Venture Capital Feature (February 2003)

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BRAVE ) NEW WORLD Aldous Huxley's seminal novel foret the coming age of biotechnology, In austere and prophetic language, Huxley penned a new world arden) championed through state-sponsored eugenics, lifelong wellness and an insatiable appetite for pushing the boundaries of science and' humanity. Today, the goal may be preventive; predictive and personalized medicine, but biotechnology offers greater challenges than cloning gene strings -from the decoded genome. If Hawaii is to develop a burgeoning: industry by commercializing intelli property, it will require the most of all qualities: ambition, suggest } L. Halloran and Nicole T. Boynto o one doubts the potential of a robust biotech- \ nology industry in Hawaii. According to the most recent projections made by the University of Hawaii's (UH) College of Tropical Agriculture and Human Resources, biotech currently generates over $320 million in annual revenues and employs more than 1,700 people. By its calculation, the biotech industry will catapult to $3.1 billion in revenues by 2010, fueled by the growth of life-science research institutes that will support UH's new medical school facilities in Kakaako. To reach those field-of-dreams projections, Hawaii will need a massive infusion of venture capital and talent -- symbiotic commodities that seek out one another with evolutionary efficiency. Ultimately it will be the people the state recruits, the leaders it seeks, and the models it develops that will foretell its own brave new world. Here then, the dramatis personae. DOCTOR IN HOUSE Dr. Leroy Hood is an incautious scientist. He believes that new ideas require new organizational structures. New concepts require new companies. And new thinking comes best from young people empowered to make decisions. He is prone to candor, and fortunately for Hawaii, he will serve on the advisory board for the John A. Burns School of Medicine as it builds its new facility in Kakaako. As one of the world's foremost experts in molecular biotechnology and genomics, Hood has pioneered technologies that enabled the decoding of the human genome and more recently founded the Institute for Systems Biology (ISB) in Seattle. Hood's cross-disciplinary An essential element of ISB's success has been its focus. It has narrowly defined the terms of science and technology transfer, and it uses this cross-disciplinary approach to distinguish ISB from other institutes and organizations seeking enterprise partnerships. "Any institute ought to have a mission statement that is really clear and unambiguous. | have a mission statement that a person on the street can understand, and that's sometimes really hard to achieve. If there were a single captivating vision here in Hawaii you could generate enormous resources that could be used to attract really first-class leaders." approach to science -- he teams engineers with chemists, biologists and mathematicians -- has earned the institute a sterling, if not maverick, reputation. The institute is driven by biology and research, but has been built on a foundation of computational expertise that begets enormous commercial potential for its intellectual property (IP). In Hood's terms, "We are trying to integrate life science, big science and small, hypothesis-driven science at the same time and at the same place. Ultimately we feel we have a responsibility to transfer that knowledge, by educating K-12, mentoring start-ups and influencing Third World medicine." With roughly 170 staff, ISB has attracted bright minds aimed at big ideas with bold prospects. (ISB recently christened anew facility that Hood believes will not accommodate the growth he anticipates.) The transfer of knowledge occurs, according to Hood, when IP is commercialized. Throughout his academic career, Hood has been involved in several spin-offs; he started at Caltech before moving on to the University of Washington in 1992, and founded ISB in 2000. Those spin-offs led to many of biotech's most notable successes, including Amgen, Applied Biosystems and Rosetta. And for Hood, start-ups are the key. "Most of our technology that is transferred goes to start-ups. We don't like to sell to companies that are too large or to sell directly to pharmaceuticals, because they typically don't put enough resources, talent or emphasis on getting the science done right." ISB looks at "industrial partnerships" to commercialize its IP. "All of the industrial support we receive is extremely narrowly defined. We want to be able to keep most of our IP for the future," says Hood. No doubt, there is an implied quid pro quo in each partnership with clear boundaries and rules of engagement. Hood cites several models: Licensing: Currently, Merck pays $1 million per year to ISB for the right to commercialize IP on a limited basis. According to Hood, Merck has already received a significant return on its investment, and he considers the relationship a good deal for both parties. Development deals: Technology providers assist with computational and manufacturing processes, including the installation and maintenance of computer systems, laboratory equipment, etc., to aid research. ISB boasts the world's foremost computational resources, carved out of agreements structured with major vendors who then commercialize some of the proprietary processes and technologies that are developed. Joint ventures: ISB actively searches for small biotech companies and invites them as joint venture partners. For companies with limited resources, the appeal is the access ISSUEO9 FEB 2003 venture >> Venture Profile | siotech 24 to the significant minds at ISB as well as world-class commercialization opportunities. Asa private organization, ISB and Hood have the luxury to structure partnerships in ways that balance immediate funding needs with long-term goals, such as retaining top scientists. "Any scientist involved in developing technology that is commercialized has a chance to share in the founder's equity of any spin-off and to share ina portion of the IP that is sold or licensed," Hood explains. A set formula is employed so recruits have a clear expectation and the institute has a revenue stream to fund its operations. According to Hood, this