Crowdfunding Is Coming to Biotech, so Get Ready for a Wild Ride
Most biotech pros will shrug, or chuckle, if you ask whether crowdfunding will transform life sciences financing in the U.S.
This, after all, is an industry where you often need to raise at least $50 million or $100 million to even have a chance at developing a new drug or medical device. Scraping together a few thousand bucks from individuals on the Internet isn’t going to go very far. One venture capitalist recently told me, “there are a lot of things I worry about, but crowdfunding isn’t one of them.”
Still, I’ve come around to the idea that crowdfunding is going to be disruptive for biotech investment. Starting this year, some cash-strapped startups will find this trend to be godsend. Some small investors will feel fleeced. Insiders who have traditionally had all the power over who gets funded will have to make some tough decisions about whether to pool their money with the masses.
Crowdfunding, for those unfamiliar, is the process in which individuals go on the Internet to donate, loan, or invest in a new company or project. Sites like Kickstarter and Indiegogo have become platforms for making these bets, and for social chit-chat about how they are doing. Often, these campaigns star some entrepreneur who describes his or her new business idea, asks for support, and offers something small in return, like a T-shirt. These are projects that friends and family might have financed before, or maybe angel investors or VCs. Here at Xconomy, we recently ran a small, independent crowdfunding campaign to expand our coverage of innovation to Colorado.
While there have been a few big crowdfunding success stories—one video game developer raised $6.2 million on Kickstarter in November—most of these campaigns run in the thousands or tens of thousands of dollars. There have been some clinical trials financed on crowdfunding, but no biotech I’m aware of has raised big money this way yet.
Health Tech Hatch and Medstartr have gotten some attention for efforts to use crowdfunding for health technologies. But one well-connected startup, a New York-based company called Poliwogg, could end up being the place where little biotech companies raise real money through crowdfunds before they hit the NASDAQ.
Crowdfunding is the kind of thing that 75 million members of the “millennials” generation—those who came of age in the ‘90s and 2000s Internet era—instantly get. Think about it. Just like how anybody can open a TD Ameritrade account and buy shares in Dendreon (NASDAQ: DNDN) to express support for prostate cancer R&D and hopefully make money, individuals will soon be able to invest in private and venture-backed startups that were previously off-limits. While most private companies have fewer than 30 investors, the JOBS Act passed by Congress last year enables private companies to stay private even with up to 2,000 investors.
Love the law or loathe it—and the lack of disclosure for pre-IPO companies is something I hate—the only thing holding it back now is some regulatory language from the Securities and Exchange Commission that will clarify the difference between wealthy “accredited” investors and the “non-accredited.” (Essentially, there are more consumer protections being designed for “non-accredited” investors, so they can’t lose their life’s savings on pipe dreams.) Once those regs are published, it will open up a new avenue for investing in thousands of companies, including your local cancer drug developers. And this opening of the floodgates is happening precisely at a moment when biotech is in dire need of cash, as the venture capital industry is going through a historic contraction.
“The potential global size off this kind of funding of equity—and I’m not talking about Kickstarter, Indiegogo, or the nonprofit stuff—is $1 trillion or more,” says Greg Simon, CEO of Poliwogg. “If we were sitting here in 1981, and you asked me ‘how big do you think it will be when the Baby Boomer generation hits the stock market,’ and I had said that the stock market will go from 1,000 to 10,000, you’d probably say I was crazy. This is going to be as big, if not bigger.”
Before you dismiss this as breathless hype, the Poliwogg crew brings a lot of experience to this task. Jeff Feldman previously worked on exchange-traded funds (ETFs) at XShares Advisors, which he sold to Deutsche Bank in 2010. Simon was a top domestic policy aide to former vice president Al Gore, the CEO of the Michael Milken-backed nonprofit FasterCures, and a senior vice president at Pfizer. Samuel Wertheimer was a partner at OrbiMed Advisors, a big Wall Street investor in healthcare. Les Funtleyder has been an analyst and source for healthcare journalists for years. The board includes Tommy G. Thompson, the former U.S. Secretary of Health and Human Services. These people know the issues in healthcare, and who’s who.
Poliwogg, well aware of how the JOBS Act opens the door to crowdfunding for biomedical R&D, has spent the last year building a social platform for these kind of transactions. It’s focusing in healthcare, community-based small businesses, and what it calls “high-yield assets” like commercial leases for blue-chip tenants like FedEx, Simon says. Each of these categories has a different risk/reward profile. People who gravitate to biotech are “passion capital” investors, Simon says, who have deep desire to do something good for, say, prostate cancer.
