Railroad barons from the 19th century ruined it for Washington State, the common business perception goes, by snookering states into coughing up egregious corporate welfare. It led to a popular uprising and a subsequent state Constitution that forever prohibited direct aid to corporations. That, politicians often say, is the reason the state can’t invest in local startups today.
So it surprised a lot of people in October—me included—when the state’s Life Sciences Discovery Fund defied the perception by funneling $5 million of state money into a biotech corporation—Seattle-based Omeros (NASDAQ: OMER). This was part of a larger deal in which the state pooled resources with Paul Allen’s Vulcan Capital to invest a total of $25 million into a basic research program at Omeros. The vision is that the company could make it possible to develop new therapies against 100 or more protein targets on cells that have been inaccessible to drugmakers.
This deal was remarkable because it represents the first time the state Life Sciences Discovery Fund has plowed its resources directly into a for-profit entity. The transaction was done through a project financing structure which has never been used by the state life sciences agency before, and which is within the legal boundaries set by the state’s Constitution, says executive director Lee Huntsman. If the bet fails, the state and Vulcan will have lost their money. If it pays off, the state could get back five times its original investment, and Omeros could end up throwing off much more cash flow into a new nonprofit entity that hasn’t yet been named, Huntsman says. That nonprofit agency could provide grants to Washington State researchers and companies long after the sun sets on the state’s Life Sciences Discovery Fund, originally envisioned by Gov. Chris Gregoire as a 10-year, $350 million plan to boost biotech in the state.
“I’m very excited about what this could mean medically, and I’m optimistic about what it could mean economically for the state,” Huntsman says. “You can do wild-eyed calculations about home run scenarios, and I don’t want to get too wrapped up in that. There are a lot of things that can go wrong. But we were convinced, and the board was convinced, they didn’t need to get any home run to justify this award. It was well within our mission, our mechanisms, and within our risk profile.”
This deal involves some complicated scientific and financial considerations which I’ve been meaning to follow up on ever since the original story broke. Huntsman talked about all of that in a detailed interview at his Seattle office a few weeks ago.
The story began back in the summer of 2009, when Omeros CEO Greg Demopulos and chairman Tom Cable approached Huntsman. They told him about the company’s opportunity to discover new drug targets known as G-protein coupled receptors (GPCRs). These are complex spaghetti-like 3-D protein structures that weave in and out of the surface of cells. Many of today’s best-selling therapies for allergies, pain, and mental illness hit these GPCR targets, including billion dollar blockbusters of the past and present like Merck’s loratadine (Claritin), Bristol-Myers Squibb’s aripiprazole (Abilify), and Purdue Pharma’s oxycodone (Oxycontin).
Omeros, through its acquisition of Seattle-based Nura five years ago, and a subsequent license it obtained to technology from Toronto-based Patobios, thought it had hit upon a novel way to make it possible for drugmakers to create compounds that could bind with an estimated 120 more targets of this same lineage. If they could prove this, then presumably Omeros would be in a strong position to outlicense these new targets to Big Pharma companies that crave promising new drug candidates to fill up their pipelines, and replace aging blockbusters about to lose their patent protection. Omeros, like most companies in this kind of situation, wants to keep some of these targets to itself, so it can create blockbusters of its own.
The catch was that Omeros needed money to realize its full potential. Demopulos and Cable outlined a plan that said if they could scrape together a total budget of about $40 million, they could launch an 18-24 month scientific program to unlock at least some of the 120 or so GPCR drug targets that are “undruggable” today. If the company could do even half that well, it would benefit not just Omeros and its shareholders, but the Seattle biotech community and Washington State as a whole, Demopulos and Cable said. After the first conversation, Huntsman says he walked away thinking about how to structure the deal so that there was a strong “public purpose” beyond just enriching Omeros.
“We had a lot of conversations early about ‘could Washington do this?'” Huntsman says. “It was about the public purpose.”
Conversations continued with input coming from the Omeros brass; Huntsman; Washington state’s commerce secretary, Rogers Weed; Washington Biotechnology & Biomedical Association President Chris Rivera; and John Gardner of Washington State University. They figured ultimately that the Life Sciences Discovery Fund was the most likely vehicle to try financing the Omeros project.
The key maneuver here is that Omeros structured its proposal so that the state could get a return on its investment in Omeros without actually receiving an equity ownership stake. Instead, Vulcan and the Life Sciences Discovery Fund will be eligible to get a “mid-teens” percentage of proceeds from any partnership income Omeros generates up to $1.5 billion. If Omeros generates $1.5 billion in cumulative proceeds from its GPCR program, Vulcan and the state agency will split a 1 percent royalty stream from revenue that flows in thereafter.