arrangement allows greater flexibility in decision-making. Ultimately, he hopes that some of ISB's spin-offs lead to initial public offerings (I.P.0.'s) to create an endowment fund. Hood does admit that Hawaii's location is a disadvantage. Its remoteness makes collaboration and scientific discourse more challenging, which may partly explain the lack of a true critical mass of scientists in the islands. There are pockets of intelligentsia, to be sure, but "there is the issue of whether you really have the talent to generate significant IP, and whether you have the engineering talent for a good company to emerge," suggests Hood. While discouraged by the lack of local talent, Hood believes Hawaii has potential capital partners -- connections to wealthy people, locally and abroad -- that can form the foundation to support biotech. The ability to recruit top people is essential to developing any industry, but it is critical in life sciences, and particularly in biotechnology, where a single researcher can generate enormous attention, cache, and revenues for his or her employer. Hawaii needs a few "rainmakers'" like Hood, scientists of vision, who can attract other venturesome young minds. "I think you would like your leader to be doing real science and contributing to science. My feeling is that leaders who only become administrators lose contact with the real world." The ideal candidates possess not only scientific acumen, but a dynamic sense of purpose and the ability to convince key influencers into the industry. "It's a combination of things. One is the vision that captures what is right for Hawaii and for the medical school. I think you would like a leader who is articulate, passionate and committed and you are not going to find all of those in one person, necessarily. There is nothing like success to convince people of what can happen." ENTER WATUMULL Hawaii Biotech (HB) is a 20-year overnight success and perhaps Hawaii's most prolif ic biotech company. At the helm is David Watumull, CE.O., a former biotech analyst and industry veteran who joined HB in early 2001 as part and parcel of its first round of venture capital funding. The funding round was led by local "angel investors" Ron Higgins, Barry and Virginia Weinman, Larry Johnson, venture capital firm HMS Hawaii and several local families. The investment, coming from Hawaii's pantheonic venture capital pool, signals that Hawaii Biotech is the Chosen One. HB's ability to commercialize IP, and thereby generate significant value creation for its investors, is a bellwether for the biotech industry in Hawaii. In order to appeal to larger venture capital firms for its next funding event, Watumull is shaping HB as a diversified science enterprise. "The company as we conceive it is really focused on having a broad pipeline of potential pharmaceutical candidates. It doesn't make sense to create a company's whole infrastructure around one product. It's a better business model than the more well-accepted model, which is to do one product and try to take it all the way through Phase 3 clinical trials." The company is currently exploring three solutions for commercial exploitation in cardiovascular disease, Hepatitis C, and vaccines for tropical-borne diseases (dengue fever and the West Nile virus). "There are a lot of factors that go into deciding whether a project has a go at HB. What we like to do is to start at the end and work backwards. What kind of treatment would this entail in the pharmaceutical marketplace? What type of physician is going to be prescribing this, for what indication?" venture ISSUE 03 FEB 2003 That eye-on-the-prize approach serves Watumull's investors well for its apparent pragmatism, but may preclude innovation in the process and true wealth creation. As Watumull explains, "Everything that we try to do is geared towards patents and IP. And that's been a part of the strategy from the very beginning. If a particular project doesn't have an IP position, then it is not commercially viable." Prior to joining HB, Watumull was the executive vice president at Aquasearch, where he assisted the Big Island company in raising capital in the 1990s to develop organically-based nutraceuticals. Aquasearch consistently struggled to bring its products to market, filed for Chapter 11, and most recently merged with Mera Pharmaceuticals, which also filed for bankruptcy protection this past fall. AstaFactor, the company's lone product, is a made-to-order diet supplement aimed at hyper-energetic Baby Boomers and marketed as a natural antioxidant. The company racked up over $20 million in accrued losses developing AstaFactor (a nutraceutical that does not fall under the strident purview of the FDA). Watumull learned two expensive lessons with AstaFactor: it is nearly impossible to create significant sales and distribution channels from Hawaii, and to deliver consistent results around a single product or concept. Instead, Hawaii Biotech's plan is to bring all of its IP to development only through Phase 2 clinical trials, at which point it will explore licensing opportunities with pharmaceuticals. The first steps are pre-clinical exploration (proof of concept) and Phase 1, both major milestones that beget significant value creation for biotech companies. VCs usually engage companies after Phase 1 to fund Phase 2 trials, which can be expensive depending on the complexity of the science. Biotech differs from most industries in that companies are unprofitable for a long period of time. The milestones are not traditional business milestones, such as sales or production efficiencies. Nor are biotech benchmarks analogous to academic goals, such as publishing a paper or achieving a scientifically interesting outcome. Products also differ in terms of testing requirements with human clinical trials accounting for the vast bulk of expenses. Which is why HB is weighing its options. "We need to look carefully at what we call the endpoint, what you study in the clinical trial, and see if those are easily, or at least reasonably, measured. How many people need to be part of the trials and how much will that cost? We also look at the viability of what kinds of animal testing, in vitro (test tube testing) can be done. We hope for something that is making a large difference in a