1. 2013 Biotech Seminar
Keeping the Devil Out of the Details:
An Ounce of Prevention
is Worth a Pound of Cure
Proactive Steps You Can and Should Take
Prior to Undergoing a Financial Audit or
Corporate Due Diligence

2. Building Biotechnology
Navigating the Current Climate and
Avoiding Common Pitfalls
Sharlyn Turner, CPA, Partner
Bob Bowman, CPA, Senior Manager

3. The Power of Biotech
“Biotech is probably the most powerful
and the fastest growing technology
sector. It has the power potentially to
replace our fossil fuels, revolutionize
medicine, and touch every aspect of our
daily lives.”
– Ellen Jorgenson, Molecular Biologist,
Ted Talks June 2012

4. Current Climate: Challenges of
Biotech
Since the collapse of the U.S. financial markets in late 2008, biotech
companies face an increasingly difficult climb to push products all
the way through to market.
Difficulties center on:
– Sources of capital have dried up
– Depressed public equity valuations
– Decline in FDA approvals
– Market movement toward investments with less risk

5. Sources of Capital of Biotechs
Historically, biotechs have had the following forms of capital available to them:
Investor Typical Funding Structure
Venture Capital Equity Investment, Venture Debt
Non-Venture Capital Private Equity Equity Investment, Project Financing,
Milestone Monetization
Investment Banks Initial Public Offering (IPOs), Follow-
on Offerings, Registered Direct
Offerings
Established Biopharma Companies Equity Investment, In-Licensing/Co-
Development

6. Venture Capital Investing
Venture capital has
been one of the
predominate sources
of capital for biotechs,
but has declined due
to trickle down effect
of the “limited
partners” of venture
capital firms, such as
pension funds, college
endowments, and
other institutions,
Biopharmaceutical Venture Capital IRR by Initial Investment Year
being unable to Source: Michael D. Hamilton, Independent Study, Tuck School of Business at Dartmouth
liquidate investments.

7. Public Equity Valuations
• Combined effect of the dot.com burst in the early 2000s and the
financial crisis of 2008 have made many investors shy away from
investments with high volatility.
• Since 2009, most IPOs have failed to achieve target prices, with
68% of the companies’ share prices falling behind the IPO price.
• The companies who have had the most successful recent IPOs,
Zogeniz and AVEO Pharmaceuticals, did their IPO after they either
received FDA approval for their lead product or their product was in
late stage development (Phase III clinical trials).

8. Biotech IPO Returns
Returns on US Biotech IPOs Post Financial Crisis to December 2010
Source: Michael D. Hamilton, Independent Study, Tuck School of Business at Dartmouth

9. Debt vs. Equity Financing
Capital Raised in North America and Europe by Year
Source: Ernst & Young 2012 Global Biotechnology Report

10. Industry Response
• Due to the increased challenges of financing for biotechs, the industry
has responded with new strategies:
– Improve efficiency through “virtual biotech” and “lean proof-of-
concept” models
– Project and royalty financing
– Acquisitions with “earn-out” terms
– Collaborative agreements with other development biotechs, or in
conjunction with large pharmaceutical companies
– Crowdfunding

11. New Research Models
Two models are becoming increasingly popular as
they limit up-front expenditures until there is more
assurance that the product is feasible.
Lean Proof Of Concept (POC)
•Targeted key studies that help inform the go/no-
go decision are performed. If those studies
indicate positive results, then more robust studies
are undertaken.
Virtual Biotech Model
•Focus on outsourcing to CRO firms who perform
the actual studies and large capital investments
are only made after the drug has been taken
through the POC stage (where failure is most
likely to occur).

12. Project & Royalty Financing
Project Financing
•An alternative to a standard merger or acquisition, in project financing
the financier purchases the rights to one or more products typically in
Phase I, forms a joint venture around those specific assets, and then
hires the biotech to conduct the studies. In most deals, the biotech has
the option to reacquire the rights at a predetermined price upon
successful completion of Phase II clinical trials.
Royalty Financing
•Also called revenue interest financing, works by turning over a
percentage of future product revenue in exchange for an immediate
cash infusion. Typically only available for products in the late stage of
development.

13. Stand Out in a Crowd
In a market with limited resources,
how do you set yourself head and
shoulders above the rest?
“Biotech is all about picking the
exception. Granting access to
capital to everyone doesn’t strike
me as the right idea.”
-Bob More, General Partner,
Frazier Healthcare Ventures
Be the exception. Limit risk to
your investors by avoiding
common pitfalls…..

