This post was written by Ros Deegan, CBO of Bicycle Therapeutics, as part of the From The Trenches feature of LifeSciVC.
Sail-away
It’s January on a ship in the South Pacific. Instead of enjoying hula and coconuts, I’m struggling to type left-handed in response to an emailed offer to set up and lead the US subsidiary of Bicycle Therapeutics. My right hand came off second best from a misunderstanding with a Polynesian Rottweiler. Yes, Tahiti has dog bites as well as blue lagoons and black volcanic beaches. But importantly – for me – not rabies.
Crossing the bright blue sea
So, why does Bicycle Therapeutics, a UK biotechnology company, want to set up shop on the opposite side of the Atlantic? The founding scientist, Sir Greg Winter, lives near the company’s UK facility. Three of the four investor board members are based in Europe. And didn’t the White House intervene to stop pharma going the other way with new US inversion rules?
To find out, I swap my final port of call, Auckland, for the biotech republic of Boston. To be honest, I had been trying to resist the pull of Boston ever since I started looking for a new position after my biotech sabbatical. Having spent a decade in Pennsylvania, most recently at Trevena, I wasn’t a great fan of east coast winters. And that was before the record setting Massachusetts winter of 2014/2015. To my surprise, I quickly become a Boston zealot. The excitement of the scientific innovation from Kendall to Longwood to Lexington is tangible. It’s JP Morgan every day. The challenge is fitting in the work around the networking opportunities.
To my mind, there are four reasons why establishing a Boston subsidiary should be on the radar for every ambitious European biotech company.
- It is difficult to find individuals in Europe with the entrepreneurial experience to succeed in biotech. Compared to the US, there are relatively few start-up companies, and thus too few successes, which can increase concerns about failure. Start-ups simply don’t have the cultural cachet in Europe that they do in America. When I left GSK to join Trevena, my British family and friends were shocked. In Boston, it’s cool to go small.
- Financing flexibility. The number of venture capital rounds in Europe involving at least one US fund is climbing. Big Pharma’s VC groups are hunting for bargains in Europe. Nevertheless, separation both in distance and time creates significant barriers for access to large and liquid US financing sources. A presence in the US helps to attract American investors and is often a prerequisite to a successful US listing. The majority of those investing in public biotech companies prefer to do so on US exchanges so not having a presence can be costly.
- Access to potential collaborators. As Samantha Truex wrote in her post Biotech BD Transactions: The Soft Stuff, spending face-to-face time getting to know the team at a potential business development partner company is invaluable, both to the negotiation process and to the collaboration itself. We all want to work with people whom we like and trust. A thousand details can derail a negotiation and a good relationship is the most effective way to identify potential issues before they arise, and deal with them when they do. Establishing a business development team in Boston helps to build close relationships.
- A toehold in the world’s largest healthcare market. As a preclinical company, Bicycle is not ready to build commercial infrastructure. A subsidiary in America does, however, signal an intent to be active in, and retain rights in, the US market.
Weather warning
We spent several days of our South Pacific cruise skirting the edge of a hurricane under such skillful captaincy that I barely felt the swell. My experience setting up Bicycle’s US subsidiary was equally smooth. In my case, the captain was my legal and tax team. I was familiar with all the classic start-up activities such as finding space, setting up payroll and establishing benefits programs since I had done all of this work at Trevena. I wasn’t prepared for transfer pricing, international taxation, debt/equity ratios and Passive Foreign Investment Companies (PFICs).
Understanding the implications of owning stock in a PFIC is the closest that I came to a bureaucratic hurricane. The two IRS criteria by which companies are defined as PFICs often apply to loss-making start-ups. The first criterion relates to the proportion of your income that is passive (e.g. interest). The second relates to the proportion of your asset base that is comprised of assets that produce passive income (e.g. cash). There is a one-year start-up exemption that is, of course, almost worthless in biotech.
