Innovation Velocity at American Universities

A few weeks ago, a friend of mine forwarded me an article that analyzed the correlation between the velocity of start-up creation at American universities and total research expenditures.  The author, Jerry Paytas of Fourth Economy, makes an argument that universities become more efficient at start-up creation as their research expenditures increase.  The article notes, 

“As the volume of research increases, institutions become more efficient. At $200 million to $400 million in R&D, institutions can expect only a modest increase in startup rates – getting one startup for every $92 million in research. The very best schools, those that produce more than 4 startups per year, are able to generate one startup for every $77 million in research. For the smaller institutions, implementing the best practices and doing everything you can to be efficient at producing startups might add one more startup every other year.”

It is true that smaller institutions do not create a whole lot of start-ups, but that does not mean they are not good at it.  In fact, smaller schools can be quite efficient at creating start-ups.  

If research productivity is really correlated with research expenditures, then the mega research centers (e.g. Caltech, Harvard, MIT, Stanford) that have research expenditures greater than $500 million should significantly outperform smaller institutions. 

Interestingly enough, when weighted by research expenditures, the University of Kentucky outperforms both Harvard and NYU with regards to the average amount of research dollars that are required to create a start-up.  Admittedly, Kentucky is a bit of an anomaly (later in this entry I will show aggregate data on mega research center performance), but it does highlight the fact that efficiencies do not always correlate with scale. 

What my data also shows is that it costs Kentucky more money to generate a license than it does Harvard.

Licenses are important drivers of innovation, yet often play second fiddle to sexy start-ups.  The reality is that both licenses and start-ups are proxies for the innovation efficiency of universities.  My reasoning is based upon the theory that if a license was not transformative or valuable (e.g. “innovative”), then no one would license it. 

Given the important role licenses play in promoting innovation, shouldn’t the measurement of university innovation productivity be a blending of licensing and start-up activities?

The chart above is compiled from a list of universities that have research expenditures that are greater than $200 million.  I chose $200 million as a cutoff point because schools with research budgets smaller than $200 million typically have research programs that are either incredibly specialized or lean heavily toward basic research.  Also, omitted from this list are state systems (e.g. State of Texas System), which aggregate research expenditures on a system-wide basis instead of at the university level.  In total, 59 universities made the list.

In line with the Fourth Economy data, the 59 universities in my data set required about $93 million of research expenditures to spawn a single start-up.  Interestingly, it took roughly 1/9 of that amount of investment to generate a license.  And, when licenses and start-ups were blended together, it took only $8.7 million of government investment to create a transformative piece of technology. 

Some might argue against this, but I think that $8.7 million is a reasonable return on investment for the government and is a testament to the efficiency of American universities.

Also in line with the Fourth Economy data, mega research centers do seem to be more efficienct drivers of innovation than smaller institutions.  That is not entirely surprising since schools like Caltech, MIT and Harvard typically attract premiere researchers.

What I did find surprising was the fact that universities with no medical centers seemed to outperform those with medical centers on a cost per innovation (license or start-up) basis.  Given the fact that non-medical funding sources are more scarce than medical, I did not expect non-medical schools to be more innovative than those with medical schools – and, to do it with less money!    

American universities are highly innovative and productive; however, the metrics commonly used to track innovation (e.g. start-ups per year) typically do not represent the full picture.  By leveling the playing field via weighing of research dollars, smaller schools can perform (i.e. be “innovative”) as well as large schools and non-medical universities can outshine those with medical schools.  

Stimulating Start-up Culture

“Entrepreneur’s Fund”: During a recent car ride Marc Singer, another member of the Osage team, suggested a radical idea to entice successful entrepreneurs to start their next company and help stimulate a start-up culture.  Marc’s idea (one of several he has pitched me) is to provide $1 million of seed capital to successful entrepreneurs with relatively few strings attached.  $1 million should be enough money to entice an entrepreneur to roll the dice for a year, develop a business, and attempt to market it to investors.

Fund Capital: Capital for the concept would be provided by either the local government and/or private foundations.  Sustainability is key, as program awareness is needed in order to successfully recruit the most promising entrepreneurs to leave their current job posts.  A 5-year program would produce 25 award winners from the program directly, and indirectly spur numerous other entrepreneurs to join the start-up bandwagon.

