Should biotech be part of the state's venture capital program?

The new Badger Fund of Funds venture capital program, which is just getting underway, has been touted as a great start, but it does not permit the state to make venture investments in biotechnology companies.

The same state program that promises to boost private equity deployment through the use of tax dollars and create a new class of young venture investors holds little promise for capital-starved biotechs. Given the stakes for an industry that creates high-paying jobs, biotech industry executives would like the state to adopt a more diverse investment strategy that includes biotechnology, especially when coastal venture capitalists have not stopped trying to convince Wisconsin companies to move and take their high-paying jobs and tax base with them.

Some openly wonder about the long-term implications of excluding a core sector from new investment funds, especially since biotechnology appears to be making a venture capital comeback and Wisconsin biotechs continue to demonstrate a penchant for sophisticated science. Madison-based Exact Sciences has won federal clearance for

Cologuard, its colorectal cancer test, and Cellular Dynamics International, founded by stem cell research pioneer James Thomson, has been awarded a broad U.S. patent covering the automated production of human pluripotent stem cells, including the induced pluripotent stem cells that Thomson helped develop.

Under Act 41, the law that created the Badger Fund of Funds program, a fund manager is directed to deploy capital in agriculture, information technology, engineered products, advanced manufacturing, medical devices, and medical imaging.

All of these industries represent core strengths of the Wisconsin economy, but so does biotech. Biotech, in fact, remains a growth industry here. Between 2007 and 2012, a time marked by a severe economic recession followed by only moderate growth, Wisconsin was one of only 12 states that added at least 1,000 jobs in the bioscience industry, according to a Battelle/BIO report. During that time, bioscience employment grew 8.2% in Wisconsin and wages in that industry increased by 7.2%.

Statewide, nearly 1,400 life sciences companies employ about 32,000 workers who are engaged in pharmaceutical development, research, testing, medical lab work, and medical device manufacturing. The Battelle/BIO report said the average wage in this sector was $72,604, which dwarfed the average private-sector wage of $41,749.

Kevin Conroy, chairman and CEO of Exact Sciences, is among those who believe the fund-of-funds program is a good start, but he also wants either the enabling legislation or additional legislation to follow the lead of other Midwest states. That means providing venture capital that could be used broadly by biotechnology and life sciences companies to strengthen an already strong industry. “I particularly believe that stem cell companies, including embryonic stem cell technologies, should be included in any future legislation,” he stated.

Stemming the tide

One key reason why biotechnology investments were excluded from Act 41 is that the Republican legislative majority did not want state investment dollars directed toward companies that use human embryonic stem cells in any part of their operations.

Conroy and others believe the concern is overstated. He noted the vast majority — 95% — of investments in life sciences companies are made outside the stem cell space, yet the stem cell debate seems to be controlling the broader discussion about investing in the fundamental research that comes out of the University of Wisconsin.
Elizabeth Donley, CEO of Stemina Biomarker Discovery, a Madison-based life sciences firm, noted that about 60% of the technology created in the entire University of Wisconsin System is biotechnology-related. To her knowledge, only three Wisconsin companies are using human embryonic stem cells in their work: Stemina, Cellular Dynamics, and Cell Line Genetics, all of which are located in Madison.

“So we basically legislated out every biotechnology-based company in an effort to exclude three companies,” Donley said.

In a joint statement, three organizations — BioForward, an association of bioscience organizations; the Wisconsin Technology Council, the science and technology advisor to the Wisconsin Legislature and the governor; and the Wisconsin Growth Capital Coalition, a lobbying group that supported the creation of a master fund of funds — said they do not believe the Badger Fund of Funds, as presently constituted, is a growth inhibitor. The organizations noted that Act 41 set up six broad investment categories and does not address where other private funds operating in Wisconsin can or should invest their money.

“Within those [six permitted] categories, there may well be companies that are predominantly engaged in bio-agriculture, bio-manufacturing, bio-engineering, bioinformatics and, of course, the broad mix of disciplines that are required in medical devices and medical imaging,” they stated. “BioForward, the Wisconsin Technology Council, and the Wisconsin Growth Capital Coalition all agreed Act 41 was a reasonable start toward what we believe is a long-term approach to enhancing capital opportunities for high-growth companies in Wisconsin.

“We do not believe Act 41 is a growth inhibitor for the life sciences industry — precisely because that industry is so broad and spans so many interdisciplinary sectors. In fact, it sends a strong signal that Wisconsin is developing a strategy for public-private investment in key sectors.”



The restriction on biotech investment is not the only issue biotech executives have with the Badger Fund of Funds program. Some don’t believe it’s large enough to be a true venture capital program. Under the program, the state can invest as a limited partner, just as other private investors do, in a fund that produces a return on investment over time. The Department of Administration has selected Sun Mountain Kegonsa, a merged entity, to manage the $30 million program, and the first investments are expected later this year or early in 2015.

