Contributors: Barbara Handelin, Ph.D. and Karyn Polak
To learn more about Barbara and Karyn, click here.
What Will It Take to Tackle the 90%?
We began Part 1 of this article with our fundamental premise: that
- The biotech and biopharmaceutical (biomedical) industries are failing us, medically and economically, addressing barely 10% of the solutions and preventatives for known diseases,
- We have the science to serve us better, and
- We only need the right market participants in order to deliver greater coverage, access, and outcomes to begin to tackle the 90% of known diseases causing human suffering across the globe.
In Part 2, we laid out our Theory of Change for this dire picture: if we build a new biomedical industry, focused first and foremost on health and funded by mission-aligned impact investors, we will sustainably produce affordable medicines to serve the people affected by that 90% gap.
Here we offer a blueprint for putting this theory into practice, as well as a nod to a likely category of stewards who may carry it forward along with us.
Mission-Aligned Capital in an Example Medical Impact Fund
To make the picture of Biotech Financing V2.0 visible, we offer one example of how impact-oriented funding sources can participate in this next generation of biotech investing. In this example, wealthy individuals, donor-advised funds (DAFs), private foundations, government treasuries, and impact investors can impactfully use their ‘benevolent assets’, collectively and at-scale, as mission capital for fueling the Biotech v2.0 industry. Such aggregation and professionally managed funding can deliver appropriate risk/return generated from affordable and equitably accessible medicines.
Medical Impact Funds are designed to reduce the cost of capital for biotech/pharma companies across their business life cycles. The key element for this new generation of biotech funds is a governance structure that is aligned to appropriate financial incentives for the limited partners (LPs) and Managing Partners in order to deliver the highest possible medical impact.
Figure 2 below shows a simplified structure chart for a “stacked deck” fund. The key aspect of a stacked deck fund is that certain investors serve as first-loss capital or provide concessionary capital through another mechanism. The added security can de-risk the investment for other investors, unlocking capital for riskier investments or investments where a lower return is expected.
This general fund structure is intended to bring investment capital into alignment with the capital requirements of companies in Biotech v2.0:
- Scale of capital suitable for biomedical products
- Reduced risk/reward balance
- Duration of investment
- Flexibility re debt vs equity
- Mission ‘lock’ to align investor interests to company interests = health outcomes
- Alignment of financial rewards for LPs, Fund managers and investee companies
Sponsor: Governance is modeled here to be organized by a Fund Sponsor, which could be an existing management firm, a nonprofit 501(c)(3) entity, or a Public Benefit Corporation (PBC). The Sponsor would provide ‘mission lock’ by having a ‘golden share’1 position in the Manager or appropriate governance mechanics could lock in guideposts for how investments and returns are managed by the Manager.
Management Company and General Partners: A Management Company provides the investment management services to the Fund. The Fund, through General Partners, will make investments into portfolio companies. While limited partnerships are the most common vehicle for organizing US funds, it can also be organized an LLC or a Public Benefit LLC (“PBLLC”). If organized as a PBLLC or LLC, there is less of a need for separate GP and Management Company entities. The Management Company will manage the fund’s investments pursuant to an investment management agreement, and the fund may be charged a fee for such services. The Fund can be limited in duration or evergreen/permanent.2
GPs are otherwise compensated and incentivized by earning ‘carry’3 a percentage of total profits of the Fund’s returns. Since Medical Impact Funds are intended to reduce the capital costs for investees, each of the participants in the investment flow need to be aligned to reduced costs of Fund administration, including the GP. Carry may, for example, be tied to the achievement of the fund’s impact goals, e.g., the general partner (or its members) will not receive all or a portion of the carry if the fund fails to achieve its impact goals. The carry can also be recycled into new investments or new funds. If the Fund Sponsor is not a charitable organization, for mission lock purposes, the General Partner and Sponsor could consider including a non-profit as a member of the GP.
