Even With New Crowdfunding Rules, No Easy Path Forward For Biotechs

Xconomy National — 

[Corrected 11/3/15, 1:18pm. See below.] As Xconomy reported Friday, the U.S. Securities and Exchange Commission has finally filled in the missing pieces in the equity crowdfunding puzzle, giving private startups clearer rules about selling equity to the investor masses through Internet portals.

In her opening remarks before the SEC commissioners voted 3-1 to approve nationwide regulations, the SEC chair Mary Jo White said Americans would soon be able to help out their neighborhood bakery, for example, not just by buying bread but by buying shares. (Alas, she didn’t use a more leavened metaphor, like owning “a few sweet crumbs” or “a warm buttery slice” of that platonic American bakery.)

Highly technical businesses don’t smell as good as patisseries, but they are likely to test the equity crowdfunding waters, too. One of the best tests of the new rules, indeed, will be how many life sciences companies look to the crowd to raise cash.

Some have already been trying to reach a broader base of wealthy investors by conducting early fundraising through Internet portals. But many were still operating under older SEC rules that only allowed them to raise cash from accredited investors—read, people who can prove they are rich. Until the SEC approved rules for equity crowdfunding last week, the great masses of ordinary people had much more limited opportunities to invest in private companies. They could contribute to companies through crowdfunding platforms such as Kickstarter and Indiegogo. Instead of equity, they could only receive thanks in the form of swag, such as T-shirts or plant seeds, or simple shout-outs of acknowledgment, as this father-and-son gene therapy team have promised.

Among the SEC regulations to take effect next year are a $1 million annual cap that companies can raise; an annual limit on what an investor can bet, based on his or her income and net worth, up to a maximum of $100,000; and an exemption that gives first-time issuers a pass on preparing a formal audit.

With all that, will the floodgates open for U.S. life science companies? Let’s look at several factors, starting with a baseline comparison with what’s happening across the pond. Europe has allowed equity crowdfunding for years, but biotechs there haven’t used it much to raise cash. According to a report released this summer by German consulting firm Biocom, 42 European life science companies have completed crowdfunded campaigns, raising nearly €23 million ($25 million) total. That’s over five years. The average was €550,000 ($606,000); nearly a quarter of the firms raised €1 million ($1.1 million) or more. [A previous version of this story misstated the average fundraising figure, using millions instead of thousands of dollars.]

Most of the activity has been in the U.K. and France, where rules have been set out to “highly support investments in risky technology companies,” according to the report’s author.

Wait a second, says one U.S. life sciences crowdfunding proponent, Europe’s track record is not an appropriate gauge for predicting the spread of equity crowdfunding in this country. “Europe has less of an individual investor culture than the U.S. and far less venture philanthropy,” says Greg Simon, CEO of the equity crowdfunding portal Poliwogg.

Simon also says we need to wait for the “hockey stick” growth pattern to emerge; that is, the curve of activity that starts slowly and suddenly explodes upwards. It happened with donation-based crowdfunding, and the same will happen with equity crowdfunding, he says. European crowdfunders have not yet proved his theory. The activity in Europe has been heaviest in recent months, but the totals remain microscopically low.

No surprise, Simon and other intermediaries—the portals looking to connect companies and investors and make tidy fees in the process—are bullish.

Another portal focused on healthcare, AngelMD, until now has only allowed an elite slice of investors on board—physicians wealthy enough to be accredited. The site has 2,000 registered investors and nearly 700 startups in its catalog. CEO Tobin Arthur says AngelMD will open the gates wider next year, starting with non-physicians and “most likely” non-accredited investors.

What’s more, AngelMD will raise its own cash to invest alongside its members. It plans to start with a $10 million fund, then raise another in the $50 million-$100 million range next year, says Arthur.

That’s fine in the SEC’s book, to some extent. The agency said Friday that intermediaries can take equity stakes in the companies they list only as compensation for their services, and only on the same terms the general investors receive. Those rules mean AngelMD and others that want to invest aggressively will also have to navigate the legal waters carefully.

To gauge entrepreneur enthusiasm, I took a very unscientific poll of tiny San Francisco Bay Area startups—ones most likely steeped in the Silicon Valley stew, where the donation-based version of crowdfunding has gained the most traction—and I got a mix of reactions.

Alice Zhang is a first-time CEO at Verge Genomics in San Francisco, which recently graduated from the Silicon Valley accelerator Y Combinator and aims to analyze multiple genes at once in human tissue to find drugs for neurodegenerative diseases. The firm just raised a $4 million seed round from small institutional investors, but while out fundraising, Zhang says she was approached by Internet portals with crowdfunding-like pitches. She didn’t need their money, but in listening to their pitches she became uncomfortable because “it wasn’t always clear whether the money would be coming personally from them or be crowdfunded.”

Not only was their approach confusing, but they couldn’t compete with her belief that “institutional investors are more prestigious, more well-connected, and add value to a company.”

Not all budding entrepreneurs have the same glossy perception … Next Page »

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