particular disease. Hopefully a poorly served, or unmet, disease." Watumull is also directing HB resources to new terrain, seeking to develop anti-inflammatory compounds for the treat: ment of heart and liver disease. For HB's work on a dengue fever vaccine, Watumull estimates the company will require four to five million dollars for just the pre-clinical studies and an additional half-million for human clinical trials. The dengue fever trials are unusual in the small number of patients that are required to participate, but the vaccine's complexity means higher initial expenses. "In our dengue vaccine, we have five components and two proteins, so a total of seven proteins have to be manufactured according to FDA standards. It is a complex project that will take some time and dollars to bring to human clinical trials. The good news is that the Phase 2 trials are not expensive. If we can get positive results, we'll have a major step up in value for the project and for the company." A potential windfall for HB is that the viruses that cause dengue fever and West Nile virus are close offers, "It took us more than 10 years to get the components and proteins that we are cousins. As Watumull using in our dengue vaccine. We were able to come up with the proteins for the West Nile vaccine in about three months." According to Watumull, most of HB's major initiatives are close to animal studies. He expects the results in the first half of this year to lead to further refinement of the dengue fever vaccine. By 2004, human clinical a 0 G £ G 2 = Sw 8 Eainyenk a trials are anticipated to begin, with full scale production expected by 2005. To achieve those aggressive benchmarks, Watumull will need significant capital resources to augment HB's anticipated $5 million in grants from the National Institutes of Health (NIH) and Department of Defense contracts for this year. While HB has been successful in funding itself through these vehicles (over $30 million in the past 15 years), Watumull will need an estimated $15 million by the end of 2003 to keep his clinical trials on track. Foundations such as the Rockefeller Foundation and the Bill and Melinda Gates Foundation may also be a funding source. Watumull hopes to appeal to mainland life-science venture capital fund managers. As he explains, "HB has tried to get funding for the company as a whole, rather than for each product. We will probably have to augment our local investor base with either mainland VCs or an expansion of the investor base to local institutional investors." Watumull insists that the full amount might be funded locally if insurance companies, unions, and pension fund managers step up; while he recognizes that their biotech investment experience is limited, there is technical assistance available to guide them. In the end, he asserts, investments will be made based on "the quality of the people, the background of the people involved, and the level of expertise that has been developed at the company." He also recognizes that only a remarkable success will convince reluctant local money that biotech can be a sustained, profitable enterprise. "Our number-one exit strategy for our investors is an LP.O. I would like to see Hawaii Biotech remain independent and remain in Hawaii." He is therefore reluctant to pursue an acquisition strategy, because he believes that if a large pharmaceutical were to buy the company, "I just don't think you'll have the walk-the-hall kind of intimacy that you will need to capitalize on. We can build the management teams that are necessary to accomplish the proof of concept, Phase 1 and Phase 2 type of value-creating event. That we can do here in Hawaii, So for us it is really a matter of will, more than anything else." David Watumull ISSUEO9 FEB 2003 venture 215) >> Venture Profile | sioteck LEFT OF CENTER, PENNER SPEAKS Ina theoretical utopia, is a disease-free world possible? "Theoretically yes, but practically there are the limits of physics. You can do all you want but your bones may break. Even without cells, there is only so much you can do." One of Hawaii's most renowned research-scientists, Reinhold Penner, M.D., Ph.D., is a pragmatic idealist. He has attracted worldwide attention with his innovative research in cellular-level regu: latory mechanisms and his most recent discoveries, published in Nature, may lead to treatments of many health conditions including immune system and blood disorders, liver and kidney failure, insulin shock and stroke. "We have been interested in the regulation of ion channels ever since I did postdoctorate work with Erwin Neher, a Nobel laureate. He invented a technique that truly revolutionized our understanding of cellular function." But as Penner explains, "I drifted a little away from Neher's main interest... towards immunological questions of what we call signal transduction in immune cells." The premise behind Penner's research is how cells regulate the inflow and outflow of calcium, sodium and other substances through tiny pores in cells called ion channels. Simply put, ion channels are the roads between cells. While ion channels in the brain, nerves and heart (excitable cells) have been studied extensively -- serving as the target of about one-third of all current medications on the market -- much less is known about ion channels in the immune system, liver, kidney and the lining of blood vessels (non-excitable cells) until now. Calcium is a critical component of Dr. Penner's research because it is the most ubiquitous and immediate ion channel in the body. Calcium affects everything from the heartbeat to allergic response. For example, the more calcium that enters a heart cell, the stronger the heart contracts. Calcium can also cause certain cells to secrete histamines that cause an immune response like asthma. "Practically every cellular response has a component that deals with changes in calcium, from muscle contraction to thinking. The fact that your brain releases neurotransmitters is all controlled by changes in intracellular calcium." Understanding how these ion channels function may lead to improved therapies and medications that protect the brain during a stroke by working immediately to block the calcium channel. Dr. Penner's research also has important implications for immunological