Why don’t you want to own a PFIC as a US citizen? Punitive tax rates (potentially over 50%) and extensive reporting. Unless – and here’s the out – you check a small box on your tax return in the first year of ownership, designating that your investment be treated as a Qualified Electing Fund (QEF). QEF status allows the US shareholder to eliminate exposure to these punitive tax rates, in exchange for reporting his or her share of any net taxable income from the QEF. Net taxable income for a biotech start-up would be a nice problem to have. Once the QEF commercializes, the company likely will no longer be a PFIC. The QEF election means that the non-US based company must assist the US shareholder in complying with certain IRS reporting requirements while the company is a PFIC. If a company wants to include equity in its compensation package for employees in America, then the accounting cost associated with this additional reporting is well worth the expense.
Another key requirement in setting up a US subsidiary is defining the relationship with the parent company. The subsidiary must be established as a genuinely separate entity to avoid the parent being exposed to US legal liability and US tax. The critical agreement is an intercompany services agreement which lays out the scope of services that will be provided by the US company, how IP rights will be managed and the financial relationship between the parties. We structured the US subsidiary to provide professional services to the UK parent. These services are designed to be support-based with all strategic decisions relating to the management of the parent company remaining the responsibility of the parent company. Bicycle America charges Bicycle Limited an appropriate fee for the services performed and pays US corporate tax on the resulting profit.
Our proprietary bicyclic peptides are invented in the UK and covered by the ‘UK Patent Box’, a tax regime allowing a lower tax rate on income related to intellectual property. The intercompany services agreement includes a non-exclusive license to intellectual property rights controlled by Bicycle UK for the provision of the services. We do not currently generate any intellectual property in the US but the agreement also covers the assignment of any future rights.
Initial funding was provided for the US subsidiary in the form of an interest bearing loan and equity, at an appropriate ratio. In addition to its own capital, the US subsidiary has its own office and its own bank account, and was incorporated in Delaware. All strategic decisions that relate to the management of the US subsidiary are under the control of its American board, which is comprised of US residents.
Steering the Ship
A European company wishing to establish a US office could relocate an existing employee, hire a company outsider, or work with a third party. Relocating an existing employee brings invaluable company experience and the necessary connections to facilitate real time communications between the two businesses. That said, the complexity of a personal relocation combined with key differences between European and US start-up operations (such as payroll taxation, 401(k) plans and health insurance requirements) is a significant challenge.
By contrast, a new hire brings US experience but emphasis needs to be placed on maintaining effective transatlantic communications and understanding the parent business. As a British transplant, I understood business norms on both sides of the pond. I also knew Kevin Lee, our CEO, from my GSK days. At the outset I spent a fortnight in the UK, integrating with the team and learning the science. Frequent exchanges of personnel between the two countries has become Bicycle’s modus operandi to maintain strong intercompany relationships.
European companies that like the idea of a US presence but don’t want to commit to the expense and complexity of a subsidiary can take advantage of third party services such as the Foothold America service offered by Alacrita Consulting. Alacrita will hire and manage your US employees, including benefits and HR support. You simply access your employees through a consulting agreement.
Land Ahoy
Bicycle Therapeutics has now been operational in the twin cities of Cambridge since April, 2016. Bicycle US even makes money, albeit at the expense of Bicycle UK.
The benefits of our beachhead in Boston continue to accrue. The parent company has appointed a US based board chairman, Stephen Hoffman. We are actively recruiting in the US, focused on oncology and clinical development. We continue to strengthen our relationship with Atlas, our US based investor. And business development meetings are frequent, face-to-face and usually involve Flour bakery. Although my working day starts early to maximize phone time with the UK staff, the time difference allows me to fit in networking engagements after the British contingent has left the Babraham Research Campus for the day.
I’m enjoying Boston as a place to live. I’ve even caught myself saying how much I love the seasons. But then again, it is August. Next January, dog bites or no dog bites, I’ll probably be in the South Pacific.
With thanks to Rob Johnson, Kevin Lee, Josh Milgrim and Jonathan Schur for reading drafts of this post.
