Mitigation of Risk in Venture Philanthropy


Mitigation of Risk in Venture

Philanthropy Transactions



I. S


April 12, 2011



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Who We Are

Schaner & Lubitz is a law firm dedicated to representing nonprofit entities with a particular specialty in Venture Philanthropy transactions. To date we have represented the following organizations in more than 200 completed transactions:

◊ Cystic Fibrosis Foundation

◊ Juvenile Diabetes Research Foundation

◊ Michael J. Fox Foundation

◊ Multiple Sclerosis Society

◊ Cancer Research Institute

◊ Foundation Fighting Blindness

◊ Multiple Myeloma Research Foundation

Ken Schaner and David Lubitz (and David Tiger, our new colleague effective February 1) have over 80 years of combined experience representing nonprofit, for-profit and entities in connection with corporate transactions and other matters (our resumes are included on slides 22-24). Our goals in forming Schaner & Lubitz were to apply our broad experience to the legal issues, challenges and problems of non-profit entities at rates that are not practicable in the context of large firms; participate in transactions that will lead to breakthrough therapies in the fields of interest to our clients; and assist clients in mitigating risk to the fullest extent possible in the area of scientific research in which the risk of failure is very high. The purpose of this presentation is to discuss some of the provisions we use in our agreements to mitigate risk.



The Cystic Fibrosis Foundation first began exploring the expansion of its grant program to for-profit entities in the late 1990s; in 1998 it completed its first (and perhaps the first)

Venture Philanthropy transaction with Aurora Biosciences to develop a compound to treat cystic fibrosis. Ken Schaner represented CFF in that transaction. Aurora ultimately merged with Vertex. CFF, through its affiliate CFFT, provided additional funding totaling $70M to develop both a potentiator and corrector for the treatment of CF. In early March, Vertex announced that its potentiator, called VX-770, showed remarkable success in clinical trials for a segment of CF patients; research continues to determine the effectiveness of VX-770 for a broader group of patients. CFFT announced last week that it would provide an additional $75M to hasten the development of a first generation corrector and to begin the development of a second generation corrector. Schaner & Lubitz represented CFFT in that transaction, the largest to date. A portion of the funds used to support this new research came from the monetization of a drug from another project.

Since the beginning, many organizations (including Schaner & Lubitz clients) have decided to engage in Venture Philanthropy transactions. Many of the most active charities in this arena are Schaner & Lubitz clients.


Due Diligence

 Make sure that you carefully inspect the company that you are contemplating funding for both its scientific assets and its financial staying power. The nightmare of every organization and its lawyer is to fund a company that is scientifically successful but goes out of business with the asset you create lost in bankruptcy.

 Intelligently drawn milestones are a must. Make certain that money is not disbursed far in advance of accomplishments.

 With assistance of legal counsel and accountants, prepare a due diligence checklist and ensure the organization you are considering funding satisfies most of the criteria on your checklist.


The Document: Boiler Plate Provisions

The typical funding document is 40-50 pages, but can be longer depending on particular unique issues. Of that, there are many important provisions that are rarely discussed because they are normally acceptable to both sides. Some of the provisions that fall within the boiler plate category are:






Public Disclosure



Dispute Resolution

Joint Ventures

Patents & Inventions 7.

Excess Funds

Representations & Warranties 8.

Matching Funds & Audit Provisions

Once listed as boiler plate, in certain circumstances these provisions can be quite vital and should not be ignored. When we are retained by a new client that will do repetitive funding agreements, we try to use the first document not only to learn the particular needs of the new client, but also to create a template that can be used for future transactions in order to reduce subsequent legal expense.


The Document: Boiler Plate Provisions






Publication: In certain circumstances, your organization may wish to publish articles describing the research. You will want that right.

Public Disclosure: You want to make sure your organization is given credit for its funding, whether the public disclosure comes in the context of the original deal or later when the funded entity commercializes a product or sells its stock or assets to a third party.

Patents & Inventions: You may want your organization to have the right to review patent applications and have the right to assume discarded patent applications or patents.

Representation & Warranties: We have never had a dispute on these, but they must be included.

Dispute Resolution: You want to provide for a method of dealing with disputes that does not interrupt the research and provides for an escalated method of resolving disputes without having to litigate. Companies do not like arbitration and traditional arbitration is not significantly more advantageous to funding charities than litigation. Many companies do not like arbitration because their advantage of having the deeper pocket is reduced by expeditious arbitration. The arbitration method we use seeks to resolve disputes in less than 60 days after notice of arbitration with very limited discovery.


