Taking the Money

In the spring of 2003, James Yarger and Charles Boland were faced with a decision.

Their company, Cedarburg Pharmaceuticals, was doing well. Former managers in Amoco Oil's new ventures group, they had formed Cedarburg in 1997 after failing to find a U.S. company capable of properly manufacturing a vitamin D metabolite that Amoco was developing. They sensed an opportunity and struck out on their own.

With loans from the Small Business Administration, commercial banks, and family and friends, Yarger and Boland built a facility in Grafton, Wis., and started producing pharmaceutical intermediates. They proved their mettle and moved on to commercial active pharmaceutical ingredients, making cytotoxics, controlled substances, and other hard-to-synthesize compounds, mostly for emerging drug companies and generics makers. Along the way, they took on additional small investors.

By 2003, the Grafton facility employed 60 people--mostly chemists--and was running seven days a week, 24 hours a day. But while Cedarburg's sales had grown rapidly, expenses did as well; after six years in business, the firm was still losing money.

"It was a textbook case," Yarger recalls of the decision in front of him and his partner. "We needed some final cash to take us over the finish line. We could scale back--go slower and miss some opportunities. Or we could continue on the growth line and interact with a venture-capital company."

Meanwhile, venture capitalists were beginning to eye Cedarburg. The company had filed several Drug Master Files--a document containing confidential drug manufacturing information--with the Food & Drug Administration, including one for oxandrolone, an anabolic steroid used in weight-loss prevention that had been off-patent for several years with no generic competition. "It was hard to make," Yarger says. "Others had tried and failed. We surprised people with our success and opened a lot of eyes."

One banker taking notice was James Gale, managing partner of LOF Partners, the life sciences investment arm of Sanders Morris Harris Group, a large investment bank in Houston. Unlike many life sciences investment firms, LOF stays away from risky but potentially high payback companies that are discovering new drugs. "We're not smart enough to figure out if some of these drug platforms are going to work or not," Gale says. Instead, it focuses on niche companies in generic and specialty pharmaceuticals and on firms that provide services to the drug industry.

Gale contacted Cedarburg and learned that the company was in need of funds to complete an expansion project. Of course, taking on an outside investor would compromise the independence to which Yarger and Boland had stayed true for the previous six years. "What entrepreneur who used sweat capital to build his business wants to give it up? That's tough for an entrepreneur," Gale says.

In the end, though, they took the money, staying true instead to what Yarger calls the risk-taking spirit that led them to start Cedarburg in the first place. "If we wait and go slow, we may never become the company we might have," he says. "We'd rather say we tried than not do it at all."

The pair is using the funds from LOF to pay back loans from several early investors and to complete the expansion in Grafton. At the end of 2003, Yarger says, the firm operated 1,000 gal of reactor capacity. A 600-gal reactor is being installed at the moment, and by the end of 2004, capacity will be 2,500 gal.

Yarger is well aware that a multi-million-dollar investment comes with strings attached. For its money, LOF acquired a minority share in Cedarburg along with representation on its board. Gale notes that his firm's pharmaceutical experience and contacts are also at Cedarburg's disposal. For example, he introduced Yarger and Boland to Martin Zeiger, a former executive at Barr Pharmaceuticals and Hoechst Marion Roussel who is now an independent Cedarburg director.

As an investment fund, LOF's strategy is to recoup its money, and then some, within three to five years. The three typical exit avenues are an initial public offering, a "trade" sale to another company, or a recapitalization in which the fund gets bought out.

According to Gale, an IPO would require that Cedarburg reach annual sales of some $50 million--a tall order in just a few years--leaving a trade sale as a possibility. However, Yarger is confident that he and Boland can keep control of Cedarburg. "The idea is not to sell the company but to continue to grow it," he says. "Our vision for Cedarburg is multifold."

Indeed, although Cedarburg's sales today are under $10 million, Yarger says he sees no reason they can't hit $100 million eventually, putting the company in the ranks of leading small-volume pharmaceutical chemical manufacturers like Albany Molecular Research and Solutia's pharmaceutical services division.

Flush with cash and enjoying his company's robust growth, Yarger professes to be happy with the venture-capital investment process so far. "When we began, I took pride in saying we had no venture-capital money," he says. "Now I take pride in saying we do."