Bildnachweis: WIPIT.
A major challenge for companies in life sciences is to live through the long years of turning innovation into clinical studies and subsequently into revenue. A solid legal structure of investments (private and public), intellectual property rights, and research and development collaborations is vital for a start-up to master the journey to success.
Innovation in life sciences is often brought about by new groundbreaking research originating in academia. However, before such innovation can create novel treatments, new diagnostics or procedures, it must be translated from ‘bench to bedside’ and, thus, into human studies to create new clinical data. Without such clinical data, basic research will neither reach patients nor change decision-making in health care for the benefit of society. Not all biotech start-ups succeed in translating innovation into clinical studies, with such steps being, thus, often referred to as the ‘valley of death’.
Key factors for survival
For German biotech start-ups and academic spin-offs to succeed in the long run, the availability of funding as well as cooperation opportunities with larger companies in research and development are often amongst the essential factors. To negotiate with investors, public funding institutions as well as the pharmaceutical and biotech industry professionally, it is essential to have a deep understanding of the legal and commercial background and industry/market standard regarding the underlying legal agreements and processes. In this article, we will provide you with some of our learnings from having advised on such agreements throughout our career as lawyers.
Fundraising in biotech
Convincing biotech investors of an idea requires high quality of basic research that can eventually turn into clinical science and revolutionise the industry. However, a clear pathway on the use of funds is also of great importance to investors, to demonstrate the delivery of a significant return on their investment within five to ten years (be it through a trade/share sale, licence agreement, IPO or other form of exit), often backed by predictive calculations embedded in a business plan.
Qualification of venture capital investment
Another aspect that is, however, often overlooked, is the multiple ways under German law to provide venture capital funding, each affecting the company’s long-term chances for success:
- Equity, as the most common investment form, e.g., requires a determination of a (high) company valuation growing with each subsequent financing round, which is often difficult to meet in a subsequent financing or exit, whilst bearing dry-income tax risks in case of future share issuances/transfers.
- Convertible loans do not require such valuation upon payment but can let the start-up appear to be in high debt and prevent access to public funding.
- Therefore, other funding structures such as a ‘simple agreement for future equity’ (‘SAFE’), which is often used in the US, can, with certain German law adaptions, help to overcome the above-mentioned challenges.
Retention of talent through share incentives
High-profile candidates often expect an equity incentive to be included in their compensation package. Especially for foreign talent, the virtual share programme as commonly used in Germany, is unattractive from a tax perspective (highest bracket wage tax rather than capital gains tax); thus, alternatives in the form of hurdle shares (real equity with limited profit claims) or participation rights that fall within German capital gains tax should be considered as alternatives.
Available public funding sources in Germany
In Germany, public funding (in the form of subsidies or grants) is widely available to biotech start-ups through various (regional, federal or EU-level) programmes, forming a key source of funding in addition to private investment. Especially for life-science companies, ‘GoBio’ as a translational programme for academic spin-off projects should be considered (prior incorporation) as well as the dedicated programmes of the German federal ministry for R&D, ranging from pre-clinical to clinical funding of – mostly – consortia (prior project start) or e.g., the general ‘KMU-innovativ’ and the ‘Central Innovation Programme for SMEs’ (‘ZIM’).
Public funding as financial safeguard
The advantages of public funding (mitigating the dilution effect for founders, ‘leveraging’ the venture capital investment, no repayment obligation in practice) outweigh, in our view, its possible disadvantages (complex application process, reporting requirements, certain obligations with regard to intellectual property (IP) developed), especially as reports and documentation created to receive public funding have the possibility of a ‘secondary utilisation’ for future investor reporting, due diligence, and business plan creation. Therefore, despite a certain amount of additional administrative and time expenditure associated with it, combining public funding with a venture capital financing round (also from a contractual and timing perspective) is an important step for biotech start-ups to avoid financial shortages.
Intellectual property documentation and protection
Moreover, a sound IP and licensing foundation is essential for a successful future biotech product as well as for documentation to investors and cooperation partners of the company’s intellectual property journey (through a patent applications, research and development agreements, licence or transfer agreements covering intellectual property generated by academia prior incorporation or by third parties). Additionally, inventions must be protected as early as possible by patent applications in the relevant markets. To then avoid that the patentable information becomes ‘publicly available’ in the eyes of the law (leading to the patent application being denied, or the published patent being challenged), confidentiality agreements must be entered into with all third parties having access to the invention.
Licensing and collaboration
Another key to success is the company’s freedom to operate, i.e. the ability to implement the planned business model without infringing on third-party property rights. Such freedom to operate is achieved by concluding licence agreements, with academic institutions (having the rights under German law on inventions made by formerly or currently employed founders of a spin-off) or research and development companies (e.g., to obtain a drug candidate). In each case, the terms of the licence agreement have a long-term effect once the product is placed on the market and are, thus, of high relevance to the business and its shareholders. Furthermore, collaborations with third parties on research and development can share (and thereby ease) the financial burden of bringing a life sciences product into the market.
Pathway to success
Before a new life sciences product will generate the first income on the market, long years of investments into its development must be mastered. This is an immense burden on all life sciences start-ups struggling to survive day-to-day, month-to-month before seeing any revenue. Having to spend funds on legal structures that could preferably be earmarked for wages or other development costs instead might appear unreasonable under these circumstances. However, as shown, a solid structure for funding, research and development and intellectual property is a well-worthy long-term investment and will, in many instances, help biotech start-ups in crossing the valley of death.
About the authors:
Benedikt Mahr, lawyer/tax advisor/managing partner at WIPIT Munich, advises companies and investors on corporate and tax law in venture capital and M&A. He studied law in Passau (Germany) and Chicago (USA).
Britta Ness, lawyer/salary partner at WIPIT Berlin, is an expert on civil and commercial law, e.g., on R&D, IP/IT, licensing and sales, and related contracts. She studied law in Berlin and Sheffield (UK).
Kai Grunwald, lawyer/partner at WIPIT Mannheim, advises on licensing law, public funding, academic spin-offs and related topics in venture capital and M&A. He studied law in Heidelberg (Germany) and Cologne.
