After a drought of IPOs that stretched back to 2007, the JOBS Act opened the floodgates, resulting in more than 180 biotech IPOs since the law was passed in 2012, William Waddill, senior vice president and chief financial officer at Calithera Biosciences Inc., of South San Francisco, said at the SEC's annual forum on small business capital formation Thursday.

During the drought, biotech start-ups were built to sell before going public. "That doesn't provide for a sustainable industry," Waddill said, as many companies were bought so their innovative ideas could be shelved before they became competition.

The IPO on-ramp provided by the JOBS Act as the country's recession ended changed that. The value of biotechs "went through the roof in a pretty remarkable way," he said, and IPOs became viable for small biotech companies.

That success has increased direct costs for the accounting and legal services related to going public, as well as the first-day discounts. Whereas those discounts were typically 90 cents on the dollar, they're now about 80 cents.

As the drought was nearing its end, auditors, securities attorneys and others employed by biotech firms to help with IPO filings had a lot of "excess capacity," Waddill said, because so few companies were going public. Their fees reflected that; today's higher fees reflect the increased demand for those services.

The costs are even greater for emerging biotechs that don't fit the SEC's definition of "small" because their public float is greater than $75 million – a figure indexed to inflation in 2008 that has not been increased since then, Waddill noted. Due to that cap, many emerging biotechs are exposed to burdensome disclosure rules that require extensive company time and resources.

"The cost of an IPO can be staggering," Waddill said. "The cost of a failed IPO can be doubly staggering, because you're going to go out and do it again."

While biotech investors aren't interested in all the disclosures the SEC requires, the cost of those disclosures can lengthen the development of life-saving therapies and postpone the beginning of a return on what is already a long-term investment. Spending $1 million to fulfill the regulatory requirements for an IPO translates into 10 to 20 patients not being treated in a clinical trial, Waddill pointed out. That delays clinical development, which in turn delays the first dollar in revenue.

Overregulation can curb investor appetite for early stage start-ups in any sector, but the problem is particularly acute in biotech, which needs extensive capital years before it will produce revenue, Waddill explained. Biotech investors "are much more concerned with clinical trial progress and FDA outlook" than they are with the SEC reporting requirements that divert their capital from science to compliance.

The SEC could alleviate the problem by tweaking its definition of small reporting companies (SRCs) and non-accelerated filers. Raising the $75 million public float cap to less than $250 million "would more accurately reflect the state of small businesses on the market," Waddill said.

He also advised adding a revenue test that "would allow truly small companies that may be highly valued to be properly classified." Under such a test, a company with a public float as high as $700 million could still be considered an SRC if its annual revenues were less than $100 million.

WAITING TO BE TESTED

While the IPO on-ramp of the JOBS Act has been a boon for some biotechs, the impact of some of the law's non-IPO provisions has yet to be tested.

One of those provisions is an attempt to revitalize the seldom-used Regulation A as a viable route for small companies to raise much-needed early capital. In implementing the new Reg A+ rules earlier this year, the SEC created two tiers. It lifted the annual $5 million cap to $20 million for Tier 1 and limited offers by selling security-holders affiliated with the issuer to $6 million. The cap for Tier 2 is $50 million per 12-month period, with a $15 million limit on offers by selling security-holders affiliated with the issuer. (See BioWorld Today, March 26, 2015.)

Removing a large obstacle to Reg A offerings, the rules preempted state securities law registration and qualification requirements for Tier 2 offerings sold to "qualified purchasers." Companies traveling the Tier 2 path must submit audited financial statements, undergo SEC reviews and file ongoing semiannual and annual reports.

In an attempt to balance state and federal oversight, the new rules call for Tier 1 offerings, which don't have the ongoing disclosure requirements, to remain subject to both federal and state review.

Since the rules were implemented in June, there have been about 25 Reg A filings across all sectors, Sara Hanks, co-founder and CEO of Crowdcheck, said at the forum. The difficulties in using the SEC's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system makes it challenging to successfully file a Reg A or to determine how many were actually filed, she added.

Another overhang for Reg A is a lawsuit by Montana and Massachusetts challenging the SEC's authority to preempt state Blue Sky review of the private offerings. Panelists at the forum reported anecdotes of securities lawyers steering companies away from Reg A because of the uncertainty created by the litigation.

The Reg A+ caps also could push biotechs away. On average, life science companies need upward of $80 million in capital in a given year, said Chris Weekes, managing director of capital markets at Cowen and Co. While the $50 million cap per filing could work, small biotechs may need to go back to the Reg A well more than once in a 12-month period, he added.

Another JOBS Act provision that could prove challenging for biotechs in search of start-up capital is crowdfunding. The rules adopted by the SEC last month allow companies to run crowdfunding campaigns to raise up to $1 million over 12 months.

Under the rules, individual, non-accredited investors can invest as much as $100,000 each year, based on their income and net worth, in crowdfunding offerings. (See BioWorld Today, Nov. 2, 2015.)

Although the SEC rules won't go into effect until May, 29 states and the District of Columbia already allow crowdfunding within their borders. As of Nov. 1, 119 crowdfunding campaigns had been filed in those states, with 102 having been approved, said Anya Coverman, deputy director of policy for the North American Securities Administrators Association.

Medical device firms are among the companies most active in the state crowdfunding market. The common thread for those companies is that they have a direct, defined consumer base, Coverman noted.

However, the ability of crowdfunding to raise start-up funds on a more substantial basis remains unproven. Its success will depend on the willingness of average Americans to invest and their experience when they do invest, said Rick Fleming, an investor advocate at the SEC. He predicted crowdfunding will work best when the investors are motivated by something other than profit.