Jul. 5–SAN FRANCISCO–Promising young biotechnology companies backed by venture capital have found themselves shut out of a prestigious grant program because the National Institutes of Health areenforcing a decades-old regulation more strictly.
Venture capitalists and entrepreneurs say the new interpretation of eligibility rules for Small Business Innovation Research grants denies money to the start-ups with the best chances of turning their research into commercial products — at a time when private funding is scarce.
The program was created in 1982 to help businesses with fewer than 500 employees bring innovative software, drug therapies, and other technologies to market. Through the NIH and nine other federal agencies, the US Small Business Administration awarded $1.5 billion in grants to 5,000 companies last year.
“It’s a really crucial part of the innovation for which the United States is famous,” said Christoph H. Westphal, who invests in biotech companies with Polaris Venture Partners in Waltham.
In a policy change, the NIH this spring began disqualifying companies that are majority-owned by venture capital firms. Federal rules say they must be at least 51 percent owned and controlled by “individuals” who live in the United States. Venture capital firms often take more than half of the stock of the companies they invest in.
“You shouldn’t fault NIH for this because the literal words of the regs are the literal words of the regs. It’s just that those literal words have never been taken literally,” said Linda Powers, managing director of Toucan Capital Corp., a venture capital firm in Bethesda, Md.
Two companies Powers has backed had their federal funding canceled at the last minute because of the new interpretation, launching her on a crusade to change the regulation. She has been joined by the National Venture Capital Association and biotech trade groups.
“We’re going to be very aggressive on this issue,” said Nancy Saucier, manager of the National Venture Capital Association’s medical industry group. “More of our portfolio companies are applying for grants not only as a means to validate technologies but also to stretch the dollars a little farther.”
Trophogen Inc., an 11-employee company in Rockville, Md., last summer applied for $100,000 in grants to pay for Phase I clinical trials. After three decades of running labs at the NIH and teaching at the University of Maryland, Bruce Weintraub and his business partner, Mariusz Szkudlinksi, launched the start-up to explore new ways for infertile couples to become pregnant.
Their application received a score of 157 from the peer review panel, and scores under 200 almost always receive funding, Weintraub said. “We had every reason to believe we were going to be funded,” he said.
But in April, eight months later, an administrator ruled the start-up did not qualify because a venture capital firm, not individuals, owned more than half of its stock. In exchange for $3.5 million in VC funding in July 2001, they gave 80 percent of their shares to Toucan.
Other biotech start-ups, including Cognetix Inc. of Salt Lake City and Layton BioSciences Inc. of Sunnyvale, Calif., have had applications rejected even though they had received SBIR grants in the past.
Donald Ralbovsky, a spokesman, defended the NIH as “administering the program in accordance with the directives” from the Small Business Administration. He would not say whether his agency in the past gave grants to start-ups majority-owned by VCs.
The SBA announced in the Federal Register last month that it would review the wording of the program’s requirements — not to deal with the VC concerns, but to allow wholly owned subsidiaries of small businesses to qualify. But there is a chance the SBA will change course.
The agency is accepting public comments on the wording change, sent by e-mail to [email protected] or via fax to 202-205-6390 through Monday. Officials said they will consider recommendations about whether start-ups majority-owned by venture capital firms should qualify for the grants.
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