CPRIT’s statute requires that the Oversight Committee establish standards requiring all grant awards to be subject to an agreement that allows the state to share in the proceeds realized from projects undertaken with grant funds. The standards should balance the state’s opportunity to benefit through revenue sharing with the need to ensure that medical research is not unreasonably hindered and should not remove the incentive for further development.
The Subcommittee on Economic Terms established a goal for standard revenue sharing terms for product development grants to meet the following major criteria:
- Simple and understandable
Provide the State of Texas with a fair and reasonable rate of return on its investment in keeping with:
- Its role as a provider of financing only (vs. other assistance provided by VCs, including access to network leads for additional capital, business and technical guidance, board members, etc.)
- Its goals of stimulating company formation and job growth in Texas, and
- Its lower cost of capital in comparison with other investors
- Facilitate state participation in any blockbuster returns on a product developed with CPRIT funds
- Fall within a range of venture capital and non-profit industry standards, and
- Do not deter follow-on investment in the company by corporate or venture capital investors.
Explanation of Major Terms
CPRIT's return of 4X the amount of funds invested by CPRIT provides a fair and reasonable yield on the state's investment by taking into account its statutory public mission to accelerate development of cancer treatments and cures and stimulate company formation and job growth in Texas.
The 4X return is within the appropriate range of industry standards and recognizes CPRIT’s role vis-à-vis the company. Generally, successful venture capital industry returns fall within a range of 3X-7X the amount of funds invested with anything above 8X considered excellent and 10X as outstanding. Most venture capital investments are unsuccessful or return little. As an investor, CPRIT provides little else to the company beyond financing. The infusion of capital is of paramount importance, however, venture capitalists may also provide additional resources valuable to the early stage company. These resources include access to the VC’s network of other investors and experts that provide valuable business and regulatory guidance to navigate early stage development hurdles. Another distinction between the state and VC as investors is that the state benefits in other ways beyond cash returns when a company successfully develops a device or therapeutic. These benefits include a growing tax base and creation of high-quality jobs in the state. In contrast, the VC’s primary and likely sole interest is a capital return when a company in its portfolio successfully develops a product. Job growth and other economic considerations have little or no value to the VC and therefore are not accounted for in terms of the potential return on investment.
Two other issues related to revenue sharing are worth noting. First, the terms provide that Texas begins receiving its revenue sharing payments in steps once the grantee company has product sales exceeding $5 million. This approach allows the company to preserve early cash for product development, approval, and product launch. Second, the terms increase the revenue sharing amounts in steps. This accommodation allows for the same set of terms to apply to all companies CPRIT funds, despite differences among the type of products developed. Generally, companies that develop research products or diagnostics have more modest sales (less than $500 million) compared to successful drug developers (billions in sales).
CPRIT receives greater return on companies with greater sales. Incorporating steps into the revenue sharing provisions allows for flexibility for all companies.
Adjusting CPRIT’s revenue sharing percentages to recognize existing license agreements facilitates needed follow-on funding while preserving a reasonable rate of return for CPRIT.
- Companies must pay royalties to use non-company owned patented products or techniques to develop new product. Due to the technical complexity of product development in biotechnology, it is common that a single drug will have several inputs with various proprietary rights attached. Royalty stacking occurs when the company must pay royalties to more than one entity; the obligations are “stacked” on one another. Unless stacking is taken into account by early investors, potential follow-on investors could be discouraged from providing needed additional financing due to a decreasing amount of product sale revenue available as income to them. Failure to adjust for royalty stacking hurts the initial investor and may be the reason a promising technology is never ultimately developed.
- The terms accommodate revenue-stacking concerns. Many products developed with CPRIT funding will also be subject to existing license agreements and other proprietary rights. In those cases, CPRIT will allow its revenue sharing to be diminished by these prior agreements so that the burden on return to the company is reduced. However, in order to preserve a reasonable level of return to Texas, the terms incorporate a floor below which the percentage of revenue sharing due to CPRIT cannot be diminished.
Continuing Revenue Sharing (Blockbuster Provision):
In addition to a 4X return on investment, the terms preserve the state’s participation in any “blockbuster” product developed with CPRIT funding.
- The terms include a continuing revenue-sharing obligation that requires the company to pay CPRIT one-half percent (0.5%) of revenue even after the company has fulfilled its obligation to pay 4X the CPRIT grant amount. The continuing royalty is not reducible by stacking or other adjustments and ensures the state’s participation in revenue from a runaway success.
Termination of Revenue Sharing:
The terms end the revenue sharing obligations once all governmental grants of exclusivity terminate. Doing so ensures that Texas companies are not disadvantaged when it becomes possible for competitors to enter the marketplace.
- An early stage company created largely through innovation has its products or intellectual property protected for a period of time with governmentally sanctioned rights to exclusivity, e.g., patents, orphan drug status. When the protection period ends, competitors can and do enter the market niche if the product is successful. The term is a typical and expected provision in licensing agreements and enhances a major CPRIT goal to grow and expand the biotech industry in Texas by starting new companies based on innovative products and attracting existing ones to Texas.
- Definitions are those used in existing CPRIT contracts.
- No pre-revenue monies to be paid. CPRIT will clarify that no revenue sharing of milestones or other monies prior to the approval and sale of a product will be required.