Sun Mountain Kegonsa is comprised of Sun Mountain Capital, a venture capital firm based in Santa Fe, N.M., that manages seven regional funds with about $500 million in assets, and Madison’s Kegonsa Capital Partners, the Wisconsin-based half of the SMK partnership. The firms are led, respectively, by Brian Birk, managing partner of Sun Mountain Capital and a former finance manager at GE Healthcare’s Waukesha office, and Ken Johnson, managing director of Kegonsa Capital Partners.

The two investors have outlined an early-stage-focused investment strategy they call “Money for Minnows.” Under Money for Minnows, instead of large chunks of capital being invested in a select number of companies with the hope of large returns on investment, the money would go to a larger number of small emerging companies that have a realistic chance to become significant players in their respective industries.

The partner funds that Sun Mountain Kegonsa works with are each likely to have $3 million to $5 million to invest, meaning they are more likely to invest in smaller companies with more modest capital requirements — at least on the front end.

For biotech companies that are interested in leveraging these dollars as part of a syndicated deal, the numbers are underwhelming. Donley would like to continue to develop her diagnostic and toxicology products while providing return on investment for the angel investors who have gotten her this far, but that will require more venture capital than the program can deliver.

“They are looking at making investments on the order of $400,000, and that’s seed capital,” she noted. “I have been critical of that as well because we have a great angel network, and we can get investments of that size, and we have been well supported by our angel community in that regard. But when you need to raise a total of $5 million, you need to have true venture capital — somebody who can put in something on the order of $1 million or $2 million at least to syndicate with outside venture firms.”

In their joint statement, BioForward, the Wisconsin Technology Council, and the WGCC noted that in passing Act 41 by wide margins in both houses, the Legislature knew it was working with a defined amount of state investments ($25 million) that could go only so far in addressing overall capital needs:

“As is evident through the selection of Sun Mountain Kegonsa to manage the fund, the intent is to spread investments over a number of early-stage ‘recipient’ funds, which will in turn invest dollars in a number of young companies in many sectors. Some sectors require smaller upfront investments than others. Some sectors require larger follow-on rounds. Because the Legislature wanted to plant as many statewide startup ‘seeds’ as possible, the Badger Fund of Funds will likely focus initially on investing in companies that can produce results, including jobs, with the most efficient use of capital.”

Adults versus embryos

In the meantime, one compromise that could get around the stem cell controversy is to allow funding for companies that use only induced pluripotent stem (iPS) cells. These are adult stem cells that have been “reprogrammed” to have the pluripotent characteristics of human embryonic stem cells (hESC), which means they can become any cell in the body and offer the same research value as hESC without the need to destroy early-stage embryos to isolate the stem cells.

Industry experts note the two types of cells have their strengths and weaknesses. Ayla Annac, president and CEO of InvivoSciences and a member of the BioForward board, said the advantages of embryonic stem cells include higher flexibility and versatility in becoming any type of cell. One could argue that human embryonic stem cells are also able to divide and proliferate without limitations.

However, while adult stem cells may have a limited capacity to maintain their pluripotency, scientists can always go back to the same patient to obtain cells; therefore, there is an almost infinite supply of adult cells. “Many biotechnology companies in the U.S. and in the state of Wisconsin, including InvivoSciences, have been using the true advantage of adult stem cells that are lacking in the embryonic stem cells,” she explained. “InvivoSciences can recapitulate personal biological replicas in test tubes through adult stem technology.”

Donley noted that studies have shown that in some cases, iPS cells are very comparable to hES cells, and for Stemina’s applications like toxicology screens, the iPS cells are a good substitute. “We study metabolomics, or the cell’s metabolism, and the metabolism of iPS cells and hESC is completely overlapping,” she says. “There is a 0.1% difference in what we call the secretome [the totality of secreted organic molecules], and Joshua Coon at the University of Wisconsin has published a comparison at the proteomic level and found about the same difference in the proteome [the entire set of proteins expressed by a genome].”



Donley points out that while Stemina is moving toward greater use of iPS cells, the aforementioned understanding of genetic differences would not have been gained “if we didn’t have human embryonic stem cells to learn from.”

BioForward, the Tech Council, and the WGCC note that adult stem cells have been studied for more than 50 years, and a solid body of knowledge about their uses and limitations has been documented. However, human embryonic stem cell research began in earnest less than 20 years ago with discoveries by James Thomson, and while there have been important developments using hESC, much work remains.

“While it holds great promise, the book is still open as to whether those [adult] cells function precisely as human embryonic stem cells do in all situations,” the organizations said. “That is why researchers continue to work with a variety of cell sources, often cross-checking results to assure safety and efficacy.”