Selection Committee: The selection committee would ideally be comprised of a representative group of start-up stakeholders from the region.  Possible members would include local members of government, economic development managers, investors, academics, technology transfer professionals, and repeat entrepreneurs.

The selection committee would be tasked with a simple goal, identify 25 promising entrepreneurs in the region and convince 5 of them to join the program.  The 25 nominees would be culled from a pool of senior-level managers who were at the helm of local start-ups that were recently sold and/or had a positive impact on the region.  Identifying backable repeat entrepreneurs is integral to the success of the program as they have a higher likelihood of raising outside capital and successfully managing a start-up company as they have done it before.

Investing in Talent:  The riskiest and most innovative part of this fund idea is that capital will be awarded based solely on the steering committee’s belief that one entrepreneur will have a better chance of successfully launching a start-up over another entrepreneur.  VCs like to say that they would rather invest in a mediocre idea that is being developed by a rockstar entrepreneur over a groundbreaking idea being led by a mediocre manager.  Well, this model puts such an investment thesis to the test.     

$1M Loan:  Awards will be granted in the form of a $1 million loan to the entrepreneur.  At the time of the award, the entrepreneur receives 20% of the loan to cover salary and other fees.  The rest of the equity ($800K) is held in escrow for up to 12 months while the entrepreneur looks for a technology to develop into a start-up.  Upon finding a technology and developing a business plan, the remaining equity is unlocked.  Should the entrepreneur fail to secure a technology within the 12 month timeframe, the $800K must be returned to the steering committee.

While I am a big fan of the loan idea, there are a number of other financing options that could be employed.  Instead of providing $1M of capital contingent on pulling together a company concept, the grant could be awarded in the form of a matching investment of up to $1M.  I am less enthusiastic about this idea as most entrepreneurs realize that raising the first $1M, even if it has matching funds associated with it, is always the hardest.  Another idea would be to offer downside protection for investors who invest in the first round of outside capital.  Should the entrepreneur raise $1M of outside capital, then the start-up’s investors would be eligible to receive compensation of up to $500K should the company fail to raise a second round of capital or successfully grow.  Offering such downside protection might entice more investors to get into the early stage mix, which would take some of the capital risk off of the table for entrepreneurs.

Measuring Success:  Over a 5 year period, the program should strive to have an 80%+ success rate (20+ awards granted) with regards to award winners receiving the full $1M.  Of those winners, 75%+ (15 companies) should be expected to raise at least one round of outside capital.  Of those 15, 80% (12 companies) should be expected to raise a second round of capital and have their doors open after 5 years.  Ultimately, 6 of the remaining 12 companies would hopefully be successful companies.  I would define success as being in business for at least 10 years and employing at least 25 people at the time of the company’s 10th year.

In the context of economic development, success can also be measured through long-term tax revenue generation.  Let’s say that those 6 successful companies each employee on average 25 people over a 10 year period and that the average salary is $80,000.  To use Pennsylvania as an example, its state and local tax burden is 9.8% (to make the math easier, I will round up to 10%).  On income taxes alone, those 6 successful companies would generate approximately $1.2M in income tax revenue per year, or $12M over 10 years.  Indirect tax payments through corporate taxes and consumer spending could easily nudge that revenue generation number closer to $15M.  While the $15M does not fully catch-up to the $25M investment, the delta on the investment should gradually close over time as the soft benefits of such a program (more start-ups, higher salaries, more jobs) build up.  

There is no quick fix or easy-to-follow manual for creating a start-up culture, but a collaborative economic development program could help pry some of the talent away from the corporate world and into start-ups.

Florida, The Next Great Biotech Hub

You heard it here first; Florida will be the next great biotech hub. While most people would find that comment laughable, few realize that Florida really has its act together when it comes to promoting biotech in the state.

Michael Porter of Harvard Business School famously wrote that there are three commonalities to all great innovation hubs: capital, talent, and resources. Many cities and even countries have tried to create innovation hubs based upon Porter s innovation thesis, but few have succeeded. It turns out that there are many intangibles that can impact why, or why not, an innovation hub flourishes. While it is too soon to tell if the Florida biotech innovation hub will be a success, the state has worked hard to increase the probability of success.

