How can nonprofit funders help launch your biotech startup?
Technological progress is the bedrock that supports human society, from the development of agriculture through the creation of the Internet, and philanthropists have long played an important role in supporting scientific discovery. The expectation has been that the marketplace could accept the fruits of basic research and translate discovery into commercial impact. Although technology transfer from research institute to corporation is still an important mechanism, truly groundbreaking science often requires scientist-entrepreneurs who are intimately familiar with their technology to see it through to fruition. Unfortunately, early-stage startups engaged in hard scientific problems often struggle to find support. Venture capital has trended toward later-stage companies and toward the web-based economy, with its easier development paths and faster returns.
At the Thiel Foundation's Breakout Labs, we use philanthropic dollars to help visionary scientist-entrepreneurs take the first critical steps to turn a breakthrough into a legacy for humanity. We believe that philanthropy can and must step in to bridge the gap between research funding and market-rate investors, by empowering entrepreneurs to transition from scientific discovery to commercial development. Often the steps required are not huge or groundbreaking in and of themselves—they can be as relatively straightforward as a prototype or a set of validation experiments and can be completed within a year or two with the right support. A modest infusion of capital at the earliest stages of a company's life cycle can support achievement of the scientific and technical milestones that are necessary for attracting the much larger investments required to bring products to market.
Breakout Labs is not alone, of course, and there are a growing number of philanthropic entities that can help a bioentrepreneur get a company off the ground. This article describes how we've developed support for our companies and where you might look to get support for yours.
The Breakout Labs model
The Breakout Labs program is based on a revolving fund of philanthropic operating dollars, which sits within the Thiel Foundation (San Francisco) and supports scientist-entrepreneurs as key effectors of technological innovation. Whereas benefactors in the foundation world are very comfortable supporting nonprofits, the interaction between foundations and the for-profit world is typically limited to program-related or mission-related investments, which are legally constrained to a very small fraction of a foundation's wealth, require coordination between the foundation's investment and philanthropic arms, and, as a result, are not widely used.
However, given widespread acceptance of the 'valley of death' in the biotech product development cycle and comparable gaps in other industries, we felt that a hybrid vehicle—neither a pure grant nor a market-rate investment—was required to spur the kind of radical innovation we aim to support.
Our funding agreements typically range from $200,000 to $350,000, and they include R&D milestones that may require anywhere from 6 to 24 months to complete. If we have built contingent milestones into the agreement, we tranche funds accordingly, with subsequent funding dependent on reaching the first milestone. The amount of funding offered is on par with phase 1 Small Business Innovation Research (SBIR) grants ($150,000 over a six-month period) and other early-stage investments (e.g., the new synthetic biology accelerator IndieBio, which invests ∼$250,000 in seed funding to its companies1).
In our grant agreement, funded companies retain intellectual property (IP) that arises from their work, while committing a modest, capped royalty to the foundation, as well as a small equity stake, which is based on the valuation given at the company's first equity financing round. These terms are standard, transparent and non-negotiable. They are designed to be generous, while providing a clear signal to subsequent investors that we are focused on the commercial potential of the team and the technology. Our estimate, over a time horizon longer than market-driven investors can tolerate, is that at least half of the money we distribute as grants will ultimately be returned into the fund. Thus, with continued additional philanthropic input, we should be able to grow available capital over time and build a community of entrepreneurs who 'pay forward' their success to support the next generation of scientific and technological innovation.
Our terms also contain an incentive, in the form of warrants, for companies to raise additional funding within a year. Once a company has received funding from Breakout Labs, it must raise at least $1.2 million in financing (including nondilutive) from outside sources within 12 months of the grant agreement. If not, we accrue warrants exercisable for an additional 6% of our converted equity stake in the company each month until this level of financing (or an equivalent event, such as an acquisition) occurs. We added this clause to our terms, in part, to make it clear that we expect our companies to move quickly and maintain their velocity, and in recognition of how quickly cash gets used and how long fundraising takes. Entrepreneurs are never not raising capital.
We know that a company's capital needs do not coincide with specific months on the calendar, so we welcome preproposal inquiries throughout the year. Our web-based preproposal form is the primary mechanism of initial contact with and assessment by Breakout Labs. Although we meet many startups through our interactions with the entrepreneurial ecosystem, most of our funded companies have applied based upon publicity or word-of-mouth, rather than direct interaction with us. If invited in, full proposals are assessed through a formalized process, which includes outside technical experts and in-house scientists and investors, and is based on the criteria in Box 1.
Philanthropy and for-profit entities are not a straightforward mix. To create a program to specifically place tax-advantaged dollars into companies, we use an internal revenue service–approved grant structure known as Expenditure Responsibility Grants. This means our companies contribute to the public good as effectors of technological change. Although the primary 'public good' these companies provide through our philanthropic support is a product or service that will put scientific advances to work in society, an additional requirement of our grant agreement is that at an appropriate time, companies must disseminate research results through open-access publication (without compromising commercial opportunity).
