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FORMING A NEW BIOMEDICAL COMPANY The Legal Basics Biotechnology Interest Group (BIG) South Carolina Clinical and Translational Research Institute David.

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Presentation on theme: "FORMING A NEW BIOMEDICAL COMPANY The Legal Basics Biotechnology Interest Group (BIG) South Carolina Clinical and Translational Research Institute David."— Presentation transcript:

1 FORMING A NEW BIOMEDICAL COMPANY The Legal Basics Biotechnology Interest Group (BIG) South Carolina Clinical and Translational Research Institute David L. Wilke & Jason S. Wood Wyrick Robbins Yates & Ponton LLP

2 ENTITY SELECTION FOUNDER STOCK/GOVERNANCE INTELLECTUAL PROPERTY AND LICENSING SUPPLEMENTAL MATERIAL: EARLY STAGE FUNDING 2 AGENDA:

3 ENTITY SELECTION 3

4 Forms of Business Entities Sole Proprietorship General Partnership Limited Partnership Corporation C corporation S corporation LLC 4

5 Key Factors to Consider In Choosing a Form of Entity Personal liability protection Tax considerations Management and governance structure Need for outside investment 5

6 Corporation Shields owners (stockholders) from liability Board members have fiduciary duties, however Regimented organizational/management structure Articles of Incorporation/Bylaws Shareholders/Directors/Officers Flexible capital structure and transferability of ownership State of incorporation is important Delaware is the leader Tax treatment: S corp: Pass-through tax treatment C corp: Double taxation Converting into an LLC can trigger adverse tax consequences 6

7 Limited Liability Companies Shields owners (members) from liability (like corporation) Management/organizational/economic structure more flexible than corporations Typically, more direct control retained by owners, but can structure around this Members/Managers However, can structure governance like a corporation (Board, officers, etc.) Pass-through entity for tax purposes Can usually convert into a corporation without adverse tax consequences 7

8 Entity Comparison on Key Drivers: C corpS corpLLC Tax TreatmentSubject to tax at corporate and shareholder level (“double taxation”) Pass-through (no corporate tax) Pass-through (but FICA and no fringe benefits for members) Ownership Limitations Virtually no limits≤ 100 shareholders Only individuals, certain trusts, and other S corps (may preclude investment) Virtually no limits (although difficult for VCs and non-profits to hold interest) Capital Structure (Equity Rights/ Preferences) Flexible – can have multiple classes with differing voting and economic rights Only one class of stock (though can have voting and non-voting stock) Flexible – although customary stock options can be a problem S automatically converts to C when disqualified 8

9 SBIR/STTR Requirements for an Eligible “Small Business” Organized for profit business At least 51% owned and controlled by individuals that are U.S. citizens, permanent residents Located in the U.S. 500 or fewer employees Above apply regardless of choice of entity 9

10 Which Choice is Right for Me? Since liability protection is similar, often comes down to: Desired tax treatment Type of business “Lifestyle” business? Owner involvement – active or passive? Employee incentive equity important? Growth and/or exit strategy Growth business? Internally or externally funded? Income stream? IPO/sale of the company likely? Structure for multiple business lines? 10

11 Which Choice is Right for Me? Each situation is unique, but generally… If require significant outside money for growth – C corp If small, income generating venture – S corp or LLC If university is to take an equity interest – C corp Most life science ventures will be C corp **Bottom line: Consult knowledgeable attorney and accountant to analyze and discuss the specific facts presented ** 11

12 FOUNDER STOCK/ GOVERNANCE 12

13 Founder Stock What is “Founder” Stock? - This is equity granted to founders of the start-up, typically at a very low price (par value). Restricted v. Unrestricted - Restricted stock is subject to vesting, unrestricted is not. If founder leaves for any reason, company can repurchase unvested shares at cost. Vesting – Investors will require, but still good idea for founder team pre-funding. Typically some portion can be vested up front, with remainder vesting over 3-4 years. 13

14 Founder Stock (Continued) ****Beware of Tax Impacts of Founder Stock Subject to Vesting**** If founder terminates service prior to all shares vesting, Company can repurchase the unvested shares at cost – this creates a “risk of forfeiture” that triggers special treatment under Section 83(b) of the federal tax code. If founder makes a proper Section 83(b) election (within 30 days of purchase), then: there is typically no ordinary income tax when the founder stock is issued (since they pay fair market value (FMV) for those shares); and founder gets capital gains treatment on all appreciation in value at time of sale of shares. If no proper Section 83(b) election is made: as shares vest (and risk of forfeiture lapses), founder taxed at ordinary income rates on difference between FMV of vesting shares and original cost basis. Shares typically illiquid, so cannot sell them to pay this tax; and founder gets capital gains treatment on all subsequent appreciation in value at time of sale of shares. 14

