Biocurious: In a torrid capital raising climate, early-stage biotechs turn to alternative funding

• Life science companies are turning to federal research & development tax refund advances to stave off capital raisings on unfavourable terms
• Biotechs undergoing eligible R&D know they will receive a federal R&D rebate, but there’s a time lag between expenditure and pocketing the refund
• The R&D scheme is a perennial target of ATO audit activity

 

The Trump Administration’s assault on the life sciences sector has exacerbated the funding challenges for clinical-stage developers well beyond US shores.

Souring market conditions mean traditional equity raisings can be unattractive, while ASX biotechs are becoming affected by US public grant funding drying up.

Locally, the spectacular failure of Opthea’s (ASX:OPT) eye disease trial and Percheron Therapeutics’ (ASX:PER) Duchenne muscular dystrophy drug trial do little to imbue confidence.

“I don’t want to use the term ‘mass chaos’ but things have become incredibly difficult,” says Holly Stefl, chief commercial officer of the specialist biotech funder Endpoints Capital.

“I don’t think anyone has ever experienced this before”.

 

Tapping an idle balance sheet asset

As biotechs scour for their next dollar, one funding source is under their nose: the Australian government’s research and development tax incentive (RDTI) rebate.

This scheme compensates SMEs with a 43.5% cash offset for every eligible dollar spent.

The trouble is, there’s a time gap between spending the funds and pocketing the refund.

As they say, time is money.

An increasing number of biotechs are turning to funders who advance an expected R&D refund ahead of time, hopefully avoiding – or delaying – an equity raising on dilutive terms.

Providers include Endpoints Capital, Mitchell Asset Management, Radium Capital, Dare Capital, Kashcade and Paddington Street Finance.

“This is a great alternative for companies to assist them with managing cashflow,” says Mitchell Asset Management, which offers such loans via its Innovation Finance Fund.

Of course there’s no such thing as free money: across the sector, the standard interest rate is in the mid to high teens.

In contrast, early-stage equity investors will demand a return of 35% or more to compensate for the high risk involved.

 

Funding help for biotechs …

According to the ATO’s R&D tax incentive transparency report, the taxman rebated $3.2 billion across all industries in 2021-22 year.

Endpoints estimates the life science sector accounted for about $500-600 million of these refunds, with ASX companies receiving around $200 million.

Endpoints CEO and co-founder Andrew Stewart says most biotech boards often have overlooked R&D advances as an option, partly because they are scientists rather than finance professionals.

“R&D advances can dramatically lower their cost of capital by leveraging a lazy asset, which is the R&D credit sitting on their balance sheet,” he says.

“They can also avoid the need for dilutive capital raisings and protracted negotiations with investors [to back an equity raising].”

Since opening its doors 18 months ago, Endpoints Capital cumulatively has funded more than $70 million of R&D advances to 23 local biotechs for amounts between $150,000 and $11.2 million.

Endpoint’s first ASX-listed (and biggest) client was Recce Pharmaceuticals (ASX:RCE), which is undergoing late-stage trials for its superbug-busting synthetic antibiotic.

Respiratory device play Adherium (ASX:ADR) secured $674,000 to support its digital inhaler technology and expand into the US remote patient monitoring market.

Oncology and inflammatory diseases house Noxopharm (ASX:NOX) pocketed $1.8 million, while the private injection-free vaccine developer Vaxxas received $9.7 million.

 

 

… but beware of the taxman

To protect their position, the lender takes security on the tax refund, which is as good as money in the bank.

Or it should be.

In 2018 and 2019, the ATO cracked down on RDTI claimants altogether.

In a note after last month’s federal budget, accountant William Buck warns that the ATO views the RDTI as a “perennial risk”.

The audit activity abated during the pandemic, but the firm notes a “steady increase” in reviews over the last 18 months.

“It is starting to feel like 2018 and the massive increase in ATO [compliance] resourcing likely spells rough seas ahead for RDTI claimants.

“The climate is clearly shifting and tech companies need to adapt accordingly.”

In the due diligence process, lenders need to be confident the ATO won’t knock back an expense on the grounds of it not being genuinely related to R&D.

Michell Asset Management says in the case of clients that have used an external R&D adviser or tax agent to assist with this rebate claim, “it is likely that a large part of the approval is already complete”.

 

ATO’s stance discourages local trials

The unfolding US public funding squeeze should encourage more clinical trials to be carried out here.

But in late 2023 the ATO cracked down on R&D refund requests from offshore entities, on the grounds the work – or most of the work – was not being carried out in Australia.

“This will significantly reduce the capital flowing into the life sciences sector,” Stewart says.

“Until the ATO does give clarity, the size of the Australian market will shrink considerably”.

He says the recent vibe from the ATO is that more clarity is forthcoming “and this will greatly benefit the life sciences sector”.

 

Growing with the client

Endpoints aims for a multi-year relationship with its clients, over multiple clinical trial stages that might span five years or more.

“We want them to let them know we are willing to invest early,” Stewart says.

This relationship might start out with a small loan at a slender margin, “but over five years we want to work with them and do some great stuff together.”

In an ideal world, the client will commercialise a product and achieve revenue of more than $20 million of revenue – the threshold at which the rebate cuts out.

“Then we lose a client the good way.”

 

An adjunct to capital raisings

R&D lending doesn’t replace capital raisings – and the client needs the funds sourced from elsewhere to undergo the work in the first place.

For example, Recce this month unveiled a placement and rights offer to raise up to $15.8 million.

But R&D advances can leverage the time gap between the biotech spending the money and the announcement of trial results.

“Often a company’s cash burn rate and the release of trial results don’t align perfectly,” Stewart says.

“We can help extend the cash runway beyond the release of results when they can then go to market to raise that capital.

“Hopefully they then have a data room full of good results data, rather than just hopes and dreams.”

 

At Stockhead, we tell it as it is. While Recce Pharmaceuticals is a Stockhead advertiser, the company did not sponsor this article.