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Insight & Intelligence™ : Jan 30, 2012

Capital Squeeze, Red Tape Mean Less California Dreamin’ for Biopharma CEOs

A recent CEO survey shows that some firms see greener pastures outside the Golden State.
  • Alex Philippidis

California is home to two of the world’s largest biopharma clusters in the San Francisco and San Diego regions. However, the financial squeeze on startups and the combination of federal and state red tape have tarnished the Golden State’s image in the eyes of biopharma CEOs, if a recent survey is any indication.

Nearly three-quarters (74.2%) of some 100 CEOs surveyed said their companies were forced to delay a research or development project in the last year. When asked why, 40.2% cited the lack of available financing, while 27.8% of CEOs blamed regulation by FDA, its state counterpart called the California Food and Drug Branch, and other state and federal agencies.

In response to what affects companies’ ability to keep biomedical research, innovation, and investment in California, 72.9% of CEOs cited the capital squeeze, while 60.4% offered another financially-focused answer: tax incentives for innovation. Just over half the CEOs (51%) cited corporate taxation. Interestingly, state and federal red tape drew just 37.5% of CEOs, behind even workforce preparedness (47.9%). This suggests that as much as the CEOs complained about red tape, it is the impact on their companies’ bottom lines that will most likely sway their decisions about staying in the Golden State.

The CEO survey was conducted in November for the California Healthcare Institute (CHI), BayBio, and PwC (formerly PricewaterhouseCoopers). They will share more details when the 2012 California Biomedical Industry Report is released on February 8.

Following the Money

Stephen Cary, Ph.D., CEO and co-founder of Omniox, told GEN the capital squeeze has his company considering expanding overseas. Omniox is in preclinical development of its oxygen-binding proteins as treatments for cancer as well as heart attacks, strokes, and battlefield wounds. The company has about 10 employees and raised over $4 million from NIH plus funds that include a $250,000 grant from the Rogers Family Foundation and a $244,000 tax grant through the Qualified Therapeutic Discovery Project program.

Omniox should be a poster child for California biopharma. Dr. Cary based the company on the technology of in-state biochemist Michael A. Marletta, Ph.D., who on January 1 became president of The Scripps Research Institute after a decade at University of California, Berkeley. Omniox occupies space at the QB3 Garage, the incubator run by the California Institute for Quantitative Biosciences (QB3), which consists of UC’s San Francisco, Santa Cruz, and Berkeley campuses. The company has a second facility in Sunnyvale, CA.

Dr. Cary says California has many strengths for biopharmas, notably a critical mass of researchers and investors with experience launching new companies as well as professionals specializing in helping startups. Two law firms have carried out “maybe a million dollars worth of work” at deferred costs for Omniox, he said, while a former FDA official has provided pro bono advice on regulatory strategy.

Despite such strengths, the availability of investor cash may drive Omniox to grow outside the U.S. “This year, we’re going to look and maybe by the end of the year have operations overseas,” Dr. Cary stated. “It could be England. It could be Asia. It could be both. There’s money outside the United States.” He pointed to programs of the UK’s Medical Research Council and Cancer Research UK.

“Depending on where we get funding, instead of expanding in San Francisco, we might expand overseas. There’s funding overseas to fund a team that’s 10 times the size, that can go 10 times as fast, and we can move the science forward that way,” Dr. Cary said.

“We’d keep our core in California. We are the most innovative here. But developing new therapeutics can require iterating around a central theme, and sometimes that just takes a lot of hard work, and people doing the science at the bench. It may be more cost effective and feasible to do that outside the U.S., especially if there’s funding support.” But if a significant investor surfaced in California, he added, Omniox would continue its growth in-state.

During the phone conference, Dr. Cary recalled how at the J.P. Morgan 30th Annual Healthcare Conference in San Francisco earlier this month, “I met a very deep pocketed Asian investor, who was practically throwing money at us from across the table to move to Asia and really expand.”

“We also met with a VC from the Cambridge area. They also asked us to move our company to Boston, and they would fund that,” Dr. Cary added. “These are options that in the absence of any other option make it tough to see your way through where we are now, which is why my top priority is to find a California investor, so we can continue to stay here and control our science.”

Battling Regulation

Dr. Cary was one of three life science CEOs who went public earlier this month during a phone conference about the strengths and shortcomings of California. Joining him were Rick E. Winningham, chairman and CEO of Theravance; and Alexis Lukianov, chairman and CEO of NuVasives. Winningham, a former Bristol-Myers Squibb executive, said California’s strengths include good weather, a strong base of research universities, a diversity of backgrounds among professionals, and their willingness to take risks such as launching new biopharma companies without fear of failing.

“Our company was founded in California. It started in California. And we’d like to stay and have operations in the state of California as long as the environment is supportive,” Winningham said. “But we work with contract research organizations or contract manufacturers all over the world, from China to India to Taiwan. We have to go out and find the best of the best to do different things of what creates value for patients and our shareholders.”

That pursuit, he said, has been complicated by the extra time and money spent by the company following FDA’s pendulum-swing toward slower, longer reviews in recent years. The agency has been striving to avoid another debacle like the deaths, heart attacks, strokes, and other side effects linked to blockbuster medications like Celebrex and Vioxx. “All the people in the FDA always try to work to do a good job, but clearly the ecosystem did not get very supportive for innovation,” according to Winningham.

“Certainly my company has had challenges,” Winningham continued. “We’ve overcome some of those, but it did lead to reductions in jobs and reductions in number of employees as we worked to overcome those challenges.” He was alluding to Theravance’s 2008 layoff of 40% of its staff—about 115 people—after finishing Phase III development of the antibiotic telavancin. Theravance estimated the layoff cost $5.8 million but would cut expenses by about $17 million annually.

“Without a level of reduction in regulatory uncertainty, you can’t attract capital into the industry. And when you can’t attract capital into the industry, you can’t hire good people and put them together on teams in order for them to solve public health problems,” Winningham added.

Keeping California Dominant

Tracy T. Lefteroff, global managing partner, venture capital and life science industries services for PwC, warned that unless both financial and regulatory bottlenecks improve, “the next couple of years could be a very, very tough time” for early-stage biopharmas.

That explains one key survey finding: Nearly half the CEOs surveyed said they would pursue funding through corporate partnering or licensing over the next 12 months. Nearly one-third said they would seek government grants, and almost as many said they would try to use corporate venture funds. Traditional VC funding finished fourth at about 25%, ahead of the “other” category, which surpassed angel investors and seed funding.

As for regulatory relief, not all the hurdles faced by California companies are at the FDA. California’s regional life science groups last year got behind a bill to preclude the California Food and Drug Branch from requiring inspections for drug and medical device manufacturers that meet federal FDA requirements. The measure passed the Assembly but not the Senate.

California biopharmas need to continue pursuing relief from duplicative requirements by multiple levels of government. The alternative will see more California-based companies expanding outside the state, as Genentech did in 2010, when it opened a $400 million fill/finish plant in Hillsboro, OR.

Biopharma can also use state legislative action to end the financial logjam heading into its third year. Since 2008, California has suspended its Net Operating Loss carry-forward for business taxpayers with $300,000 or less in pre-apportioned income. While companies can technically collect the credit for losses for 20 years per annual loss, they cannot actually use that credit until the suspension is lifted—something unlikely to happen until the economy improves.

A more balanced approach to regulatory relief, as with financing, will improve the business survival prospects for the state’s biopharma firms, which as Lefteroff rightly noted run the real risk over the next few years of going from California dreamin’ to living a nightmare.