diseases, such as asthma and allergies. His findings shed light on how immune cells respond, suggesting that if you suppress the production of the immunesignaling molecule (known as IP4), you will alleviate the symptoms. Conversely, you may also be able to stimulate the immune system by increasing the production of this an eventually leads to cell death." molecule in order to enhance a person's immune system, in the case of cancer or transplantation. Not that it's that simple. There are many signaling mechanisms, all of which impact cellular function. Penner attests: "You can actually affect one signal mechanism by working on another one and vice versa. It's a huge network and addresses many issues of pharmacotherapy studies, such as drug-drug interaction." venture ISSUE 09 FEB 2003 "Ideally you will have a little pill that you carry with you so that if you just feel you are having a stroke you can take it, like aspirin for heart attacks. During ischemia, stroke or heart attack, the energy level of a cell goes down. Normally, this causes ion channels to open, creating more energy or ATP (adenosine tri-phosphate). But when you have a stroke, parts of your brain do not get enough oxygen, because of a blocked artery. The cell tries to compensate by letting more calcium through this ion channel and giving the calcium to the little energy generators inside the cell -- the mitochondria. The problem is mitochondria need oxygen. On top of that, calcium itself can be dangerous because there are certain enzymes inside the cell that are regulated by it. So calcium comes in and tries to activate mitochondria to produce more ATP, but because of a lack of oxygen it cannot. It is a vicious cycle that The research and commercialization model Penner is pursuing has proven to be successful, combining his acumen for science with the ability to develop licensable IP from the novel gene sequences he and his team identify. After the IP is patented, Penner et al. typically form a new company to commercialize the discoveries. "Once we have identified genes we express them, study their function, analyze their characteristics and then we try to find out where they function, based on what we know. When we know where they function, we can look at disease relevant mechanisms they may be involved in. Then we can look for compounds that modulate the activity of these proteins. And once we have such compounds we can start licensing." So far Penner has been able to successfully commercialize his scientific discoveries in two arenas: immunosuppressive and cardiovascular diseases. "We have cloned and characterized three novel ion channels, patented the genes, and patented the activation mechanisms of these ion channels. These are very exciting targets." A Massachusetts-based pharmaceutical bought the company Penner formed, less than a year after its inception. He says, "I think we have demonstrated what can be done here, we have created a company in collaboration with three other people and that company was already acquired by another bigger company." The Queen's Medical Center recruited Penner from the prestigious Max-Planck Institute in Germany and provided the start-up funds for Penner's research. While the financial and administrative support from Queen's has been critical to the development of Dr. Penner''s research, today his research is funded solely through NIH grants and contributions from pharmaceutical companies, including Boehringer Ingelheim, Yamanouchi Pharmaceutical in Japan, and a collaboration with Bristol-Myers Squibb. The financial relationship with Queen's has been reciprocal, according to Penner; Queen's Medical Center benefits from the research because it essentially pays for itself, and Queen's shares in the IP royalties generated by the research. Dr. Penner is clear about what conditions will work for Hawaii in developing a biotech industry, and his vision for the future does not include moving to the new biomedical research facility being built in the science Kakaako. He opines, "If you want research excellence, you really need to shoot big. You need to create a center that has significantly more square feet than what is currently planned." Penner is also cautious on how commercialization agreements are structured. "I think that it's fine to enter into collaboration with pharmaceutical companies, but to have an umbrella agreement that takes away the liberty of licensing IP to other entities is a big mistake. Certainly each investigator should be able to spin off a company." The most important thing for any research institution, Penners suggests, is the recruitment of world-class researchers. Hawaii is not yet regarded as a prime, basic research place and therefore, Penner believes, it will not be so easy to attract people of high talent. "What you need are crazy young people who are willing to risk something. You encourage these people to do it by providing exceptional possibilities for advancing their career." According to Penner, biotech is something that comes naturally with the work of any good researcher, an organic expression of commercial enterprise and science united. Leave the science to researchers and the business of science to others. "Biotech goes where it's best for them, not where a university thinks it's best." Reinhold Penner, M.0., Ph.D. DOWNSTAGE, PASHKOW WAITS With no local investors in sight, Hawaii may at first seem like an unusual landing spot for Colorado-based Biophorix. But according to Dr. Fredric Pashkow, president of Biophorix Pacific (a subsidiary of Biophorix), Hawaii will serve as the hub ofa contemplated biotechnology enterprise as it expands to the Pacific. The goal: to create new drugs from natural products and indigenous plant and aqua biomass. The draw: access to large collections of biomass through a pending partnership with UH, that includes the school's ethnobotany collection and its famous Moore Patterson microalgae collection. The stake: possibly millions of dollars in licensing fees. Currently, Biophorix Pacific is theory in motion. It doesn't have an agreement with UH (still being contemplated at press time), it doesn't have office space and, outside of Pashkow, it doesn't have any employees. What it may have is the momentum to capitalize on an opportunity. As Pashkow, former