Our funding vehicle is not without its challenges. Clauses in our grant agreement call for access to technologies that we fund, in the event that companies are unable to take them forward—this has been viewed with suspicion by startup lawyers, who after all, are paid to find any potential loophole their clients might eventually suffer over. Despite having funded 26 companies to date with very little change to our grant agreement, each new company and lawyer must be walked through the various scenarios and understand our intentions in the agreement.
Since we began accepting proposals in November 2011, we have received more than 1,000 preproposals, and we have funded 26 companies, the majority of which are engaged at the intersection of biology and technology (Table 1). Because we accept and fund proposals on a rolling basis, it is difficult to judge the performance of the whole portfolio at any given moment. The typical pattern we have observed (and which is, no doubt, in part due to our selection criteria) shows that after receiving our funding, companies will raise $1–2 million more in the form of a convertible note from angel investors, family offices, matching economic development funds and government grants, before going on to raise an equity round, typically from venture capitalists, within two to three years.
Although we do not expect returns to the Breakout Labs fund for several years, we can track intermediate success. With less than $10 million in philanthropic investment, so far our portfolio has generated over $100 million in value in just four years. Our companies have gone on to raise six times the money we invested, and they are four times as likely to secure federal SBIR or Small Business Technology Transfer (STTR) grants than the average acceptance rate. One of our portfolio companies was acquired; five others closed series A funding in 2014, with several more raising funds in 2015.
Of major advantage to our companies is the good will that flows into our program, because it operates within a philanthropic organization. It begins with scientific experts from around the world who review proposals for us for a small honorarium. Most have not heard of the program before we contact them, but almost all are willing to sign our nondisclosure agreement and lend their expertise to our decision-making process. One reviewer became so interested in a proposal that he became a scientific advisor to the company subsequent to our funding.
Then, when companies join our program, they benefit from connections we have built with corporate strategic partners, investors, family offices, IP attorneys, public relations experts, human resources talent, accountants, regulatory consultants and more. These people recognize the value of encouraging a startup ecosystem and see the advantage of leveraging the foundation's initial support. This network has turned out to be perhaps the most valuable resource our companies gain from association with Breakout Labs. We have a portfolio director dedicated to building out and maintaining this network. When we bring a new company into the Breakout Labs fold, among our first actions is to discuss their specific needs going forward and to make new connections on their behalf where we identify gaps in our network.
Although we have built our program to scale as we grow our portfolio, it is necessarily a high-touch enterprise. We take an old-fashioned approach to building relationships with our companies, modeled more on the matchmaker of yesteryear than match.com. Moreover, as part of our grant agreement we take a board observer seat—something that company lawyers may contest but often can be a valued service, particularly when companies do not yet have strategic boards established. By enforcing the structure of regular status update calls, we are able to help our companies maintain a focus on their business goals while they are working through research goals. When their boards do mature with the addition of external investors, we still often find ourselves called upon for advice as trusted advisors with a long-standing relationship.
Philosophically, ours is a bottom-up approach, which is to say that we aren't omniscient enough to know when technologies have grown to meet a particular need, such as curing cancer. Therefore, we find it inefficient (if not impossible) to fund a particular need, if the science is not yet ready to follow. The result of this philosophy is that our companies span a much larger range of technologies than are typically brought together.
This range can be difficult to support, both from the diligence and program perspectives, but we've found that our companies nonetheless directly benefit from interaction with one another. Silos like “biotech” do not always capture the breadth of scientific platforms and may limit creative thinking for company building. Our portfolio company, Modern Meadow, for example is a biotech engaged in new materials. Another of our companies, nanoGriptech, shares potential customers and investors with Modern Meadow, but only touches the life sciences by virtue of the “bioinspired” design of its materials. Many of the challenges in bringing technologies to market are universal, whether one is creating space propulsion technology or biofabricating meat, and we've found similarities in guiding companies through the uncertainties of technological de-risking, fundraising and team building. When we bring our entire group together in San Francisco—something we do twice a year—we solicit programming requests; more time to interact with each other is usually high on the list.
Find your support
Scientific entrepreneurs require three things to build their companies: capital; mentorship and networking; and physical infrastructure. Breakout Labs provides capital and mentoring early on, but we do not develop a physical space for our companies, mostly owing to their scientific range and, in some cases, important ties with their local scientific ecosystem. But, there is a range of other models out there, offering varying combinations on those three core needs.
Entrepreneurs seeking to start ventures in the United States have an expanding range of options to explore the commercial potential of their technologies. The US National Science Foundation (NSF) and the US National Institutes of Health (NIH) I-Corps programs offer grantees mentorship and a small amount of financial support to develop commercialization hypotheses and engage in market research with potential customers. Many universities also offer similar exploratory opportunities. For example, one of our entrepreneurs was first supported through the MIT Deshpande Center (an MIT program supported by the Deshpande Foundation); another benefited initially from the University of California QB3 Start Up in a Box program; a third came through Stanford's StartX Med program. Many academic institutions also have associated seed funds to invest in emerging startups.
