Managing Risks, Maximizing Investor Returns


by Thomas C. Melzer

Co-Founder & Managing Director of RiverVest Venture Partners

Eyes on the Exit

(March 23, 2023) – Venture capital is known for its higher risk/return profile. VC firms make multiple bets with the hope that a significant percentage will pay off, thereby yielding a profitable fund. But to be successful, particularly in a difficult market environment as we have today, a firm can’t rely on luck or probabilities. It must have a sound strategy.

In this article, Managing Director Tom Melzer breaks down RiverVest’s investment strategy, which centers on managing risk and capital efficiency with one goal in mind: a successful and profitable exit that will maximize investor return.

There is no question that early-stage venture capital investing is risky. The question is how does a firm take steps to manage those risks? To start, a firm must cultivate a “taste” for certain types of investments and, by inference, a distaste for others, according to personal appetite and tolerance for risk.

There simply are too many opportunities that come a firm’s way to consider them all; the quicker they can be triaged, the better. Indeed, if diligence indicates the collective risks are too great in relation to the probable return, a prudent venture capitalist moves on to the next opportunity, rather than invest.

“Having been patient over the last 12-18 months, we find ourselves with a well-reserved fund that has plenty of dry powder to capitalize on the investment opportunities that lie ahead, always mindful of our disciplined approach.”


Since co-founding RiverVest more than two decades ago, I’ve seen the primary risks in life sciences venture capital fall into five key categories: financing, technology, clinical and regulatory matters, reimbursement, and management teams. Our success has been rooted in identifying and managing these risks. 


Let’s walk through each of them.

Five Types of Risk in Life Sciences Investing

  1. FINANCING. Perhaps as no surprise, most life science startup companies fail when they are unable to raise their next round of funding. Twenty years ago, early-stage venture investors were more willing than they are today to raise relatively small rounds and hope that the milestones reached would attract later-stage investors.

    Today, we see many Series A financings that are quite large, with the rounds tranched based on achieving successive sets of milestones— ultimately one that could lead to exit. This approach clearly reduces financing risk, particularly if the round is syndicated with large VCs capable of funding the company beyond the Series A. Key aspects of selecting syndicate partners include knowing where they are in their fund cycles, the amount of the reserves they will be setting aside for the future investments in the company, and most important, whether they share a like vision on the best stage at which to exit.

  2. TECHNOLOGY. Another major risk in life science investing relates to the introduction of a foreign chemical, biologic entity, or medical device into a living organism: Will the product have a beneficial effect, without causing a safety issue?

    Such risks are clearly within the purview of well-trained scientists or physicians who understand, among other things, biologic systems and pathways. Broadly speaking, efficacy and safety risks associated with drug development can be mitigated by addressing validated biologic targets; perhaps using an antibody rather than a small molecule to lessen off-target side effects, using chemical entities that have already been proven safe in humans (likely for an indication other than that for which they were originally tested), and avoiding compounding risks by pursuing an unvalidated target with a new chemical entity. That said, the risk of failure in drug development is known to be significant: Across the industry, only 1 in 10 new drugs being developed for testing makes it to market.

  3. CLINICAL AND REGULATORY MATTERS. As a rigorous oversight body, the United States Food and Drug Administration (FDA) has an important focus on safety. Thus, it is critical to anticipate the questions that are likely to arise during a specific development program and, where possible, address those questions in pre-clinical testing. There are no shortcuts when dealing with the FDA. It is better to do that which is required than to try to convince the FDA that the data being requested is unnecessary.

    When designing clinical trials, it is imperative that experienced clinicians determine enrollment criteria, other trial protocols, and clinical endpoints. The stakes are very high during this phase: One poor decision can set back an entire program for years and increase the expense by tens of millions of dollars. Proper powering of the trial is also important to ensure the prospect of statistically significant outcomes. Finally, having a strong clinical operations staff to onboard and supervise trial sites can facilitate timely enrollment of patients who meet the admission criteria.

