Crowdfunding Is Coming to Biotech, so Get Ready for a Wild Ride

1/28/13Follow @xconomy

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.

Greg Simon, CEO of Poliwogg

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.

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  • http://twitter.com/steen1969 Andrew Steen

    Related thoughts; http://storify.com/steen1969/more-guerilla I see opportunity at the university spin-out stage.

  • http://www.VentureDeal.com Don Jones | VentureDeal

    Amazing – biotech is about the highest risk of all technology venture. To think that completely clueless, small-time investors can pick ultra-high technology winners in biotech is ridiculous.

    But here’s an idea – maybe with your $100 investment in a Biotech Newco, they’ll give you a Pebble watch!

  • http://twitter.com/BiotechStockRsr BiotechStockResearch

    Don, I don’t disagree, but that doesn’t stop “completely clueless, small time investors” from spending hundreds of millions of dollars on this in the public markets where only one of ten companies succeed. With as bad a name Wall Street has earned for manipulation, cheating, and insider information, more than a few individual investors will see this as equivalent risk.

    With the record for any crowdfunding at around $8M, I don’t see this as a source of big money. I see this as a way to acquire angel and seed capital. Raise a couple of million to get the IP started, some lab space, and some next steps. Perhaps also a supplement to grants or to use as a source of funds in a matching grant program.

    Six months ago I would have scoffed. After watching Chris Roberts handiliy break the crowdfunded game record by raising now over $7.4M from gamers for his latest effort at RobersSpaceIndustries.com, I’m a believer.

    Is this the best place for investment capital? Probably not. But it won’t stop people from donating (and the majority will think of it as “donating”) to a promising startup doing work in a disease that matters to them.

    David Miller
    BiotechStockResearch.com

  • cvrichard

    > To think that completely clueless, small-time investors can pick ultra-high technology winners in biotech is ridiculous.

    Don’t forget that in crowdfunding, many investors/donors are not trying to pick winners. Some (or even many) of them are activist investors who just want to make a difference in research. They don’t necessarily pick winning technology. Rather, they pick their favorite causes to support.

  • LJStewartTweet

    Luke. Great article. I think your right. People go to Vegas every day and loose hard earned money. Yeah. Biotech is risky. But where else can you make a bet on a new breakthrough for patients in need? VCs and high net wroth people shouldn’t be the only ones allowed to make those bets.
    Interesting article, just on the same day when the new SBIR eligibilty rules opened up SBIR grants to VC owned biotechs. With the new Jobs act and crowdfunding, maybe the new SBIR rules werent needed.

  • Andrew Johnson

    Great insights into this new form of funding in the Life Sciences. Time and experience will ultimately determine how well this model works. One sector to keep in mind is the Life Science Tools market. The risk / reward profile of Life Sciences tools companies might be a better fit for this type of funding. These companies typically do not need the tens of millions to commercialize new intruments, software and consumables since there are no clinical trials to pay for. The smaller amount of capital required, the time needed (typically no more than a year or two from concept to market) and no risk of regulatory hurdles could be attractive to some of these investors. Remember, it was the guys selling shovels that had the best chance of striking it rich during the Gold Rush.

  • http://www.facebook.com/samantha.paxton.54 Samantha Paxton

    Interested to see if the crowdfunding model will allow individuals outside the US to invest in US firms.

  • http://twitter.com/SteveBairdCEO Steve Baird

    It works.

    1. Small investments.

    2. Connection to passionate customers.

    3. Disrupts distribution channels by connecting to passionate and invested customers.

  • http://www.currentpartnering.com/ Steve Poile|Current Partnering

    This is something that incidentally cross my desk recently. There is a new UK crowdfunding company called CrowdCure that is seeking to do something similar whilst taking a cut of funds raised, with a minimum target funding for a project of $100,000.

  • http://twitter.com/IntegralBionow Mark Hollingworth

    Great article Luke, and you call out the risks well. It concerns me that many of the crowdfunding platforms to date set the bar very low indeed when it comes to what should be disclosed in the business cases on their platforms and I’ve blogged about this a few times. Let’s hope Poliwogg sets the bar higher.

  • Cornelius Diamond

    Personally, it is so-called VCs that are clueless and follow the crowd. They have been terrible at picking winners, and most of them have migrated to late-stage plays, further evidence of that their so-called insight has anything to do with what will work 5-10 years down the road. Most biotech funds I know are zombies, just partners collecting their 2% from LPs, yet you usually see their members on investment panels offering their take on what VCs are looking for. Thus this platform for money might not be ideal, but it will certainly break up the cozy little club that has held back truly innovative biotech for the last five years.

    • shirtbrigade

      I am smiling as I read your comments. Why do people buy the story and ignore the intellectual property? I am about to embark upon funding my Biotech startup. I think Crowdfunding is going to be key for me.

  • Cornelius Diamond

    Consider this: An major LP, who has, let’s say, $50m to put in biotech, hires a consultant for $25K to scan the opportunities on this crowdfunding platform & make the decision on what to pursue. They spend another $25K for someone to negotiate the deal. Then they invest, and wait. Thus for .1%, they do the same job as an VC, and they keep all the upside of their winners, with no ongoing management fees. So you can see, once companies start migrating to such platforms to showcase their opportunities, then LPs will as well, with VCs reduced to what they should be- either consultants or direct investors, with their own money on the line, so their is no more conflict with the carried interest tax deduction.

  • http://twitter.com/steen1969 Andrew Steen

    I see this as a potential opportunity for Quadrant 1 biotech startups
    based on academic science (à la BB), but my main question relates to the cap
    table. Does it make the cap table screwy? Will VCs fund a crowdsourced biotech
    startup?

  • http://twitter.com/JPZaragoza1 Juan P. Serrate, DVM

    Good article, but I’d like to see some more information about biotech companies that have actually raised funds from crowdfunding platforms. There are a few examples, mainly in France: Antabio raised €300,000 from 200 investors in 2 months, and Urodelia and Ambiotis are on their way to raise funds using the crowdfunding site WiSEED. It wouldn’t be realistic to think that biotech start-ups are going to raise a large amount of money with this, but it’s useful for those first seed funds to start the business.

  • http://twitter.com/YlvaSante Ylva Sante Nicolae

    This is a very interesting and potential vehicle for
    financing new investments in growth projects! And there is a obvious market for
    it, since there is already a platform in place for buyers and sellers to trade.
    I agree with David Miller; the question is now not about being or not being, but rather about how to proceed
    with the regulative and ethical hurdles in a way to maximize the return for all
    parties – the non-accredited investors, the risky start-ups, patients,
    physicians, kins, the healthcare society as a whole and the economy.

  • Hally-Joe Zak

    Feel free to check out our latest interview with Dr. Wertheimer, the Managing Director of Poliwogg and how he got started in science crowdfunding following his postdoc. What’s the future of science crowdfunding? Check out http://thepostdocway.com/node/160