Michael P. Drzal, Chair, Venture Capital Practice Area Team, LeClairRyan (September 2010)
Give any business owner the chance to win a 50 percent tax credit and the response will likely be "Where do I sign?" As part of the healthcare reform package, the federal government has handed small- to mid-sized pharmaceutical, biotech, and medical device firms a deal with precisely these once-in-a-lifetime terms.
Unsurprisingly, the response to the government's Qualifying Therapeutic Discovery Project tax credit program - which allows companies with 250 or fewer employees to collect up to $5 million - has been largely positive. "This program brings a much-needed shot in the arm to small life science companies for whom the capital markets have been frozen," wrote Jim Greenwood, president and CEO of the Biotechnology Industry Organization, in a statement. "It allows research-intensive small businesses to continue cutting-edge projects to develop advanced medicines and, ultimately, cures to help patients suffering from the world's most debilitating diseases."
It is hard to argue with this logic. But while it makes sense to note the program's potential to turn a few fledgling firms into big winners, a corollary must be included: The federal government cannot pick winners without also creating some losers.
So enticing were these incentives that some expected hundreds, if not thousands, of small- to mid-sized biotech firms to apply for them. Some firms likely submitted multiple applications for promising devices and therapies. With total tax credits and grants capped at $1 billion, significant oversubscription to the program has always been a foregone conclusion. Given the long odds, the program began to resemble a lottery instead of a panacea for emerging biotech companies. It would be downright illogical not to apply for these incentives. But when the government picks the winners, the effect on the marketplace will be noticeable. Suppose five biotech startups, all of which focused on novel cancer therapies, applied for the grants. If the firm that specialized in a chemotherapy cocktail for a certain cancer won a $500,000 grant, its competitors would find themselves at a competitive disadvantage, with relatively less money to spend on marketing or R&D.
Over the long run, what might prove more valuable to that company is the legitimizing effect the federal government lends when it assists one device or treatment over another. Let's say the firm was a pre-revenue company. The $500,000 grant would mean less pressure to raise capital. And the government's stamp of approval could improve the startup's chance of receiving follow-on funding from private-sector sources. The government would have given its support to this cancer treatment.
At some point, all new therapies or devices must cross the crucial hurdle of securing reimbursement status from Medicare, Medicaid, and private insurance providers. Regardless of whether the government intended such a broad interpretation of its actions, observers might see the grant award as evidence that the aforementioned biotech firm had developed promising, cost-effective, and reimbursement-worthy technology. If three of that company's four direct competitors failed to win $500,000 grants of their own, they would find themselves at the back of the pack. One could hardly blame them for being displeased.
This otherwise helpful incentives program actually puts pressure on eligible firms to play the game and submit their applications. Not only do companies want to gain a competitive edge from winning these incentives, they also wanted to avoid competing with other companies that have benefited from a lucrative tax credit or grant. The savviest firms took this program seriously. Over the past few months, companies have been advised to put their best and brightest on the application process, and to think strategically about boosting their odds of being one of the fortunate few to secure these federal handouts.
The Application Game
It is anyone's guess how the review process will actually play out. (The IRS will issue certifications by October 29.) The stated review criteria for these tax credits and grants are quite broad. According to the federal government, priority will be given to those projects that show a reasonable potential to:
• Result in new therapies to treat areas of unmet medical need or prevent, detect, or treat chronic or acute diseases and conditions;
• Reduce the long-term growth of healthcare costs in the United States; or
• Significantly advance the goal of curing cancer within 30 years.
According to the government, the incentives will be given based partly on the potential of research projects to "create and sustain high-quality, high-paying U.S. jobs and to advance U.S. competitiveness in life, biological, and medical sciences." These criteria make sense, but it is hard not to wonder how reviewers will make some of these speculative and subjective judgments.
In discussions, companies were urged to carefully weigh these criteria, however broad. For example, novelty stood out as a review factor, as did the ability to address "unmet medical need." It was also wise to examine the federal government's public health priorities. The focus on childhood obesity and diabetes is visible in First Lady Michelle Obama's "Let's Move" campaign, as well as in the raft of fresh-food incentives included in the proposed federal budget. As firms weighed what to submit for review, those that considered the current public health agenda might have boosted their odds for success. The bottom line, however, is that federal review processes are always something of a black box, and there is no guarantee that the most promising science will win out.
One cannot help but wonder about the role of language in the application process. This arises periodically with biotech clients - there are a lot of jargon junkies in the field. Accuracy and technical detail are important, but many proposals have been so impenetrable that even a scientist would struggle to get through them. For the current grants, some firms might beat out their competitors simply because they were smart enough to ask a wordsmith - perhaps the general counsel or head of corporate communications - to edit their applications for tone and clarity. Such small details can make a big difference.
And those details, while not arbitrary, may not directly relate to improving American health and wellness. Playing the odds in Las Vegas is a lot more fun than dealing with the federal government's bureaucratic application process in this incentives "lottery." Whether or not their efforts prove successful, firms will be forced to deal with the competitive implications of this program. It is common for multiple biotech firms to compete within the same niche. Sometimes the solutions offered by these companies are remarkably similar. So a scenario in which one firm sees its competitor get a leg up partly because of a decision made by an application reviewer in Washington is plausible.
Those that succeed in the application process might enjoy a significant advantage in obtaining follow-on funding from private-sector sources, and they could even gain a first-to-market advantage. Those that go unnoticed by the money-givers will have no choice but to race against their competitors' head start.