The board that oversees California’s stem-cell agency is expected next month to create a loan program intended to finance state-based research in regenerative medicine, especially by startups seeking to raise capital during the so-called valley of death between angel and revenue-generating phases.
The Independent Citizens Oversight Commission had been expected to discuss and vote on the loan program last week, but could not take any action due to the lack of a quorum at its monthly meeting, held at Stanford University.
The 14 members of ICOC’s 29-member board who were present approved a “sense of the committee” resolution supporting a set of policies hammered out by its nine-member Loan Task Force Subcommittee over nearly a year [BRN, Dec. 17, 2007].
The policies will not be revised by the time the ICOC board next meets on Sept. 24-25 in San Diego, the chairman of the task force said in an interview last week.
“I think it would pass unanimously,” Duane Roth, chairman of the Loan Task Force Subcommittee, told BioRegion News last week. “It’s now in shape that if we pass it in September, then there are still some more details to work out — not so much on the policy, but on the procedures to get things issued.”
Losing a month will not hurt the loan program, he added.
Roth is also chairman and CEO of Alliance Pharmaceutical, a San Diego maker of diagnostic imaging and medical products, and is CEO of Connect, a San Diego nonprofit group that links early-stage life sciences and high-tech entrepreneurs to financing, talent, and other resources.
If passed, the September vote would create an interim loan policy that would take effect immediately, pending completion of more detailed regulations subject to review and hearings by state officials, a process that can take up to a year or more. Pending that outcome, no timetable has been set for issuing requests for loan applications.
CIRM is a state-created agency charged with overseeing the distribution of the $3 billion California voters agreed to spend on stem cell research under Proposition 71, approved in 2004.
Its task force subcommittee, working with PricewaterhouseCoopers, agreed to fund both commercial and nonprofit research institutions by issuing six- to 10-year loans for research projects.
Loans will be issued to applicants that reach pre-approved milestones and will offer borrowers the option for “recourse” loans, which require repayment whether a project succeeds or fails, or “non-recourse” loans.
Options will determine the proportion of the loan for which CIRM will hold warrants, or securities entitling it to buy in the future a corresponding proportion of ownership at a price set when the borrower has either obtained previous financing, or will obtain its first financing.
“What makes [the loan program] work are the warrant coverages.”
CIRM will hold warrants equal to 10 percent of the loan amount on recourse loans and 100 percent of the amount provided in non-recourse loans, though capped at the right to a 20-percent ownership stake in borrower companies, according to the policy statement.
Earlier this year, the task force considered a warrant proportion for recourse loans ranging from 10 to 25 percent. Roth said he chose the low number “when I realized that for the ones who are going to take a recourse loan and repay it, plus the interest rate, 10 percent was more appropriate.
CIRM will hold the warrants but would likely outsource the management to an outside manager.
“We’re looking at a model where we would have a dedicated underwriter, something like a Silicon Valley Bank … that has this expertise that would step in for a fairly small fee and administer the loan,” Scott Tocher, CIRM interim associate legal counsel to the vice chair, told BRN last week. “There would still be reports that would be due to CIRM, just like any grant, and that would be handled internally, just as grants would be.”
In return for the financing, loan recipients would agree to spend all proceeds, and carry out all of the research being funded, in California. And reflecting a bill making its way through the state legislature [BRN, Aug. 11], recipients would also have to agree to provide drugs and therapies “at benchmark prices” described in the California Discount Prescription Drug Program, also known as CalRx, both for CalRx individual participants and “entities” purchasing those drugs and therapies with public funds.
The drugs and therapies must also be available to uninsured state residents, and loan recipients must notify CIRM in advance of issuing press releases referring to research funded through the agency.
$500M ‘Likely Target’
The policy statement up for a vote next month does not address how much money CIRM will set aside for the loan program — a key detail Roth said ICOC’s standing committee on finance would decide at a later date. The panel will also parcel out portions of the money for loans to be awarded through RFAs.
The policy statement also doesn’t address several other specifics of the loan program — the range of loan sizes to be awarded, the number of loans to be issued, and the duration of the loan program. The task force needed, and will get, more time to forge consensus on those specifics.
“After the task force listened to and worked with [CIRM] President [Alan] Trounson, it was sort of agreed that the financial details are separate from the overall direction of the principles that would follow, regardless of loan size, loan amount, or loan term. There were some basics that would be universal. And so it was thought best to keep that on a two-track system,” Tocher said.
Earlier this year, the task force received a series of reports by PricewaterhouseCoopers that studied the feasibility of a $500 million loan fund. “That is still the most likely target” for the size of the fund, Tocher said, though Roth added that the amount ultimately “could be bigger or could be smaller.”