Here’s how it is supposed to work. Poliwogg, under the law, will advertise that it’s a new place for people to invest in healthcare. In the beginning, it will allow anybody to look at the companies, but it will need to verify whether players are “accredited” investors before they invest. “Just like how a casino advertises, ‘come and gamble,’ you still can’t get in if you’re 15 years old,” Simon says.
Before listing companies, Poliwogg will review them to make sure they have viable technology, a real business plan, and a management team that isn’t “just led by somebody’s nephew,” Simon says. He adds: “We’re not picking winners and losers, but we want to make sure these are investable entities.”
Once a company gets listed, the crowd gets involved. The company sets a goal, like, say $5 million to run a Phase I clinical trial of a new drug for ALS (Lou Gehrig’s disease). If the company reaches that goal, it gets the money, and it will pay a fee to Poliwogg, Simon says. If the company doesn’t reach its goal, investors get their money back. At least in theory, serious money could flow. Under what’s known as Regulation A, pre-IPO companies previously could only raise $5 million, but they can now raise up to $50 million under the new law, Simon says.
Investors, especially those putting in big bucks, will want equity. If Poliwogg is successful, it will build a deep roster of companies, so investors can put their eggs in multiple baskets for treating cancer, Alzheimer’s, or diabetes. Diversification, Simon says, is the key to making these biotech offerings work for investors.
It all may sound great, but there’s surely a lot of pain to come. Most people would agree that buying lottery tickets, or going to the casino, is a good way to throw away hard-earned money. Investing in biotech, without doing the homework (or even when you know the science), offers bad odds. If you think the NASDAQ and the OTC Bulletin Board already have too many shady biotech operators, then just wait for a lightly regulated exchange for lesser-known private companies.
Even if Poliwogg does an exemplary job of disinfecting its platform, it’s still questionable in my mind how much money its companies will raise. Biotech still often takes a decade of work, and tens of millions of dollars to gather solid medical evidence required to start selling a new product. No crowdfunding effort to date that I’m aware of has ever raised that kind of cash. Will people want to shell out massive sums for some promising drug that has shown in rats that it might help 7 percent of children with Duchenne Muscular Dystrophy? How about some platform technology like a new gene sequencer, which doesn’t tug at people’s emotional heartstrings?
And then there’s the question of who will want to be listed on platforms like Poliwogg. Most of the viable private biotech companies that I follow around the country have already raised $10 million or $20 million or more in venture capital. Will the venture backers of those outfits allow them to run a crowdfund campaign to raise another $5 million to do another experiment? Even if it means diluting the value of their holdings, and potentially creating investor relations and communications hassles with a far-flung base of rookie shareholders? Will the VCs be willing to let go of control, and allow some transparency into what’s really going on in their portfolio companies?
I doubt it. That means most promising private biotech companies in the U.S. will probably shy away from this new fundraising vehicle. The folks who are more likely to benefit are the ones with a new idea spinning out of a research center or a Big Pharma company, and who just need their first $1 million or $2 million to get going.
Despite all the caveats, David Miller, the president of Biotech Stock Research in Seattle, says he believes crowdfunding will have broad appeal among individual biotech investors. There’s a longstanding tradition in this country of generous support for research at places like the Dana-Farber Cancer Institute in Boston or UC San Francisco. Many of those donors also want to take the next step, by investing in companies building on that research to develop treatments. And while there are places to invest on the NASDAQ—like Dendreon (NASDAQ: DNDN) or Medivation (NASDAQ: MDVN) in prostate cancer—there’s always some new up-and-coming competitor to watch in private biotechland, like Cambridge, MA-based Tokai Pharmaceuticals.
“I think these guys at Poliwogg have read the market correctly,” says Miller, who writes a subscription-only newsletter for biotech stock investors. “People will be jazzed about the idea of investing in things they care about, and getting equity.” It’s less likely that investors will fully understand the risks, or how much their equity will be diluted through endless future stock offerings, he says.
Consumer groups opposed the JOBS Act for some of these reasons, to protect investors. Simon dismisses the arguments as outdated. “Let’s take my sister for example. She’s a schoolteacher, a non-accredited investor. She can go on the public stock market and buy anything at any time. She can buy stocks in Malaysia if she doesn’t even know where Malaysia is. But she can’t invest in a friend’s store down the street because it’s a private company. She can’t invest in a biotech company that’s private. That’s crazy.”
You could argue that it’s also crazy for people to be able to be able to dump their life’s savings into a single biotech stock they don’t understand, and watch it vaporize. But sadly, it’s part of what happens in a democratized investment world. I hope that the operators of the new biotech crowdfunding platforms are responsible, and that regulators stay on their toes. If not, a lot of people will end up thinking that “biotech” and “crowdfunding” are a couple of dirty words.