[Senate Hearing 112-315]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-315

 
 ACCESS TO CAPITAL: FOSTERING JOB CREATION AND INNOVATION THROUGH HIGH-
                            GROWTH STARTUPS

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                            ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

 EXAMINING POTENTIAL STARTUPS TO CREATE JOBS AND SPUR ECONOMIC GROWTH 
                             AND INNOVATION

                               __________

                             JULY 20, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                       Will Fields, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

                    Subcommittee on Economic Policy

                     JON TESTER, Montana, Chairman

           DAVID VITTER, Louisiana, Ranking Republican Member

MARK R. WARNER, Virginia             ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina            MIKE JOHANNS, Nebraska
TIM JOHNSON, South Dakota

             Alison O'Donnell, Subcommittee Staff Director

         Travis Johnson, Republican Subcommittee Staff Director

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JULY 20, 2011

                                                                   Page

Opening statement of Chairman Tester.............................     1

                               WITNESSES

Ted D. Zoller, Vice President of Entrepreneurship, Ewing Marion 
  Kauffman Foundation............................................     2
    Prepared statement...........................................    24
Elizabeth Marchi, Founder and Fund Coordinator, Frontier Angel 
  Fund, LLC......................................................     5
    Prepared statement...........................................    25
Robert F. Bargatze, Executive Vice President, Chief Scientific 
  Officer, LigoCyte Pharmaceuticals, Inc.........................     7
    Prepared statement...........................................    56
    Responses to written questions of:
        Senator Hagan............................................    65

                                 (iii)


 ACCESS TO CAPITAL: FOSTERING JOB CREATION AND INNOVATION THROUGH HIGH-
                            GROWTH STARTUPS

                              ----------                              


                        WEDNESDAY, JULY 20, 2011

                                       U.S. Senate,
                           Subcommittee on Economic Policy,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jon Tester, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN JON TESTER

    Chairman Tester. I call to order this hearing of the 
Economic Policy Subcommittee. The title of this hearing is 
``Access to Capital: Fostering Job Creation and Innovation 
Through High-Growth Startups.'' I want to welcome the 
witnesses. We will get into a description of them very, very 
soon here.
    I look forward to hearing from you folks this morning about 
the potential startups to create jobs and spur economic growth 
and innovation, provided that they have an essential resource 
for growth, and that resource is access to capital.
    Capital provides new opportunities for Main Street 
businesses and families in Montana and across the Nation. It 
creates jobs and it boosts local economies. Clearly, we have 
work to do to rebuild our economy and to make sure that we 
strong investments. Smart investments foster innovation and pay 
dividends into the future for us, our kids, and our grandkids.
    The role of startups in creating jobs and driving 
innovation has been well documented, provided that they have 
access to financing to scale and grow their firms, and to make 
sure capital markets are in reach for startups. Understanding 
this potential, it is critical that we empower these businesses 
with the tools that they need to survive and thrive, creating 
new jobs and growing our economy. We must respond to the unique 
challenges that small businesses face in accessing financing, 
giving the relative risks associated with new and innovative 
firms and the difficulty in collateralizing assets. And we must 
ensure that these young companies are able to access the long-
term capital that they need to bring innovative ideas and 
products to the markets.
    Today I hope that we can examine the challenges and 
opportunities that face innovative startups and their ability 
to access capital in various stages of their development, the 
significance of capital to the success or failure of these 
startups, and what public policies we can better facilitate the 
formation of innovative startups and enhance their ability to 
access capital.
    I look forward to hearing from all of our witnesses this 
morning. I am particularly pleased that we have two Montana 
witnesses here with us. I know they will be able to address 
some of the unique challenges and opportunities facing startups 
in rural communities. They are entrepreneurs, and they clearly 
reflect America's entrepreneurial spirit, which is part of what 
keeps rural America strong and makes our economy the most 
innovative in the world.
    Senator Vitter is due to come, and when he comes, we will 
kick it over to him, as well as some other potential 
Subcommittee Members if, in fact, they did not get tied up with 
something like debt limit conversations.
    So with that, I think we will start with our witness 
introductions, and once again I'd like to welcome all three of 
you. I am going to start with Ted Zoller, and we will just go 
from my left to right.
    Ted is vice president of entrepreneurship of the Ewing 
Marion Kauffman Foundation, where he guides the foundation 
entrepreneurship programs. He also serves as executive director 
of the Center of Entrepreneurial Studies at the University of 
North Carolina, Kenan-Flagler Business School, and the founder 
of Commonwealth Ventures, a private equity and venture 
accelerator firm. I want to welcome you, Dr. Zoller.
    Elizabeth Marchi hails from Polson, Montana, currently 
served as the fund coordinator of the Frontier Angel Fund, 
Montana's first angel fund, and is cofounder of Northfork 
Strategies. She is also working with the Governor's Office of 
Economic Development to build the Montana Angel Network and 
Innovate Montana and is an entrepreneur herself, selling all 
natural Montana-raised Kobe beef from a ranch outside Polson.
    Finally, last but not least, Dr. Robert Bargatze joins us 
from Bozeman, Montana, and is founder and executive vice 
president and chief scientific officer of LigoCyte 
Pharmaceuticals, which is developing innovative vaccine 
products, including a product to prevent norovirus. He has 27 
years of experience in immunological research and also serves 
as chairman of the Montana Bioscience Alliance, the public-
private partnership to grow and sustain the biotech industry in 
Montana.
    I welcome you all. Before we get to your testimony, I want 
to kick it over to the Ranking Member, Senator Vitter, for his 
opening statement.
    Senator Vitter. Thank you, Mr. Chairman. I am going to save 
my time. I want to hear the witnesses, and I would rather save 
my time for discussion and questions.
    Chairman Tester. Absolutely.
    We will start with you, Dr. Zoller. Thank you for being 
here.