15 Governance Board of DirectorsKeep small for start-up, but never too early for knowledgeable independent directors Election determined by stockholder agreement OfficersCEO/President Secretary Treasurer Assistant Secretary StockholdersCertificate of Incorporation Bylaws Stockholders/Voting Agreement (buy/sell, ROFR/co­ sale, drag­along, tag­along, etc.) Scientific Advisory BoardProvide expertise and guidance to Board and management No fiduciary duties, but should agree to confidentiality and assignment of inventions 15

16 INTELLECTUAL PROPERTY AND LICENSING 16

17 What is Intellectual Property? New or original ideas, information or technology Patent – the right to exclude other from making, using or selling an invention Trademark – any word, symbol or device used in commerce as an indication of source for products or services Copyright – protects the right to copy, distribute, sell, publicly perform or display, or make derivative works of an original work of authorship fixed in a tangible medium of expression Trade Secret – information that is (1) valuable or creates a competition advantage, (2) protected by reasonable efforts to prevent disclosure, and (3) not known by others 17

18 Common Types of University Technology Chemical compounds Biological products (peptides, antibodies, cell lines) Diagnostics (assays, genetic markers, imaging devices) Animal models In vitro assays Mechanical/electronic devices Materials Software Combination of potentially patentable technology, copyrightable work and trade secret May not be worth seeking (or paying for) patent protection Cost Uncertainty of enforcement Speed of product/market evolution 18

19 Patents Three basic requirements: Utility (useful) –supporting data usually submitted to show therapeutic utility New – “first to invent” (U.S.) v. “first to file” (most foreign) Nonobvious One year statutory bars for proving novelty (only U.S.): Offer for sale Publication Public knowledge (disclosure) or use (demonstration) Inclusion in previously issued patent Term 20 years from filing Costly ($1,000s to $10,000s) Owned by inventor unless rights assigned by contract (they usually are!) 19

20 Trade Secrets A trade secret is any information that is Valuable or provides a competitive advantage; Protected by reasonable efforts to prevent disclosure; and Not known by persons other than the owner. Companies protect trade secrets by requiring employees and consultants to sign nondisclosure agreements and by taking other protective security measures (locked filing cabinets, areas with restricted access, etc.) Information is entitled to trade secret protection for so long as such information retains its status as a trade secret Keep it secret! 20

21 How Do You Protect Your IP? “Perfect” Your Rights Patents – File with PTO Trademarks Common Law Registration – File with PTO Copyright Common Law Registration – File with Copyright office Trade Secret – Keep it a secret Contractual Protection CDAs/NDAs/MTAs Employment/Consultant Agreements Appropriate provisions in all contracts (sponsored, research, contract research, CRADA) Enforcement is costly 21

22 Licensing University IP Assume any technology developed by university faculty/personnel is owned by the university Stakeholders: institution/technology transfer office, inventors, licensee/management, investors, acquirors and strategic partners Early and open dialog with technology transfer office University inventor should be part of the process It can take a long time Involve counsel or entrepreneur with extensive university licensing experience before discussing specific terms 22

23 What Does the Institution Want? Advance Science and Its Educational Mission Benefit Society Technology/Product to Market Create Jobs/Economic Development Direct Economic Return Cover Patent Costs Subsidize Research Activities Reward/Retain Active/Entrepreneurial Faculty 23

24 What Does the Licensee Want? Technology/Product Freedom to Execute and Evolve Change Business Plan Strategic Partnerships “Exit” (eventual IPO or sale of the company) Economic Return 24

25 What is a License? The right or authority to use someone else’s property or exercise someone else’s rights In the case of technology developed at an academic or non-profit institution, that means the right, under intellectual property rights owned by the institution, to use and/or exercise such rights 25

26 Anatomy of a License License Grant: What are you getting? What can you do with it? Payment Obligations: How much does it cost? (and when?) Diligence/Performance Obligations: How do you keep it? (How can the university it get back?) Patent Prosecution and Infringement Provisions: Who’s in control? 26

27 Typical University Start-Up License Exclusive patent rights (sometimes field limited) Equity (common stock) with antidilution protection Single digit sales royalties Sharing of sublicensing revenue Reimbursement of patent costs Milestone payments Diligence milestones The devil is in the details – the “standard form” almost always requires negotiation to minimize barriers to investment, strategic partnerships, and/or sale of the company 27

