June 17, 2005
Presented by
Morrie Ruffin,
Executive Vice President for Capital Formation and Emerging Companies,
Biotechnology Industry Organization Introduction
Good Morning. My name is Morrie Ruffin. I am the Executive Vice President for Capital Formation and Emerging Companies at the Biotechnology Industry Organization. On behalf of BIO, I would like to thank SBA and the members of the Hearing Panel for conducting this series of Public Hearings to provide the small business community an opportunity to comment on the future of SBA's size standards. My comments today will focus on an issue that directly affects many biotech companies -- that is the exclusion of companies with majority venture ownership from participation in the SBIR and STTR programs.
Our organization, BIO, represents more than 1,100 biotechnology companies and the universities and research organizations that collaborate with them. We have member companies in all fifty states. While we represent the established companies in the industry such as Amgen and Genentech, the vast majority of our members, over eighty-five percent, are small, emerging companies with less than 500 employees. In fact, more than fifty percent of the companies in our industry have fewer than 50 employees.
As the Executive Vice President for Capital Formation and Emerging Companies, I am responsible for working with all of our companies to assist them with the daunting, never-ending process of raising capital to fund the expensive pre-clinical research and extensive clinical investigative work necessary to bring novel therapeutics to the market and the patient. Over the past two years, we have been contacted by hundreds of companies, members and non-members, who are looking for guidance on how they should determine their size for the purpose of qualifying for SBIR grants. Frankly, they are confused and many of them are very angry. For a company with 20 employees, struggling to make payroll, with less than two years of cash available to fund their research, it strikes them as inconceivable that they would be considered ineligible for an SBIR grant because they are deemed to be too large. Under the current interpretation of eligibility, they are considered large because as a start-up biotechnology company they did what virtually all of our early-stage member companies must do to continue their research; they raised an early round of venture financing.
In our industry, even the relatively small amount of money a company will raise in its first round of financing (Series A), $5-8 million, will usually result in the new investors - usually a collection of venture funds - owning more than 50 percent of the company. Indeed as we have surveyed our members, the majority of them that have raised venture funding have an ownership structure where the collection of venture investors and other outside investment groups usually own more than 50 percent of the company. I am only aware of a few cases, however, where a single venture investor owns more than 50 percent of the company.
While almost all of our companies will need to raise venture financing to advance their products toward the marketplace, many small biotechnology companies have come to rely upon the SBIR program Phase I and Phase II grants to fund cutting edge research in areas where venture capital and other sources of financing are difficult to obtain. This is typically the case for companies that need early-stage funding for proof-of-concept, while they are putting together their initial rounds of financing. The other instance in which SBIR grants have been very useful to early-stage biotech companies is to fund new research on programs that are different from the lead programs around which they have raised their venture financing. Many companies will raise a venture round that is deliberately sized to the amount of funds needed to advance a lead program. This is the case because the amount of money required is usually relatively high and the company does not want to take on more debt and dilution than necessary. While they are working on these lead programs they often come across new potential indications or new project opportunities that they will want to test before raising additional money. The SBIR program is ideally suited for this purpose, because the company has already demonstrated that it can successfully raise follow-on financing, one of the key criteria in evaluating an SBIR Phase II grant proposal.
In the biotechnology industry, there is a specific need for both SBIR and VCC funding. The lengthy and costly clinical development process for biotechnology requires investment that is out of reach for most small business entities. In the biotech sector, government investment is one leg of the stool, with industry as the second leg, and private investors the third leg, be they angel investors or venture capital companies. By limiting government support for this type of R&D to firms without VC funding as a main source of additional financing, it effectively cuts out the smaller firms with the best science. This restriction risks delaying the discovery of promising new therapies for cancer, diabetes, Parkinson's and specifically many disease areas where there is less commercial focus, like tuberculosis or diseases that would qualify for an orphan drug classification.
The nature of the risk and expenses required in biotechnology development means that even the strongest small, private biotech firm suffers from constant financial stress. VCC financing is all but required for this industry to continue doing quality research. The current rule interpretation eliminates many small biotech firms from taking advantage of the SBIR program. By choosing to participate rather than forgo their SBIR eligibility, a firm may have to defer much needed venture capital, placing it in financial jeopardy. Yet, many biotech firms would be unable to exist at all without the funding provided by venture firms.