STATEMENT OF TED D. ZOLLER, VICE PRESIDENT OF ENTREPRENEURSHIP, 
                EWING MARION KAUFFMAN FOUNDATION

    Mr. Zoller. Chairman Tester, Ranking Member Vitter, and 
other Members of the Subcommittee, I am Ted Zoller. I am vice 
president of entrepreneurship at the Kauffman Foundation. I am 
also a business faculty member at the University of North 
Carolina at Chapel Hill. I am a business owner, I am an 
investor. I just wish I was a Montanan. That would round it 
out.
    [Laughter.]
    Mr. Zoller. I would invite Members of the Subcommittee this 
morning to put yourself in the shoes of a founder of an 
American firm, and I am guessing with all the deficit wrangling 
going on right about now, that sounds pretty good.
    As a promising entrepreneur, your business concept solves a 
problem and fills a customer need. As you know, starting any 
new enterprise requires capital. The investment period every 
business experiences until it reaches cash-flow--a concept 
called the ``J-curve''--is a perennial issue to any startup. 
This need for investment is precipitated by capital 
requirements, labor costs, and the negative cash-flow you will 
experience until your business is established in its market. 
The J-curve can only be remedied by access to capital, and when 
capital is not forthcoming, this represents a substantial 
barrier to new firm starts. While a small percentage of firms 
can be ``bootstrapped'' or self-financed, the vast majority of 
all new enterprises--and in particular high-growth firms that 
rely on innovation and capital investment--require outside 
funding in the form of equity and debt to shoulder the J-curve.
    The picture I paint for you this morning is that, 
unfortunately, your job is harder today than it has been prior 
to the financial crisis because both equity and debt financing 
are not as readily available. The J-curve is now a barrier to 
your entry as opposed to simply a hurdle in becoming a going 
concern.
    Why is it harder today to finance your startup? Well, there 
are three reasons:
    First, venture capital and other forms of private equity 
have largely abandoned early-stage investing, opting instead to 
pursue more reliable returns in later-stage ventures.
    Second, while angel and friends and family investors have 
entered to fill the gap, they are not as adept in connecting to 
later-stage capital partners that will fuel the firms' growth, 
and angel capital availability is a fraction of the equity that 
we have enjoyed in the past.
    Third, the consolidation of the banking institutions and 
their current conservative posture toward risk precipitated by 
the Wall Street crisis has choked off needed debt financing. If 
you cannot access equity financing, you can no longer start a 
business today without collateralizing the debt against your 
personal assets, and the line of credit that you need to smooth 
your cash-flows now comes with higher interest rates, more 
punitive terms, and generally not at the limits needed to 
finance your firm. So I am sorry to say today large banks are 
simply no longer a partner to small business. This is a bleak 
picture that we all face as entrepreneurs.
    While we have seen a clear resurgence of angel investors 
and are hopeful by innovation occurring in the community and 
commercial banking sector, our early-stage pipeline is under 
unprecedented stress. This has staggering implications on our 
economic future. Since the recession in 2008, Kauffman data 
indicate that more firms than ever are being formed. That is 
the good news. The bad news is that this result is hollow--as 
the new firms that are largely being formed today are sole 
proprietorships as opposed to job-creating firms. New firms 
with employees during this same period, in fact, have been 
dropping--a troubling indicator suggesting a slowdown in the 
formation of potential scale companies.
    Contrast this fact to another study published by our 
foundation that up until the financial crisis, U.S. job and 
output growth was driven by the formation of new firms and 
startups, and firms younger than 5 years old were responsible 
for virtually all the net new job creation. We have concluded 
from our research that if the U.S. were to consistently 
generate between 30 and 60 new companies whose annual revenues 
eventually reach $1 billion, our country would enjoy 
permanently a 1-percentage-point increase in its growth rate. 
So guess what? This promises a solution to our fiscal future.
    So if our goal is to motivate our economy and create new 
jobs, we have to focus on job-creating, early-stage firms--
especially focus on those firms that have the potential to 
achieve high growth and scale.
    Yesterday, the president of the Kauffman Foundation, Carl 
Schramm, presented a solution we are calling the Startup Act. 
This proposal speaks to many of the dilemmas faced in my 
testimony providing access to capital, by:
    First, modifying the tax code to facilitate the financing 
of small business, with a permanent capital gains exemption on 
investments in startups held for at least 5 years. This is an 
idea supported by the National Advisory Council on Innovation 
and Entrepreneurship.
    Second, reducing corporate tax burdens for new companies in 
the first 3 years they have taxable income with a phased 
exclusion on taxable profits. Again, an idea supported by the 
National Council.
    Third, making it easier for growing private companies to go 
public, by allowing shareholders who invest in firms with a 
market cap of $1 billion or less to decide whether to comply 
with the requirements of Sarbanes-Oxley. If the IPO window is 
opened, investors will be a lot more willing to finance early-
stage companies when they have at least the option of going 
public after they have reached scale, rather than simply 
selling out to larger firms.
    So these proposals, among others, are needed to undertake 
the course correction required to make the United States once 
again the best place to found, grow, and scale an 
entrepreneurial venture in the United States. Putting us back 
on course will require the creativity of our Government and 
business leaders and, of course, our entrepreneurs. I am 
confident we will achieve these aims and look from to the 
leadership in making America's entrepreneurial future again 
possible.
    Thank you very much for the opportunity.
    Chairman Tester. Thank you, Dr. Zoller, for your testimony, 
and thank you. I did not point out the 5-minute time limit, but 
you were almost right on the money.
    Mr. Zoller. Thank you very much.
    Chairman Tester. Liz Marchi, you are up next.

 STATEMENT OF ELIZABETH MARCHI, FOUNDER AND FUND COORDINATOR, 
                    FRONTIER ANGEL FUND, LLC

    Ms. Marchi. Thank you. Mr. Chairman, distinguished Members 
of the Subcommittee, Ranking Member Vitter, my name is Liz 
Conner Marchi. I am the coordinator of the Frontier Angel Fund, 
Montana's first angel investment fund; a former economic 
development executive in Flathead County, which I might say is 
about the size of the State of Connecticut; the coordinator for 
Innovate Montana; and a business consultant with Northfork 
Strategies. I live on a working cattle ranch in the Mission 
Valley of northwest Montana near Glacier National Park.
    I am honored to have the opportunity to speak before you 
today with a voice informed by 10 years of work in economic and 
business development in Montana. I want to thank my great 
fellow Montanan, Senator Jon Tester, for offering this 
privilege to me today. Prior to moving to Montana, I worked in 
business and economic development in North Carolina where I was 
a constituent of Senator Hagan's.
    The most interesting people I have ever met in my life live 
in rural America. Most of them are innovators and entrepreneurs 
because they have had to be to survive. As my business partner 
at Northfork Strategies, Diane Smith, author of TheNewRural.Com 
says, ``When I worked in Washington, DC, I knew a hundred 
patent lawyers and not one innovator. Within months of moving 
to Montana, I knew dozens of inventors and only one patent 
lawyer.'' That speaks volumes about the challenges and 
opportunities we face in America to retool an economy deeply 
impacted by globalization and technology.
    I want to speak today to three issues that I think merit 
your attention as we focus on new job creation: financial 
capital must be available to entrepreneurs; innovation and 
discovery are everywhere; and telecommunications infrastructure 
and regulatory policy are critical to this effort.
    Today's capital environment is incredibly difficult for 
entrepreneurs. Before the recession, many entrepreneurs 
bootstrapped startups with personal credit cards. Banks would 
just ask you to mortgage your house for a business loan, and, 
frankly, that was a pretty significant barrier to 
entrepreneurship even before the economy went south. In today's 
climate, it is hard to know what your house is worth, so 
lending on an asset is pretty rare. Most bankers will tell you 
today that they are working for regulators, not for customers. 
So bank lending today is driven by cash-flow, and most startups 
have no cash-flow, and some do not have any liquid assets. 
Banks look at history. As a result, bank debt is a very 
unlikely source of capital for entrepreneurial ventures which 
rely on a forward-looking opportunity.
    Angel investors look forward at opportunities. In 2005, we 
initiated a conversation with a number of high-net-worth 
individuals who were living in Montana. In addition to 
investment capital, they had deep skill sets in starting and 
building successful businesses. So in 2006, the Frontier Angel 
Fund closed with 33 investors who put in $50,000--and some put 
in $100,000--each to invest in early-stage businesses located 
in our region. So what is an angel investor? It is an 
accredited investor, according to the SEC definition, that is 
generally the first professional money in a business after 
family, friends, and fools. I want to thank all of you 
responsible for the compromise on the accredited investor 
definition in the Dodd-Frank bill. Without the compromise, more 
than two-thirds of the potential angel investors in Montana 
would no longer have been accredited.
    Angel investors differ from venture capitalists in that 
they are investing their own money, not other people's money. 
And most angels have a double bottom line: they want to make 
money, but they also want to see their communities and regions 
prosper. Many angels are successful entrepreneurs, and they 
share a real affinity for mentoring and coaching others. The 
estimated size of the angel and VC markets in the U.S. are 
roughly the same amount, $20 to $30 billion annually. But in 
2009, venture capital went to 3,800 companies in the entire 
United States while angels funded almost 56,000 new startups. 
Two-thirds of all VC investments were in California, Boston, 
and New York, and half of all States had only one or no VC 
deals. Angel investments happen in every State in America.
    The Frontier Fund is easy to find. We have an online 
application process. We screen deals every other month; we meet 
every other month. We have looked at over 300 companies since 
inception and have investments in 10 regional startups, most of 
which have a proprietary product or service.
    Government policy and investment play a critical role in 
enabling the kind of telecommunications infrastructure required 
for businesses to operate today. In last-mile locations like 
Livingston, Montana, companies like Printing for Less have 
developed sophisticated business platforms for serving global 
markets, telecommunication infrastructure is critical. 
Bandwidth and speed are their lifelines.
    Bandwidth supports many new enterprises throughout Montana. 
TeleTech has 900 employees in the Flathead. Bandwidth and a 
trainable workforce brought them there. Profitability keeps 
them there.
    Innovation and discovery are everywhere, but we must find 
better ways to connect capital to ideas and to entrepreneurs. 
This is the recipe for new jobs in all of America.
    We need Federal policy that does all it can to minimize 
regulations, provide essential telecommunications 
infrastructure, encourage angels, provide real-world business 
education and strategy to entrepreneurs, and does not lose site 
of the incredible talent and ambition we find today all over 
America.
    I have never regretted bringing my children to Montana to 
be educated there in public schools. In addition to a great 
education, they have learned values like thrift and self-
reliance that are part of the fabric of life in rural America. 
We cherish our landscape, and with your continued vigilance, 
rural America will be an important part of the path to economic 
prosperity and national renewal.
    Thank you very much.
    Chairman Tester. Thank you, Liz.
    Dr. Bargatze, I will need you to turn on your microphone, 
if you can, or bring it closer to your mouth.

  STATEMENT OF ROBERT F. BARGATZE, EXECUTIVE VICE PRESIDENT, 
    CHIEF SCIENTIFIC OFFICER, LIGOCYTE PHARMACEUTICALS, INC.