28 So what does this all really mean? Make sure the company has the IP it needs License from university or corporate source Assignment from individual inventor/founder Keep things confidential - control access Use NDAs/CDAs/MTAs Use good contracts whenever IP might be involved Every founder, employee and consultant should sign an agreement assigning IP to the company IP is (almost) always involved Don’t assume the company owns IP created on its behalf Start-ups should use IP counsel early and often (but judiciously) 28

29 EARLY STAGE FUNDING 29

30 Early Stage Funding Model 1.Discovery alone typically not enough for VC 2.Need proof of principle – Animal models, prototypes, etc. 3.Technology “Incubating” longer these days 4.Must obtain sufficient Early Stage Funding to bridge to VC 30

31 Early Stage Funding Opportunities Local, State and Federal Governmental Programs (Like SBIR) Private Foundations and Public/Private Sector Initiatives Personal Resources; Friends and Family High Net Worth Individuals (“Angels”) Small Venture Funds Venture Capital Funds Strategic and Collaborative Partners and Licenses 31

32 Early Stage Funding Opportunities Governmental Programs SBIR/STTR (NIH, DOD, etc.) Direct Federal Grants State Matching Programs and Tax Credits 32

33 Early Stage Funding Opportunities Private Foundations and Public/ Private Sector Initiatives 1.Research Foundations: - Typically (but not always) targeted therapeutic areas Examples: Cystic FibrosisDiabetes Parkinson’s DiseaseSchizophrenia CancerBlindness 2.SCRA/SC Launch! Grants/Loans 33

34 Early Stage Funding Opportunities Personal Resources (Friends & Family) 1.Your own money: “Skin in the Game” (not just sweat) 2.Friends, family, business relationships Only amounts they can afford to lose Silent partners or, if not, direct industry expertise “Accredited” (high net worth) individuals Stockholders Agreement 34

35 Early Stage Funding Opportunities High Net Worth Individuals (“Angels”) State of Angel Investing – Impact of 2009 Capital Market Crisis Organized Angel Networks Angel Investors – What to look for? Industry expertise Can afford to lose money Personal interest (therapeutic area?) Connections to other capital, industry-specific relationships Small number 35

36 Early Stage Funding Opportunities Angel Investing Pitfalls/Red Flags 1.Angels get Board control/veto power 2.Unrealistic expectations (ROI, timing, future valuations, risk) 3.Lose interest, change priorities – but still want to “protect investment” 4.They are anti-VC 5.Many, small investors 6.Want to create complex capital structures 7.At some point prefer capital losses over continued patience 36

37 Early Stage Funding Opportunities Small Venture Funds Typically targeted technology/region focus Limited capability for downstream investment Connections to bigger VC? Validation if right group/Red flag if not Can pay a big price in dilution/control for small $ Not as many of these as there used to be 37

38 Early Stage Funding Opportunities Venture Capital Funds Link to Early Stage For most technology driven ventures, particularly University spin-outs, will need to consider VC funding. It is rarely a question of if, but when. Start Process Early Begin dialogue before you need funding. Build relationships. It is a multi-step process that takes time and thick skin. 38

39 Early Stage Funding Opportunities Strategic/Collaborative Partners Partnerships with larger/funded companies (Big pharma, public biotech, CROs) Unlikely at earliest stages of development – more risk averse than other forms of capital Deal terms improve dramatically the further you develop the technology 39

40 Funding Process and Structures THE SEARCH FOR EARLY STAGE CAPITAL Start early, it’s always longer than you think Pursue alternatives simultaneously, not sequentially Utilize your contacts Added significance gained by due diligence of potential investors Beware Investment Brokers 40

41 Funding Process and Structures TYPICAL EARLY STATE INVESTMENT VEHICLES (INVESTOR DRIVEN TYPICALLY): Bridge Loan – A convertible promissory note, typically with a kicker (warrants, conversion discount) Do not have to value company – converts into first equity financing Capital structure clean, transaction quicker But, debt senior to equity Preferred Stock – A “Series” of Preferred Stock with preferences, privileges over Common Stock (liquidation, anti-dilution, voting) Must value company (art > science) Complicates capitalization, typically slower transaction Can result in future “down round,” complications with investors 41

42 About Wyrick Robbins 70 lawyers focused on corporate transactional work for growth-oriented entrepreneurial companies Named No. 1 in North Carolina for Biotechnology Law by Best Lawyers in America Recognized as a top firm by Chambers USA in 2009 and lawyers selected as North Carolina Super Lawyers for 2010; 17 lawyers included in Best Lawyers in America 2011; 13 lawyers selected to Legal Elite Dow Jones Private Equity Analyst rankings: 22nd most active law firm in the nation for venture capital and private equity transactions; ranked 17th nationally for closed venture capital deals Top law firm in Carolinas and Southeast for venture capital and private equity transactions 42

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