director of the Cardiovascular Institute at the Queen's Medical Center, explains, "We're here because fundamental aspects of our business plan take place here in Hawaii, so we feel it is very important for us to invest in Hawaii and be physically close." What Biophorix hopes to do is methodically plumb the entirety of UH's collection of natural plant and marine biosources in order to "discover" medicinal plants that have been used worldwide by indigenous healers but overlooked by pharmaceutical companies. And while the process of isolating curative substances is not new, Pashkow describes previous attempts as hit or miss. For example, 100 years ago Bayer (the German pharmaceutical giant) analyzed the properties of dead plant specimens, but not those in live plants. Biophorix claims to be different from the other 95 percent of biotech companies that start with a single drug, since its aim is to amass a large collection of lead compounds and then match them to target compounds in demand. "We estimate that if we can get off the ground here in the first quarter, as we are anticipating, we will ISSUEOS FEB 2003 venture >> Venture Profile | siotecH have 10,000 lead compounds by the end of the first year," offers Pashkow. The plan is to focus on multiple compounds, rather than a single compound, "since only one in ten new chemical entities get to the clinic, let alone through the clinical experience." The pending UH partnership will allow the company access to the university's collection of 12,000 plants, and as Pashkow explains, "The next step is to take the natural products and then apply proprietary conditions to these compounds, and when you do that they change into new compounds. Those new compounds are patentable." From there, the company will catalogue the collection and connect it to a computerized database to search for potential targets. These candidates will then be matched to companies which have targets but no lead compounds to work with. (Targets refer to what you are trying to fix, such as high blood pressure or diabetes.) Pashkow states, "We find company after company that knows what they need to fix, but they don't have the lead compounds." One such company is Hawaii Biotech, which is interested in screening and sampling the collection of lead compounds that Biophorix plans on generating. It's not pure science, but rather "service science," by providing an efficient, computerized matching system to speed the development of new drugs. Although there are other companies that license botanical collections, Pashkow believes that, as a local company, Biophorix Pacific's advantages include proximity, existing relationships with key local decision-makers, and a "first mover" opportunity to explore the open terrain of Hawaii's nascent biotech industry. Pashkow would not disclose financial details of the pending agreement with UH, but the Biophorix model is certainly unique for Hawaii. Pashkow says, "The outline of the agreement involves access to collections, agreements about sharing royalties, reciprocal research opportunities, and they are going to be providing us with incubator space....We feel that partnering with UH is an obvious thing to do, we need each other. We're going to find out specifically if ourrelationship is going to go beyond the licensure of access to collections and partnering on resource development. The implications of that are for them to have an actual equity position in the company." Indeed, much of its business and revenue models assume a strong and sustained presence in Hawaii, predicated on access to UH's collection. Biophorix's chief drug-discovery research scientist (recruited from Amgen) insisted on basing its operations in Hawaii, venture ISSUE 09 FEB 2003 According to Pashkow, "The typical drug development biotech start-up scenario is a professor, say at UH, who stumbles across a compound, either in its natural state or as a byproduct of something else, and realizes this may have other applications, say for cancer, heart disease, obesity or hypertension. They are so convinced that this is the holy grail for compounds in this class, or a new class, that they want to develop it on their own and go out and start a company." according to Pashkow. Not that setting up shop here has been easy. As Pashkow says, "We not only had to think outside the box, we had to think outside the carton. Hell no, we had to think outside the container, when we looked at the issue of wet lab space, for example. But we persevered, because for us, Hawaii is critical. We are willing to put up with a lot of inconvenience, meaning really having to dig to find solutions." The company's founders are largely a collection of wayward scientists, mainly from biotech stalwart and media darling Amgen, who have grown dissatisfied with business as usual at a big pharmaceutical company. Michael Handley, C.E.O. and president of Biophorix, jumped ship because he felt that, even with a company as new as Amgen, the industry was still working under an antiquated paradigm of drug discovery and design. Handley felt there was too much of a disconnect between each step of drug development, which can be up to 15 years from inception to FDA approval. According to Pashkow, "The person who is identifying the target and the person who is working on the chemistry of the molecule aren't in close enough proximity mentally with the people who are going to be using the drug." He reports that Handley personally experienced the development of drugs at Amgen that got all the way to human clinical trials, the last step in the process of drug approval, only to hear clinicians tell him the drug wasn't going to work because of the way it was designed. Perhaps out of frustration, Handley set out to develop a business plan for Biophorix that would fill its pipeline with a huge collection of lead compounds or potential clinical drugs, in contrast to the traditional biotech business model of pursuing a single drug incrementally. Pashkow and Biophorix believe their model offers better opportunities to partner with drug manufacturing companies by directly licensing the compound, speeding the process to ultimate delivery. The viability of this goal remains to be seen, but one thing the team at Biophorix realizes, "The professor with his