    Mr. Bargatze. Good morning, Chairman Tester, Ranking Member 
Vitter, and Members of the Committee. My name is Rob Bargatze, 
and I am the founder and vice president and chief scientific 
officer of LigoCyte Pharmaceuticals and chairman of the Montana 
Bioscience Alliance. I want to thank you for the opportunity to 
speak with you today about the unique hurdles to accessing 
capital that innovative biotech startups face today.
    Biotechnology has an incredible potential to unlock the 
secrets to curing devastating disease and helping people to 
live longer, healthier, and more productive lives, but barriers 
that small biotech companies encounter on a daily basis raise 
some important questions: Would we rather see the next 
generation of breakthrough cures discovered by researchers in 
Bozeman or Beijing? Do we want the jobs associated with this 
groundbreaking science to go to workers in Missoula or 
Malaysia? If we want more scientific breakthroughs that allow 
us to enjoy a high quality of life, then shouldn't we be 
putting in place policies that encourage innovation through 
private investment?
    While the biotech industry faces significant challenges, we 
nonetheless are uniquely positioned to deliver the next 
generation of cures and treatments to the bedsides of patients 
who desperately need them, at the same time creating a 
healthier American economy.
    The leash that holds our industry back from helping more 
people is, in large part, the devastating effect that a lack of 
access to necessary capital that can help grow our biotech 
companies. Today Congress has the opportunity to help speed 
lifesaving cures and treatments to patients by bolstering 
capital formation in our industry.
    My company, LigoCyte, is a private biopharmaceutical 
company based in Bozeman, Montana, with 38 employees. When I 
cofounded LigoCyte in 1998, we were the quintessential small 
business. My four cofounders and I each gave the new company 
$5,000 to get things off the ground--our first round of 
financing. With our startup funds, we bought kitchen cabinets 
from the local home improvement store down the street and 
installed them ourselves, giving ourselves our first laboratory 
in the Montana State University Technology Park. Our first 
contracts for service were with large pharmaceutical companies 
which gave us enough income to cover overhead while we wrote 
SBIR grant proposals. We were able to use the SBIR funds to 
advance our research enough to be awarded a contract with the 
Department of Defense for our vaccine pipeline. Our success 
there led to venture capital financing, the true lifeblood of 
the biotech industry.
    We currently are entirely privately funded with the 
exception of ongoing contracts with DOD. Getting to this point 
was not easy. There is no ``beaten path'' for small companies 
like ours to follow. Instead, we have to break new ground, both 
in our science and in our search for funding.
    Biotechnology R&D is a long and difficult road. It takes 
more than a decade and upwards to $1 billion to bring a new 
medicine from discovery through clinical trials and on to FDA 
for approval. Due to this capital-intensive process, companies 
lacking research and development funds turn to private sector 
investors to finance the early stages of development.
    Montana startups are at a particular disadvantage due to 
the dearth of venture capital firms in and around our State. 
Venture fundraising continues to be on the decline, and small 
companies have borne the brunt of the investors' reluctance.
    The shift in the economy has also harmed companies like 
mine that already have venture financing. Historically, venture 
capitalists receive a return on their investment when a company 
goes public through an IPO. However, IPO markets are closed. 
Investors are not able to exit and companies do not have access 
to large public markets necessary to fund late-stage clinical 
trials. This hampers critical research, forces companies to 
stay private for longer, and depresses values of later-stage 
venture rounds.
    The breadth of the financing problem in the biotech 
industry calls for comprehensive solutions to ease capital 
formation. In addition to the difficult financing landscape and 
struggling public markets, growing biotech companies also face 
regulatory burdens which further hinder capital formation in 
our industry. One such burden is the financial reporting 
standards of Sarbanes-Oxley Section 404(b). Dodd-Frank made 
permanent exemptions for small businesses with market caps 
under $75 million do not have to comply, but most biotechs are 
valued much higher than that due to successive rounds of 
financing. Because we have no product revenue, we do not have 
the resources needed to focus on complex reporting. By raising 
the exemption ceiling to $700 million and adding a revenue test 
to Section 404(b) and SEC Rule 12b-2, Congress could allow 
cash-poor companies, small, innovative biotechs, to focus on 
speeding cures and treatments to patients rather than Sarbanes-
Oxley compliance.
    There is already an avenue for these small companies to 
raise funds and avoid unnecessary burdens in the form of SEC 
Regulation A, which allows for companies to undergo a direct 
public offering valued at less than $5 million without 
observing traditional disclosures requirements. However, the $5 
million limit was set in 1980 and no longer provides a real 
view of small companies looking for access to public markets. I 
believe Regulation A could have a positive impact for biotech 
companies if its eligibility threshold was increased from $5 
million to $50 million while maintaining the same disclosures. 
This a result of the increased company valuations and higher 
levels of capital needed all driven by the impact of inflation 
on the cost of development.
    Although SEC policies like Rule 12b-2 and Regulation A are 
designed to monitor public companies and offerings, the agency 
also keeps tabs on private companies when they reach a certain 
size. Currently the limit is 500 shareholders. However, most 
biotech companies provide employees with stock options during 
that decade that it takes to develop a single treatment. 
Employee turnover pushes the shareholder number to over 500. 
Increasing the shareholder limit from 500 to 1,000 and 
exempting employees from the count would relieve a small 
biotech company from unnecessary costs and burdens to grow.
    These measures I recommend have no burden on the taxpayer, 
but would have a substantial impact on the viability of our 
biotech industry.
    The U.S. biotech industry remains committed to developing a 
healthier American economy, creating high-quality jobs in every 
State, and improving the lives of Americans. While there is no 
single solution to the challenges facing our industry, the 
portfolio of options I have presented will help biotech 
companies in Montana and across the Nation weather the current 
economic storm and continue working toward delivering the next 
generation of medical breakthroughs--and, one day, cures--to 
patients who need them.
    Thank you.
    Chairman Tester. Thank you for your testimony. I am going 
to kick it over to Senator Vitter for his comments and 
questions at this point in time. Could you put 7 minutes on the 
clock, please.
    Senator Vitter. Thank you, Mr. Chairman. I do have another 
hearing, as you know, and I appreciate the courtesy. And thank 
you all for your testimony and, more importantly, thank you all 
for your work.
    Dr. Bargatze, let me start with you on one of the topics 
you mentioned near the end, which is the mandate under 
Sarbanes-Oxley. As you mentioned, the SEC Small Business 
Advisory Board suggested an exemption of $700 million, but 
Congress instead, through Dodd-Frank, passed an exemption of 
$75 million--obviously a big difference.
    I take it from your testimony you support more reasonable 
robust exemption like $700 million. Why don't you put a little 
bit more meat on the bone of what that would mean and what 
burden that would lift?
    Mr. Bargatze. Sure, certainly. Where we are as a company in 
our stage of development, we are only entering into Phase II 
clinical trials now, and we have a long way to go. We have 
already raised in excess of $80 million in that process, so we 
actually are approaching that point where Sarbanes-Oxley is 
going to be a major issue for us. Our valuation is not yet that 
high, but I feel that, you know, as we move forward, we begin 
to talk with pharma companies, and we are valued, I think we 
are going to be dealing with Sarbanes-Oxley, and this could 
make a significant difference in the cash resources that we 
have to actually move forward our products rather than putting 
that into essential accounting.
    Senator Vitter. And how major a burden and a drain would 
that requirement be?
    Mr. Bargatze. It makes the difference between being able to 
hire a critical person who is necessary for our vaccine 
development to move forward. Not being able to hire that 
person, having to meet these SEC regulations is something that 
essentially is an incredible burden in terms of us getting the 
job done.
    Senator Vitter. Right. Would you all also like to comment 
on that Sarbanes-Oxley issue?
    Ms. Marchi. I would. I know I have had another Montana 
company, not in the biotechnology space, say it cost them 
between half a million and a million dollars a year to comply. 
You know, I do not know if the number is $700 million or the 
number is $250 million, but it is higher than $70 million.
    Senator Vitter. OK. Thank you.
    Mr. Zoller. I would also argue that in the case of 
Sarbanes-Oxley it represents more or less a new barrier for 
mid-cap companies that are on their way up. I think that more 
attention should be placed on that transition. So if you were 
to look at the life cycle of a firm as it grows, Sarbanes-Oxley 
is designed ultimately for a company that is quite established. 
I do not think we were thinking at the time when we did 
Sarbanes-Oxley about the implications on growth companies, what 
we are calling ``gazelles.'' And what we have found is that 
gazelles are our employers; whereas, as large companies, more 
mature companies, actually become so productive that they 
destroy jobs. Emerging companies, young companies, small-cap 
companies, mid-cap companies grow jobs. So if we are looking to 
grow jobs, we should not be selling the golden cow that is 
ultimately the great tool we have.
    Senator Vitter. Great. Thank you.
    Ms. Marchi, in your testimony you say, ``We need Federal 
policy that does all it can to minimize regulations.'' How 
would you grade Washington the last few years on that central 
core statement?
    Ms. Marchi. With all due respect, I think you need to go 
