While grants are an effective funding mechanism for early growth companies, foundations are beginning to take larger stakes in start-ups by retaining equity or by taking a percentage of royalties from sales once the product is on the market.
- The Michael J. Fox Foundation for Parkinson’s Research has poured $170MM into Parkinson’s research, with $18.6MM into 39 industry-led projects
- FasterCures, a Maryland-based non-profit, has allocated over $500MM in foundation capital to emerging growth biotechnology companies
This phenomenon is known as Venture Philanthropy, a term coined in the 1960’s as a new means for foundations to become more actively engaged in the affairs of the grant recipient. Today, Venture Philanthropy is viewed as an investment rather than a contribution, allowing executives to to take an active role in project management and set benchmarks and goals as a condition for additional funding; in other words, Venture Philanthropy allows foundations to apply private sector models (capitalizing on efficiency, effective management, and organization) to their charitable venture.
Under the Tax Reform Act of 1969, foundations are required to give at least 5% of their yearly assets to a charitable cause or charitable purpose in order to maintain a tax-exempt status. Program Related Investments (PRIs) are a means for a foundation to invest in a forprofit or educational purpose as long as profit is not the end goal. Examples of PRIs include interest free or below-market loans, loan participations or guarantees, letters of credit, and equity investments. For foundations investing in biotech companies, royalties from cures or drug therapies can be re-invested into research or other opportunities.
For example, the Alzheimer’s Drug discovery Foundation helps fund drug discovery programs in both academia and biotechnology companies. Recognizing the major gap in funding, the ADDF proposes a larger aim on their website:
To fill the critical translational funding gap between basic research and later stage drug development. We fund high risk, early-stage drug discovery and development projects and catalyze scientists to enter the drug discovery field. We have adapted the operating model and principles of Venture Capital investing to our philanthropic mission in biomedical research. We help to create new biotechnology companies, and to fund early-stage biotechnology companies, with investment for all of our grants based on the achievement of scientific and/or business milestones. When these milestones are met, funds return to the Foundation to increase our ability to support more research. (Alzheimers Drug Discovery Foundation.” Alzheimers Drug Discovery Foundation RSS. N.p., n.d. Web. 28 Nov. 2012.)
For the emerging growth companies, working with foundations espouses several benefits: Unlike Venture Capitalists, foundations and non-profits generally don’t have stringent terms, investment return requirements, and are a source of non-dilutive capital. Foundations have the resources to assist emerging growth healthcare companies during the clinical trial period by increasing participation through their patient networks, can help attract scientific experts to drug development program, and assist researchers in understanding the needs of the patient at an early stage.
While Venture Philanthropy has a positive outlook for future investment in emerging growth companies, the mechanism alone cannot fill the major funding gap in the biotech sector. In the coming pages, we will look to the prospect of Crowdfunding as a supplemental funding mechanism to Venture Philanthropy, strategic, and financial investments and suggest new hybrid mechanisms that can breathe new life into medical innovation.
Read our 38-page complimentary white paper on venture philanthropy: “Breathing Life Back into Biotech: Crowdfunding and the Hybridization of funding Mechanisms for Early Growth Companies.” Learn how L3C Crowdfunding can be used to raise capital from foundations and individuals with “compassionate use/charitable” intent.
If you’re running an emerging growth healthcare company, learn how to:
- Identify and Source Capital from Foundations Using L3C Crowd Finance
Investors and foundation directors will learn how to:
- Leverage HealthiosXchange’s due diligence to make the most impactful donations / investments: (HealthiosXchange ranks emerging growth healthcare companies by indication)
- Comply with IRS regulations pertaining to Program Related Investments (PRIs) and ensure IRS compliance for foundations/emerging growth companies
On April 5, 2012, President Obama signed the JOBS Act, The “Jumpstart our Business Startups Act,” H.R. 3606. The JOBS Act was the culmination of a year-long bipartisan effort in both the House and Senate to address concerns about capital formation and unduly burdensome SEC regulations. The JOBS Act enabled Equity Crowdfunding, a method of raising capital in small amounts from a large group of people using the Internet and social media.
Prior to the JOBS Act, money raised through Crowdfunding in the U.S. was relegated to micro investments or donations to causes and ventures within a framework of providing rewards including sponsorships, loans (microfinance), and gifts.
The growth in worldwide Crowdfunding volume has been astounding. In 2011, over $1.4 billion was raised through Crowdfunding with projections of $2.8 billion in 2012 (91% growth rate). Two leading U.S. based “Donation/Gift” based Crowdfunding platforms, Kickstarter and Indiegogo, have experienced exponential growth as measured by funding volume and number of deals/participants.