favorite compound that he wants to make into a drug to save the world doesn't work anymore. Those kinds of companies burn investments on a continual basis, so we had to come up with an approach for drug discovery that would help pay our way through the licensure of our compound collection," says Pashkow. Pashkow also believes their model can accelerate the academic track: "We screen it and purify it, produce natural products, then we kick them back to the UH faculty who are interested in them. Then they go ahead and publish scientifically about them. But if we modify them, if we condition them, they go into the enterprise track, they can feed back to the university eventually." In addition to the UH collection, Biophorix is pursuing similar opportunities with the Crown Institute of Geology and Natural Sciences in New Zealand and the Channel Island Maritime collections. Of course, the company's success hinges on developing strong partnerships with institutions that have the collections it desires. The pending agreement with UH may redefine its role with the private sector -- setting a precedent and enabling Biophorix to expand rapidly. If UH elects to be more involved in biotech, and succeeds, it will certainly help the university raise critical funds for other initiatives, as well as raise the profile of biotech in Hawaii. The present state of Hawaii's biotech industry is filled only with promise and potential. And like any captivating story, the plot must evolve from early dialogue. An anxious audience awaits. Enter Pashkow and Penner, Watumull and Hood. Curtains rise. The brave new world unfolds. << After decades of silence, the buzzword in Hawaii is biotech. The din is barely audible amidst the loud roar of states across the nation cheering on their home team. In major league biotech there are seasoned professionals (San Francisco, Boston and New York); minor league teams quickly gaining speed (San Diego, Seattle and Raleigh-Durham), and an inordinate number of expansion teams (from Detroit to Honolulu), shooting for the big leagues, writes Nicole T. Boynton. ISSUEOS FEB 2003 venture >> Venture Profile | siotecu tists and researchers -- with the kind of sloganeering found in professional and college sports. Kentucky, for one, lures academic stars to its universities by supplementing their salaries with its "Bucks for Brains" program. Once on the playing field, start-ups vie for venture capital, million-dollar contracts, fame and regional supremacy. Hawaii has not been home to a major professional team for many reasons: S tate legislators and universities are recruiting new talent -- academic star scienisolation, expense, lack of investors, and limited resources to recruit top talent. Biotech will hopefully be the first start-up industry in years, but can it make it to the national playoffs? STIFF COMPETITION At the annual Biotech Industry Organization (BIO) conference in Toronto, Canada, last June, 130 U.S. cities and regions tried to lure biotech to their community, dangling everything from local attractions, such as golf courses, to real attractions, such as the number of Ph.D.'s. Hawaii is just 1 of 41 states pouring millions in state and private funding to develop a biotech industry, according to a report commissioned by BIO last year. These states are upping the ante on incentives, moving beyond the traditional R&D tax credits to include funding for incubator facilities and even venture capital and grant funds. For example, Michigan is setting aside $50 million a year (totaling $x billion over 20 years) from its $8.2 billion settlement with tobacco companies to develop the Michigan Life Sciences Corridor. St. Louis is trying to position itself as the heart of "BioBelt," with major investments in research. Texas appropriated $800 million last year, including $20 million to establish the Southeast Texas Biotech Park in Houston. Baltimore is proposing a bioscience park near Johns Hopkins Hospital, while Pennsylvania recently committed $100 million to set up incubator space for biotech start-ups. So which regions are edging out the competition? Joseph Cortright, author of the new Brookings Institution study on biotech clusters, notes that the industry is already heavily concentrated in nine metro areas, led by Boston, New York and San Francisco. Three of the nine are becoming new centers of biotech: San Diego, Seattle and Raleigh- Durham. The study reported that the best results are achieved by "early movers," regions that got into the field years ago and now have a base of research and entrepreneurial experience on which to build. Hawaii was not mentioned in the study. THE RIGHT EQUIPMENT The state needs to invest in the requisite infrastructure to compete with, and recruit, major players. Many experts believe that Hawaii's white sand beaches and recent Act 221 tax incentive are not enough to succeed. They suggest three key ingredients: local universities that teach students how to turn discoveries into products; recruitment of venture capitalists into the community to commercialize local breakthroughs; and finally, networking groups. Considering that every other state is investing in this basic equipment, Hawaii needs to customize its approach to make the most of the state's natural resources and overcome some of the inherent obstacles to doing business here. General partner of Morgenthaler Ventures, Robert Bellas, specifically suggests, "The key to growing this industry in Hawaii is a source of capital such as an angel network; a locally visible success like Verifone; a wonderful support network of lawyers, accountants and bankers who aren't willing to charge huge fees initially; and access to intellectual property." venture ISSUEOS FEB 2003 NATURAL TALENT In addition to the diversity of flora and fauna, Hawaii's climate, multiethnic make-up, and enviable position in the Pacific Rim are proving to be compelling selling points for attracting biotech. As Elizabeth Corbin, ocean resources development manager of the state's Department of Business, Economic Development and Tourism (DBEDT) suggests, "Hawaii's geographic isolation, microenvironments and mixed races combine to create gene pools of remarkable diversity and uniqueness." DBEDT has identified four potential biotech sub-sectors that Hawaii can