back to school.
    [Laughter.]
    Senator Vitter. Good. I agree. I appreciate that. And, 
specifically, how do you think Dodd-Frank addresses that issue?
    Ms. Marchi. Well, certainly, on the accredited investor 
definition, I submitted, in addition to my written testimony, 
the net worths of individuals who tend to be angels, and, 
frankly, the preponderance of them are in the $2 to $3 million 
category. And I will submit to you that somebody in Polson, 
Montana, who has got a $2 or $3 million net worth is doing 
pretty well and is not real excited about the U.S. Congress 
telling them that they cannot make an investment in their local 
technology company that is trying to create jobs. So in that 
respect, we appreciate the compromise, but we were not happy 
about any change, frankly, in the accredited definition. And 
the same thing with Regulation D, we appreciate your help on 
that. That had some very unintended consequences for small 
startups.
    Senator Vitter. Right. Mr. Zoller, I would invite your 
reaction with regard to Dodd-Frank generally.
    Mr. Zoller. Well, as a matter of fact, there is a trend 
occurring now that I am not sure we are totally recognizing in 
the policy arena, and that is, you know, we are seeing a 
democratization of capital and equity, and we are seeing that a 
number of small investors can be crowd-sourced to actually 
accomplish things that would have otherwise been only in the 
domain of people with high net worth. And what we are seeing in 
the case of even someone with $1 million net worth is the 
capability to actually fund extraordinarily high growing 
companies given the advances we have had and the scale of new 
businesses and the development of cloud computing, things of 
that nature that have lowered the barrier to entry.
    So the fit of capital to firm has changed fundamentally, 
and we should be encouraging everything we can do to bring 
private net worth into capital investment, especially when it 
comes to building new growing concerns that will grow jobs. So 
the Kauffman Foundation would advocate for, you know, policy to 
actually focus on the democratization of equity.
    Senator Vitter. OK. And, Mr. Zoller, also to follow up on 
that, you make a major point about bank consolidation and other 
trends hurting traditional bank financing. In your opinion, has 
that in recent months, in the last year or so, been getting 
better or worse?
    Mr. Zoller. Hard to say. I do not have any data that would 
reflect it, but I will give you a personal anecdote that I 
think will bring some illumination to it.
    I own a small business myself, and I recently called one of 
the three largest banks that will remain nameless for the sake 
of this testimony, and they could not even find my account, and 
I have been doing business there for over 3 years. This is a 
good example of how, you know, scale I think affects the 
performance of our banking institutions, and I am quite excited 
about the innovations I have seen in the community banking 
environment where, you know, folks are recognizing the 
relevance in regional banking settings. But we need to focus 
very carefully on how large banks are working with our small 
business sector because right now I would argue that it is 
completely broken.
    Senator Vitter. Well, I share that gut feel. Let me say in 
closing I share the gut feel. I am very concerned that what 
Washington has done in this sector recently not only enshrines, 
does not dismantled too big to fail. I think it simply adds a 
new category on the other end of the spectrum, which is too 
small to cope, and it is creating more consolidation and moving 
the trend in the wrong direction, not the opposite direction in 
terms of size and consolidation.
    Thank you all very much.
    Chairman Tester. Thank you, Senator Vitter.
    I am going to kick it over to Senator Toomey from 
Pennsylvania for his comments and questions, and 7 minutes on 
the clock again, please.
    Senator Toomey. Thank you very much, Mr. Chairman and 
Ranking Member Vitter. I also want to thank you for allowing me 
to kind of crash this party. Since I am not on your 
Subcommittee, it is kind----
    Chairman Tester. We appreciate you being here.
    Senator Toomey. Well, it is kind of you to do this, and I 
just want to assure you that I have a great interest in this 
topic generally. I am somewhat of a serial entrepreneur myself. 
I have been through the process of raising capital. I have been 
an investor. And I have seen how difficult it is for small, 
growing firms to access the capital that they need. And so I 
really want to give you all the credit I can for raising this 
very, very important issue.
    This is about economic growth and job creation, and the way 
I look at it is there are two categories that I really hope 
that this Congress will make some progress on, and I know you 
are both interested in doing that. One is making it easier to 
raise capital privately because that is how things get started 
and how that initial growth occurs.
    And the other part that is equally important to me is 
accessing capital in public markets. We can lower the burdens 
and obstacles in both of these categories, and if we do, we are 
going to have more startups. We are going to have more growth. 
We are going to have more jobs. And it is very, very 
encouraging to me that you are addressing this.
    One of the things that I wanted to invite anybody to 
comment on is in the life cycle, the early life cycle of 
startup companies, we often have a, often, a fairly predictable 
sequence of capital raises for a growing company. It often 
starts with maybe angel investors, moves on to venture 
capitalists, then maybe an expanded private offering before 
ultimately a public offering. If we made substantial progress 
in facilitating capital raises at any point along that 
sequence, does that not help all along the sequence?
    Even, for instance, the liquidity event of an IPO. The mere 
fact that that becomes more achievable, more doable, less 
costly, does that encourage the earlier scale investment? Does 
that do something to encourage angel investors or venture 
capitalists because they see a more realistic exit strategy? 
Would each of you comment on that.
    Mr. Bargatze. Yes, I would be pleased to comment on that. 
Essentially, our company has raised capital a variety of ways, 
actually. A critical part of that is in addition to the 
traditional private markets, certainly SBIR is a very important 
aspect. It is our seed capital in Montana. We really do not 
have a significant number of other sources. I think Liz's angel 
efforts fairly recently have made a huge difference in 
providing some early-stage capital, but when we look at what 
can be provided through SBIR, where you have phases of 
funding--for example, one of the programs that we funded, we 
have raised over $8 million in SBIR funds to develop a product, 
and that is significant in terms of resources that help you 
move forward to the point where you have proof of concept.
    I think the other aspect you asked about, with regard to 
IPO, I think this is really critical for our investors now that 
we have venture investors on board. They are looking for an 
exit in which they get a multiplier, and right now in biotech, 
it is very difficult to do, simply because of the long time for 
development, and actually, at this point, very low returns on 
investment that we are seeing in terms of what investors are 
getting. The deals that are happening seem to be driven down 
right now by the Pharma industry. They are trying to get cheap 
products. Essentially, they are bidding low on what these 
products are in terms of what it has cost to develop them. And 
so that is really driving down the deals and driving down the 
multiple investment that the investors are getting as a 
consequence of being in for 8 or 10 years before they actually 
see a return on their investment.
    Ms. Marchi. And I would like to speak to that. Angels very 
rarely invest in life science or biotechnology, simply because 
of the amount of capital required to product development--even 
though we did invest in Bob's company, because we think it is 
an awesome company.
    But we encourage ``bootstrapping'' to begin with, without a 
doubt, and as angels, we are looking more and more at companies 
that do not ever need venture capital because it is such 
expensive money right now. But the IPO markets are critical for 
exits and I think our whole notion of scale is changing. When 
we look at a company like Facebook, with the kind of market cap 
it has, it is still a small company.
    Senator Toomey. Yes.
    Ms. Marchi. You know, it is a very different world we live 
in in terms of adding value.
    Mr. Zoller. Mr. Toomey, I think it is an outstanding 
question in a lot of ways because it occurs to me that when a 
new firm begins, it begets another new firm, right. There is a 
champion effect. And I would argue that when a firm goes 
through an M and A or an IPO, that would beget a new trade sale 
or IPO.
    But to a certain extent, getting it right will involve kind 
of solving on a quadratic equation. What I mean by that is you 
have to solve at every level for it to occur, and I would 
submit to you right now, as we speak, while we have new starts, 
improving our capitalization engine at the early stage is 
broken so that any chain in the link, at some point, if it is 
broken, will actually have an effect throughout the entire life 
cycle, as you suggest.
    So a focus on each of the life cycles is going to be 
critical to maintain kind of critical mass and ultimately the 
momentum that will keep our economy surging forward. And at 
this moment, we have got two of the four key stages, I think, 
in distress.
    Senator Toomey. Right. And one other question, Mr. 
Chairman. You know, Pennsylvania is a home to a very large 
number of very, very successful bio companies. The life 
sciences are a booming sector in various parts of Pennsylvania 
and it is a very, very encouraging area for us for job growth, 
for quality of health care.
    Dr. Bargatze made a very interesting observation in your 
suggestions about the cost of compliance with Sarbanes-Oxley. 
You are suggesting that, in many cases, not only is it very 
costly to comply, but it is not very useful information because 
the nature of the business, there are other activities that are 
more interesting and more useful to investors than the items 
that are demanded by Sarbanes-Oxley. I was wondering if you 
could elaborate on that a little bit and share with us the 
importance of diminishing this burden.
    Mr. Bargatze. Yes. Certainly, I think, in limiting this 
activity, it certainly frees us up to do a lot of activities 