Crowdfunding is a big advantage for the Crowdfunders since it allows them to participate in angel investing, whose returns have outperformed over the past decade.
The Crowdfunding model is disrupting the traditional fundraising ecosystem. Research from the Angel Capital Education Foundation shows startups raise $60 million annually through friends and family, compared with $20 billion for Venture Capital and $20 billion from Angel investors. (Schroter, Wil. “Crowdfunding Streamlines the Friends and Family Round.” PandoDaily. N.p., 6 July 2012. Web. 28 Nov. 2012.) For emerging growth companies with revenues under $10 million per year, there is a huge funding gap, making it extremely difficult for business owners to get loans or credit lines from banks.
The legalization of equity crowdfunding for nonaccredited investors will allow the average American citizen (who makes less than $200,000 per year) to invest in start-up companies and widely expands the pool of potential investors for early growth companies.
The biggest question that remains is whether life sciences companies see opportunities for small scale financing within a model that requires drastically high operating costs and expectations of significant returns.
The innovation period, the time a biotechnology company needs to develop a product, can be up to a decade or more. During this time virtually all small biotech firms have not product revenue, so all product development costs must come from investors.
The Securities and Exchange Commission and FINRA, the two organizations tasked with implementing the JOBS Act, will render Equity Crowdfunding regulations in 1013/2014. Until then, Accredited investors interested in funding early-stage companies can fund private companies under current exemptions.
S. Jordan Associates has published a complimentary, informative Crowdfunding White Paper: “Life Sciences Private Placements – Is Equity Crowdfunding a Viable Financing Vehicle?”
The White Paper answers some of the most pressing questions posed by industry executives and financiers, including:
- What would need to change about Equity Crowdfunding, as it is conceived today, to make it a truly viable and complementary component of the startup capital markets?
- How can Equity Crowdfunders and Angels/Venture Capitalists work together?
- Can Equity Crowdfunding augment the traditional lifeblood of startups, Friends and Family and Angel Seed Rounds?
- When should life sciences’ companies raise Equity Crowdfunding Capital?
- What are the benefits of diversifying the investor base through Equity Crowdfunding?
- Why is $300,000 – $500,000 the most likely Crowdfunding range for life science companies?
- Why are investors with philanthropic/compassionate use goals ideal Crowdfunding investors?
Crowdfunding is a method of raising capital in small amounts from a large group of people using the Internet and social media. Unlike funds from venture capitalists or angel investors, the money raised through crowdfunding doesn’t necessarily buy the lender a share, and there is no guarantee that it will be repaid if the venture is successful. Instead, individuals are asked to make microinvestments or donations to causes and ventures within a framework of providing rewards including sponsorships, offer to make a loan (microfinance), and gifts.
The purpose of crowdfunding varies, from disaster relief to citizen journalism to artists seeking support from fans, to political campaigns. Crowdfunding is also used for startup companies.
In February 2011, a group of entrepreneurs banded together and formed ‘The Startup Exemption’ with the goal to lobby Washington, DC to update the Federal Security Laws to make it legal for entrepreneurs to use crowdsourcing for a limited amount of early-stage equity-based financing. With the assistance of the Small Business and Entrepreneurship Council (SBEC) they partook in two hearings on Capitol Hill. Their framework was the basis for the Entrepreneur Access to Capital Act (H.R. 2930) introduced by Rep. Patrick McHenry (R-NC). In November 2011, the U.S. House of Representatives passed H.R 2930 in a vote 407-17. It reduces restrictions on small-scale crowdfunding of for-profit businesses currently present in state and securities law. The Democratizing Access to Capital Act (S.1791) and Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure of 2011, or CROWDFUND (S. 1790) bills are awaiting action in the U.S. Senate.
President Barack Obama signed the “JOBS Act” (Jumpstart Our Business Startups Act) on April 5th, 2012
- JOBS Act leaves many of the details of crowdfunding and private offerings in the hands of the Securities and Exchange Commission (SEC) and FINRA; had 270 days to conduct rulemaking, at which time crowdfunding was supposed to become available for issuers. Final regulations from SEC/FINRA projected late 2013/2014
- Rule 144 (shares pursuant to a registration exemption have restrictions on transferability) may not govern equity sales.
