R&D Partnership Structures
Biotech companies have among the largest capital burdens and longest development pathways of any industry. High costs and long timelines can scare off investors who may be looking for investment strategies with earlier prospects for success. Amending the Internal Revenue Code of 1986 to allow certain tax incentives stemming from R&D to flow from life science projects through to their investors would result in immediate tax benefits and attract more investment in small biotechnology companies.
Section 382 Net Operating Loss (NOL) Reform: Development-stage biotech companies typically generate significant losses, which can be used to offset future gains if the company becomes profitable. Section 382 of the Internal Revenue Code currently restricts the usage of net operating losses (NOLs) by companies that have undergone an “ownership change.”
There are two reforms to Section 382 that would be beneficial to many biotechnology companies. First, we should exempt NOLs generated by qualifying research and development by a small business from Section 382.
Second, we must redefine “ownership change” to exclude certain qualified investments, like those in rounds of venture financing. These reforms would allow small biotech companies to retain their NOLs and include them as tax attributes on the balance sheet, thus increasing their value when preparing for additional rounds of financing like mergers or initial public offerings.
Section 1202 Capital Gains Reform: Section 1202 provides a small business investment tax incentive allowing taxpayers to exclude 50% of their gain from the sale of a qualified small business stock that has been held for more than five years. This tax exclusion could incentivize investors to invest in biotechnology companies early and hold their investments longer.
Changing the definition of “qualified small business” to include companies with gross assets up to $150 million, indexing the cap to inflation, and excluding intellectual property and follow-on rounds of financing from the gross assets test would more accurately represent the capital-intensive nature of innovative industries like biotechnology.
Additionally, a graduated increase in the exclusion for qualified small business stock, rewarding investors who hold stock for longer and incentivizing them to continue to do so, would be extremely beneficial.
Section 197 Amortization Reform: When the assets of an early-stage biotech company are purchased, the acquirer may amortize certain intangibles under Section 197 over a 15-year period. Accelerating this amortization period to five years could encourage large company investors contemplating acquisitions of specific intangible assets of small biotech companies to invest at an earlier stage in the company’s research.