14. Avoiding Common Pitfalls
What can you do now to get your company ready for potential investors
and limit the amount of work, time, and money needed later?
•Establish policies, procedures, and processes
•Ensure accounting is complete and in accordance with GAAP
•Understand the impact of complex agreements and transactions
•Decide if you need to work with an expert
•Make sure you are ready for your audit

15. Establishing Policies and
Procedures
Develop, review, and/or enhance your policies and procedures now.
Items to consider:
•What type of accounting system will you use?
•Who has access to your systems and electronic records?
•How is cash handled and who is authorized with the bank?
•Where and how are documents stored? How long are they stored?
•What checks and balances are in place to prevent error or fraud?
•How are records backed up to prevent loss or corruption of data?
•Who monitors the company to ensure compliance with regulations?
•When a transaction occurs, what is the process for ensuring it’s
accurately recorded? Which employee is responsible?

16. Don’t Wait to Implement
Establish polices and procedures now to ensure accurate records from
inception.

17. Complex Agreements and
Transactions
Complex agreements, including those related to the new financing strategies and
complex transactions discussed previously, can have significant accounting
implications. Equity-based transactions (options, warrants, convertible debt, and
other special provisions) are extremely common among start-ups and they can
seem like an easy answer to financing. But companies need to make sure they
understand the accounting ramifications of the agreements and transactions they
enter into.
Examples:
•Convertible debt, mandatorily redeemable stock, or down-round provisions can
result in large derivative liabilities needing to be recorded
•Derivative liabilities tied to stock prices can be affected by large swings in
volatility and impact net income
•Stock options frequently involve complex valuation and tracking calculations
•Awards contingent on milestones require probability analyses and potentially a
valuation expert

18. Avoid GAAPs in Your Accounting
Know the differences between “modified cash” and GAAP accounting.
Frequent mistakes in accounting for emerging companies center
around:
•Incomplete or inaccurate entries for equity-based and debt
transactions
•Not accounting for what is not transacted in cash currently or in the
near term
– Complex agreements can have significant accounting implications. Review
all agreements for provisions and terms which will impact accounting
•Improper revenue recognition (depends on the nature and type of
revenue sources and terms of agreements)
•Incorrect treatment of start-up and R&D costs (including collaborative
arrangements)

19. Working with an Expert
Assurance and attest services:
– Audit
– Review or Compilation - “Audit-Lite”
– Agreed-upon procedures, such
as an internal control evaluation
Other services:
– Valuations
– Litigation support
– Accounting
– Process improvement
– Tax
– Grantwriting

20. Benefits of “Audit-Lite”
Even if you don’t currently need an audit, electing to have a review or
compilation (“audit-lite”) performed can be valuable and help put your
company ahead of the competition.
Potential benefits:
•You will get an expert opinion on your accounting policies
•You will receive recommendations on how to improve your internal
controls
•You will gain confidence that your records are accurate and ready to
be presented to investors and lenders
•When and if an audit is required you will be that much more prepared
and the process will be more efficient
•You’ll have an experienced professional a phone call away to consult
when complex issues arise

21. Audit-Ready
If and when you are ready to undergo an audit, organization and
detail in advance are key to reducing the time and cost involved.
Before your audit, make sure you have:
•Properly closed your books and recorded all necessary entries
•You have retained documentation of the transactions that have
occurred
•Identified significant and unusual transactions which may need
accounting assistance
•Read the document request list from the auditor, and all
requested documents have been pulled in advance of the
auditors’ arrival
•Key employees are available to answer questions during
fieldwork

22. Thank You!
Sharlyn Turner & Bob Bowman
Peterson Sullivan LLP
601 Union Street, Suite 2300
Seattle, WA 98101
(206) 382-7777
sturner@pscpa.com, rbowman@pscpa.com

23. Corporate Due Diligence
Heidi M. Drivdahl

24. What is Due Diligence?
Legal Definition: “a measure of prudence, activity, or assiduity, as is
properly to be expected form, and ordinarily exercised by, a
reasonable and prudent person under the particular circumstances;
not measured by any absolute standard but depends on the relative
facts of the case.”

25. When is Due Diligence Important?
• Prior to equity investment
• Mergers and acquisitions
• Strategic partnerships/joint ventures
• In connection with bank loans
• Public offerings – underwriters’ responsibility
• Grants
• Financial audits

26. Reasons for Due Diligence
• Identify strengths and weaknesses of the business
• Gives a fair value of the investment (directly affects valuation of
company in both financing and M&A transactions)
• Helps in identifying problems
• Assessment of risk

27. Areas of Due Diligence
• Financial:
– Financial information (historical, current, and projected); tax
issues
• Legal
– Corporate records; IP ownership; securities compliance;
litigation risk; contracts review
• Operational
– Checks and balances; key employees; suppliers; independent
contractors

