Ever wonder what goes on inside a venture capital firm? Four Motley Fool writers spoke with principals of Arthur M. Pappas & Associates, a venture capital and advisory firm specializing in the life science industry -- including new biotech start-ups targeting the drug making process. Here's how folks on the front lines view the current scene:

The Motley Fool: Thanks for taking time to talk with us today. Why don't we start by asking for an explanation of what you guys do and how you view the investing opportunities in biotechnology.

Pappas, Chairman and CEO: Let me take a couple of minutes to explain our operation, I think it will tie in to the questions you've asked. And by the way, I've taken a look at your Biotech Investing Guide, very impressive document, and a great primer to someone who wants to get into this space. Really well done. One of the finest I've seen.

TMF: (blushing)

Pappas: As far as our company is concerned, we consider ourselves a venture development company. And our objective is to build long-term value by investing in technologies, products, or companies. We do that through two arms of our business: we have an advisory group that to date has advised close to 100 companies in the pharmaceutical, biotechnology, and biopharmaceutical space... [from] large pharmaceutical companies including GlaxoSmithKline(NYSE: GSK), BioChem Pharma [now merged with Shire Pharmaceuticals (Nasdaq: SHPGY)], Bristol-Myers Squibb(NYSE: BMY), and Pharmacia Corp. (NYSE: PHA), [to] a whole range of mid-to-small-sized companies. And our advisory group helps these companies with everything from partnering transactions to M&A [merger and acquisition] transactions, to acquiring technologies or searching or assessing their clinical trial pipelines.

The other side of our business is our investment business. And there we manage approximately $150 million, and most of those funds are in private equity investments, very typical venture capital-type investing. We also do invest in public companies, in what I would consider micro caps and small-cap companies under $500 million (in market cap). The combination of being able to provide advisory services as well as manage money makes our business model fairly unique.

TMF: How so?

Pappas: We employ more than 25 full-time employees, and most of them are PhDs and MDs. We also have another 35 professionals in our associate network, which is a worldwide network of pharma professionals who come out of the industry or academia and who help us with due diligence and analytical support. A typical venture capital fund that would manage $100 million would typically have four partners, and maybe four associates. As you can see from our numbers, we have over three or four times the resources than a typical private equity group of the same size would have. And that's primarily driven by our advisory business.

Our model is such that if we bring in a client company on the advisory side of our business, they pay us for services to do work for them. We do not invest in those businesses on the advisory side of our business -- they are advisory clients only. On the investment side of our business, however, if we make an investment in a company, we give them at no cost many of the services that we provide on the advisory side of the business. That provides huge value to our target investment companies. They can tap into all of our resources -- which is something that most early-stage private equity companies cannot do on their own.

For example, a drug discovery company may be able to tap into our natural product chemists, or our combinatorial chemistry folks, or whatever. This gives us huge leverage in a value-added approach to our investment companies.

Ford Worthy, Senior V.P.: Important in our structure is that we've built substantial relationships in the industry that allow us to gain further intellectual capital and help us make better decisions, not just on the investment side, but also when we take on an advisory role in helping a client to execute a partnering or clinical trial type of strategy.

To that point, some of our alliances include groups like Quintiles (Nasdaq: QTRN), the largest CRO [contract research organization] and Alza Corp, the leading drug delivery company, just recently acquired by Johnson & Johnson(NYSE: JNJ). With that relationship, Johnson & Johnson now becomes an alliance of ours.

In addition, we have a relationship with Alexandria(NYSE: ARE), a publicly traded real estate investment trust (REIT) that specializes in life science facilities and technology facilities, so we can assist clients who have a need in this area. Those are examples of how we use our partner relationships to further develop our own information base and our due diligence process. 

TMF: Okay, where do you see investment opportunities right now?

Pappas: We see opportunity in three primary categories.

First, as you may have seen, at least in the private equity group, the dollars coming in to the private equity venture capital groups specializing in biotech have been relatively flat for the past seven years.   

What's interesting is that the dollars that are coming in tend to go to the larger funds, and these larger funds often don't really weigh in and do early stage deals that are so important in developing a value added chain and taking it into a capital market exit or acquisition by a large pharma company. So we find that by having assets under management of less than $200 million dollars allows us to very effectively go after and work with the early stage opportunities either coming out of the university or being spun out of the large pharma companies. So that's one opportunity that we see to be addressed.

The second opportunity we've seen relates to the life science development cycle. And the way that you capture that in your Biotech Investing Guide here is that there are bottlenecks that occur in the life cycle of a product from the biology to the chemistry to clinical trials to commercialization. We see three significant bottlenecks that are occurring in the life sciences development cycle, which we will address in a minute.

The third opportunity that we see is the demand among the large pharmaceuticals for new products. You have probably seen in your analysis, back around four or five years ago, or longer, CEOs would get up and say they need to have two or three major new chemical entities being launched per year in order to maintain their 15% growth rate.

That demand hasn't dropped off, they've just stopped talking about it. But that demand is still there, not so much a bottleneck as a gap that's occurred that needs to be looked at. We think that large pharmaceutical companies will need to acquire new products or new technology to achieve this, and that creates demand for new investment in early-stage companies or technologies.

Next: Venture Capital, Part 2 »

Motley Fool Research Analyst Zeke Ashton looks at the first-generation biotechs in The Motley Fool Select . The Motley Fool has a full disclosure policy.