Background
About 10 years ago Florida decided that it needed to stop relying on the housing and tourism for economic growth (a prescient observation in the wake of the 2008 stock marker meltdown), and find a way to get high-paying technology jobs to move to the state. Most people equate Florida with orange production and senior citizen retirement communities, so enticing companies to move to the state would be a tall order. To quantify just how stacked the odds were against the state, in 2005 only $6 million of seed and startup was raised by Florida companies.

In 2003, using money from a stimulus package passed by Congress after 9/11, then-Governor Jeb Bush led the effort to galvanize a biotech revolution in the state. Instead of creating a single biotech hub, Gov. Bush would use his substantial war chest to setup a statewide network of biotech clusters that in aggregate would rival the intellectual and technical capabilities of other more prominent biotech hubs.

Florida initiated an aggressive strategy to create a sustainable biotech hub by focusing on:

• Recruiting world-class research institutions to the state
• Requiring those institutions to collocate with existing universities, in order to promote a pipeline of local talent to feed into research centers and startups
• Create shared core facilities to drive down drug discovery costs
• Create sustainable capital sources to entice out of state companies to move to the state and promote the creation of startups
• Promote benefits of Florida: cost of living & lifestyle (beats Boston winters!)

Innovation Generation / Resources
While Florida already had a robust university system, the government sought to augment its basic and translational research capabilities by enticing some of the top research centers to create Florida outposts. By providing well over $1 billion in construction grants, the state has attracted 8 marquee research organizations to the state, including:

• Scripps Florida
• Burnham Institute for Medical Research
• Torrey Pines Institute for Molecular Science
• Cleveland Clinic
• Max Planck 
• Mount Sinai Medical Center
• SRI International
• MD Anderson Cancer Center

The cost of living, weather, and substantial grants available to researchers have enabled these new research centers to attract a substantial amount of top-tier talent in a very short amount of time.

One of Florida s most promising biotech clusters is in Jupiter, a well-healed community north of Palm Beach. In Jupiter, Max Planck and the Scripps Institute have created large outposts located adjacent to Florida Atlantic University. Florida provided almost $775M in current and future grants to support the construction of these two new research centers.

Scripps Florida, which opened in 2009, now employs more than 400 people, of which 120 are postdoctoral fellows. Of note, academics at Scripps Florida have already filed 62 patents. Patents alone do not drive job creation, so the state provided funds to create a state of the art incubator to take those fledgling ideas and turn them into commercial endeavors.

The state worked with Alexandria Real Estate to setup the Alexandria Innovation Center in Jupiter. Because the incubator is literally next to two research centers and a university, startup companies can leverage core facilities and academic talent.

Because the research centers are just getting up and running and have yet to create academic spinouts, the state has recruited several promising startups to move into the incubator. As those startups mature, they could provide a management talent pool for the next generation of local startups.

Talent
These new research institutes are collocated with the state s existing university infrastructure, allowing the organizations to tap local talent to fill their labs and leverage existing core facilities at the universities. Managerial talent is also finding its way to the research centers and startups companies thanks to the scores of pharma folks who were let go over the last few years.

At Osage University Partners, we work closely with the University of Florida, which has one of the most well run and progressive tech transfer offices in the country. U of F boasts some of the top biomedical, bioengineering, and agbio undergraduate and graduate programs in the country. However, due to few postdoctoral positions and startup opportunities, most of this talent typically leaves the state after graduation. The establishment of large research institutions that require large pools of postdoctoral talent to conduct their research will enable much of that talent to stay in state. Hopefully it will be those postdoctoral researchers that identify groundbreaking discoveries that can translate into startup creation.

Capital
Because Florida was traditionally never a hotbed for investment, the state realized that it would need to fill the capital gap until enough momentum was built to stimulate out of state investment. The state created the $30 million Florida Opportunity Fund, which is a Fund-of-Funds to entice venture capital investment in Florida companies. In addition to attracting venture capital, the state allocated 1.5% of the net assets of the state retirement system trust to high growth investments (direct, grants, and awards) in local startup companies. Such capital strategies send a strong signal to the investment community that Florida is serious about promoting biotech for the long haul.