28. Some of the Most Common Problems
Uncovered in Due Diligence
• Disputed claims of equity ownership
– Often based on informal written communications like emails,
short contracts, etc.
– Sometimes due to sloppy drafting of agreements
– Unsigned documents

29. Some of the Most Common Problems
Uncovered in Due Diligence
• Ownership of patents, trademarks, copyrights
– Often overlooked is founders’ assignment of IP
– Trademarks not necessarily owned by a company; if licensed,
could have significant limitations on use
– Software copyright is owned by the person who wrote it – unless
specifically assigned

30. Some of the Most Common Problems
Uncovered in Due Diligence
• Contracts that provide “springing” rights or obligations upon
occurrence of certain events
– Payment obligations triggered
– Equity issuance provisions
• Third party consent or termination rights
– Change of control provisions

31. Some of the Most Common Problems
Uncovered in Due Diligence
• Problems with early equity fundraising rounds
– Improper or missing board and shareholder consents
– Noncompliance with right of first offer
– Antidilution provisions
– Could give rise to rescission right

32. What Should You Do Now?
• Start early to develop a system for collecting and managing
documents
• Work with experienced advisors
• Know your strategy, and keep it in mind when negotiating with third
parties

33. Thank You!
Heidi Drivdahl
Summit Law Group, PLLC
315 Fifth Avenue South, Suite 1000
Seattle, WA 98104
(206) 676-7018
heidid@summitlaw.com

34. Ensuring a Seamless
IP Due Diligence
Gary M. Myles, Ph.D.

35. Ensuring a Seamless IP Due Diligence
• Steps taken NOW will greatly enhance your success LATER when
seeking:
– An investment round
– An acquisition or merger
– A big pharma/biotech partner

36. Ensuring a Seamless IP Due Diligence
1. Do you have a sound strategy for identifying and protecting your
company’s inventions?
2. Is your company’s patent portfolio aligned with its business
objectives?
3. Do you own your patents?
4. Will your patents withstand challenges to validity and/or
enforceability?
5. Will you infringe another’s patents when your product enters the
marketplace?
6. Are you relying on the patents of others?

37. 1. Do you have a sound strategy for identifying
and protecting your company’s inventions?
• Patents vs. Trade Secrets
– Patents
• Exclusive rights
• Easy to reverse engineer or independently develop
• Medium length product cycle
– Trade Secrets
• No exclusive rights
• Difficult to reverse engineer
• Very short or very long product cycle
• Value in not being generally known
• Reasonable efforts to keep secret

38. 1. Do you have a sound strategy for identifying
and protecting your company’s inventions?
• Periodic vetting of R&D activities
– Patent protection strategy accommodates changes in R&D
direction and emphasis
• Open lines of communication between technology, business,
and legal functions
• Keep outside counsel informed
– Formal invention disclosure system
– Policy regarding publication and public disclosure
• Patent first, publish/disclose/sell later
• Obtain confidential disclosure agreements with third parties

39. 2. Is your company’s patent portfolio aligned
with its business objectives?
• Barriers to Entry
– Do you have issued patents or patents pending?
– Do your patent claims “read on”
• Your commercial product?
• Your competitor’s commercial product?

40. 2. Is your company’s patent portfolio aligned
with its business objectives?
• Barriers to Entry
– Are your patent claims difficult to design around?
• Claim scope
• Picket fence
– Seek protection for compositions, formulations, and
methods
• Life-cycle management
– Patent term is 20 years from date of filing
– Continue to supplement portfolio as R&D activities
progress

41. 2. Is your company’s patent portfolio aligned
with its business objectives?
• Are you seeking patent protection in key commercial markets?
– Consider commercial markets of potential acquirers and
partners

42. 2. Is your company’s patent portfolio aligned
with its business objectives?
• Are you over-investing in patent protection?
– Stay focused on your commercial objectives
– Out-licensing for profit is an unlikely value proposition for an
immature company

43. 3. Do you own your patents?
• Ownership of inventions vests in inventors
– Transfer of ownership achieved through assignment from
inventors to company
• Beware the lessons of Stanford v. Roche (S.Ct. 2011)
– “Actual assignment” trumps “obligation to assign”
– Consider obtaining actual assignment of future inventions upon
employment of all inventors
• DO NOT DELAY in obtaining and recording assignments with the
USPTO
– A former (esp. terminated) employee is often reluctant to
cooperate in assigning inventions

44. 4. Will your patents withstand challenges to
validity and/or enforceability?
• Are your patent claims free of the art?
– 35 U.S.C. § 102, novelty
– 35 U.S.C. § 103, non-obviousness
• Premature publication/non-confidential disclosure/sale will invalidate
your patents
– Inside U.S. -- 1-year grace period
– Outside U.S. -- Absolute novelty
• Have you disclosed to the Patent Office all material prior art of which
you are aware?
– Duty to disclose
– Inequitable conduct renders a patent unenforceable