The Document: Boiler Plate Provisions




Joint Ventures: We include such a provision to make sure that any income earned from the collaboration is not characterized as Unrelated Business Taxable Income. The companies will want this provision also and, therefore, it should not be disputed. However, it should not be overlooked.

Excess Funds: We always provide that such funds will be returned if there are any. This should be considered an absolute requirement to demonstrate that funds are being used solely for your exempt purpose, but don’t expect there will be any excess. Unless the company has been sold during the research term, your funded entity will find a way to spend funds provided. Our Agreement always provides strict requirements for documenting expenditures and a corollary audit provision if there is any question that funds were expended properly.

Matching Funds & Audit Provisions: If you can, provide that the funded entity has “skin in the game.” Often the company will argue that it already has substantial investment, but requiring the company to have significant additional funding in the project will make the work more meaningful to it.


The Guts of the Document

At the end of this presentation we will include a takeaway checklist that we use internally to ensure we have not forgotten an important provision. One of our clients that does many transactions asks that we include the checklist with each signed deal specifying that each item on the checklist is included or specifying why not. Next is a discussion of the items on the checklist that usually engender the most controversy, encompass the most negotiating time and the methods we try to apply in handling them.





A: Royalties

Let’s start with the provision that generally takes the most time. When charities first started thinking about engaging in Venture Philanthropy transactions, some resisted asking for royalties and others were exceedingly reluctant to make this the focus of negotiations. To the contrary, I came to this field with the pre-disposition to maximize potential return. After 200+ transactions, we met somewhere in between.

I recognize that the research is the absolute priority. A day delayed is a day that a possible cure or mitigation for a terrible condition might be relieved. However, after more than 10 years of transactions, I have experienced the joy of not only approvable therapies that will improve the health of many people (a goal that caused me to re-focus my practice into this area), but the satisfaction of monetizing royalty streams for use in future research. At year-end, one of our clients sold a royalty stream for tens of millions of dollars and immediately re-invested the money in future therapies. The CFF’s VX-770 drug potentially will produce hundreds of millions in royalties that could change its entire fundraising profile. We never forget this potential in negotiating a transaction.


Tips for Negotiating Royalties

Always make sure they are characterized as royalties. Some royalties will be in the form of a multiple of the funding—an “X” royalty—while others will look like a traditional royalty as a percentage of Net Sales. Make sure you call them royalties, since royalties are excluded from UBTI, while other forms of income could be subject to UBTI.

On larger deals—maybe in excess of $5M—try to get a percentage of Net Sales with no cap. You will be taking a large scientific risk as well as a market risk. Since you cannot avoid this risk and you are making a significant investment, likely at the riskiest point of the research (pre-clinical or early clinical trials), you deserve to earn market rewards if they occur.

On smaller deals, you may want to consider an X royalty. We are usually able to negotiate an X royalty in the 4-6x range, depending on the timing of the funding and other circumstances. X royalties should be paid within three years of FDA approval. Try to include a “kicker” for successful sales. Thus, you may want to include an extra X if sales reach $500M and another if sales reach $1B.


Tips for Negotiating Royalties




 Do not, or resist if you can, an X royalty that also subjects you to market risk. Some companies will, in addition to capping the royalty by the multiple, seek to make the payout based on a percentage of Net Sales and/or limit the royalty cap if it is not reached within Y years. Try to avoid this since it imposes the “worst of all worlds” on your charity—a market risk without a market reward.

 Make sure the “Field” and the “Product” are broad enough to cover other uses.

Thus, for CFF we include pulmonary so that chronic bronchitis is covered. In your disease field, make sure other potential diseases are covered if possible. Also, ensure that the “Product” on which royalties are calculated is broad enough to cover derivative compounds and successor products.


B: Equity Instead of Royalties

The prior slides pre-suppose that your charity will want to negotiate for royalties instead of an equity stake. Most charities want to do just that because equity investments are treated by your accountants as non-program investments and could have a serious adverse effect on you fundraising ratio.

Even discounting the potential effect on fundraising ratio, pricing equity investments is difficult unless your investment is made at the same time as other investors and you can coat-tail on their pricing determinations if you agree with them.

Equity investments do not have the same adverse effects for charities that are private foundations, and some charities, despite the potential adverse effects, will do some equity deals.

Equity deals have the advantage of offering a potential for payoff even if the product you fund does not work out.

We have done numerous Venture Philanthropy transactions in the form of equity investments and some with mixed royalties and stock (usually warrants); these can be advantageous in the proper circumstances.


C: Interruption License

An interruption or reach-in license is among the most important provisions in your agreement.

It is a license that ripens in the event the entity you wish to fund decides to shelve its research, or it goes out of business.