specialize in: agriculture, marine, medical and environmental. Ed Cadman, dean of the John A. Burns School of Medicine (JABSOM) at the University of Hawaii, hopes to specifically nurture Hawaii's field of biomedical research, including biogenesis, marine and rainforest drug discovery programs, molecular genetics, tropical infectious diseases, and complementary and alternative medicine. Regarding the latter Cadman explains, "Here in Hawaii, we're more open about using these therapies and medicines than the mainland. Our strategic plan has identified this field as a primary focus area, and NIH grants are rapidly growing for this research. I'm confident we can become a leader in this field." The university has already demonstrated leadership in biogenesis research due to the world-famous mouse cloning work of "Team Yana," as well as by developing the Institute for Biogenesis Research facility at the UH Manoa campus. Marine and rainforest drug discovery programs are also currently underway, as groups work on taking the biomass of the rainforest and oceans and discover how to separate bioactive compounds. Cadman states, "We need to take advantage of our rainforest and oceans and work on drug discoveries." In molecular genetics, Cadman envisions Hawaii as a world leader in matching gene patterns with diseases. Hawaii's multiethnic mix makes research in this area a natural fit, more so than many areas in the continental U.S. The emerging field is extremely important to pharmaceutical companies. Cadman explains, "Pharmcos really think that we have a tremendous asset: ethnic diversity. Then there is this new field called pharmacode genetics -- how various ethnic groups metabolize drugs differently. It's a whole new field of investigation." Hawaii's location in the tropics also gives the state an advantage on research into tropical infectious diseases and genetic engineering of antibodies and vaccines. Defense is Hawaii's second largest industry after tourism, and increasing concern about biological terrorism has meant more research money is being allocated to this area. "There's this tremendous worry about emerging infectious diseases and we have a program for that. A lot of emerging infectious diseases come out of Asia and Africa. We have several laboratories that are collaboratively working with laboratories in Thailand, Vietnam and Japan. That's of tremendous interest to the military," Cadman says, Other collaborations with the military include developing simulation environments or virtual operating room situations. He says, "I foresee a time in the not-too-distant future when physicians will need to go to centers just like airline pilots go to centers that simulate flying a 747." THE STADIUM Biomedical research parks attract researchers, grow companies and harness intellectual property. Biotech is one of the most research-intensive industries in the world, with the U.S. spending $15.6 billion on R&D in 2001. According to Dr. Carl-Wilhelm Vogel, director of the Cancer Research Center of Hawaii, "Not only would a state-of-the-art biomedical center be a boon to basic research, but medical schools are the focal point around which new companies are created. Research attracts the interest of venture capitalists who fund the intellectual property created at the university and turn it into new products and new companies." The state legislature advanced monies for the planning of a biomedical research center in Kakaako. Construction began this past October. Dean Cadman proposes that the new, 10-acre medical school campus will be ideally situated amidst 200 acres of land, 100 acres of which is owned by the state and another 100 of which is owned by two private organizations: Kamehameha Schools and General Growth Properties. The expectation is that Kamehameha Schools will provide ten acres across from the medical school to build leasable research space, residential areas, shops and private research institutes. The campus will include a 138,000-square-foot research building, and a 116,000-square-foot educational administrative building, with room available for another tesearch building plus a child care center, fitness center and cafeteria. Leasable research space, virtually nonexistent in Hawaii, is a crucial component of Cadman's vision: "Look at Honolulu. There are high-rises and leasable business spaces. Biotech, like any other business, can't afford to build its space; it needs to lease it." Cadman compares this to San Diego, where a small company can lease up to 50,000 square feet in one location. In addition, Cadman strongly supports the development of private research institutes, such as Scripps and Salk in San Diego. "Private research institutes have the ability to do things much faster. They are out from under the university bureaucracy and they can pay top-flight wages, just like any other business can." The dean justifies the expense of the biomedical research park by advocating that it will be cheaper to build new than renovate an aging medical school. "Research space is probably the most expensive you can develop because you need top-quality air handling, requirements for handling caustic chemicals and working with biological agents: viruses, bacteria, infectious diseases." The funding for the medical school is a $150 million bond that was issued last June by First Hawaiian Bank. The interest and principal payments will be coming out of the tobacco settlement fund, with $10-$11 million (out of $42 million) allocated to pay off the bond. According to Cadman, "16 states are using tobacco money to support some sort of biomed research, including research parks, while some states are just putting it into the general fund and not using it for health related purposes at all." RECRUITING PLAYERS Biotech runs on brilliant, driven researchers, and Cadman believes Hawaii can successfully recruit once it has adequate space, despite direct competition from other biotech hotspots. He suggests that one of the state's main assets is Hawaii itself. Rather than seeing the region as geographically isolated, Cadman views it as an advantage for attracting scientists from China and Japan and California (where 50 percent of the biotech industry is currently located). The dean's strategic plan includes hiring more physician-scientists to