that are much more important in terms of generating clinical 
data, providing that data in a context where we can take it out 
to investors to raise more capital. It is also important to be 
able to generate this kind of data to partners that we 
potentially could bring online that brings more resources as a 
consequence of their interest in codevelopment that may 
associate with this data.
    And so it is really a distraction from our main focus. In a 
company, in a biotech, I mean, you are not profitable until you 
actually have a product that reaches the market. And now we are 
looking at a life cycle of, in our case, it is something in 
excess of 14 years, and this is not atypical from the time you 
start on a particular product until the time it either makes it 
or fails.
    And so I think that just simply because it is a capital-
intensive activity, anything that distracts us from being able 
to focus on the activity that is providing the value, is of no 
value to us.
    Senator Toomey. And also, as you point out in your 
testimony, it is not very useful to investors to have the reams 
of data about Sarbanes-Oxley for a firm that has no revenue 
yet. What is much more important is the actual--the tests, the 
trials, the development of the science, and the application----
    Mr. Bargatze. Precisely. That is where the interest is. We 
do accounting at a level that is sufficient for our investors 
to be quite happy with how their investment is being managed. 
Accounting is certainly something that we put in place and have 
had in place for a number of years as a consequence of our DOD 
contracts. And so we can certainly pass a DOD audit. There is 
no reason why that should not be sufficient for investors.
    Senator Toomey. Thank you. Thanks very much, Mr. Chairman.
    Chairman Tester. Absolutely, Senator Toomey. There will be 
another round. If you have got one more, I would let you do it, 
but otherwise, I am going to continue with more.
    Senator Toomey. I have got to run, but I appreciate your 
having me.
    Chairman Tester. Absolutely. I appreciate you being here 
and I appreciate your line of questions.
    And with that, I want to thank the panel for being here. 
The first question I have, you have all three addressed it in 
one way or another, but I would like you to address it again, 
and that is from your perspective, is the biggest challenge out 
there for startups in rural and urban areas, and some of you 
have had experience in both, is it capital alone? Is it 
expertise? Is it infrastructure? And could you kind of give me 
an idea, if you could rank them, and it is probably going to be 
pretty tough to do that, but we will start with you, Dr. 
Zoller.
    Mr. Zoller. So a lot has been said about the concept of 
champions. Serial entrepreneurs are a critical element to 
creating an ecosystem that ultimately is going to be high-
performance, people who have done it, who have been there, who 
have had experience and are facile in developing their 
understanding of the market, being able to bring their ideas to 
the market in the form of a venture.
    You know, I am very bullish on what I am seeing now because 
I think many people are now understanding the impact of 
entrepreneurship and now entering as founders into the market. 
We have a very healthy kind of culture that is evolving now, 
especially among our young people. I see a young generation 
that gets it and are really driving into entrepreneurship.
    Unfortunately, enthusiasm is not enough. It might be a 
necessary but not sufficient condition, because you need to 
solve on several parts of the equation. The other part would 
ultimately be the environment in which they operate. Are the 
barriers high? And I would submit to you that under the current 
economic climate, there is tough sledding now. So as a 
consequence, it is harder to build your venture into a going 
concern in today's environment.
    All that being said, there are some natural opportunities 
that are coming about as a consequence of technology 
development that are dropping the barriers at the same time to 
certain aspects of building your firm from a technical 
standpoint.
    Then the pieces that I have outlined in my testimony 
regarding capital. I think that, unfortunately, debt partners 
are not as readily available today. I think it is harder to 
access debt capitalization. And, frankly, debt capitalization 
in particular, when you are talking about line of credit, is 
really critical to an early-stage company because you are 
trying to smooth out and use your assets as carefully as you 
possibly can.
    One of the challenges you have in accessing a credit 
facility easily is that you lose control of your own resources, 
and as a consequence, it becomes inefficient. What we found is 
that this equity scenario has turned out to be the only 
solution, but equity is very, very precious, and in order to 
use your equity efficiently, you need to understand how to use 
debt. So banking has got to be a critical element to solving 
this challenge.
    And then we have all outlined the challenges in accessing 
early-stage equity. You know, fortunately, we have got angels 
coming to the rescue now and I think it is becoming a little 
bit more systematic, which is exciting. But that also takes the 
same leadership that I mentioned at the very beginning. The 
serial entrepreneurs become the angel investors. So it is a 
virtual cycle and you have to have health at every level of 
that cycle for ultimately us to maintain that critical mass.
    Chairman Tester. Thank you, Dr. Zoller.
    Liz, do you want to address this.
    Ms. Marchi. And I certainly echo, and I think the key word 
is ``ecosystem'' here. I just want to give the example of Avail 
TVN, a company that was born in Kalispell, Montana, with a 
native Montanan who had put $50,000 on his credit card. Married 
him with an experienced corporate executive who had done a 
couple of startups, some angel investors, and we have a company 
today in Montana that had $150 million in revenue. One of their 
employees from Belt, Montana, has actually probably become kind 
of a rich kid when the company exits.
    But it is all of those things. It is the expertise. It is 
the ecosystem. It is the entrepreneur. It is the enthusiasm. 
But the guidance--building a company is not easy and we 
confuse--we have not embraced that business development is 
economic development. We get distracted by a lot of other 
things. But if you want jobs, you have got to have new 
companies.
    Chairman Tester. Rob.
    Mr. Bargatze. To address the issues you brought up, I think 
certainly what we find is there is really an incredible amount 
of expertise in Montana. Our schools are graduating kids with 
incredible experience and biotechnology capabilities. So we 
really are well stocked in terms of that.
    The thing we have learned is that location in Montana is 
just outstanding. I mean, we have all the resources that we 
need to run the facility from the standpoint of the connection 
with information. The University provides us with the necessary 
expertise and facilities that we do not have within the company 
that are very expensive that we can get through contracting 
through them and working with them closely.
    I think that one of the things that we are missing, is a 
business infrastructure that really helps us to provide the 
necessary expertise to provide our entrepreneurs with the 
ability to navigate the business world. We have a lot of 
scientists at the universities that would really like to spin 
out companies, but in fact, with few sources of this type of 
schooling, so to speak, it is very difficult for these folks to 
move forward.
    One of the things that truly is limiting is capital, 
because in the State of Montana, getting VCs from the coasts to 
come and see what we are doing there is very difficult. Once we 
get them there, they are really excited because they actually 
see that we have great things going on and we have great 
technologies coming out of the universities and there is a lot 
of opportunity for startups within the State. So getting our 
round of VC funding is a consequence of a summit a couple of 
years ago. As a consequence we have more people that are now 
looking at opportunities in the State. But because of the 
economic climate, it has been a lot more difficult to get the 
deals done there, but they are slowly happening and we are 
getting help in starting.
    Chairman Tester. I want to follow up on that just a little 
bit. As far as access to capital in rural America, is the issue 
distance from available capital, or is it knowing where to look 
for the available capital? Which is the bigger impediment?
    Mr. Bargatze. Well, OK. It is sort of a two-step problem. 
One, we traveled to all these sites for 10 years to try to 
raise venture capital, and it really was not until the sixth or 
seventh year of this effort that we were able to bring in 
capital from outside of the State. Part of that was the fact 
that these guys do not want to travel. They have got deals 
going on right in their local areas and if they do not have to 
get on an airplane to go somewhere, that is a much better deal 
for them. However, once you get them to Montana and they see 
the fly fishing, they see the skiing, all the opportunities 
there, they think it is a really good place to visit and so we 
actually have a bunch of really dedicated investors that are 
now strongly supporting us.
    So that plus the fact that we found that you really need to 
get into the clinic with the biotech company. You have to have 
human clinical data at this point to get an investment in 
Montana. This is not the case on the coasts, where people can 
be at earlier stages to get VC investment. So we have a hurdle 
to overcome there, but I think we are getting there, and if we 
continue to be successful with the companies that we have been 
able to start, I think we are going to get more folks to the 
State that are going to be looking at deals.
    Chairman Tester. Thank you.
    We have been joined by Senator Hagan from North Carolina. 
You can go ahead, Kay. Seven minutes on the clock.
    Senator Hagan. Thank you, Mr. Chairman, and I really do 
appreciate you holding this hearing today because I think that 
small businesses, new firms, are really the job creators in our 
Nation today, and it certainly is proof positive in my State in 
North Carolina.
    And I do want to welcome Dr. Zoller here today, Vice 
President of Entrepreneurship of the Ewing Marion Kaufmann 
Foundation. I have looked at a lot of your work and I actually 
cite it, so I do appreciate the great work you are doing. Also 
the Executive Director for the Center for Entrepreneurial 
Studies at the Kenan-Flagler Business School at UNC-Chapel 
