#19: Equity-based Crowdfunding Likely To Become Law - Implications for Early-Stage Biotechnology Companies

On March 22nd, 2012, the U.S. Senate passed the JOBS Act 73-26, paving the way for equity-based crowdfunding. Following this announcement, Life Sciences industry professionals are now evaluating the merits of utilizing crowdfunding to raise capital for early-stage biotech companies. In a recent article from Genetic Bioengineering & Biotechnology News, contributor Alex Philippidis discusses the potential challenges associated with this funding vehicle in a highly regulated industry with unforgiving timelines, high drop-out attrition rates, and capital intensity.

Biopharma Will Need More than New Law to Embrace Crowdfunding -

Since product development takes longer and industry has more regulation, financing alternative has yet to prove itself.

Several bills pending in Congress would make it easier for biopharma and other tech startups looking for financing other than the traditional—and increasingly hard to secure—venture capital.

The bills would encourage an alternative that has met with success in other fields, namely crowdfunding —the practice of soliciting small amounts of capital from numerous funders rather than a large lump sum by one or more investors.

The House of Representatives signaled its interest in crowdfunding on November 3, when it passed, by a rare bipartisan 407–17 vote, HR 2930, the Entrepreneur Access to Capital Act introduced by Patrick McHenry (R-NC). This prompted President Barack Obama to support the measure, calling for “a national framework that allows entrepreneurs and small businesses to raise capital through crowdfunding.”

The bill would exempt from SEC registration rules any transactions to offer or sell crowdfunded securities by businesses raising $1 million or less within the previous 12 months or $2 million or less if the issuer provides potential investors with audited financial statements. Individuals can invest up to $10,000, or 10% of their annual income, whichever is less. Current rules require companies with 500+ shareholders and more than $10 million in total assets to register with SEC and report their activities.

Sherwood Neiss, co-founder of entrepreneur group The Startup Exemption, noted that new crowdfunding rules could bridge the “valley of death” funding void that startups face. “The VCs’ role has been taken over by the private equity folks. Their role has been taken over by the angels. Now there’s this real big funding void for startups. That’s what makes crowdfunding even that much more necessary today,” Neiss told GEN.

Legislation

Two Senate crowdfunding bills differ from the House measure. Sen. Scott Brown (R-MA) introduced the Democratizing Access to Capital Act of 2011, which would require investors to buy securities through crowdfunding sites, allowing sales via social media sites. The Brown bill would also cap all fundraising to $1 million per 12 months, limit investments to $1,000 per company per 12 months, and require registration with both the state a business is organized in and any state where buyers of more than half the securities are residents.

The Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure (CROWDFUND) Act of 2011, introduced by Sen. Jeff Merkley (D-OR), caps individual investment at $500 or 1% or 2% of annual income, whichever is more, per company per 12-month period. Total investment per 12 months is capped at $1 million, with companies required to send audited statements to SEC if they are raising more than $500,000. And securities must be sold through registered broker-deals or non-advisory funding portals.

At hearings in December, some speakers raised objections to the bills. Addressing the Senate Banking, Housing, and Urban Affairs Committee, John C. Coffee, Adolf A. Berle professor of law at Columbia University Law School, said the potential for investor fraud was great enough to limit sale of securities to broker-agents or crowdfunding websites that only displayed offering materials.

“Failure to adopt this approach or some similar variant would likely mean that every barroom in America could become a securities market, as some unregistered salesman, vaguely resembling Danny DeVito, could set up shop to market securities under the crowdfunding exemption,” Professor Coffee testified. “Such a person could open his laptop on the bar, show slides of a half dozen companies to the bar’s patrons, and solicit sales. This will create few jobs, except for dubious unregistered salesmen, and much fraud.”

Not so, Neiss and crowdfunding advocates counter, saying the limited exemption from SEC rules “will not cause the fraud that WorldCom and Enron did to their employees and investors or that Wall Street and Bernie Madoff perpetrated on the American people. It will create a peer-to-peer system where communities become the de facto seed and early-stage funders to entrepreneurs.”

Will It Work?

Even if the Senate were to pass a bill and work with the House to hammer out compromise legislation, the key question is: Can crowdfunding work for a biotech company? David Geertz, founder of the crowdfunding platform SoKap (short for Social Kapitalist) takes a dim view. Asked on the LinkedIn Crowdfunding Panel, organized by the blog Crowdfunder.org, where crowdfunding “does not fit,” Geertz replied: “An example might be that a biotech firm creating a new drug or product would not be able provide a guarantee of a finished product within a reasonable time period. I think as a result of this they would be ineligible for this process.”

SoKap offers entrepreneurs and other “smart people with big ideas” two ways to fund their projects. Funders can use “perks” to pre-order a product or service, though they are not charged if the project can’t raise enough money to get going. Or funders can buy a license granting advanced rights to a portion of the startup’s future earnings from the product or service for a limited time. Only one person is allowed to own the license for each city for each project listed on SoKap.

That’s not to say entities on the periphery of biopharma haven’t successfully crowdfunded to date. A good example would be Rare Genomics Institute, a nonprofit that connects rare disease patients with researchers and clinicians from 13 institutions worldwide, to offer genomic sequencing and interpretation services at lower cost than commercially equivalent solutions. The institute also raises funds by presenting the stories of each of its patients online. As of March 1, donors raised $4,180 toward the $7,500 needed for genetic sequencing of a boy named Gram whose father’s family has a genetic history of hypertonia.

More optimism about biopharma startups themselves using crowdfunding someday comes from the blog BiotechStart, which in November posted a list of four crowdfunding organizations with interest in the life science industry: “This funding avenue for start-ups is set to explode in the coming years and it will be interesting to see what new financial business models emerge from the convergence of web-based crowdfunding and evolving government regulations.”

Examples of Crowdfunding Firms

One company on BiotechStart’s list, Crowdcube, is limited to startups in the U.K. seeking to raise a minimum of £10,000 (about $16,000), with no maximum limit, within 180 days, otherwise funders keep their money. Crowdcube announced last month its startups raised more than £2.3 million (about $3.7 million) from investors in its first year, with more than 8,800 people registered.

However, no biotech startups are among the 11 companies successfully funded by Crowdcube. And two other crowdfunding sites have maximum limits that do not offer much for a biopharma startup contemplating a decade or more of preclinical research followed by years of clinical trials. The fourth company on BiotechStart’s list, ProFounder, shut down February 17 after three years in business. “Despite our progress, the current regulatory environment prevents us from pursuing the innovations we feel would be most valuable to our customers,” co-founders Jessica Jackley and Dana Mauriello said.

The two largest crowdfunding platforms are focused on arts: IndieGoGo and Kickstarter. Of 131 technology projects seeking funding via IndieGoGo, which hosts 65,000 campaigns across 212 countries, none involved biopharma startups.

One Kickstarter-funded venture, though, may someday prove useful to the biotech industry: Hypothes.is, a nonprofit open-source platform for collaborative evaluation of information, has potential applications in peer review of scientific articles. Hypothes.is raised $105,000 from Kickstarter as part of a $230,000 first fundraising phase that drew 791 donors. Kickstarter has more than $145 million pledged toward 17,000 successfully funded projects by more than 1.25 million project backers, spokesman Justin Kazmark told GEN.

For crowdsourcing to emerge in biopharma, the amounts raised would have to be multiple millions of dollars. Then there’s the issue of who will invest, given the perpetual uncertainty about whether molecules will work plus recent concerns about regulatory red tape raised by industry and investors. Valuable as new laws may be, biopharma’s best hope for growing crowdfunding is first to grow the crowd.