- SEC expected to provide a safe harbor for crowdfunding securities; Congressional intent is to make transferability as inexpensive as possible
- The Capital Raising Online While Deterring Fraud and Unethical non-Disclosure Act of 2012, or the “CROWDFUNDING ACT” allows issuers to raise $1 million in a 12-month period from investors over the Internet.
- Fraud protection provisions include limiting the amount investors can risk and requiring that crowdfunding equity sales take place through an intermediary
- Investors are limited to investing: (i) the greater of $2,000 or 5% of the investor’s annual income or net worth, if the investors income or net worth is under $100,000; or (ii) the lesser of $100,000 or 10% of the investor’s income or net worth, if the investor’s annual income or net worth is $100,000 or greater over a 12 month period
- Investors can fund one company or several companies as long as they remain within these annual limits
- An investor must wait 12 months before selling her/his securities unless the sale is to a family member, the issuing company, or an accredited investor
- Offers must be made through a Broker-Dealer or a “funding portal” that is registered with the SEC
- Intermediaries would have to obtain a “background and securities enforcement regulatory history check” on an equity-issuing company’s officers, directors and investors holding stakes of at least 20%
- Prohibits issuers and intermediaries from paying promoters, finders, or lead generators to obtain information on prospective investors
- The current version augments the previous with disclosure requirements for companies raising capital. The requirements, which tend to lack the stringency of Sarbanes-Oxley requirements, depend on the amount of the offering. Those seeking to raise $100,000 or less will need to provide tax returns and financial statements certified to be true by the company’s principal
- For offerings of more than $500,000, companies would have to provide financials reviewed by an independent accountant
- In terms of state law, the current version of the bill was also amended to add funding portals to the entities state regulators can oversee. The previous version limited the states’ purview to broker-dealers.
The past five years have been one of the more challenging periods for raising capital in the biotechnology industry, especially for early-stage companies. Numerous factors, including a challenging FDA environment upon NDA submission, long timelines to approval and the high rate of drug failure, have contributed to a dim venture capitalist view of the sector’s prospects. As a result, emerging growth biotechnology companies are increasingly pursuing alternative financing vehicles, including Equity Crowdfunding, to advance their drug development programs.
Watch this live webinar, recorded Feb. 26, hosted by ShareVault and S. Jordan Associates:
- Learn about the different platforms available to Life Science companies including Equity and Non-Equity/”Compassionate Use” Crowdfunding
- See a review of the JOBS Act and its provision for Equity Crowdfunding
- Assess the value of Equity Crowdfunding for Life Science companies including Seed, Bridge and Side Car financings
Scott Jordan was profiled in the Sept. 7, 2012 edition of Nature Medicine. Though slightly taken out of context, his comments reflect the challenges associated with raising equity crowdfunding in the life sciences industry. Subscribers to Nature Medicine can read the full text of the article here.
Crowdfunding platform EarlyShares raised $1.15 million in its first round of funding, according to VentureBeat. EarlyShares raises money for businesses by selling equity shares to small investors, a different business model than competing platforms like Kickstarter or IndieGoGo which follow a donation-based model.
Miami-based EarlyShares hopes to support a broad variety of companies, “ranging from technology startups to organic dog food companies.” According to VentureBeat, people would be able to invest up to $10,000 per year, or 10% of annual income, and no more than $2,000 per investment.
Learn more at VentureBeat’s website.
Recently, a charity and non-profit Crowdfunding platform, Rally.org, raised $7.9 million from investors including Greylock Partners and Google Ventures. Read more about the deal here.
In a recently published white paper, S. Jordan Associates profiled how emerging growth biotechnology companies can leverage Crowdfunding to raise non-dilutive capital from investors with “compassionate use” goals:
“In many cases individuals may not come to expect their financial investment to solely yield monetary gains. Startups wanting to explore Crowdfunding might attain success through “medical interest networks” such as patient advocacy groups, foundations or clinical societies that are dedicated to a certain condition or diseases. The entertainment industry has demonstrated success in appealing to hobbyists and aficionados (often offering nothing more than free movie tickets or screenplays), and a similar case may be made for healthcare companies attracting those with philanthropic goals. Investors at the lower end of the spectrum ($1,000 – $5,000) may see investments as glorified donations; a way to further a good cause.
Healthcare is one of the few spaces where an investor can see a direct quality of life improvement through a financial pledge. It is also one of the few spaces so obviously rooted in moral tenets; the power and interests of patients and their families. This will be important especially for those companies looking for effective treatments in fields where there are no therapies available (i.e., Alzheimer’s disease, Huntington’s disease).”