create a critical mass and ignite research synergy. By providing these recruits with first-class facilities, they can pay for their own salaries by winning federal research grants. "On average, an excellent to outstanding researcher can bring in between $750,000 and $1 million annually in biomedical research grants. Each faculty member should end up covering the cost of his or her own salary, plus generate 10 additional, good-paying jobs. That translates into $25 million in grants for UH, plus 250 additional scienceoriented jobs for the state's economy. It's a doable number." The hope is that researchers will generate licensable IP and invent products that can form the basis for spin-off companies, further boosting the local economy. TEAMWORK In order to grow a globally competitive industry, the university, private sector, and state organizations need to work together. One key to San Diego's development has been the creation of a group called Connect. Begun in part by the extension service of the University of California San Diego, the group has linked the research world with business services, from accounting to venture capital. Qualcomm, San Diego's largest company with about 7,500 employees, was a product of Connect. Hawaii is adopting this model with University Connections, a pro: gram begun two years ago to get the business community familiar with the university. The seminar program meets in downtown Honolulu and is open to faculty, scientists from the private sector, investment bankers, venture capitalists, the business community and any other interested parties. ISSUE 09 FEB 2003 venture el >> Venture Profile | siotech Another essential ingredient for expansion is to form a statewide biotech trade association affiliated with BIO. The challenge is creating a trade association that enlists the full cooperation and involvement of the private sector, the government, and the university. In all 26 states with dedicated BIO trade associations, the private sector has taken the lead in its organization and development, versus a state agency. The Hawaii Biotechnology Council (HBC), formed under the auspices of the Hawaii Technology Trade Association (HTTA) and headed up by Hawaii Biotech C.E.O. David Watumull, plans to affiliate with BIO. While some are wary of the state setting the agenda, the state has committed its resources -- via DBEDT and the High Tech Development Corporation (HTDC) -- by targeting biotech as part of the state's economic development plan. BIO suggests that the state will be helpful in dismantling regulations that hinder the biotech industry (e.g, restrictions on the importation of microorganisms for research). In addition, government can champion industry incentive packages, such as tradeable R&D tax credits, net operating loss carry-forwards, sales tax exemptions for R&D equipment, capital gains incentives, clinical trial grants/loans and investment of state funds in local biotech start-ups. MANAGING THE TEAM Hawaii's success will ultimately depend on how effectively the team is managed. "The research part, which a lot of communities have, is necessary but not sufficient," says Cortright. "The commercialization is the hard part." Indeed, while good scientists are crucial players, the key is finding owners, entrepreneurs and investors who can muddle through the challenges of raising capital and negotiating through the FDA approval process. Unfortunately, most of those talented individuals are already heavily clustered in the major biotech hubs. According to a recent study conducted by Battelle Memorial Institute, only three states -- Michigan, Ohio and Pennsylvania -- have set aside funding specifically to foster commercialization of scientific discoveries in bioscience. (Battelle is a $1 billion non-profit organization that focuses on the development, commercialization and transfer of technology). In Michigan, which has provided seed funding, the effort is already paying off: 22 new biotechs were launched in 2001, triple the number in 2000. Based on Battelle's recommendations, the Georgia Research Alliance (GRA) is asking for a $5 million state-supported seed fund this year for start-up biotech ventures. Samuel Golella, general manager of Institutional Venture Partners, believes, "Management of healthcare companies is more challenging than IT companies; there isn't a good training ground. We always look for serial entrepreneurs ora great scientist to get something off the ground, but that is when you have to bring in the management team." venture ISSUEOS FEB 2003 One of Hawaii's drawbacks, notes Fredric Pashkow, president of Biophorix Pacific, is that "The community here doesn't understand biotech at all. There is zero appreciation for what is involved here." Pashkow adds that professionals here understand the service economy very well, but that Hawaii lacks the necessary expertise in biotech. And without raising local venture capital, the best discoveries will inevitably end up leaving the state. Ivor Royston, co-founder of Forward Ventures in San Diego and founder of the city's first biotech company, Hybritech, says he often looks for opportunities outside of San Diego but rarely funds them unless they agree to move. He recently convinced a biotech entrepreneur in Pittsburgh to move his company to San Diego. "VCs have a big impact on where companies develop," he says. Mergers and acquisitions also allow companies to gain more intellectual property, which serves as a safety net in the future. According to Bellas, "With the right amount of intellectual property, if one idea fails, companies can still back another drug candidate. FOR THE LOVE OF THE GAME The real reason most players participate is for the love of the game, one that helps 325 million people worldwide afflicted with various cancers, heart disease, diabetes, multiple sclerosis, Alzheimer's, AIDS and arthritis. With the annual number of drugs approved by the FDA declining by half since the mid-1990s, and with an average drug development time span of 10 to 15 years, "You must have a long-term view and you can't waiver on that view," says Richard Sherman of Goodsill, Anderson, Quinn and Stifel. "We need to ask ourselves what is Hawaii best at today and can become better at over the next ten years, then focus, focus, focus." <<