That means that Vulcan and the state’s ability to see returns depends on Omeros’ ability to unlock these new drug targets and then strike partnerships with big drugmakers. Those deals typically provide upfront fees, milestone payments based on progress in development, and royalties on product sales if the targets ever form the basis for an FDA approved product. While many of these deals are pitched in grandiose terms with aggregate sums of $1 billion or more, usually only a small bit of that money comes upfront, and it takes years for a program to ever produce a significant percentage of the full partnership value, if ever.
But if any deal like that is struck, the Life Sciences Discovery Fund will be in line to see returns. Huntsman says the state agency could get a maximum of a 5-fold return on investment, meaning it could get $25 million back. But that’s not the upper financial limit of the deal, he says.
As part of this transaction, Huntsman says an as-yet-unnamed nonprofit entity is being established with a similar mission to that of the Life Sciences Discovery Fund. If Omeros truly hits the mother lode with drug targets that are deemed super-valuable by Big Pharma, then all the extra proceeds beyond the $25 million to the state agency will flow into this nonprofit, Huntsman says. This nonprofit, dubbed “the initiative” at this point, is still in its earliest of phases, as it needs to form a mission statement, and decide on who will serve on its board of trustees, Huntsman says. Omeros and the Life Sciences Discovery Fund will have equal say in who serves on the board of trustees, Huntsman says.
The structure is considered workable, Huntsman says, because it’s really not different at least in concept, than the way the Life Science Discovery Fund works now. Currently, if a state grant goes to a University of Washington researcher who develops a hit drug, then the state can get its original grant paid back in full, Huntsman says. And if the UW hits that kind of licensing home run (like inventing a new vaccine such as Merck’s Gardasil) then the university (a nonprofit entity in its own right) has the opportunity to spread the loot all around campus to help support other researchers.
The Omeros grant is like that in concept, Huntsman says. One difference is that any additional windfall would accrue to a new nonprofit that would then re-invest the proceeds in a multitude of nonprofits around the state, like the University of Washington or Fred Hutchinson Cancer Research Center, he says. He added that the nonprofit “initiative” could be established to invest in shared facilities that could benefit the entire biotech community, and it might be free to invest in biotech startups.
The major limitation on doing this deal wasn’t actually legal parameters, but financial constraints, Huntsman says. The Life Science Discovery Fund entered this year after having its budget cut 40 percent, giving it a little more than $20 million to spend. So a $5 million grant to one company is a big chunk of what the agency is capable of offering in the broader context. It’s really the second big grant the fund has made this year, after a round of grants totaling $15 million to the UW, Hutch, and Sage Bionetworks in April.
What struck me as particularly new and interesting is Huntsman’s interest in creating the new nonprofit. Anyone following state politics knows the state has a serious budget crunch, which puts a huge amount of pressure on lawmakers to cut everything in sight. That includes the Life Sciences Discovery Fund. By structuring the Omeros deal so that it can provide returns to both the state agency, and a new nonprofit agency that could be its mirror image, there is a possibility that Huntsman could be creating a new vehicle for life science investing with its own independent source of cash that is insulated from the budget cutting whims of future legislatures.
Huntsman didn’t deny that’s a possibility, although he said it wasn’t the prime motivation of the deal structure. He stressed that if Omeros has success in this GPCR project, the benefits will flow all around the community. While I’m sure many people would measure the success in the number of jobs created, he declined to provide a number of jobs it might create.
“If Omeros has upside success and it flows back to the nonprofit which has a purpose similar to ours, it’s just like having the UW or Hutch or somebody else here prosper,” Huntsman says. “Except this could have an even broader impact.”
Since the deal was announced, Huntsman has had a few entrepreneurs come in for meetings, asking lots of questions about the deal. A few have been perplexed, saying they didn’t think the state could do anything like this for a corporation. But the state life sciences fund may consider doing another deal like this for a company if it has the money, Huntsman says.
The state surely won’t have a lot of proceeds to invest anytime soon. Real money from drugs developed by Omeros, or by Omeros’ partners, may take decades to materialize, if ever. Huntsman, being a scientist by training, knows all about the high-risk, high-reward proposition that biotech offers. Even so, he insists his agency doesn’t need to hit the jackpot to justify the investment. The state’s $5 million grant is justified on the fact that it helps catalyze a $40 million scientific project that pools money from Omeros, Vulcan, and the state in an intense local R&D effort.
“If Omeros hits a home run and this new nonprofit gets off the ground, it’s good for life sciences in the state,” Huntsman says. “We don’t have to worry about whether the Life Sciences Discovery Fund survives or doesn’t. If the new nonprofit exists with a mission of advancing life sciences, it’s good for our mission.”
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