Hill, which has definitely spun off a number of thriving 
companies from the University.
    One of my children graduated from Chapel Hill about 2 years 
ago under the business school and Chinese and got a great 
education there, and I know, Ms. Marchi, you, too, have North 
Carolina connections. Although you are in a great State in 
Montana, come to the beaches in North Carolina. Fly fishing is 
great in both places.
    [Laughter.]
    Senator Hagan. But, Dr. Zoller, you mentioned that certain 
changes to the tax code would be useful in facilitating the 
financing of small businesses, and you suggested that 
exemptions from capital gains taxes for small businesses could 
have a beneficial impact on growth. And I have heard that other 
tax changes suggested for this purpose, such as allowing 
partnership structures to pass through tax assets or providing 
credits for angel investors. Can you discuss the effectiveness 
of these types of tax changes and the associated risk.
    Mr. Zoller. Well, first off, I am glad to have you here, 
Senator Hagan. We were outnumbered by Montanans three to two 
now----
    [Laughter.]
    Mr. Zoller. ----and we are Tarheels, so I think we can make 
up for the difference----
    Senator Hagan. Right.
    Mr. Zoller. ----but it is a tough act. These are tough 
people. Good people.
    Senator Hagan. I agree.
    Mr. Zoller. I have got to admit, we were having this 
conversation right before the hearing, and it is not altogether 
clear, frankly, that incentives on the investment side or the 
equity side have as much effect as perhaps tax relief on the 
founder side or the entrepreneur side.
    I have been involved in a number of investments, for 
instance, where the investors were not aware that tax credits 
might be available both at the State and Federal level, are 
available to them. So it is an untested question as to whether 
or not a tax credit on the equity side would, in fact, have an 
impact.
    I think part of it is because Government really has a hard 
time marketing those opportunities. What investor would not 
take advantage of that credit if they knew about it? So I think 
it is worthwhile to present as an experiment, and I think that 
experiment is something that I think would be critical to 
investors.
    But I honestly think the most important solution would be 
reducing corporate tax burdens on the entrepreneur side, and 
the idea that we are proposing is a phased exclusion of taxable 
profits. So the problem is the investment period of an early-
stage company, negative cash-flow period. That is one of the 
key challenges in getting a company started, and survival rates 
are a key problem. Companies fail during that negative cash-
flow period. So if we can give tax relief during the building 
of a firm to the founding team and entrepreneurial venture, I 
think it will pay huge dividends. So I think you should solve 
on both sides, not just on the investor side, but on the 
entrepreneur side. We are suggesting both.
    Senator Hagan. Can you discuss why you would target the 
investors and small businesses rather than changing tax 
policies for the businesses themselves? And also, I have heard 
it suggested that we could change the way the net operating 
losses are calculated or how intangibles are amortized to 
achieve a similar effect for small firms.
    Mr. Zoller. I think that those would be outstanding 
solutions, because there are differences in the ways companies 
scale. Some companies are very capital-intense. Others can be 
brought to high growth without a lot of capital investment. So 
solutions that would help use, for instance, a capitalization 
or amortization of investments that are made both in tangibles 
and in intangibles, I think, would have a pretty substantial 
benefit as you are building a company.
    You know, Dr. Bargatze was talking a little bit about the 
notion of bootstrapping and how you bring valuation to a 
certain point so it is attractive to an equity investor. These 
tools would allow the entrepreneur to actually build a stronger 
case for their valuation prior to going out to the market for 
equity, and that would actually put them in a much stronger 
position to actually be able to lead the firm through time and 
maybe even retain more of the equity as time goes on. And, 
frankly, I would rather have the equity in the form of the 
founder and the entrepreneur than in the form of professional 
investors.
    Senator Hagan. You know, I talk with a lot of different 
companies and some of the new, I think, some of the biotech, 
biomedical companies that I was speaking to recently said they 
were actually going to Ireland to start some of their 
businesses. And I was just curious if any of you have seen the 
fact that we are not doing this type of taxation policy here, 
that we are, in fact, losing companies that either had started 
here or would have planned to start here and then we have lost 
them to other companies.
    Mr. Zoller. One thing I will mention just briefly, and cede 
the time to the rest of my panel, is that we have been working 
with the Start-Up Peru Group. This is a group that just has put 
out a simple proposal. In order to bring companies to Peru, we 
will give you $25,000 and provide a space. And Americans are 
flocking in hoards there.
    I have been shocked by the differences in early-stage 
capital available in Europe relative to the U.S. It is easier 
to form a $5 million premoney evaluation type of equity 
investment for a venture that is started in Denmark than it is 
in the United States. So this is something we need to really 
focus on. The money is not getting to where it is needed most, 
and that is among early-stage companies that can actually take 
this opportunity to market and to growth.
    Mr. Bargatze. Although I do not have any direct experience, 
I do have anecdotal experience in terms of knowing that there 
are a number of Asian companies that are creating biotech 
centers and then offering the opportunity for companies to move 
there with incentives. So there are certainly deals there that 
are providing companies with less cost in terms of 
infrastructure and incentives in terms of investment to help 
move the firm and establish the firm, and then most likely, I 
would think, providing them capital for operations. So that is 
something that certainly I have seen. I have been approached, 
but we have not had any details in terms of discussions, 
because we want to stay in Montana.
    Senator Hagan. Well, I will tell you, with unemployment 
rates where they are around the Nation, and in North Carolina, 
about 9.7 percent, we have got to be forward-thinking in our 
policies to be sure that small niche companies can grow and 
create jobs, have access to capital, and, in my case, employ 
more people in North Carolina and around the country, certainly 
without losing these companies overseas.
    Thank you, Mr. Chairman.
    Chairman Tester. Thank you, Senator Hagan. I appreciate 
your comments.
    It is interesting, what you said about Peru and potentially 
Ireland. It would be great to sit down and figure out what we 
could do that could actually make a difference, and I think 
back to when I first got in the State legislature. I went to a 
farm convention and there was an economic developer there that 
said--now, this was in 1998--that said, it is evident to me 
that with the incentives that are out there--this is the other 
end of the spectrum--that you could make a good living just 
fleecing the Government and not do one doggone thing when it 
comes to economic development. So there must be some middle 
ground there, where we can stop the fleecers but yet allow the 
bona fide companies to really grow, and we could have another 
hearing on that at some point in time.
    But I want to talk about community banks, because community 
banks are something you talked about, Dr. Zoller, with your 
experience with the big guys, and I have always looked at them 
as being a supporter of established businesses, particularly in 
rural America, for operating loans and those kind of things. 
Can they play a role, or would they play a role, or do you see 
even a possibility of them playing a role when it comes to 
startups?
    Mr. Zoller. You know, as a matter of fact, I am quite 
enthusiastic about what I am seeing in community banks. You 
know, that simple relationship between the founder and the 
banker is the relationship that helped build our country and we 
have to go back to that simple concept. Because of the Internet 
and because of the scale of our enterprises and the scale, 
frankly, of banks today, it is difficult for that relationship 
between the regional banker or the local banker and the 
business owner to actually be established, and community banks 
offer the opportunity to reduce the scale so that the bankers 
understand the business impact of capital to the growth of that 
business.
    A banker can understand the risk that is being placed on 
the part of the founder, can understand the promise of that 
business, and actually can position debt in such a way to help 
fuel the dreams of that individual. I honestly think that that 
is risk taking that we cannot afford not to be doing. That is 
exactly the kind of risk taking that built our country to what 
it is today.
    I think back even to the very first days of Standard Oil. 
When John D. Rockefeller outlined the opportunity, he turned to 
the banks to actually open up the opportunity. Without that 
partnership between the banks and John D. Rockefeller, Exxon 
would not exist today. Now, that is a very strange example to 
bring up, but in the day, it was an entrepreneurial company, 
right? That dyad of the banker with the founder is something we 
have to come back to, and by going through a five-level CRM 
system through a telephone-based menu is not the way to get 
there.
    Chairman Tester. I appreciate that. Would anybody else like 
to comment? Liz.
    Ms. Marchi. I would. We have watched in Montana our banks 
literally live in fear of regulators. They are completely risk 
averse. And one of the big issues that we have, as you well 
know, is we do not do comps very well. The nearest comp is 100 
miles away, and that just does not work in this system today. 
So I could not agree with you more, and the sad thing in 
Montana is that we still have that relationship, but hands are 
tied. They are just tied.
    Chairman Tester. Yes. Rob.
    Mr. Bargatze. Actually, we have had some very good 
experiences with local banks in Bozeman. It has really been a 
result of a track record we developed locally as a consequence 
of federally guaranteed loans that we got from the city. We 
were able to borrow over $600,000 over a number of years. As a 
result of us being able to pay those back, we developed 