“The Loan Task Force instructed PwC to assume a distribution of roughly $70 million per year in loans that would range between $1 [million] and $5 million, comprising approximately 20 loans per year for a period of eight to 10 years,” the subcommittee wrote in its Draft Policy Components of the ICOC Loan Program, available here.
According to a financial model within the PwC reports, over 10 years CIRM would issue 183 loans, with Phase 2A research accounting for a 45-percent plurality of the agency’s loan portfolio or $225 million, followed by Phase 1B with 30 percent or $150 million, Phase 1A with 15 percent or $75 million, and pre-clinical with 10 percent or $50 million.
PwC’s reports consisted of a “benchmarking analysis” comparing CIRM’s proposal to loan programs in 10 other states, as well as in France, Sweden and the UK; a “loan financial model” with a sample CIRM term sheet evaluated in interviews with 14 industry representatives, venture capital, and venture debt groups; and a set of “loan model scenarios” showing possible results, with variations in interest rates, pre-money value, the terms of loans, warrant coverage, and other criteria.
Among these scenarios:
- $500 million would be lent to borrowers over seven years.
- Companies could receive loans at stages ranging from pre-clinical to phase 2a.
- Loans could vary from $1 million to “several” million dollars.
- Loans would have terms of between six and 10 years.
- Interest rates on the loans could range from Prime plus 2 percent to Prime plus 4 percent.
“A financial review of the CIRM Loan Program, based upon the current term sheet and the above assumptions, suggests the following: The program could be sustainable; that is, it could be self-renewing as the returns and recoveries on loans exceed write-offs,” PwC concluded.
The program would be sustainable enough, PwC added, to increase CIRM’s assets by between $100 million and $500 million above the initial $500 million loan fund, creating a fund of between $600 million and more than $1 billion.
“What makes [the loan program] work are the warrant coverages,” Roth said.
CIRM could grow its loan fund to $1.057 billion if it issued loans at an interest rate of prime plus 4 percent; if 70 percent of its loans required repayment over 10 years and the rest, six years; and if 60 percent of loans were non-recourse loans fully covered by warrants, and the remainder recourse loans with 10-percent warrant coverage.
And if all loans were non-recourse and CIRM held warrants equal to the size of those loans, the fund would balloon to $1.28 billion. Each 1 percentage point increase in the interest rate would add about $30 million to the loan fund’s value, PwC estimated.
“Given the base assumptions, we found that the structure of the loan program could yield sufficient returns to enable CIRM to perpetuate its loan program beyond the proposed 10 year window, if CIRM makes prudent investments and has reasonable levels of losses,” PwC concluded.
Roth said any additional money CIRM generates through the loan program will be plowed back into the agency.
“We intend to recycle that back into more loans and/or grants — either one,” Roth told BRN.
CIRM’s loan program would help the agency maintain its distinction as the world’s largest source of stem cell research funding, having approved a total 229 research and facility grants totaling more than $614 million — including the 23 New Faculty II grants totaling $59 million approved for 23 California researchers on Aug. 13.
California’s creation of CIRM and its funding of stem cell research were responses to the difficulty of obtaining such funds — especially in the so-called valley-of-death period — due to the risk of such investments, and their longer-than-traditional return on investment.
“Where CIRM fits is in between before seed money and after seed money, and prior to venture investment in most cases, not in all cases,” said Jeff Karan, a senior partner with Proteus Venture Partners in Palo Alto, Calif., a venture capital firm focusing on regenerative medicine companies, during a panel discussion at the 2008 Biotechnology Industry Organization International Convention, held in June in San Diego.
But because the timeline is longer and regulatory reviews more detailed for introducing new products to the market, Karan said, “I think unfortunately we’re seeing that valley of death show up more than in one stage [of a] company life cycle,” Karan said.
Traditional sources of capital are not easily available to companies in that so-called valley, he acknowledged, even as the climate for private investment in stem cell startups has warmed in the three years since CIRM’s creation.
Proteus itself reflects that situation. Last month, it told the San Francisco Business Times it was lining up lead investors for a $225 million firm that will fund 10 to 15 regenerative medicine companies at levels of between $10 million and $20 million. The companies could be at various stages, from early-stage research spun out universities to public companies with clinical trials.
The climate for stem-cell investment, Karan told the convention panel, continues to be chilled by issues of regulation, intellectual property, and technology — including the creation, expansion, and controlled differentiation of cells for therapies [BRN, June 30].
“The pushback we get from institutional investors and other venture capitalists is, ‘You’re not going to see a return in five to seven years,’” Karan said.