Added Conroy: “There is clearly an important role for the induced pluripotent stem cells in research and potential life-saving products in the future, but the fact of the matter is that human embryonic stem cell research continues to be very important. And there is an enormous amount of potential for stem cell research to change how many, many different diseases are treated, and I personally think that it is the highest moral calling to continue to do that research to help save lives and cure disease.”

Politics of investment

At one point, the Legislature considered establishing a $100 million venture capital fund, and Gov. Walker offered his support, but backers eventually settled for a smaller program with the understanding that funding support could grow in subsequent state budgets.

Walker’s gubernatorial opponent, Democrat Mary Burke, has outlined an economic plan that calls for $120 million in annual state-sponsored venture funding and the inclusion of life sciences companies. The chances for an accommodating legislative shift are mixed. State Rep. Melissa Sargent, D-Madison, believes Democrats can regain control of the State Senate, but the odds are longer in the Republican-dominated State Assembly.

Sargent sponsored an amendment to the Badger Fund of Funds bill that would have included biotechs, and she believes the entire Dane County legislative delegation would be on board. “I have not had the opportunity to bring the caucus together and talk to them about priorities, but when we voted for the amendment that inserted biotechnology language into this bill, it was definitely supported by the Dane County delegation,” she said. “I can’t imagine that support is diminishing.”

State Rep. Mike Kuglitsch, R-New Berlin, a co-sponsor of Act 41, declined to be interviewed for this article, saying it would be premature to look at changes to the program at this time. Kuglitsch did issue a statement saying that he remains confident that Act 41 will be a success and add much-needed capital to promising new Wisconsin companies. “I am excited that Act 41 is moving along positively,” he added, “and I look forward to the growth and innovation in startups in Wisconsin.”



Heart-Rendering Research

Ayla Annac’s elevator pitch for venture capital might strike at the heart, but that’s only right. Her company, InvivoSciences, tests the effects of drugs on reconstituted human tissue, particularly heart tissue.

Invivo’s scientists are reconstituting and manufacturing mini-replicates of human heart muscles in test tubes, in part to understand the mechanisms of inherited diseases that affect heart functions. The company is establishing an advanced center to manufacture bioengineered tissues, which represent the physiological functions of individuals, including their susceptibility to specific drugs and stress. At some future point, the center could also regenerate heart muscles and repair damaged hearts.

Heart disease is the number one cause of death for both men and women in the United States, claiming approximately 1 million lives annually. For Annac, a native of Turkey, fighting heart disease is personal — her father died from an ailing heart — and so is ensuring that her company is well financed.

Invivo is launching the first study to generate replicates of heart muscle derived from adult cells isolated from Duchenne muscular dystrophy patients for the purpose of analyzing disease mechanisms and screening compounds that could slow and reverse the loss of heart muscle function.

Annac can’t say Wisconsin’s prohibition on state-sponsored biotech investments is impeding her ability to raise venture capital because that capital can come from anywhere. But her company is on the verge of commercialization, and that requires growth capital to support the hiring of a professional management team to capture national and international sales.

“I will say that it is challenging in Wisconsin to raise money, [especially] in the $5 million to $10 million range,” says Annac, who thus far has developed her technology with the help of federal grant money. “Many are looking for growth capital for their companies to raise money, and that is challenging in Wisconsin, but it can be done in syndicated form.”


Testing Biotech Staying Power

In Beth Donley’s ideal world, the State of Wisconsin would be devoting many millions more to state-sponsored venture capital investing, and there would be no prohibitions on using state dollars for investments in biotechnology companies, even those that use human embryonic stem cells.

For Donley, CEO of Stemina Biomarker Discovery, there are roughly eight balls in the air in her quest for venture capital. Thanks to the state’s efforts to build an angel capital network, she’s secured plenty of that seed capital, but those angels want to recoup their investments, so she’s on the hunt for larger game.

She also hopes to avoid the so-called “Valley of Death,” which is the term used to describe the funding gap for early-stage companies caught between their initial rounds of investment from family, friends, founders, and angel investors and follow-up rounds from venture capitalists.

In Wisconsin, that gap falls someplace between $2 million and $5 million, and Donley knows that life sciences companies like hers are particularly susceptible to getting caught there. A $10 million contract with the Environmental Protection Agency will help, but Stemina also needs growth capital to develop an autism diagnostic test and to accelerate its toxicology business.

Donley would very much like this to unfold in her native Wisconsin, but coastal venture funds are pitching woo as she tries to raise $5 million. “Every time I talk to a venture capitalist on the coast, they want me to move where they are, so we really have to solve this [venture capital problem], and not just for me,” she said. “What I’d love to do, before five to seven years is over, is provide an exit to my angels, where they get their money back and more, and they are able to take that and enthusiastically invest in the next thing that either I come up with or someone else comes up with.”

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