relationships with local banks that have given us lines of 
credit of up to a million dollars, and so that has been very 
instrumental in us being able to make it through gap periods 
where we have needed to borrow and then repay when we had 
additional funds we were able to bring in to move the company 
forward.
    Chairman Tester. That is good.
    I would like to start with Dr. Zoller again, but I would 
like you to talk broadly about the shift away from IPOs to 
mergers and acquisitions and its impact upon jobs.
    Mr. Zoller. It is a very troubling type of barrier that has 
been placed. You know, there are only two exit windows, and 
when you look at it from the investor's standpoint, they are 
looking ultimately to return capital for their investment and 
they look, quite frankly, at the exit opportunities. The only 
two exit opportunities that are available to a firm--well, I 
guess there are three exit opportunities--one is M and A, or a 
trade sale. The second one would be an IPO. And the third would 
be failure, which is not an exit opportunity that people look 
for.
    For all intents and purposes, the last several years, the 
IPO window has been closed, and while we have seen some, 
perhaps, recent examples of things that make us optimistic, I 
am just as nervous about those opportunities because I think we 
are dealing with an inflated valuation scenario in most cases.
    We really need to think about build-to-last companies, not 
build-to-sell companies. Entrepreneurs can build companies that 
will employ millions, and if you think about the companies just 
after the bubble, for instance, that have really made our 
economy--I am talking about the Ciscos and the NetApps and the 
Genentechs and different sectors--these were build-to-last 
companies, not build-to-sell companies. And, frankly, an IPO is 
the best way to deliver on a build-to-last opportunity.
    Chairman Tester. Would either of you want to comment? It is 
up to you.
    Ms. Marchi. And what we have seen in Montana, actually, is 
a couple of companies go into Canada and doing sort of the 
reverse shell market, and the real reticence on the part of a 
lot of companies to pursue the IPO market is just the expense 
is just enormous. It is absolutely enormous to be a public 
company today.
    Chairman Tester. OK. You talked about firms that were ready 
to go public, and Dr. Bargatze, you have a firm like LigoCyte 
who has been, I would say, reasonably successful, if not very 
successful. How does a firm know when it is ready to go public? 
I can start with you, Rob, or I can start with Dr. Zoller. It 
does not matter. Go ahead, Rob.
    Mr. Bargatze. Yes, I think that there are some critical 
elements in terms of, at least in biotech, what stage you are 
at with regard to your clinical development. Have you got a 
proof of concept? Have you gotten to the point where you have 
shown that your product is actually working and it is safe? We 
actually have reached that point, and I think if we were 
looking at earlier times, you know, before the economic 
downturn, there is a very high likelihood with the IPO markets 
open, with additional things that we have had in our pipeline 
that we have had to shelve as a result of difficult access to 
capital, we would have been in a position to actually move to 
potentially go to an IPO. But because of the current 
conditions, you know, that IPO window is not open, and 
certainly mergers and acquisitions are not as attractive as an 
IPO in terms of both the founders and VC investment group, 
because frequently these mergers/acquisitions are staged 
events, and they pay out over a long period of time. There is 
essentially no return on investment that comes back to our 
investors.
    Chairman Tester. OK. All right.
    Mr. Zoller. One thing I would add is that there is an 
interesting psychology when you are preparing a firm for an 
IPO, and usually it is the run-up in understanding how to 
position it for that event. The investment bankers will signal, 
you know, what is the best outcome for the firm, both from the 
standpoint of its future market takedown as well as its 
valuation, and will literally shop the opportunity among 
potential acquirers at the time when they are preparing an IPO.
    I would submit to you, however, that in most cases when the 
first is acquired, fundamentally the structures are upset 
because the acquirer will integrate the company into its own, 
you know, identity, its own body. In many cases there is 
radical downsizing. In most cases there are innovations that 
are left on the table because they do not synchronize with the 
acquirer's goals; whereas, in the case of the IPO, the founding 
team can maintain its strategy, preserve its employees, and 
ultimately develop the capacities to actually take it to the 
next level. There is no question in my mind, if you are looking 
for employment growth, IPO is definitely the way to preserve 
it.
    Chairman Tester. OK.
    Ms. Marchi. And, frankly, at the level--we are usually the 
first money in. What we are finding is we are having to start 
working with our companies much earlier in order to coach them 
to exit so that we retain our investment value.
    Chairman Tester. I got you. In parting, I would like to 
have you share with me what you see out there that is very 
exciting that gives you hope and that we should know about. Who 
wants to go first? I hope there is an answer. Liz, do you want 
to go first?
    Ms. Marchi. Never a problem.
    Chairman Tester. I did not think so.
    Ms. Marchi. I actually think that it is an incredibly 
exciting time in Montana and across the United States. I love 
that this audience today has so many young people in it. We 
have smart kids. They have a global perspective. They have 
grown up with technology. And, frankly, I think the opportunity 
that technology gives us is amazing.
    We are going to soon be in a business world where it is not 
about your resumes or your referrals. It is going to be about 
the product that you have produced because everybody can see 
it. I love in Montana, I am watching software developers work 
from Yemen and Estonia and Arlee and Bigfork. And we talk about 
clusters. It is not clusters geographically anymore. It is 
communities of interest, and they are building them online.
    So I see the opportunity to create value and discovery and 
solve problems within this country unprecedented because of our 
ability to connect and communicate. And I want to thank you 
very much for holding this hearing.
    Chairman Tester. Thank you for being here, Liz.
    Rob.
    Mr. Bargatze. I think there are two factors that I think 
are very promising. One is that Montana is ripe, actually for 
development of industries like biotechnology. One of the things 
that I have not talked about that is really critical is the 
cost of doing business there is far lower than doing business 
on the coast. So our venture capitalists have actually made 
note of the fact that it takes a third more money to get to the 
same place in a clinical development plan on the coast than it 
does in Montana. So we really offer a great economic equation 
in terms of efficiency of what we do with that dollar and how 
far we can go with it.
    The other thing that collides with that and provides a 
great opportunity is the big pharma companies are downsizing 
their research and development groups. Those groups are no 
longer producing the products internally. Biotech is really the 
source of innovation. And so when you look at those two things 
together, it is basically saying if we bolster the biotech 
community in Montana, we potentially are going to be providing 
the solutions that the big pharma companies need to build their 
pipelines to continue to make products. And with that we will 
actually be able to have a huge impact on health, and 
particularly with vaccines, because the best preventative way 
to lower costs and prevent disease is really to create vaccines 
that prevent diseases that can otherwise be quite devastating 
and quite costly for the health care system.
    Thanks for the opportunity.
    Chairman Tester. Thank you, Rob.
    Dr. Zoller.
    Mr. Zoller. Senator Tester, I really appreciate you putting 
together this panel today. This is one of the most critical 
issues, I think, facing our country, and we have got one heck 
of an opportunity, and it is because of the people that are 
behind you and the people that are behind us on the panel, the 
young people that are here. They really get it. Fundamentally 
why I am bullish is the young people are taking charge of the 
situation, and they see the opportunity, I think, to leverage 
entrepreneurship as a tool to really make progress in our 
society. They realize that the promise of a large enterprise is 
in the future. They know that they are going to try to solve a 
problem and they are not going to take no for an answer. So I 
am very bullish on the opportunity.
    To a certain extent, clusters have been an abstraction. I 
think now we have to talk about networks, and ultimately what 
the young people do not realize and what I would kind of 
suggest they should be focused on today is that they will need 
some of us gray hairs to kind of help unlock some of the 
potential. My hope is that we are seeing a democratization 
among our entrepreneurs, and that democratization is also 
flowing on the equity side. If we can bring the two communities 
together, investors and entrepreneurs, I think we are going to 
unlock a potential that will be a great opportunity for the 
United States.
    Chairman Tester. Well, thank you, and I thank all three of 
you for being here. Just to kind of give you my perspective on 
this, I could not agree with you all three more. I get the 
opportunity to meet with a lot of young people in this job, and 
it gives me incredible hope for the future. They do have it 
figured out very, very well. They understand this world in a 
way that gives me hope for the future in a very positive way.
    I want to thank you all for testifying today. I very much 
appreciate your insight and your knowledge about how to create 
jobs and how to grow the economy. I think you are right. The 
companies that you folks work with every day, the startups, the 
entrepreneurs, is really how we are going to get out of the 
economic downturn that we are in, and I look forward to working 
with all of you into the future on the issues we discussed here 
today.
    For the record, the record will remain open for 7 days, and 
any additional comments and any questions that might be 
submitted will be in that record for the next 7 days.
    With that, I once again thank the panelists, and this 
hearing is adjourned.
    [Whereupon, at 11:09 a.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]

