|
by Carl B. Feldbaum
originally printed in BIO News -- Dec 2003/Jan 2004
Sometimes federal business legislation enacted with the best of intentions has unfortunate consequences for biotechnology companies, consequences that have kept BIO busy this past year.
Exhibit A: Sarbanes-Oxley, 2002's lightening-rod legislation. In a climate rocked by scandal and staggering investor losses, this legislation was urgently needed, but a few of its provisions are now hurting biotechnology companies, many of which have struggled to conserve scarce R&D funds over the last two years.
For one thing, the law dramatically increases auditing costs. Basic compliance costs are typically $250,000 to $300,000—a modest amount for a large, profitable company, but a significant expense for a small, unprofitable one. A young biotech company may have to eliminate scientists or a promising line of research in order to comply.
Sarbanes-Oxley also creates a dilemma for companies that offer programs allowing "cashless" stock-option exercise. Under these programs, critical to biotech recruitment, employees borrow the money to exercise their options and then pay it back upon sale of the stock, a transaction that usually takes no more than a week. Are these programs now considered illegal loans? The law isn't clear.
As the Securities and Exchange Commission begins to interpret, implement and enforce the new law, BIO is urging SEC leaders to consider the effects on biotechnology when setting policy. We've also met with members of Congress to discuss the need for clarification and fine-tuning.
It's important to note that the lawmakers who wrote and voted for this legislation were not aiming to hurt biotech-most, in fact, are avid supporters of this industry. But like many other federal laws governing business, Sarbanes-Oxley is one-size-fits-all, with no special provisions for biotechnology.
That's actually not surprising, since ours is a business model never even seen before the 1980s—small companies with outsize capital needs developing products over timelines of a decade or more.
The tax code, for example, penalizes companies that undergo a technical change in ownership by almost completely wiping out their credits for net operating losses. This rule, part of the 1986 tax overhaul, was designed to prevent abuses in which companies were acquired solely for the value of their accumulated losses. Unfortunately, biotech companies practicing routine equity financings get caught in that net as well.
By accepting a large infusion of cash—an infusion characteristic of biotech companies entering Phase III clinical trials—a company can experience a technical change of ownership and trigger section 382, which takes away the net operating losses the company has incurred up to that point. The additional losses that accumulate as the trials proceed are then lost if a subsequent financing to run still more trials results in yet another change of ownership.
By the time a biotech company becomes profitable, it can't apply any of these losses against its tax bill. It's as if selling your house meant losing the interest write-off for all the years that you had lived in the house.
The effects on biotech are measurable: Because of tax inequities, biotechnology companies' cost of capital is up to 48.6 percent higher than that of other firms, according to a BIO-commissioned study by American Enterprise Institute economist Kevin Hassett.
BIO's advocacy on this issue has led to the introduction of corrective legislation in both the House and Senate (H.R. 2968 and S. 1773). The legislation has won bipartisan cosponsors, and we are hopeful it will be attached to a larger tax bill when Congress returns early next year.
Ownership issues also underlie another unintended consequence of otherwise beneficial legislation. Under a new interpretation of a 1982 law, biotechnology companies that are majority-owned by investment entities, including venture-capital firms and pension funds, are banned from receiving federal grants designed to encourage small businesses to develop innovative technologies—the kind of projects that might otherwise be abandoned in favor of those with more immediate commercial payoffs.
These grants, ranging from $100,000 to several million dollars, have been instrumental in helping small biotech companies pursue high-risk, high-benefit R&D in fields such as cancer, cardiovascular disease, diabetes and HIV/AIDS. Our industry's two largest firms benefited from these grants in their infancy.
But today, companies like Trophogen, an 11-employee firm in Rockville, Maryland, are being locked out of the program. The company specializes in infertility therapies and had sought $100,000 from the NIH to support clinical testing. Despite an excellent NIH peer-review score, the application was denied under the new ownership rules.
Ironically, the grants remain available to publicly traded companies that are often much larger than venture-backed firms. Companies with up to 500 employees—more than 45 times the size of Trophogen—are eligible. Yet even the small startup companies that state-funded venture-capital pools are incubating will be excluded under this new interpretation when the state fund and/or other institutional or venture investors end up owning more than 51 percent.
As with the tax code inequities, a possible legislative solution may be at hand, in the form of the Small Business Administration reauthorization legislation (S. 1375), which is expected to be passed by March of next year. The biotechnology industry, joined by the National Venture Capital Association and other high-tech industries, is urging that the bill include a remedy for the grant problem.
These grants—as well as the tax code correction—are critical because investor support for biotech R&D tends to be volatile. It can vary 50 percent or more from one year to the next. In 2002, more than 60 biotech companies laid off employees and many nearly ran out of cash before the investment climate brightened.
Innovation grants are part of the complex public-private web of support that keeps these vital companies alive and relatively stable through such tough times. Correcting tax inequities would further strengthen their ability to survive downturns.
At this writing, we don't know what the outcome of our efforts on these issues will be, but we are optimistic. Members of Congress and their staffs so far have been receptive even though correcting flaws in legislation sometimes more than a decade old isn't the stuff of headlines—it's merely essential.
Carl B. Feldbaum is president of BIO.
| 
Printer Friendly
