San Diego Biotech Gets Boost From Reform Tax Credit

SAN DIEGO — Small biotech, medical device and life sciences companies in San Diego have a chance to go after free money.

Signed into law with the health reform package, the Qualifying Therapeutic Discovery Project Tax Credit will make $1 billion in federal funding available to biotech companies engaged in projects aimed at:

  • Advancing unmet medical needs;
  • Preventing, detecting or treating chronic illness;
  • Reducing long-term health care costs; and
  • Curing cancer.

To qualify, companies need to demonstrate that their work will help to reduce the long-term costs of health care, advance U.S. competitiveness in the fields of life, biological and medical sciences, and help to create and sustain high-quality, high-paying jobs in the U.S. 

San Diego is home to nearly 500 biotech and therapeutic companies, most of which have fewer than 250 employees — a requirement for application. No more than $5 million will be granted to each company for research and development costs incurred in 2009 and 2010 in the form of a 50% tax credit toward qualifying research costs. Companies can also opt for non-taxable cash grants in lieu of the tax credit.

“The option to take it in the form of a grant is very valuable to start-up companies, many of which generate losses for the first five to 10 years and only at the end of the process start to generate income to make a tax credit useful,” said David Kahn, a partner in the Los Angeles and San Diego offices of law firm Latham & Watkins.

The Shrinking Pot of Gold

Up until the Treasury released guidelines on May 21, few details about the application process were known, sending biotech firms into a whirl trying to figure out how to guarantee their piece of the $1 billion pie.

“When it was first enacted, no one knew how it would be divvied up,” Kahn explained of the $1 billion. “What if it’s first-come, first-served and all the money is gone? I’ve never seen activity quite like that in the tax world before.”

As it turns out, the pot of money will be equally divided among projects that HHS and the Internal Revenue Service determine meet all criteria. While the maximum payout is $5 million per project, most qualifying firms are unlikely to see that much money because most experts believe thousands of companies are likely to apply.

Kahn says since the notice was published the number of questions he’s received about the program has dropped markedly.

“Is it because they’ve come to the conclusion that there are likely to be a lot of applicants, and the pot is not so big?” he asked.

While disappointing, Bruce Steel, chief business officer at Anaphore, a biotech firm based in San Diego, doesn’t think the prospect of less money will be a barrier. “Most companies will view any money as worth pursuing,” he said.

Anaphore is among many San Diego-based biotech firms preparing to apply. The company is testing a new class of drugs aimed at treating a number of serious and life-threatening diseases — including cancer, a cure for which the government has identified as a top priority.

Steel expects there will be a large number of qualified applicants. But that won’t keep small firms away, he said. “The possibility of a lower dollar amount isn’t dampening enthusiasm. People will still get applications in. Any money is good money.”

Still, there’s no denying the decrease in action since the May 21 notice, tax experts say, and privacy concerns could be another reason for the decline.

“The information provided in the application can become public record,” said Shane Orr — senior tax manager with Grant Thornton, an accounting firm based in San Diego. “The companies I’m working with are still going to file,” he said, but acknowledged that privacy issues have soured some to the process.

In Need of Money

That the Therapeutic Discovery Project Tax is delivering pennies from heaven is a sentiment felt by many in the biotech industry, which is highly dependent upon venture capital funding that has all but dried up over the past few years.

“The industry is clearly in need of additional funding,” said Ian Wisenberg — a consultant with CFO Connect, a company providing business management and financial services to venture-backed early- to mid-stage life sciences and technology companies. 

“There’s this thing called the ‘valley of death’ where you can’t get money between research and Series A financing, so this kind of additional stimulus is very important for our industry to promote innovation and drug development,” he said. Most Series A investors are venture capital funds backing the early stages of a company.  

Challenges of Applying

If things have quieted down in past weeks, Orr said, it’s partly because companies are putting their heads down to craft a winning application, which is due to the Treasury Department no later than July 21.

“A lot of applicants have gone silent because there is a significant amount of guidance to grasp and to prepare the documentation,” Orr said.

One of the challenges companies will face, according to Wisenberg, has to do with the heavy reliance the industry has on consultants, such as contract research organizations (CROs), and the requirement that firms demonstrate evidence of contributing to a U.S.-based workforce.  

“Proving the costs of consulting to build up full-time equivalents is something that will be a challenge for most companies,” Wisenberg said. Most biotech firms can only track the amount of money they’ve spent on CRO services, not how many people are actually working for them within the vendor organization.

“It’s not an insurmountable challenge, but one people should keep in mind,” Wisenberg said.

And while the application is not as complicated as initially anticipated, simplicity doesn’t always translate to ease. A strict word limit has been placed on each section, keeping the application brief, but requiring companies to bring their project to life in very concise language.

“By design, this is not intended to be long, so it’s important to put it together in a way that answers the questions competitively,” said Joe Panetta, CEO of BIOCOM, the San Diego life sciences trade group. He added, “It’s not complicated, but it takes the ability to understand how to respond to a government form.” 

For that reason, Panetta said San Diego firms should not to go it alone. “Experts can be very helpful in pulling together a competitive application,” he said.

Bringing Jobs to San Diego

Any money flowing into the biotech industry is good news for the San Diego job market. 

“I think it will have an impact because the challenges companies have had have been to bring in the additional funding they need to hire and grow the workforce,” Panetta said, adding, “Any additional revenue they can bring in to hire people will be significant.”

Still, this tax credit only scratches the surface of what’s needed in the industry, experts acknowledge.

“It will have a bigger impact on the industry if [the government] does this on an annual or bi-annual basis,” Wisenberg said, adding, “I think when the government sees the amount of interest in the program and how many companies apply and get so little … hopefully they’ll see that as a reason to continue.”

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