You can imagine the outcry from the general public about diverting so much money for an endeavor that will not have tangible benefits for at least 10 years. But, the idea of capital investment is to invest in the future, and even if the biotech gambit doesn t pan out, no one will be able say that Florida went down without a fight.

Did Dendreon inadvertently create a new regulatory agency?

In March 2010, the FDA voted to approve Dendreon’s Provenge for the treatment of metastatic castrate resistant prostate cancer.   The FDA’s decision was based upon the fact that the immunotherapy could extend the lives of patients by 4.1 months.  While equity analysts expected the therapy to cost $50,000, many were startled to learn that Dendreon would instead be charging $93,000.  At that price point, people wondered if it was ethical for a company to charge so much for prolonging life by only an additional 4.1 months.  The cost was so high that the Center for Medicare & Medicaid Services (CMS), the agency that administers Medicare, which normally rubberstamps reimbursement after FDA approval, asked for additional time to review the drug.  After one year of deliberation, CMS finally gave their coverage blessing for Provenge.

By delaying coverage approval for Provenge by one year, CMS set an awkward precedent for drug development companies and their investors, leaving many to wonder if the tactics used by the agency would portend to stricter approval standards for Medicare coverage.

Investors and pharmaceutical companies have traditionally taken Medicare approval for new products as a given.  One of the functions of CMS is to regulate Medicare coverage for drugs and biologics to make sure they are reasonable and necessary.  At $93,000 and 4.1 months, many doctors believed that Provenge was neither reasonable nor necessary.  While doctors and consumer advocates might have cried afoul, Medicare had little recourse in negotiating the price and utility of the therapy due to the passage of the Medicare Cancer Coverage Improvement Act of 1993, which states that Medicare must cover “any drugs or biologicals used in an anticancer chemotherapeutic regimen for a medically accepted indication”.  Therefore, by definition, Medicare must pay for Provenge.  Instead of following their normal course of action, CMS decided to put up a fight.

CMS asked Dendreon for additional time to review Provenge’s application for payment.  While no one knows for certain why CMS asked for extra time, there are several compelling reasons why the agency might have pressed the pause button. 

First, the agency might have wanted to signal to the market that despite the 1993 Amendment, it would no longer blindly approve products.  While the agency cannot technically deny payment, it is not prohibited from asking for additional data to make its decision.  In Dendreon’s case, this slowed their Medicare reimbursement approval by a year, which is a significant penalty for a company whose only product primarily targets men over the age of 65.  Losing one year of possible revenue is a hefty price to pay for a publicly traded company.

Second, CMS explicitly brought up future off-label use of Provenge.  Medicare has a finite budget, and off-label drug use, especially for $93,000 therapies, can consume vast amounts of money.  Medicare lacks the authority to regulate the off-label use of FDA-approved oncology products due to the 1993 Amendment, which also specified that Medicare must cover (depending on compendia recommendations) the use of FDA-approved chemotherapies that are used off label. 

The mere fact that CMS brought up off-label use of chemotherapies is a telling sign about the future direction of the agency and possible congressional action.  While the agency cannot directly discourage the use of Provenge in off-label settings, CMS did not exactly give doctors their blessing as the agency stated “we are hopeful that unlabeled uses in the near future will take place only in the context of bona fide clinical studies”.

Lastly, being the first approved immunotherapy, CMS might have wanted more time to figure out how to appropriately bucket Provenge.  The 1993 law states that Medicare must cover drugs and biologics used as chemotherapies, but is Provenge a drug, biologic, or even a chemotherapy?   Chemotherapy is defined as “a treatment of an ailment by chemicals”, while an immunotherapy is defined as a “treatment of disease by inducing, enhancing, or suppressing an immune response”.  Hard to say whether a cell handling process is really a chemotherapy, which might have been why CMS wanted some extra time to think about their coverage decision. 

