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NIH grant cutoff upsets biotechs

THE BALTIMORE SUN

Doug Doerfler says his Gaithersburg company has had to bag its flu-vaccine manufacturing project.

Carol A. Nacy says her Rockville business might not be able to develop treatments for tuberculosis.

And in Colorado, Kirk Christoffersen says an HIV vaccine his company was developing will have to be shelved because his corporation can't afford to proceed.

"It's extremely costly" to find new cures and treatments, said Doerfler, chief executive officer of MaxCyte Inc., a 22-person company developing technology to help scientists work with cells. "It's just too speculative for companies like ours."

Small biotech businesses across the country are setting aside research because grants they once received from the National Institutes of Health have dried up due to a 2003 ruling that bars the financing to companies that have become more than half owned by venture capital firms.

The change has sent tremors through the biotechnology world, where many companies rely on the NIH money to develop the drugs that in turn attract the venture capital needed to bring them to market.

Once a company becomes majority owned by venture capital firm, it's no longer counted as a small company and becomes ineligible to receive NIH money that might allow it to create other products suitable for venture funding.

Some say that's the way it should be, that venture capital ownership should make a business ineligible for government aid meant to stimulate small businesses.

Biotech companies and their supporters in Congress say the limits on Small Business Innovation Research (SBIR)grants ignore the unique characteristics of businesses that might need a decade and $1 billion to develop a marketable product.

Some federal agencies are legally required to spend 2.5 percent of their research and development budgets on SBIR grants each year. The program is meant to bolster new ideas, help small companies and improve the economy. In 2003, 10 federal agencies distributed $1.8 billion in SBIR grants to more than 6 million businesses.

In 2001, a Small Business Administration judge interpreted program eligibility to exclude companies more than half owned by other companies. In 2003, the same judge specifically said that ownership by venture investors was not acceptable.

And ever since, the National Institutes of Health has stopped giving grants to biotech businesses that fall within that category, forcing some companies to abandon projects.

'Research stops'

"You can see what happens when you suddenly become a VC company: The research stops," said Christoffersen, senior director of development at GlobeImmune Inc. in Aurora, Colo.

His 45-person company, which recently brought in $8 million in venture funds, will set aside an HIV vaccine developed with SBIR money to concentrate on other products. "We had to choose," he said.

The NIH's grants have been a relatively easy source of financing, with 1 in 5 applicants earning an award last year. Because of that, they have become increasingly popular, with the number of applications doubling from 2001 to 2004.

Some contend that the quality of applications is dropping now that biotechs with venture funding have been excluded. The change, they say, will ultimately curtail research and set back the development of new treatments for cancer, West Nile virus and other diseases.

The NIH would not comment on the applications for grants, other than to say they are increasing.

Others say the danger is overstated and unsubstantiated. Even so, the argument has continued for two years, picking up speed this month and gaining attention from legislators and the SBA.

"These [grants] have been a wonderful thing. It's free money, kind of, with no strings attached. If somebody wants to offer you free money, you take it. When it goes away, you're upset," said J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland's Robert H. Smith School of Business.

"On the other hand, the [SBA] had, I think, sound reasons for limiting their grants to companies that get institutional financing. Really, their main goal is to help startups."

SBA to hold hearings

The SBA will hold nationwide hearings on grant eligibility this month to gather information to determine whether changes are needed, a process likely to continue into next year. The SBA has received 160 letters on venture capital participation, with opinions divided.

Some in Congress aren't content to wait for the findings. Sen. Christopher S. Bond and Rep. Sam Graves, both Missouri Republicans, said they would introduce bills to allow venture-controlled companies to apply for the grants. A similar measure failed last year after it stalled in committee.

"I think it's important for all small businesses to be able to access these grants based on the merits," said Maryland Rep. Chris Van Hollen, a Democrat who plans to co-sponsor Graves' bill and whose Montgomery County district includes NIH headquarters. Van Hollen called the exclusion of companies controlled by venture capital firms "arbitrary" and a "mistake."

The SBA suggests that the grants previously awarded to companies owned by venture funds were inappropriate.

"The plain language of the statute is fairly clear," said Gary M. Jackson, an assistant administrator.