It is our belief that restoring the eligibility of majority venture-owned companies and granting the VCC exclusion from affiliation would not adversely affect the ability of small business concerns without such access to private capital to compete for SBIR awards. Based on our discussions with NIH officials, they believe there is more than enough funding to allow for the participation of venture and non-venture backed companies in the program. However, restricting VCC backed companies from partaking in the grant program will have a significant negative impact on the quality of applications and the type of science that will be studied.
We have had numerous conversations with the NIH about the impact of the new eligibility interpretation on the quality of SBIR proposals being submitted. One of the largest institutes informed us two weeks ago that they have seen a "significant" drop-off in the overall quality of applications for the program. Even more disturbing, they say, is that the quality companies they want to work with and had hoped would be submitting proposals through the SBIR program, are no longer submitting proposals. They view this as a direct blow to the translational research objectives expressed by NIH and welcomed by Congress in the NIH Roadmap report issued in 2003.
Finally, I wanted to highlight some of the findings from two surveys we conducted this year to understand the nature and scope of this problem for our industry.
The first survey, conducted in January of this year was aimed at privately funded BIO members with less than 500 employees to understand the nature and extent of VC ownership in their companies and the impact the eligibility interpretation was having on their plans to use the SBIR program. The survey results confirm that SBA's interpretation is limiting many small biotechnology companies from participating in the SBIR program. Fifty-two companies responded to this survey.
Specifically:
- According to the results, 70% were majority owned by multiple VCs. The number of VCs that have an equity stake in the small businesses range from 2 to 22.
- Only one survey respondent said they had a VC that had an equity stake greater than 40%, while most VCs owned between 7% and 25% of the company. The average ownership stake was les than 20%.
- Over the last 5 years, 62% of the survey respondents applied for SBIR grants. Exactly half of these applicants were either denied SBIR grants immediately because they could not meet the SBIR eligibility requirements due to their ownership structure, or were subsequently denied the grant due to an adverse size determination.
- Finally, over 60% of the respondents said that they have chosen not to apply for SBIR grants due to perceived eligibility concerns.
The second survey was conducted earlier this week and was designed to measure the larger impact the eligibility ruling is having on our overall membership and the industry. The survey results are still coming in and with them an extensive series of comments on the breadth and scope of this problem. I can only provide the preliminary results today, but would be happy to provide you with the final results as soon as they are available in 1-2 weeks.
To date the survey shows:
- Of the 140 surveys we have received so far, 112 were completed by private firms. Of those, about 65 percent had VC funding.
- Among those with VC funding, the average firm has 63% VC ownership.
- It is important to note that BIO has a large number of public BIO companies that have historically used the SBIR program as well. Many of these companies are what we call micro-cap or orphaned companies because they have very low market capitalizations and a very difficult time raising money. For them, the SBIR program is just as important as it is for the private firms. Because of diversified ownership by institutions in these public companies, most of them are now ineligible for the program.
- As in our earlier survey, the results show that the average ownership stake by a VC firm in the company is less than 20%.
- Fifty percent of the respondents said they are no longer applying for SBIR grants and 16 companies have actually been turned down.
- Finally, even though the survey does not explicitly ask whether the respondent is in favor of restoring eligibility for venture-backed companies, so far only 4-5 companies expressed opposition to our position. These results came from member and non-members companies.
The Solution
To remove this barrier to participation in the SBIR program, we urge SBA to revise the SBIR eligibility requirements and issue a proposed rule that reflects Congress' original intent to encourage awards to small businesses that have successfully attracted outside investors. The approach proposed by SBA in its December 3, 2004 Advanced Notice of Proposed Rulemaking to disregard affiliation is a step in the right direction. However, it does not address the fundamental obstacle which is SBA's requirement that small businesses be majority owned and controlled, directly or indirectly, by individual human beings.
We recommend that SBA adopt a rule that addresses the actual ownership structure of small biotechnology companies that are owned and controlled by venture capital companies. Specifically, we suggest that the size requirements be revised to permit VCC ownership of SBIR applicants to count toward the 51% U.S. ownership and control requirement. This would allow greater participation in the SBIR program by small biotechnology companies, but would not permit participation by venture-owned firms that are affiliated with large companies.
If these proposed changes were enacted, small businesses would be able to take advantage of this important program and participate in research efforts that are critical to our nation's health, safety and security.
Thank you.
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