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Sept. 23, 2004 – August proved to be a fruitful month for Nanosphere Inc. First, the federal government expanded a $2.5-million contract for its biodetection technology and tossed in another $750,000 for tests to diagnose gruesome diseases like plague and anthrax. At the same time, the Northbrook, Ill.-based nanotechnology company was gearing up for the fall debut of an automated diagnostic device for hospitals and clinics.
About 250 miles to the east, another startup was busy meeting its own milestones. NanoBio Corp. in Ann Arbor, Mich., was nearing the end of six-month Phase II clinical trials for a topical treatment for cold sores and was preparing for a similar round of testing for a nail fungus treatment. It also was using $3.2 million in federal funds to prove that its microbe-killing nanoemulsions posed no safety threats to people.
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The stars seem to be in alignment for biotech and nanotech hybrids. The tools for molecular biology and genetics have allowed scientists like NanoBio’s founder, medical researcher James Baker, to explore not only microbes and cells but also the tiny parts and pathways within them.
Simultaneously, increasingly sophisticated microscopy devices and fabrication techniques have given chemists like Nanosphere’s co-founder, Chad Mirkin, the capability to make and manipulate materials that can interact with DNA, proteins and other biological building blocks.
Adding to that capability is money, lots of money. The crossroads of biotech and nanotech are being well paved by government, particularly as concerns grow about terrorist attacks. The National Institutes of Health (NIH) shelled out more than $1.5 billion for biodefense research and development in 2003. The Department of Defense added about $1 billion to its biodefense coffers that year.
The pot is expected to grow even larger, thanks to the Project Bioshield Act of 2004 signed by President George W. Bush in late July. The act authorizes agencies to spend up to $5.6 billion over the next decade for vaccines, drugs, detection methods and other countermeasures to biological, chemical, radiological and nuclear attacks.
But the opportunity also may carry some baggage for companies like Nanosphere and NanoBio, industry analysts warn. Bioshield, which was designed to piggyback onto existing and developing biotech products for defense and homeland security, is riddled with tradeoffs. So many, in fact, that lawmakers began working on a “Bioshield II” bill before the ink had dried on the first act.
“They passed it, and they knew it was flawed from the beginning,” said Nancy Saucier, head of the medical industry group at the National Venture Capital Association. “It’s not a bad start, but we all look at it as a start.”
Their concerns range from liability and intellectual property issues to the bureaucratic double-whammy of regulations from the military or homeland defense plus the Food and Drug Administration. “This is the toughest kind of contract you’ll ever do,” Saucier said.
Experts involved in the development of young companies add a list of other potential perils that apply not only to Bioshield but to many federal programs: dependence on government funding for revenues, an unrealistic view of markets and price points, personnel distracted by federal bureaucracy and an expensive, niche product designed to meet governmental but not consumer needs.
“Can you develop a nano-based technology and make it cheap enough and simple enough (for the consumer market)? Where do you go after the military application?” said Scott Anthony, a partner at the management consulting firm, Innosight. Companies that fail to test assumptions about the worth of their products in the “real world” market may be in for a rude awakening, he said. “Different people will use a different lens to evaluate it.”
Post 9-11, pre-Bioshield
The terrorist attacks in New York, Washington, D.C., and Pennsylvania, and the anthrax mailings later that year served as a wake-up call throughout the nation. Allocations for protective and preventative technologies soon followed. The NIH’s biodefense budget, for instance, is now about 30 times higher than it was in 2001.
“The environment changed between 2001 and 2002,” said Vijaya Vasista, Nanosphere’s chief operating officer, referring to shifting fiscal priorities. Nanosphere was established in 2000 to develop and market metallic nanoparticle-based DNA detection technologies.
Nanosphere won its $2.5-million award in 2002 from the Technical Support Working Group, the government’s counter-terrorism body, to develop a field-deployable system that identifies toxins. It captured another $750,000 in August from the National Institute of Allergy and Infectious Diseases, the NIH’s primary biodefense agency, to develop and evaluate diagnostic tests for anthrax, plague and drug-resistant forms of staph bacteria.
NanoBio, incorporated in 2001, already had experience in biodefense initiatives before 9-11. The company’s technology, emulsions that use nanoscale oil-and-water droplets to kill certain kinds of bacteria, viruses and spores, was developed under a Defense Advanced Research Projects Agency (DARPA) grant. DARPA wanted a nontoxic product that protects soldiers exposed to anthrax.
Both companies insist their respective key markets are in diagnostics and drugs, and not strictly for the military or homeland security. The funding allows them to develop and refine basic platforms that serve both purposes, they say, and help them get commercial products to market.
“Everything we do to develop biotoxic detection is leveraged into medical detection,” Vasista said. “That’s what prompted us to pursue the grants. … The development we do for them we would have had to do anyway.”