Provide that your entity automatically receives an Interruption License if an “Interruption” occurs—a cessation of commercially reasonable efforts for a prescribed period.

In order to be of use, the Interruption License must be “exclusive” and “sublicensable.”

The Interruption License is required to avoid the fruits of your funding being locked inside the company you funded because of bankruptcy or change in priorities.

In a recent example of its advantages, one of our clients received such a license, sublicensed it to a viable company and later sold its income stream. In another situation, our client received it and established its own laboratory to further the research (which could be sublicensed later).

Funded companies often vigorously resist the inclusion of an Interruption License. Below is a brief list of some possible compromises:


Offer to share any income with the company if a product results



Reserve the possibility of re-offering a more advanced product to the company later but at a greater royalty

Depending on the timing of the Interruption, offer a buy-out of your interest at some amount that will allow you to recover your investment plus


D: Change of Control or Out Licensing

Unless the company you fund is a member of “big pharma” (which is not often the case), you will want to receive a return in the likely event the company you fund either licenses the potential product you are funding or its shareholders sell a majority of the assets/shares (the latter, a “Change of Control”).

If the company you funded experiences a “payday” at a time that it is still uncertain whether there will be a product, you should share in it.

If your product is licensed, you should be able to get a return at that time and still preserve your royalties. The negotiation will likely revolve around what percentage of the payments you will receive.

If the transaction is in the context of a Change of Control, the negotiation will be more complicated if the company being sold has assets other than the program you are funding.

Nevertheless, you do not want to be omitted from a payday that the company or its shareholders are experiencing, because their payday may never come.

Any amount you receive could be offset against your X royalties or your first royalties if you have a percentage of Net Sales.


E: Governance and Reporting

 The goal here is not to have so much involvement or decision-making that you will be considered a partner or joint venturer for tax and liability purposes.

 Require periodic reporting and the right to follow-up with questions.

 Require the formation of a Joint Research Committee so you get your say, even if your recommendations are not binding. Escalate any disagreements to upper management and then to some form of expedited arbitration.

 Provide for continued reporting even after the research term and provide for continuing representation on a Joint

Development Committee.


F: Indemnification

 To underscore the passive nature of your participation, require the funded company to indemnify you for all liabilities associated with the project and the Product.

 Obtain evidence of insurance that the indemnification is covered.

 Avoid the knee-jerk response of most opposing counsel to include an indemnification from your charity unless you take over the Product pursuant to an Interruption License.

 Including an indemnification from your charity, even for gross negligence or willful misconduct, could cause the nature of your participation to change visà-vis third parties and could result in liability or adverse tax consequences.


Every Deal is Different

 My scientist friends have often asked me why I still get excited about doing deals after 40 years of lawyering and hundreds of closed deals.

 I tell them that every deal is different: the subject matter changes; the negotiating personalities vary; the riddle has unlimited combinations; and the satisfaction of the craft sustains you.

 For several years on many for-profit deals, I was satisfied with the culmination of a potentially profitable deal, but

Venture Philanthropy offers the much greater satisfaction of the ultimate promise of a lifesaving therapy.

 I have had a few where that promise has reached reality and those few have fueled my appetite for more.


Thank You for this Opportunity!

To help in your future transactions, the next two slides provide a checklist of the points discussed herein, as well as a few more.

Do not hesitate to contact us if we can be of help.

I have enjoyed sharing this presentation with you!


Deal Checklist


Obtain and analyze financial statement prior to the deal and require periodic updates if the awardee is not public.


If FTEs or outsourcing is in the deal, give funding entity the right to audit. Require that personnel assigned to the project be identified and that timesheets are kept.

Include audit rights for this and other purposes.


If Company funds are not spent for agreed-upon purpose, they must be returned.


Require matching funds in appropriate circumstances and accord Company the ability to ascertain they were spent for the agreed-upon purpose.


Make Covered Field broader than the principal Company research focus.


Define Drug or Product to include successors and derivatives.


Award triggered by clearly defined milestones.


If X royalties, bonus royalty for extraordinary sales.


Project Advisory Committee generally with equal voting of the parties.

10. Periodic progress reports no less frequently than annually.

11. Control or mutual agreement on publications

12. Intellectual property ownership or exclusive license to Company activated upon

“Interruption” (scientific information furnished upon activation in usable form).


Deal Checklist


All payments to Company will be characterized as “royalties,” with Company license of possible rights to support characterization. Multiple (“X”) royalties with increase for delay, or royalties based on net sales.

14. Provide payments/remedies in the event of a Change of Control or licensing of

Project IP.