As an investor, the actions by CMS are troubling.  By delaying the approval of a drug, without giving a definitive reason, CMS has added yet another level of confusion and risk associated with drug development.  If Medicare approval becomes a sliding scale, like FDA approval has become, drug developers will start to shy away from high-risk / innovative products.  Innovation requires a price premium to offset the risk associated with developing a novel product. Without the prospect of a price premium and a defined regulatory and coverage path, drug developers will focus on me-too products and incremental improvements that do little to benefit the health of Americans.    

Pharma-Academic Partnerships & The Impact on Venture Funds

This past week, Yale University and Gilead announced a collaboration where the pharma company will provide $40 million in research support over a four-year period to the university to discover new oncology therapeutics, with a possible six year / $60 million extension.  Gilead has made no secret of the company’s intent to become an oncology powerhouse as they recently acquired Arresto Biosciences and Calistoga Pharmaceuticals for a total of $600 million upfront.  As the pharma company seeks to develop an early stage oncology pipeline, partnering with a strong academic center is a logical step to filling that desire.

Yale is a great choice for Gilead as an academic partner.  The Yale Cancer Centre is one of 41 comprehensive cancer centers in the nation designated by the National Cancer Institute.  In addition, Yale recently purchased the old Bayer headquarters in West Haven and a lot of Bayer’s oncology talent has remained in New England.  As Yale builds out the West Haven site, one can imagine many former Bayer vets working in their old stomping grounds.  The last essential piece of the partnership is the fact that Yale researchers are incredibly entrepreneurial and have a lot of experience in developing novel pharmaceutical compounds. 

The Yale-Gilead partnership comes on the heals of several other high profile pharma-academia partnerships such as: 

• Sanofi / Harvard
• AstraZeneca / University College London
• Genentech / UCSF
• Veridex / Mass General
• Takeda / Sanford-Burnham
• Pfizer / UCSF

Early stage development of academic technologies used to the bread and butter work of life science VCs. With pharma encroaching on the VCs territory, one has to wonder how the partnerships will impact venture firms. 

Below are my thoughts on of some possible outcomes:

The Uh-Oh Scenario:  Pharma companies will pick off all of the most promising molecules, leaving the VCs to choose from the leftovers.  This would be bad for all parties - VCs, drug companies, and academics.  If there is not an equitable distribution of quality molecules between pharma and VCs, the VCs will simply stop looking for academic assets.  This leaves academic centers exposed, especially if the pharma companies choose not to renew their partnerships. 

The Business Development Person’s Special:  Pharma companies will work closely with academics to discovery promising molecules and development them through the Hit stage.  Pharma companies will then seek to partner with venture capital funds and create spinout opportunities for the VCs to invest in.  This model works well for all parties involved.  For pharma companies, they can outsource later stage development and early stage commercial activities to VCs (activities VCs are good at) and retain rights to buyback assets at predetermined terms.  For VCs, they will assume less risk, and therefore give up some of the potential upside to pharma companies, but can expect a reasonable rate of return on their investment. 

Too Much to do Scenario #1:  Pharma companies are the first ones to acknowledge that they cannot do everything at once.  A successful partnership will most likely produce a lot of promising assets, meaning that the pharma company will have to pick and choose which ones to develop.  Many good molecules will be passed over due to nothing more than bandwidth issues.  Many of the partnerships include terms that enable the universities to license unused technologies to startup companies.  This could be net positive for investors as some of these assets will have already hit development milestones and be more de-risked than a typical academic spinout compound.

Too Much to do Scenario #2: Some assets that are not initially picked up by the pharma company could be co-developed with a VC.  The VC would fund the pharma scientists working at the academic center and take an option on the work.  That option could grant the VC the ability to purchase the asset outright or enter into a joint development project with the pharma company.

I don’t believe that anyone really knows how the trend of pharma-academic partnerships will impact venture capital firms in the long run.  The most likely answer is a mix of outcomes that will be drawn from the scenarios I listed above.  In some cases, pharma companies will certainly pick off the best assets at a research center, but in other cases they will openly partner with venture firms. 

Overall, I think pharma-academic partnerships are positive because at the end of the day, increased drug discovery activity at academic centers should result in the creation of novel therapies to improve the lives of patients and that is why we are all in this game.