The SBIR and STTR programs are in many ways intended to address a similar stage of transition as our grants, from laboratory research project into commercial focus. The funding levels are roughly similar to ours, but support is strictly financial, and the use of funds is restricted. For example, SBIR and STTR funds cannot be used to file or prosecute IP or for general laboratory infrastructure. Although nondilutive capital can be hugely beneficial to companies, and we encourage our companies to seek it out from public and nonprofit sources, it should be noted that it is very difficult to build a company on such sources alone, and companies must be careful not to let the attraction of free money take them in directions that are not aligned with their business objectives.
Bioentrepreneurs in the energy sector should also investigate the PRIME Coalition, a nonprofit seeking to catalyze innovation in energy by bringing together philanthropies concerned with reducing greenhouse emissions2. It recently announced its first investment, Quidnet Energy (Framingham, MA, USA) a startup developing grid-scale energy storage. Also in the energy sector, the Clean Energy Trust has a philanthropic model that closely matches the Breakout Labs fund. Given the disillusionment of the investment community with 'clean energy' and the obvious need to develop new technologies, these new funding sources are welcome.
As mentioned earlier, several foundations, many with an interest in particular diseases, support companies at all stages of their life cycle through program-related investments. Famously, the Cystic Fibrosis Foundation (Bethesda, MD, USA) invested heavily in Vertex Pharmaceuticals (Boston)3. These are typically investments that are made first and foremost out of mission alignment, not financial return (e.g., treating cystic fibrosis). Specific to early-stage investments, we are only aware of The Wellcome Trust's (London) program to support small companies with program-related investments, through its Translation Fund and Seeding Drug Discovery Fund.
Meanwhile, a cadre of incubators has arisen, particularly in the life sciences, to support companies at similar early stages through networking, guidance and laboratory space. A variety of financial models accompany these initiatives (which can be for profit or nonprofit), ranging from straight fee-for-service agreements to equity-based models. We find that our companies benefit from the synergy of local, domain-specific support coupled with the nationwide, transdisciplinary perspective we represent. Many of our portfolio companies have found homes in incubators concurrently with or subsequent to our funding, including in Harlem Biospace (New York), QB3 (San Francisco), Janssen Labs (San Diego; San Francisco; Cambridge, MA, USA; Houston; and London), Fogarty Institute (Mountain View, CA) and Matter (Chicago).
Although not a nonprofit, Y Combinator, which is classically associated with the software engineering ecosystem that currently drives Silicon Valley, is now also supporting biotech companies4. In exchange for its mentorship, Y Combinator negotiates with its companies a “simple agreement for future equity (safe)”5. We see this as a brilliant opportunity to bring into the fold a new network of investors, not traditionally attuned to biotech.
We are also excited by new models for networking with investors, such as Propel(x)6, which seeks to provide the much-needed diligence for hard-science companies to help guide angel investors who want to put their money to work in meaningful innovation. There are several investors that regularly follow us into funding new companies, and our imprimatur is often key to companies closing on funds from interested angels who are excited about the company's vision but less confident in their ability to assess its scientific merits. Two of our companies have been listed on the platform; and the Propel(x) team has taken great care to help them present their companies to maximum effect.
Foundations exist, in part, to support opportunities that have value to society but cannot be supported by a market driven strictly by financial incentives. We, and others7, would argue that startups in the hard sciences fall distinctly in that category. Society clearly agrees that 'translation' should be a key goal for science even at its earliest phases, and research proposals increasingly ask about potential impact on society. However, the incentives associated with academic success—novelty and high-impact publication—do not necessarily coincide with commercialization goals, which rely heavily on robustness and repeatability, and, of course, minimizing costs. Startups bring necessary scientific expertise into commercial focus.
Foundations and nonprofit institutions are typically slow to innovate, but many are now experimenting with new mechanisms, for which bioentrepreneurs should remain alert. In principle, our model would be straightforward to replicate. In practice, most traditional grantmakers would need to add expertise and connections from the for-profit world to successfully leverage their financial contribution. Although we support only US-based companies (with the occasional exception from Canada), we originally opened Breakout Labs to companies around the world. However, we soon realized the opportunity (and need) to provide so much more than financial support. That support takes time and resources to build and does not easily scale internationally.
Breakout Labs is a startup itself, an experiment in supporting scientific entrepreneurship. We have not created the perfect program, and our ability to evolve quickly to meet the needs of the ecosystem is critical to our success. We are, for example, currently exploring the creation of a follow-on fund that would allow us to catalyze further growth for our companies. With the current capacity to fund only eight to ten companies per year, we know that Breakout Labs cannot 'solve' the problem of bringing remarkable research advances out of the laboratory and into the economy. We hope to be a part of the creative thinking that must bridge the nonprofit and commercial worlds to create new models for funding true innovation.
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