing cannot provide company with enough amount of funds and can be used only in combination with another types of financing. Also, it is only one-time investment, so if company will run out of cash it wont be possible to have another tranche of financing. Conclusion: it is an appropriate way of financing for Cronor but it will meet only the part of companys needs in funding, so it should be combined with other scheme of financing. Royalties Scheme: selling 4-6% of future product sales for royalties to distributors of medical devices (maximum 5 mln USD).The only advantage of this method of finance rising is that its not dilutive. Among disadvantages are: a) Product is not completed yet, therefore, its hard to find risky enough distributors to invest, and hard to estimate adequate royalties payments against future revenues (royalties may be undervalued). b) can lead to decrease of valuation of the company at exit (as profits are 4 to 6% lower). Conclusion: its not reasonable to employ this scheme and share abnormal profits with distributors (Conor might become monopolist in the market of scents for the first several years after launching the product, while patent is still valid). Sale of side patents scheme: 4 mln USD+royalties on future sales (4-6%). Patents for usage of scents in cardiology and eye medicine do not represent valuable assets and should be sold according to efficient redeployment hypothesis due to following reasons: a) Conor is sticking to cardiology and do not have time, money and technical specialists to develop side usage of their product; b) Even if patents are left within firm as options to research in future, they do not increase value of the firm for the possible acquirer at the exit (according to Mr.Litvack, CEO). Conclusion: patents should be sold; however, sale should be scheduled after main financing is raised. We do not consider debt financing in the case of Conor, as firm did not yet reach necessary for private or public debt stage of development (including stable cash flows and sales).

Venture capital (VC): $16 million from two VC firms and their help in raising another 19 million from existing investors and other sources (First $20 million, the rest after successful European trial results, which are not expected for another 10 months). Among the advantages are the assistance with expertise, strategic planning and sometimes operational decision making that VC provides for firms management as well as the fact that this form of financing can raise the entire needed sum for Connor ($30 mln) and even bit more (extra $5 mln), so VC could be a leading investor in this round. On the other side the tremendous risk that VCs take require them to adopt different inconvenient for the firm they invest in measures to mitigate possible losses, like: provide financing in stages where additional funds depend on the outcome of previous stage, rely on the goal of mainly providing economic returns rather than some strategic focus (often leads to difference in opinions with respect to what should the company do and loss of the firms strategic independence) etc. Conclusion. Considering the fact that Connor already has a VC on board and risks that come with stage financing (even if Litvack could negotiate about removing staging structure it would take too much time), venture capital doesnt seem as reliable source of funds on this stage. Corporate Venture Capital (CVC): between $5 mln and $10 mln. The advantages of raising funds with CVC can be limited to 5 main as follows (D. Z. KnyphausenAufse , 2005): 1) corporate certification - reputation effect, which results from the co-operation with a well-known player; 2) stimulation of business by initial orders; 3) access to distribution channels; 4) support of R&D; 5) arrangement of (national and international) industry relationships. On the potential downsides are: CVC programs tend to be unstable (when the highly possible down cycle of R&D hits, program can be disbanded), high level of information disclosure which can lead to the loss of secrets, CVC investors often suffer from severe information asymmetries with the result of adverse selection. Thats why firms avoid accepting investments from corporate investors unless their intellectual property can be protected with the help of so called safeguards: restriction the ownership share given to the corporate investor, declining to give a board seat and a right of first refusal. Yet again, Gompers & Lerner (1999) state that compared to independent VC-financed start-ups, CVC-financed start-up companies are more likely to reach the IPO stage and less likely to be liquidated, especially if there is a high strategic fit between the parent company and the start-up. Furthermore, their research shows that the pre-money evaluation of start-ups with a CVC investment is higher during the different investment rounds than with an independent VC investment, which lies in a line with the Litvacks final goal to sell the company at the highest price. Conclusion. While there are potential threats with a CVC financing, they can be significantly reduced with the use of different safeguards, so all in all the source could be used at this stage of fund raising. Though, the amount raised wont cover the entire needed sum, and Connor would still need to look for a leading investor.

Final composition of financing: Having previously discussed the positives and negatives for each financing alternative we considered the following structure as the most reasonable according to the given facts.

y y y y

Corporate Venture Capitals: $ 5-10 M Existing shareholders: $ 15M Sell patents: $ 4M Hedge Funds: $1-6 M (depending on the amount raised from CVC)

At this stage Conor owns 25% of the shares and Highland Capital Partners, which are reliable partners with the same vision of the companys future as Conors and have been a leading investor in the series B funding, owns 30% of the shares. This results in control ownership of 55% and according to the case Conor wants to avoid dilution and keep control (blocking package). Therefore we suggest non dilutional instrument such as preferred stocks. However, this may not be possible depending on the negotiations and the fact if other parts accept the terms included. In the case they do not accept, another option is convertible stocks. With the preferred stocks we will have to pay a dividend that we assume would be around 7% at cumulative basis and transaction costs at 7-10%.1 There is also a possibility of a hostile take-over in Conors case because of the amount of cash they will have and no debt on their balance sheet as well as a ready product within 10 months. From this point of view convertibility can serve as an antitakeover mechanism. We propose Highland Partners to be the leading investor and do the valuation of the company and place issued stocks. The companys final goal is to be acquired by one of the major players of the market (J&J, Medtronic or other). Suggested capital structure helps to negotiate exit terms because current management retains control over the company.

References: Dodo Zu Knyphausen-Aufse (2005) Corporate Venture Capital: Who Adds Value? Venture Capital, 7(1), p.25. Gompers, P. & Lerner, J. (1999) The Venture Capital Cycle (Cambridge, MA & London: MIT Press).

Ogden

Exhibit 1 Drug Development: Time Invested and Success Rates2

http://faculty.london.edu/ppuranam/Practice/AURIGENE_case-1.pdf