Out-Law Guide | 15 Jul 2021 | 10:17 am | 4 min. read
Founders that put the basic corporate and commercial documents in place, plan ahead before entering licensing arrangements, spend smart on protecting their intellectual property, take advantage of available tax reliefs and grant funding, and find ways to retain and recruit talent, will be well placed to grow their fledgling biotech business.
In practice, the bigger venture capital (VC) funds will insist that the biotechs they are investing in sign up to their corporate documentation, but it is helpful for biotechs to have their own paperwork in place as a starting point. Standard corporate documents, such as those endorsed by the British Private Equity & Venture Capital Association (BVCA), can be a springboard for early stage VC investment, and can be adapted for angel investment too.
Common issues that can be overlooked are what happens in the event of a disagreement between founders or if one or more of the founders wish to leave the organisation
One of the standard corporate documents is the articles of association, which are the written rules that govern how the company will operate. In the UK, a biotech and its shareholders must comply with its articles of association, and they must be registered at Companies House – the public register for all companies in the UK.
A founders’ agreement will set out the split of rights enjoyed by each of the founders of the biotech at the outset. Common issues that can be overlooked are what happens in the event of a disagreement between founders or if one or more of the founders wish to leave the organisation. In respect of a company, a founders’ agreement can give the founders some comfort that shares owned by founders who are leaving can be returned to the company.
Once external investors are involved, a subscription agreement or letter will set the terms on which new investors invest in the company and a shareholders’ agreement will set out the rights of shareholders and obligations of the management, being directors, of the company.
By using confidentiality agreements, biotechs can protect their valuable proprietary information and know-how, thereby protecting their current and future strategic assets, including important Intellectual property such as patents.
Employment contracts are another important tool in protecting your business and attracting investment. Intellectual property (IP) is central to the value and growth of a fledgling biotech, so ensuring junior staff are signed up to contracts that clarify that any IP they generate belongs to the company is vital.
VC investors will require founders to assign any IP they own personally to the company.
Early-stage biotechs commonly need to partner with others to progress their R&D. However, before tying themselves into commercial arrangements, it is important that founders think ahead to where they want their company to be in 10 to 15 years’ time. That exercise will assist founders in understanding the licensing terms they can accept, and those that may be disadvantageous and prohibitive in the years ahead when they may be seeking to licence out their IP for commercialisation.
Universities are regular partners for early-stage biotechs, providing them with access to laboratories and a pool of scientists who can work with them to advance their R&D. One of the common pitfalls for biotechs to avoid is entering into agreements that are later difficult to terminate as that can be a barrier to future licensing deals and investments.
A biotech that has a sound IP strategy will be in a better position to demonstrate its value to investors and partners
With cash tight, biotechs also need to box smart with their IP strategies by protecting their own IP and also developing awareness of potentially useful or obstructive IP belonging to third parties (third party IP).
A ‘freedom to operate’ (FTO) assessment can consider the IP landscape – in particular, patents – and provide guidance as to which activities are likely to infringe third party IP and also identify opportunities that are still open to innovation, thereby maximising their R&D.
Similarly, biotechs will want to secure patents for their own innovations. However, this strategy should be carefully calibrated to focus on innovation and IP which is likely to be the most valuable in the biotech’s target fields and markets. Typically, biotechs will want to register their patents in Europe and the US; with prospective investors and partners commonly attributing value to patents and other IP registered in those markets. Consideration should also be given to the protection of other valuable rights, such as confidential information and trade secrets.
As R&D progresses, new opportunities may arise. This may require a change in the scope or types of patents being secured and also necessitate further FTO assessments and other strategic reviews of the IP landscape.
A biotech that has a sound IP strategy will be in a better position to demonstrate its value to investors and partners.
Fledgling biotech companies face a challenge in accessing the cash they need to operate and grow, so getting tax relief – particularly in the form of cash back – can be extremely valuable.
The main form of relief that biotechs are likely to be eligible for is R&D tax relief for SMEs
In the UK, the R&D tax relief system is currently under government review, with potential implications for life sciences companies. As it applies currently, there are opportunities for biotechs to benefit significantly.
The main form of relief that biotechs are likely to be eligible for is R&D tax relief for SMEs. Where certain conditions are met, relief is available for SMEs in the form of an effective deduction of 230% on qualifying R&D costs. Loss-making SMEs may have the option of receiving a cash repayment of the tax credit in return for surrendering R&D related losses. Any repayment is capped at 14.5% of the losses available for surrender. For accounting periods beginning on or after 1 April 2021, any repayment is also subject to an annual cap of £20,000 plus three times the company’s total PAYE and national insurance contributions’ liability.
The reason why the SME relief is particularly useful to biotechs is because SMEs that sub-contract R&D activity to others can still benefit from the relief available themselves. It is common for biotechs to partner with universities on R&D, for instance, to access research labs and talent. Biotechs would be at a significant disadvantage if they were not eligible to claim tax relief for the R&D activity undertaken by those they collaborate with.
Another initiative relevant to biotech start-ups is the Enterprise Management and Incentive (EMI) scheme, which is a tax-advantaged employee share scheme in the UK that is pivotal to attracting and retaining talent.
The tax advantages of an EMI option means that no income tax or National Insurance contributions are payable on the grant
Fledgling biotech companies are unable to pay the salaries and competitive benefits packages that larger life sciences companies can offer, so being able to remunerate staff through a share scheme that costs little in cash to set-up and offers employees, and employers, tax advantages in return gives those start-ups a better chance to hire the quality of staff they need. Biotech companies can structure EMI options in such a way to incentivise staff to meet performance conditions and they are often granted subject to leaver provisions to not only help in recruitment of staff but also in retaining them.
Options work by giving employees a contractual right to acquire shares in the future, at a price fixed at the date the shares are granted. In the case of biotech start-ups, the future acquisition date is generally linked to a liquidity event such as an initial public offering (IPO) or share sale, meaning employees can exercise their right to sell the shares acquired at such times.
The tax advantages of an EMI option means that no income tax or National Insurance contributions (NICs) are payable on the grant, and, assuming the option was granted at market value, no income tax or NICs are payable upon the employee exercising their EMI options.. Instead of paying income tax, employees will pay capital gains tax (CGT) on the sale of their EMI option on the full growth in value between grant of the option and sale of the shares.
A company must meet a number of qualifying conditions before it can grant EMI options and a number of legislative requirements must be met in order for the employees to benefit from the advantageous tax treatment available. Biotch companies wanting to take advantage of the benefits of EMI options to recruit and retain employees are advised to take specialist advice before proceeding, not least in respect of agreeing the market value of their shares with HM Revenue & Customs (HMRC) before the options are granted.
Biotech start-ups can be caught out by rules that apply to raising capital.
Financial promotion rules under the Financial Services and Markets Act (FSMA) can be strict, but biotechs that confine their promotional activities to seeking money under high-net-worth-individuals (HNWI) and sophisticated investors will fall within an exemption. It can be helpful for biotech companies to obtain certificates to confirm that those they are seeking investment from are HNWI or sophisticated investors.
Similarly, to avoid having the burden and cost of preparing a prospectus when raising private capital, biotechs will want to ensure they fall within an exemption. This means limiting their fundraising to less than £8 million or targeting less than 150 people with their pitch for investment.
Pinsent Masons specialise in advising biotech and medtech clients throughout their development and product lifecycle. Our innovative Biotech Express solution helps fledging biotechs to operate on a sound legal footing, for a fixed-fee.
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