The Fund takes in capital from concessionary investors who provide guarantee of ‘first loss’ in order to facilitate investment from investors seeking market returns. Note this scheme assumes the first loss capital will invest as an LP and will serve as the first loss capital by sitting at the bottom of the waterfall4. For example, the governing documents can provide that the “market LPs” receive their capital back and some set preferred return prior to the first loss capital receiving its money back. As an alternative, the first-loss capital could provide a guarantee or other de-risking measures. We think federal or state funding programs could be well suited to serving in this role. In any event, concessionary investors will typically require the fund to produce robust impact metrics and reporting, especially if they are foundations making Program Related Investments.
Investors seeking market-rate returns who, by virtue of their position in the waterfall, have their investment de-risked by the presence of the first loss capital. Note that this simplified structure chart assumes two classes of LPs (first loss and market), but variations are possible. For example, there could be multiple classes of “market” LPs, with varying levels of seniority in the waterfall and shares in the fund’s upside. Additionally, there could be concessionary LPs who expect their capital back plus below market rate of return, thus balancing the combined rate of return.
Incorporate More Women into Leadership of Biotech Financing V2.0
It may surprise you to learn that often the best stewards for this kind of ownership are women. No, we’re not arguing to take down the patriarchy or to exclude the millions of others who operate in this space. The simple fact is women are the new face of wealth, the new force in business and asset ownership, and their (our) presence is only growing.
Today, women control more than $10 trillion (about 33%) of total U.S. household financial assets, and research by McKinsey found that in the United States that percentage will rise to more than 67% by 2030. Women are also the largest beneficiaries of the current transfer of wealth, living an average of five years longer than men. As a consequence, an unprecedented amount of assets will likely shift into the hands of U.S. women over the next three to five years, representing an estimated $30 trillion by the end of the decade.
Moreover, women are more likely to invest in ventures that have positive impacts on society and the environment and more likely to consider and seek to influence collective outcomes. Triple Pundit offers some clear markers from two of the most influential leaders in the space for why this is the case. As Jackie VanderBrug of U.S. Trust has said, “Women have a more holistic view of investment. Yes, they do care about returns, but they also care about the role of their investments in society.”
They’re doing so by exercising their asset agency outside of their retirement accounts: according to Fidelity, as of 2021, 67% of women invest outside of their retirement accounts, up from 44% only five years ago. They do so when they control the investment reins in private equity and in other investment institutions. And they certainly do so in philanthropy and government roles. The Case Foundation produced a thorough accounting of the extensive influence of women in these arenas almost a decade ago – so you can imagine what the picture would look like today.
Conclusion:
Biomedical Financing V2.0 + The Power of Women = Biomedical Industry v2.0
Heartbreaking articles in the press regularly appear these days about better drug options being sidelined until every last dollar of profit is extracted from the existing, protected patents; about therapies being ignored in favor of more profitable (and yet less effective) options; and about exorbitant drug prices being charged simply because they can be. We must begin to shift the dialogue from big corporates to individuals, shift the balance from profits to patients. And we can: there is purpose-driven capital in the hands of people who care about others, who want to see a different result. Whether via a stacked-deck fund such as the one we’ve posited here, or another structure that equally empowers mission-aligned asset owners and utilizes efficient development and manufacturing processes, we can manifest a sustainable, equitably accessible, and medically effective biomedical system that works for all. We expect our example will raise many questions and perhaps some doubts. We also hope it will spark many more ideas and ignite action from a variety of sources.
The 90% gap in diagnostics, drugs, and preventatives is not getting any smaller. We can no longer wait for others to build the shelter while the world is deluged by the tsunami of healthcare demands. The need is urgent, and the time is now. Join us in creating Biomedical Industry v2.0!
Contact Barbara at: [email protected]
Contact Karyn at: [email protected]
References
- Golden share is a type of share that gives its shareholder veto power over changes to the company's charter. It holds special voting rights, giving its holder the ability to block another shareholder from taking more than a ratio of ordinary shares.
- See upcoming Fund structures from The 90~10 Institute
- Carried interest is a share of profits from a private equity, venture capital, or hedge fund paid as incentive compensation to the fund's general partner.
- A distribution waterfall is a way to allocate investment returns or capital gains among participants of a group or pooled investment. Commonly associated with private equity funds, the distribution waterfall defines the pecking order in which distributions are allocated to limited and general partners.