  4. REIMBURSEMENT. While commercialization is typically some years down the road, it is never too early to think about reimbursement—how will the company get paid for its product? A good starting point is addressing an unmet medical need, rather than seeking to develop a “me-too” product.

    In the pharmaceutical space, the blockbuster drugs prescribed by general practitioners are probably best left to big pharma, as the trials are likely to be very large, possibly with long follow-up periods, and too expensive for a venture-backed company to fund. Also, these widely prescribed drugs are likely to be directly in the sights of pharmacy benefit managers. On the other hand, orphan drugs or those prescribed by specialists tend to be an ideal focus for venture-backed companies.

    For medical devices, pursuing opportunities that can qualify for some reimbursement under existing procedure or specific device codes is advisable; waiting one to two years to commercialize after product approval for a new device code can be a very costly proposition.

  5. MANAGEMENT TEAM. In the specialized field of life sciences venture capital, the management team is critical to a company’s success. Accordingly, working with experienced management teams who have previously led a startup company to an exit is highly desirable. From the outset, the sense of urgency across the team must be high in order to achieve particular milestones in specific timeframes and on a limited amount of capital. As a company evolves, so too does the optimal type of management.

    In the early stages, when the focus is usually on developing the technology, the CEO will likely have a scientific or medical background. As the company advances, the focus shifts toward commercial expertise. At all times, the ability to build and retain a strong team is an essential quality of a CEO. Sometimes, the founding CEO can lead a company all the way to an exit; often however, a change is needed. While venture-backed company boards might recognize that new leadership would be in the best interest of the company, they typically are not quick to act. Someone on the board, often the RiverVest representative in our experience, must build a consensus for making a change, communicating with the current CEO, and initiating a search process. Ideally, the momentum of the company can be maintained with minimal disruption.

Capital Efficiency as a Portfolio Company Grows

In addition to properly assessing and managing risks, perhaps the most important factor affecting returns is capital efficiency. It is prudent to have a formal framework for evaluating an opportunity’s return potential: What is the current valuation, how much additional capital will it take to reach likely exit milestones, what are strategic buyers likely to pay at different potential exit points, and how long will it take to reach those points? 

When capital markets are highly liquid, as was the case from 2018 into early 2022, it could be easy for management teams to overlook the importance of tracking these metrics. If more funding were needed, it could readily be raised.

From a venture capital perspective, the easiest way to compromise capital efficiency is to overpay at the time of initial investment, although undisciplined spending as a company develops can be just as damaging to returns. Accordingly, venture-backed company boards, which are typically populated with venture capital firm representatives and independent directors, must be diligent in monitoring portfolio company operating plans and budgets.

Maximizing Odds for Success

In summary, by being selective about what risks we are willing to assume, strategically supporting each portfolio company so that it can realize its full potential, and focusing on capital efficiency throughout the investment cycle, we at RiverVest are able to maximize the odds for meaningful returns to our investors. Our disciplined commitment to these practices serves us well. 

Opportunities for exceptional returns exist regardless of market conditions, but particularly in volatile, challenging markets as we have today. At such times, capital is scarce, and valuations for new investment reach their most attractive levels. Having been patient over the last 12-18 months, we find ourselves with a well-reserved fund that has plenty of dry powder to capitalize on the investment opportunities that lie ahead, always mindful of our disciplined approach.

About Tom Melzer

As a managing director at RiverVest, Tom has worked with portfolio company CEOs as an adviser on financing, strategy, and management. 


Before co-founding RiverVest in 2000, Tom served as President and CEO of the Federal Reserve Bank of St. Louis, where he was one of a handful of individuals who directly influenced U.S. monetary policy via his role on the Fed’s Federal Open Market Committee. 


At the Fed, he chaired the investment committee for the Federal Reserve pension and thrift plans and oversaw the Eighth Federal Reserve District’s role in the regional economy, payment services, and supervision of banks. 


Prior to that, he was known for his trailblazing, troubleshooting, and organization-building roles as a managing director at Morgan Stanley & Co., Inc.