To be eligible for the awards, businesses must be for-profit, have fewer than 500 employees and be at least 51 percent owned and controlled by "an individual" who is a U.S. citizen or a permanent resident alien.

In the years after the program was instituted in 1982, "individual" was typically interpreted to include venture capital firms if they were based in the United States. That changed after the judge's 2003 ruling.

'Not individuals'

"Institutional investors, whether organized as limited partnerships or trusts, clearly are entities and not individuals," Judge Gloria E. Blazsik wrote in a ruling that rescinded an NIH grant given to Cognetix Inc., a Salt Lake City pharmaceutical company.

The decision surprised the bioscience world and other industries dependent on venture capital.

"It certainly was not the intent of Congress to restrict the program in this way," Democratic Sen. Edward M. Kennedy of Massachusetts wrote to SBA Administrator Hector V. Barreto. Massachusetts is second only to California in life science research and manufacturing, while Maryland has been ranked third or fourth.

Some said the limitation on SBIR grants was a welcome injection of realism in a program whose purpose, they said, was being skewed and whose money wasn't being used to stimulate small companies but to pad already large ones.

"It's a scam, in my opinion," Bruce Gjovig, chief executive officer and entrepreneur coach at the University of North Dakota's Center for Innovation, said of the previous arrangement.

Biotechnology supporters say the industry is disproportionately affected by the grant limitation.

"The SBA really up to this point has not understood the relationship between venture capital and our industry," said Morrie Ruffin, executive vice president for business development at the Biotechnology Industry Organization, a trade group. "It's significantly more expensive in our industry up front than you would find in most other industries."

Biotech venture funds can pay for bringing a drug to market - which can take a dozen years and nearly $1 billion - if the treatment has been proven promising by various studies. But the companies say they still need the grants to pay for exploratory drug research, a risky area venture investors typically won't touch.

"I can't think twice about [seeking] venture financing," said Carol A. Nacy, chief executive officer and founder of Sequella Inc., an eight-year-old Rockville company focused on fighting tuberculosis. "I can't do clinical development without it, and I've got a drug that's got to get into humans. That's the distressing point."

Nacy's 17-person company, which grew out of a 1996 meeting at the National Institutes of Health, has largely survived on more than $10 million in Small Business Innovation Research grants from NIH. But this summer, if she completes her first round of venture capital financing, as expected, she will no longer be eligible for the grants.

She says that could prevent Sequella from conducting research into therapies, even with millions of dollars in venture capital moving one of her tuberculosis products toward commercialization.

"You're between a rock and a hard place," she said.

The SBA says a small portion of a federal agency's budget is reserved for SBIR grants, leaving billions available to larger companies.

But Nacy said winning those other funds is unlikely. She routinely reviews grant applications for the NIH and said the academic institutions would prefer to keep those funds in the education family, rather than giving them to commercial companies.

Small businesses in other areas aren't sympathetic to the biotech argument.

'High horse'

"Why should biotech have a different set of rules than any other industry?" asks Lloyd Chapman, president of the American Small Business League, an advocacy group in California. "What makes them so special? It's a business like Sears Roebuck, right? And I think it's absurd for them to get up on a high horse and say, 'Well, we're biotech and we should get special rules.' That's ridiculous."

The University of Maryland's Baum said there might be a middle-ground solution if the SBA changes the rules to allow companies owned by venture capital firms to participate as long as the investment firms were small businesses and not banking giants.

But he's sensitive to all sides of the issue, he said, understanding that taxpayers might be upset by a rule change that would elate biotechs and peeve companies competing against them for money.

"It's a complex issue," he said. "I wouldn't want to be a legislator right now."

The issue

Should companies majority-owned by venture capital firms, particularly biotechnology businesses, be able to receive grants to stimulate small business innovation?

Pro: Proponents say grant money is needed to pay for experimental research into the next generation of medical cures, which venture capital firms are less likely to fund, and point out that the biotechnology industry has greater financial needs than most.

Con: Opponents say allowing venture capital-owned companies to compete for this public money defeats the purpose. Let biotechs go after other grants, they say.

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