Michael Nold, NanoBio’s chief financial officer, said biodefense money has helped fund clinical studies for medical applications. The company wants to expand from remedies for cold sores and toenail fungus to genital herpes, shingles and vaginal infections.
“As a corporation we have a policy that you don’t aim a product specifically at the Department of Defense, at the government,” Nold said. “If you don’t have a parallel product for which there is a commercial application outside of that, you can find yourself in the cemetery of small companies. You just can’t rely on them.”
Spend, but spend wisely
Stuart Pulvirent, a managing director and senior research analyst with ThinkEquity Partners, said he’s seen less-savvy startups fall in that rut and never emerge. “The company gets used to taking that money,” he said. “It keeps taking research money but its revenue line stays the same.”
Pulvirent conducts nanotechnology and healthcare research for ThinkEquity, a company that identifies growth sectors for institutional investment. Nanosphere is not likely to fall victim to the syndrome.
Nanosphere unveiled its first product in 2003: a DNA-based detection technology marketed to research and clinical labs. It plans to showcase an automated version, the Verigene System, at the Association for Molecular Pathways meeting in Los Angeles in November. Vasista said Nanosphere anticipates sales of the new system in 2005.
The FDA approved the manufacturing of NanoBio’s emulsions, which are now progressing through the health and safety regulatory process. Nold said that once the company gets results from its current testing, it will be in a position to seek venture capital or partner with a drug company to begin the more expensive process of later-stage clinical trials.
Government support can be critical for startups with long development cycles such as a biotech or nanotech, Anthony and Saucier said. The challenge is maintaining a company vision and focus.
“The thing you have to watch out for is the perverse effects,” Anthony said. Too much money can blind companies to market opportunities that would seem more attractive if they felt leaner; it can compel them to hire workers who remain on the rolls after funding has dried up; it can skew product development toward a niche market, and nurture business models that complement government collaboration rather than capitalist competition.
“It is rarely just the technology that drives disruption,” said Anthony, whose consultancy specializes in potentially lucrative disruptive innovation. “It is the business model.”
Room for improvement
Project Bioshield passed the U.S. Senate unanimously. But even before its passage, Sens. Joseph Lieberman, D-Conn., and Orrin Hatch, R-Utah — the bill’s original cosponsors — were said to be preparing a second version to address a number of disincentives in the act.
Foremost on industry’s list of complaints are weak liability protections. Drug companies balked at the potential risks of introducing novel products in dire conditions such as anthrax or smallpox attacks. Liability costs from unanticipated side effects also concern them.
“People aren’t flocking because it isn’t covered,” Saucier said. “So far, they are still liable because there is no indemnification. Large pharmaceuticals aren’t going to bite on it.”
Indemnification, or protection from damages in the event of a lawsuit, has gummed up biodefense efforts in the past. Northrop Grumman Corp. and its partners wrestled with the government over liability protection in 2002 after the corporation was awarded a $175 million contract to install anthrax detectors in mail sorting facilities, according to Elemer Piros, senior biotechnology analyst with the investment and banking firm Rodman and Renshaw Inc.
He tracks Cepheid Inc., whose miniaturized DNA testing device provides the detection part of the system. It took several months for the government and companies to come to terms on the issue, which delayed rollout of a pilot system and temporarily depressed Cepheid’s stock.
The possibility of a crippling lawsuit concerns NanoBio’s Nold as well. “We are very comfortable with the safety of our emulsions, but we live in a very litigious society,” he said. “Our concern is that the emulsion that is being used is not the cause of the problem, but there is a problem and the whole world gets sued. … It costs you a tremendous amount of money to defend yourself when you were innocent to begin with.”
Critics also say passages covering intellectual property rights and pricing of products are too vague, leading to potential problems. But Nold, who hired a part-time staffer to pursue funding opportunities like Bioshield, sees IP and pricing as unlikely stumbling blocks. Ideally, he’d like to see the government buy one and only one installment of NanoBio’s protective emulsions.
“Hopefully, it is a one-time market,” he said. “They stockpile what they need in supplies and never use it; that’s the hope.”
Companies that accept Bioshield deals may be in for some surprises, Pulvirent and Saucier say. Pulvirent warns that companies may face restrictions about partnering with foreign corporations.
The government also may insist that no foreign nationals work on the project. Saucier also cautions that the government can pull the plug on finances at any time through the Termination for Convenience Clause. “The government has the right to get out of a contract, to zero out in the budget process,” she said. “Most people are terrified of that clause.”
Bioshield II is expected to rectify the shortcomings of the initial act, observers say, but it is unlikely to move forward during an election year. Saucier predicts it will take two years to iron out the issues.
Despite its flaws, she considers Bioshield good for companies like Nanosphere and NanoBio — as long as they remain aware of its potential sand traps. In the end, the companies making biodetection devices and protective drugs that help soldiers and citizens at home will become the shining stars in the project, she predicts.
“This is my personal view,” she said. “I think detection and prevention are where they’re going to find their money is best spent.”