15. Possible revenue sharing/reference to Patent Policy.

16. Possible control of patent prosecution.

17. Indemnification.

18. Evidence of insurance.

19. Without cause, periodic termination.

20. State that the transaction does not constitute a partnership or joint venture.

21. Consider prohibiting awardee from engaging in competing research.

22. Equipment paid for by Company designated to third parties.

23. Continuing Reporting after completion of Research Program and/or participation in Development Committee.

24. Dispute Resolution pursuant to abbreviated arbitration.


Ken Schaner

6931 Arlington Rd.; Suite 200

Bethesda, MD 20814

Phone: 240-482-2848

Fax: 202-470-2241

During more than 40 years of private practice, Ken has represented many for profit and nonprofit entities in the corporate and tax aspects of a wide variety of agreements, transactions, financings, licenses, mergers and acquisitions.

Since 1983, Ken has served as general counsel to the Cystic Fibrosis Foundation. In that capacity, Ken represented

CFF in its first venture philanthropy transaction with Aurora Biosciences Corp. (now Vertex). Since then, Ken has represented CFF, Juvenile Diabetes Research Foundation, Stanley Medical Research Institute, National Neurovision

Research Institute, National Multiple Sclerosis Society and others in numerous venture philanthropy transactions and related legal matters. Ken also serves as general and outside counsel to other nonprofits. He advises on the full range of issues faced by Section 501(c)(3), (c)(4) and (c)(6) organizations including board governance, business and taxexempt compliance issues. Ken began his career at the IRS’s legislative and regulations division. During his time with the IRS, Ken worked on the 1969 Tax Reform Act and was one of the principal drafters of the new private foundation provisions. In 1982, Ken, with several others, founded Swidler Berlin. While a partner in that firm, Ken also served as managing member and chair of the corporate group. After Swidler’s 2006 merger with Bingham McCutchen, Ken remained a partner until 2008, at which time he formed a new firm to focus on representing tax exempt organizations.


• University of Illinois College of Law, Juris Doctor, 1966

• University of Illinois, Bachelor of Science, 1963


David Lubitz

6931 Arlington Rd.; Suite 200

Bethesda, MD 20814

Phone: 240-482-2849

Fax: 202-470-2240

David has been practicing law for almost 20 years. He represents nonprofits, commercial enterprises and individuals.

His practice includes contracts, litigation, regulatory compliance, employment matters, governance, nonprofit tax issues, intellectual property and immigration work. He serves as counsel to the CF Foundation, American Clean Skies



Global Impact, Michael J. Fox Foundation for Parkinson’s Research, and Multiple Myeloma Research

Foundation. David was a law partner at two firms in Washington, D.C., Swidler Berlin and Bingham McCutchen, before forming Schaner & Lubitz. He practiced litigation and managed the firms’ public interest programs. David has extensive federal and state court experience at all levels of both systems—trial courts, appellate courts and supreme courts—and experience representing clients before various U.S. government agencies, including the IRS, Department of Health and

Human Services, the Department of Justice and the Department of Homeland Security. David began his career as a law clerk to a U.S. District judge. He has worked as a lawyer for the Legal Aid Society in New York City and as a supervising attorney and trainer for a U.S. non-governmental organization providing legal systems development services in

Cambodia. He also was an associate in the litigation department of Morgan, Lewis and Bockius in Washington, D.C.


• Columbia University School of Law, J.D., 1991 (honors 1990-91)

• Harvard College, A.B. with honors, 1986


David Tiger

6931 Arlington Rd.; Suite 200

Bethesda, MD 20814

Phone: 301-907-2683

David concentrates his practice in representation of nonprofit organizations and commercial real estate transactions.

He represents nonprofit organizations with respect to entity formation, corporate governance, risk management, asset protection, contracts, transactions, UBTI issues, organizational efficiency, financial controls, in-kind donation policies, social media policies and other matters. David often acts as outside general counsel for these organizations. David also represents clients in all aspects of complex commercial real estate transactions, including acquisition, disposition, financing, development and construction of projects; structuring of credit facilities; workouts of distressed assets; and all types of leasing, including headquarters leases, industrial and flex leases, long-term ground leases, telecommunication operations site leases and licenses, and leases involving substantial construction components.

David also provides counsel to entities engaged in corporate transactions such as mergers, asset sales or stock sales in which owned or leased real estate is one of the underlying assets. David has significant experience representing clients in public-private real estate transactions and real estate transactions involving substantial public engagement or financing. Prior to joining Schaner & Lubitz, David was a partner at Bingham McCutchen and previously at Swidler

Berlin, before Swidler’s merger with Bingham.


• University of Maryland School of Law, Juris Doctor (1992)

• University of Maryland, Bachelor of Arts (1989)









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