Prof. Dr. Bodo Liedvogel and Dr. Heinz Haubruck founded the company DIARECT AG in Freiburg in 1998. They not only brought 20 years of experience in industry to the company, but also their entire savings. In the following interview, Dr. Heinz Haubruck tells Christoph Bächtle about the return investors expect from companies, how to win over potential clients and the risks associated with setting up one’s own business.
When you first founded DIARECT, you took the liberty of showing some potential investors the "red card". Does this paint a fair picture of the situation?
Not really. We knew that we would not be able to make enough money with diagnostics and that our profits would not be high enough to satisfy investors. The kind of margins that investors require can only in fact be earned in the pharmaceutical industry. Our decision not to take on traditional investors also turned out to be our saving grace. In 2001, when the financial situation got worse for biotechnology companies, we would have gone under had we not relied on private financing. At that time, we would not have been able to obtain the returns required by venture capital companies.
What is the difference between investors' expectations of a company's return and the realistic return a diagnostics specialist such as DIARECT can make?
It is difficult to say, as expectations can change depending on the conditions in the venture capital sector. At the time we founded DIARECT, investors would have expected a long-term return of around 20 to 25 per cent. In the field of diagnostics, returns of about 10 per cent are regarded as fairly good. It is possible to achieve this kind of return after a certain time, but certainly not in the first five years of a company’s existence.
Is this why you avoided venture capital and chose the traditional way of acquiring money, i.e. contacting banks. This is quite unusual for biotech start-ups, isn't it?
Yes, it is. We've always carried the entire risk ourselves and have run into heavy debts. However, we knew our products and clients inside out. And we also knew that our clients already knew us. What is also rather unusual is that the two DIARECT founders had more than 20 years' experience in industry between them. Normally, people in this position do not tend to choose to set up their own company.
The foundation of DIARECT was therefore unusual for two reasons. But we knew what to expect. Although it took us a year longer than we originally thought, it still worked. The advice I would give to company founders is to plan in sufficient buffer. A financial buffer that gives company founders the necessary time is very helpful.
How much did you have available in terms of capital resources for setting up DIARECT?
We founded DIARECT with an initial capital of 500,000 German Marks. We put all our savings into the establishment of the company. This showed the banks that we believed in our idea. But I would also like to point out that the risks we took were actually too high, considering our situation back then.
Why did you decide to establish your own business nevertheless?
Maybe it was an arrogant belief that one can do better and an ignorance of how the market works. When the start-up company is finally on its way, one is often too submerged in the actual process and it then becomes difficult to opt out. If company founders really want to set up their own company, and enjoy being independent in addition to having some degree of audacity, they will take on the venture. If company founders thought about everything that could go wrong, they would never dare to take on the risk of starting their own business.
You had a wide-ranging experience in the diagnostics industry, didn't you?
Yes, we did. But when we set up the company, we made a clear decision not to go into the final product business, although this was the market segment we knew best. We wanted to go back one step and focus on the component business because we anticipated better returns in this field. We came from a company that offered ready-to-use assays and knew the problem of providing high quality components of this type. That’s why we anticipated better market opportunities in the component business, rather than attempting to compete with hundreds of companies with an own assay. And these same companies are now our clients.
There were a lot of component suppliers at that time, weren't there? Did you actually see a market niche for your products?
We produced recombinant proteins, something that wasn't being done by anybody else at that time. We were the first to use recombinant proteins on a large commercial scale for the "autoimmunity" indication. This means that we knew that we had a special product. But we did not know whether clients were prepared to switch to these new components. From the point of view of the clients, they were initially taking a risk by abandoning the known natural sources and using recombinant components instead. This required a lot of persuasion, which was quite time consuming. That is why we took a year more than anticipated to start the company.
I am sure that the effort to try to convince the market of the company's performance and the quality of the product is one of the major challenges start-up companies meet.
Yes, this is true. However, our problem was to convince clients to buy not only one product from us, but a number of products. But the advantage of our business is that we maintain long-term relations with our clients because we supply components for the production process. Otherwise, I think we are quite atypical company founders, because we knew the market, the margins, we had contacts and industry experience, and had led cost centres for many years. For example, our spending budget was always spot on. Nevertheless, it took us a year more than we had anticipated to set up the company.
Do you have many competitors?
There are three companies in the world that do something similar. However, we are the only ones that had specifically focused on recombinant proteins from the word go. We now have a number of products that are only sold by DIARECT, but we supply a niche market. Our major problem is not the competition, but in the long term it is the market size. We are therefore obliged to enter other markets with new products.
"Recombinant" is a standard term in biotechnology. What makes your products special, despite the fact they are based on a rather common biotechnological technique?
The special thing about our product is its application in immunodiagnostics. We now supply components for test kits that can be used to carry out more than 50 million blood tests. This provides us with the entire range of individual immune responses. Our goal is to manufacture such specific components that they only react with pathological sera. Many people are able to produce recombinant proteins. But it is something else to produce recombinant proteins of a quality that allows their application in such a large number of tests. This is our internal know-how, which we have developed over many years.
What kind of advice would you give company founders?
The most important thing for company founders to do is to find out whether they have a product and whether they are able to make money with it. Everything else is just risk taking. At the end the only thing that counts is the invoice paid by the client. Money needs to be generated by products and not through funding programmes.
I also believe that too many founders see laboratory-scale as the same as production-scale and underestimate the time and costs required for switching from one to the other. Natural scientists have a tendency to believe that once something works it will work forever. But this is not the case.
Is the issue of "standardisation of products and services" underestimated?
Definitely. Nowadays, quality is no longer a sales argument. This has been shown in surveys. People take quality for granted. Start-up companies that encounter quality problems at the start will never recover. Information about bad quality spreads quickly; nobody talks about good quality; good quality is simply expected.
Your company is now established on the market. Would you nevertheless regard company establishment as a risky venture?
The risk you take when you set up your own company is relatively high in Germany. People like us, who finance company establishment themselves, face a massive risk. People setting up their companies with external money should think about how they are going to pay back the money at some time in the future. If you fail just once in Germany, you have a problem. The situation is much better in other countries, for example in the USA.
What needs to be done to limit company failures in Germany?
In Germany, the inclination to finance risky projects is a lot more restrained than in other countries. A lot more venture capital is available in the USA. This means that investors are more inclined to finance more unusual ideas. I believe that venture capital in Germany is often synonymous with investors only wanting to finance watertight projects in order to achieve higher margins. But this does not take into account the term “venture”.
Would you consider setting up a company again?
The answer is yes and no. Once you have a privately-owned company you also have a 24/7 job. Sometimes I wish that the relaxation phases when you can go and do something else were longer. And you are also taking on a great deal of risk. So much for the negative side of company foundation. However, the positive aspects of setting up one’s own company is that it gives you the freedom to decide. This is a truly impressive thing. Now that our company is doing well, now that it is 11 years old, and we are focusing on proprietary developments and making our own project decisions, now that we are able to use the cash-flow to finance new equipment, it is a wonderful way of working.