“There are very few areas of the nation’s economy that are as dependent on patents as the biotechnology industry,” King said. “Our investors rely on the strength of patents in order to make investments in companies like ours and we need to make sure that these rights are robust and enforceable.”
On the morning of Wednesday, July 25th, the U.S. Congress Joint Economic Committee held a hearing titled The Innovation Economy, Entrepreneurship, and Barriers to Capital Access. The day’s discussion focused on various federal policies that could be pursued by Congress to increase avenues for financing innovative businesses and improve the ranking of the United States as an innovative economy.
Congressman Erik Paulsen (R-MN), Chairman of the Joint Economic Committee, began the hearing by citing the United States’ recent slip to 11th place in the most recent Bloomberg Innovation Index published this January. “Innovators start their work from a difficult place,” Paulsen said. “Innovation is just as likely to happen in a suburban garage as it is in a corporate lab.” In discussing barriers to business funding, he cited research which indicates that nearly 70 percent of startups receive less financing than they request and nearly 28 percent of startups receive no financing. Problems with America’s innovation economy are also felt in numbers of initial public offerings (IPOs) of companies looking to be publicly listed on stock markets. Paulsen noted that, in 2017, one-third of all IPOs worldwide happened in China whereas U.S. IPOs were currently half the number of IPOs launched 20 years ago.
In his opening statement, Senator Martin Heinrich (D-MN), ranking member of the committee, spoke more to the issues surrounding capital access for rural and underserved communities. Rural communities were hampered by inadequate access to both Internet broadband access as well as banks. Heinrich cited research showing that 86 banking deserts, regions in which there are no banks within 10 miles, were created in rural communities between 2008 and 2016. He also noted that more than three-quarters of U.S. venture capital goes to companies situated in four metropolitan areas: New York City, Boston, San Francisco and Los Angeles. “There are entrepreneurs across this country with good ideas and smart business plans,” he said, “but they need access to investors who can help transform these ideas into growing businesses.” Heinrich pushed back against a proposal made by President Donald Trump to eliminate funding to the Community Development Financial Institution (CDFI) fund, saying that such activities “moved in the opposite direction” of improving financial access to rural businesses.
Although it wasn’t a major topic of discussion during the day, one panel witness spoke directly to the financial issues posed by patent validity challenges available through inter partes review (IPR) proceedings at the Patent Trial and Appeal Board (PTAB). Rachel King, CEO of the Rockville, MD-based biotech firm GlycoMimetics, said that she was greatly concerned by the effects of the IPR process and how it weakens the company’s ability to enforce its own patents. “There are very few areas of the nation’s economy that are as dependent on patents as the biotechnology industry,” King said. “Our investors rely on the strength of patents in order to make investments in companies like ours and we need to make sure that these rights are robust and enforceable.” King was very supportive of the STRONGER Patents Act as a piece of legislation that properly addresses the current deficiencies with the IPR process. A search of Lex Machina’s legal analytics database shows that GlycoMimetics hasn’t faced any IPR petitions at the PTAB up to the time of this writing.
Lisa Mensah, President and CEO of the DC-based Opportunity Finance Network, spoke mainly to the importance of CDFIs in ensuring that innovative business startups get necessary funding. “Small businesses… turn to CDFIs when they can’t access capital through traditional lenders,” Mensah said. She added that, since the Great Recession, small business loan originations have decreased by 30 percent and in rural communities, small business lending is half of the levels seen in 2004. Mensah urged the committee to support a continuation of the $250 million appropriation for the CDFI fund, noting that every dollar awarded to CDFI turns into $12 worth of investment funding.
Speaking on issues related to the IPO slowdown was Phil Mackintosh, Global Head of Economic Research at NASDAQ. The importance of IPOs on growing the nation’s workforce was underscored by the fact that companies that went through an IPO to list on a public market between 1996 and 2010 employed a total of 2.2 million more workers than they did prior to going public. However, Mackintosh noted that more companies were staying private longer as evidenced by the 2,000 fewer public companies with a market cap below $250 million currently as opposed to the number of such companies in 2003. More organized and competitive private equity interests as well as foreign stock exchanges changing their standards to attract more listings have also contributed to stagnant public listings in the U.S. “We shouldn’t ignore the fact that the U.S. has the deepest, most liquid and most efficient capital markets in the world, but we need to make sure we keep it that way,” Mackintosh said.
Even where companies have access to capital, costs that are added through regulatory financial reporting requirements can be a real burden to a small company’s ability hire new workers or invest in research and development. King urged the committee to consider extending the exemption to financial reporting rules enacted under Section 404(b) of the Sarbanes-Oxley Act of 2002; these exemptions were enacted in 2012 with passage of the Jumpstart our Business Startups (JOBS) Act. “Without additional action by Congress, many of the pre-revenue biotech companies like GlycoMimetics will lose that JOBS Act exemption,” King said. “In our particular case, that means that our financial reporting requirements will nearly double to over one million dollars a year in order to comply with Sarbanes-Oxley 404(b).”
Although recent tax reforms were by and large seen as positive developments for supporting the prospects of innovative startups, some aspects of the current tax code still pose an impediment for firms devoting a good deal of capital to early research and development efforts. Chairman Paulsen said that a legislative fix to Section 382 of current U.S. tax code was in the works; that section is intended to prevent companies from acquiring other firms that lose money just to offset taxable income. That statute proves to be an impediment to companies like GlycoMimetics which operate as pre-revenue companies. “We’ve actually had to address this in the context of some of the financing that we’ve done at GlycoMimetics,” King said. “The problem… is that you want to prevent what is known as this ‘loss trafficking,’ but what you don’t want to prevent is smaller companies raising money which also sometimes results in significant ownership changes through the natural course of investors coming in and out of a company like ours.” As the statute currently stands, it hurts the capital fundraising ability of companies which are pre-revenue and reporting net-operating losses but hope to become profitable in the future.