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Mission-Based Biz Model Might Benefit Biotechs

By Trista Morrison
Editor

This year, California became the seventh state to allow benefit corporations and the first state to allow flexible purpose corporations. Both are new business structures with a non-profit flare; they let companies pursue a social mission and make decisions based not only on profit maximization for shareholders, but on non-financial factors such as the interests of their employees, community and environment.

Since all biotech companies are, by definition, pursuing the social mission of improving human health, they might qualify for these new business structures. But the capital intensity and complexity of drug development present challenges to making these structures worthwhile.

Benefit corporations, sometimes referred to as B-Corps, are allowed under state law in California, Hawaii, Maryland, New Jersey, Vermont, New York and Virginia. Most biotechs are incorporated in Delaware, which has not yet jumped on the B-Corp bandwagon, but supporters of the legislation said they are in discussions with the state and expect it to come on board once the B-Corp movement gains enough momentum.

B-Corps are defined by their purpose, accountability and transparency. They must have a general positive impact on society and the environment, but they can also define a specific purpose such as providing a beneficial product to impoverished customers or donating a percentage of their profits to charity. The company's directors and officers must consider all stakeholders, not just investors, and they have the discretion to give particular stakeholders priority as long as it serves their public benefit purposes – even in liquidity/sale decisions.

There's no oversight committee that certifies B-Corps, although each must have an independent benefit director prepare an annual report assessing its overall social and environmental performance against a third party standard. As Heather Van Dusen, community development head for nonprofit B Labs – a supporter of the B-Corp movement – explained, "they have to use a ruler, but no one has to measure them."

That makes B-Corps distinctly different from "Certified B-Corps." The latter are not governed by any state law, they are simply companies that have voluntarily agreed to meet certain social, environmental and legal standards and thus been certified by B Lab, much the way TransFair certifies Fair Trade coffee or USGBC certifies LEED buildings.

Closer to a B-Corp in structure is the flexible purpose corporation, or FPC – a model that thus far only exists in California. The difference is that while a B-Corp must support general public benefit, an FPC can choose a particular public benefit, such as rare diseases, to the exclusion of others, such as environmentalism. An FPC can also create its own standards by which to measure its success. But since its social goal is narrower, the company can only make decisions contrary to shareholder value when they support that specific goal.

Thus a biotech company that wanted to have a social mission exclusively focused on healthcare might consider becoming an FPC, while a biotech that wanted to focus on healthcare and also meet higher social and environmental standards might consider becoming a B-Corp.

Neither B-Corps nor FPCs are non-profits; they are still taxed as a C or S corp. A company can become a B-Corp or FPC by including the appropriate language in its articles of incorporation, either upon founding or upon approval by the existing shareholders in a two-thirds vote.

Understanding the Benefits

What benefit, exactly, a biotech might get out of structuring itself as a B-Corp or FPC remains unclear.

The main benefit is that such structures allow directors of a company to have "lightened liability, and more discretion to take into account considerations other than profit maximization," said Lisa Tran, associate with law firm Paul Hastings.

So theoretically, such a company might have more freedom to reinvest its profits in its pipeline rather than paying out a dividend – but development-stage biotechs have no profits. Or perhaps the structure might allow a biotech to price its product at a level it feels is fair to patients and sustainable for the healthcare system rather than at the maximum the market will bear – but the majority of biotechs involved with pricing a product must do so in collaboration with a big pharma partner that would likely overrule such a strategy.

Van Dusen noted that the structure might give a company greater appeal with impact investors, or with nonprofits. Biotech companies already receive a fair amount of venture philanthropy money from nonprofits, but it is possible a nonprofit might be more enthusiastic if it knew the biotech's articles of incorporation contained a commitment to a certain disease or approach.

Rob Carlson, partner with Paul Hastings, agreed that socially conscious investors and nonprofits might be attracted to the model, as might certain wealthy individuals, family foundations and academic organizations. But that attraction might come at the expense of interest from traditional venture capitalists, he cautioned.

Even so, Carlson noted another benefit could be a company's desire to set up a structure that helps it remain true to the mission of the founders even as the company grows. It would be easy for a company closely held by a few founders to vote to convert to a B-Corp or FPC, with the understanding that "they may not be the only shareholders forever," he said – particularly in the capital-intensive, dilution-heavy biotech industry. Of course, if the shareholder base grows, enough of them might vote to reverse the B-Corp or FPC status, or a big pharma might acquire all the shares and then do the same.

But, Van Dusen said, if the B-Corp or FPC status has by that point become a significant contributor to brand loyalty or employee morale, the acquirer might think twice about changing things.

Experimenting with the Structure

That's what Lisa Conte, CEO of Napo Pharmaceuticals Inc., is hoping.

Napo has a subsidiary called CAP Global that is a Certified B-Corp. While Napo develops lead product crofelemer for diarrhea-predominant irritable bowel syndrome and AIDS-related diarrhea, CAP global is developing the product for pediatric indications.

"The people who die from diarrhea are small children with no resources," Conte said. Thus rather than seeking approval of the adult formulations and pursuing pediatric use sequentially, Napo wanted to advance the pediatric product "simultaneously in an accelerated way." The solution was to set up a subsidiary as a Certified B-Corp.

The business model "indicates to investors that what they are supporting is not going into general purpose funds but is earmarked for the pediatric product," Conte said. She noted that Napo already considers itself a triple-bottom-line company, and about 30 percent of its investors are mission-based. The creation of CAP Global as a Certified B-Corp attracted a couple of new investors, but also resonated with existing investors.

Conte added that her understanding is, should Napo be acquired, the board has to at least consider CAP Global's commitment to pediatric development of crofelemer; they can't just decide it would be financially better to dump the pediatric formulation. But as Conte emphasized, the pediatric indication is crofelemer's largest market, so getting there sooner will actually make the company more money.

"There is nothing in our mission or what we've done that is a compromise to shareholders," Conte said. "If the only thing you care about is money, money, money – or the only thing you care about is the unmet need – it doesn't matter. The two are indistinguishable because you achieve both."

B Lab estimates there are about 70 B-Corps in the U.S.; only two FPCs are known thus far. There are 521 Certified B-Corps. "We are at the beginning of a shift in corporate structure," Van Dusen said. She predicted that additional ideas for socially responsible business models will begin to arise, and companies will have to experiment to "see what sticks."