45. 4. Will your patents withstand challenges to
validity and/or enforceability?
• Are your patent claims supported by a well drafted specification?
– 35 U.S.C. § 112, first paragraph
• Enablement
– Teach how to “make and use” the claimed invention
• Written Description
– Demonstrate that applicant had “possession” of the
claimed invention
– Beware the trap of a poorly drafted provisional

46. 5. Will you infringe another’s patents when
your product enters the marketplace?
• Do you have freedom-to-operate?
– Patent ≠ FTO
– Are you familiar with the patent landscape?
– Have you conducted a formal FTO search/analysis?
– Have you received letter from third parties that identify their
patents?
– Have you obtained formal opinions of non-infringement and/or
invalidity?

47. 6. Are you relying on the patents of others?
• Have you in-licensed another’s patent portfolio?
– To obtain exclusive rights?
• Exclusive license
• Right to litigate
– To obtain freedom-to-operate?
• Non-exclusive license
• No right to litigate
• Does the licensor own those patents?
– Chain of title
• How involved are you in patent prosecution?
– Can you control scope of issued claims?

48. Thank you!
Gary M. Myles, Ph.D.
Of Counsel
Merchant & Gould
Columbia Center
701 5th Avenue, Suite 4100
Seattle, WA 98104
gmyles@merchantgould.com
(206) 342-6226

49. SALT & Biotechnology
Rachel A. Le Mieux, CPA, CMI
Partner, State and Local Tax

50. State & Local Tax
• Washington State Taxes –
Generally
• Local Jurisdiction Taxes –
Generally
• Tax Incentives
• Legislative Climate
• Importance Of Staying Current

51. State & Local Tax
• Washington State Taxes – Generally
– Business & Occupation Tax
• Gross Receipts – due whether there is a profit or a loss
• Various Rates - .0471 – 1.8%
• Paid Monthly, Quarterly, or Annually

52. State & Local Tax
• Washington State Taxes – Generally
– Business & Occupation Tax Deductions/Exemptions
• Income received from the Life Sciences Discovery Fund
• Sale or distribution of biodiesel or E85 motor fuels
• Grants/Endowments – not for profits

53. State & Local Tax
• Sales & Use Taxes
– Sales tax is paid at the time of purchase of tangible personal
property, unless there is an exemption
– Use tax is self assessed if sales tax was not paid at the time of
purchase, unless there is an exemption
– State tax rate is 6.5% and various local rates are added –
depends upon where the item purchased is delivered or where it
is first used

54. State & Local Tax
– Local Jurisdiction Taxes - Generally
• 40 cities impose a gross receipts tax
– Big 5 are Seattle, Tacoma, Everett, Bellingham &
Bellevue
– City of Kent – became effective January 1, 2013
• Mostly follow the state’s taxing scheme but be careful
• The B&O is paid directly to the city, the local portion of the
sales/use tax is collected by the state.
• Various rates - .001 - .00215
• Usually paid quarterly
• Federal Life Science Research Grants Deduction
– Annual Report Requirements (April 30, 2013)

55. Tax Incentives – Available to
Biotechnology
– Biotechnology & Medical Device Manufacturing Sales & Use Tax
Deferral/Waiver – RCW 82.75.005
• Available to biotechnology & medical device manufacturers
• Qualifying activity is certain construction & equipment
purchases for new and expanding business
• Expires January 1, 2017
– High Technology B&O Tax Credit for R&D Spending
• Available to businesses in the biotechnology industry
• Qualifying activity – qualifying R&D in the state

56. Tax Incentives – Available to
Biotechnology
– High Technology Sales/Use Tax Deferral/Waiver
• Available to biotechnology businesses conducting R&D and
pilot scale manufacturing
• Qualifying activity is certain construction & equipment
purchases for new and expanding businesses
Annual Reporting Requirements
– 2012 Annual Surveys
• Must be filed electronically
• Due April 30, 2013
• Penalties for not filing are severe

57. State & Local Legislative Climate
– Governor Inslee’s
loophole pronouncement
– Desire for tax
simplification by the state
• Vehemently opposed
by the cities
• Cities tax
simplification efforts

58. The Importance of Staying Current
– Tax codes are constantly
changing
• Incentives expire
• Government and new
interpretations
• Crowdfunding???
– Errors may impact your
value
– You can make a difference

59. Thank You!
Rachel A. Le Mieux
Peterson Sullivan LLP
601 Union Street, Suite 2300
Seattle, WA 98101
(206) 382-7711
rlemieux@pscpa.com