                  PREPARED STATEMENT OF TED D. ZOLLER

  Vice President of Entrepreneurship, Ewing Marion Kauffman Foundation
                             July 20, 2011

    Chairman Johnson, Ranking Member Shelby, and other Members of the 
Committee, my name is Ted Zoller, and I serve as Vice President of 
Entrepreneurship at the Ewing Marion Kauffman Foundation, am a faculty 
member in the business school at the University of North Carolina at 
Chapel Hill, and an entrepreneur. I appreciate the opportunity to share 
some perspectives on capital access to start-up and scale businesses in 
the United States.

The Entrepreneur's Dilemma
    I would invite Members of the Subcommittee this morning to put 
yourself in the shoes of a founder of a new firm in the United States--
this is perhaps one job more exciting than being a United States 
Senator. As a promising entrepreneur, your business concept solves a 
problem, fills a customer need, and fulfills what the market demands. 
However, starting any new enterprise requires capital. The investment 
period every business experiences until it reaches cash flow break 
even--a concept termed the ``J-curve''--is a perennial issue to any 
start-up. This natural need for investment is precipitated by capital 
requirements, labor costs, and the negative cash flow you will 
experience until your business is established in its market and has 
gained a loyal set of customers. The ``J-curve'' can only be remedied 
by access to capital, and when capital is not forthcoming, represents a 
substantial barrier to new firm starts. While a small percentage of 
firms can be ``bootstrapped'' or self-financed and can achieve break 
even through their own cash flows, the vast majority of all new 
enterprises--and in particular high-growth firms that rely on 
innovation and capital investment--require outside funding in the form 
of equity and debt to shoulder the J-curve.

Pressure on Early-Stage Capital Access
    The picture I will paint for you this morning is that your job is 
harder today than it has been prior to the financial crisis and 
recession in the United States, because both equity and debt financing 
are not as readily available. The J-curve is now a barrier to your 
entry as opposed to simply a hurdle in becoming a going concern. Why is 
it harder today to finance the start-up? Three reasons:
    First, venture capital and other forms of private equity have 
largely vacated early-stage investing, opting instead to form 
syndicates to pursue more reliable returns in later-stage ventures, 
largely abandoning early-stage concerns.
    Second, while angel and friends and family investors have entered 
the early-stage financing market to fill the gap, these angels are not 
as adept in connecting to later-stage capital partners to continue the 
financing needs of the venture over its lifecycle to fuel the firms' 
growth, and angel capital availability is a fraction of equity 
investment that was available in the past.
    Third, the consolidation of banking institutions and their current 
conservative posture toward risk precipitated by the Wall Street 
financial crisis has choked off needed debt financing. If you cannot 
access equity financing, you no longer can start a business without 
collateralizing the debt against your personal assets and signing a 
``personal guarantee,'' and the line of credit that you need to smooth 
your cash flows now comes with higher interest rates, more punitive 
terms, and generally not at the limits needed to finance your firm. The 
large banks are no longer a partner to small business. Indeed, I have 
personally operated a family business now for 3 years and recently 
contacted my bank for service--one of the three largest banks in the 
United States that for the sake of my testimony will remain nameless--
and they could not even find my account, claiming on the phone that I 
was not their customer. This is a bleak picture that we all face as 
entrepreneurs.

Macroeconomic Relevance of the Start-Up
    While we have seen a clear resurgence of angel investors and the 
trend toward democratization of equity investing and are hopeful by 
innovation occurring in our community and commerce banks, our early-
stage pipeline is under unprecedented stress. This has staggering 
implications on our economic future. Since the recession began in 2008, 
Kauffman data indicate that more firms than ever are being formed each 
year. Unfortunately our research reveals that this result is hollow--as 
the new firms are largely sole proprietorships and ``consultancies'' as 
opposed to job-creating firms. New firms with employees during this 
same period in fact have been dropping--a troubling indicator 
suggesting a slowdown in the formation of potential scale companies.
    Contrast this fact to another series of studies published by the 
Foundation--that up until the financial crisis and subsequent 
recession, United States job and output growth was driven by the 
formation of new firms or start-ups, and firms younger than 5 years old 
were responsible for all net new job creation. Moreover, we have 
concluded from our research that if the United States economy could 
consistently generate 30-60 new companies whose annual revenues 
eventually reach $1 billion, the United States would enjoy permanently 
a 1-percentage-point increase in its growth rate. This promises a 
solution to our fiscal future. So if our goal is to motivate our 
economy and create new jobs, then we must focus on job-creating, early-
stage firms--especially those firms that will achieve high-growth and 
scale and require long-range financing. Achieving this goal will 
require a continuous stream of new, bold entrepreneurs, fewer 
roadblocks to the formation of new enterprises, and low-cost capital 
available to finance startup and growth.

A Solution to Our Entrepreneurial Future
    How can we do this in light of the looming budget austerity at all 
levels of government? We must do this, as our fiscal future is at 
stake. Yesterday, the President of the Kauffman Foundation, Carl 
Schramm, presented a solution we are calling the Startup Act. This 
proposal speaks to many of the dilemmas faced by the entrepreneur that 
I have framed in my testimony and are the subject of this hearing--
providing access to capital, by:

    First, modifying the tax code to facilitate the financing 
        of small business, with a permanent capital gains exemption on 
        investments in start-ups held for at least 5 years. There is a 
        strong case, given the job creation and innovation benefits of 
        start-ups, for exempting from any capital gains tax patient 
        investing in early-stage companies--an idea supported by the 
        National Advisory Council on Innovation and Entrepreneurship.

    Second, reducing corporate tax burdens for new companies in 
        the first 3 years they have taxable income. To ease the 
        pressure on start-ups precipitated by the J-curve and initial 
        cash flow, the National Advisory Council has also suggested a 
        full exclusion on corporate taxable income earned by qualified 
        small business on the first year of taxable profit, followed by 
        a 50-percent exclusion in the subsequent 2 years--an idea our 
        research would support.

    Third, making it easier for growing private companies to go 
        public, allow shareholders who invest in firms with a market 
        cap of $1 billion or less and are in the best position to judge 
        the cost-benefit of financial auditing mandates to decide 
        whether to comply with the requirements of the Sarbanes-Oxley 
        Act. If the IPO window is opened, investors will be a lot more 
        willing to finance early-stage companies and their continued 
        growth when those companies have at least the option of going 
        public after they have reached scale, rather than simply 
        selling out to a large firm, thereby retaining the 
        entrepreneurial energy of the scale enterprise as a long-term 
        business venture and employer.

    Fourth, reforming Federal regulation by sunsetting all 
        major rules after 10 years, requiring all new major rules to 
        pass a benefit-cost test, and collecting data on regulation at 
        the State and local levels to allow for the objective 
        evaluation of how regions can promote business-friendly 
        climates.

    These proposals, among others, are needed to undertake the course 
correction required to make the United States once again the best place 
to found, grow, and scale an entrepreneurial venture. The economic 
shocks of the financial crisis coupled with the challenges of our debt 
have fundamentally changed our direction. Putting us back on course 
will require the creativity of our Government policy makers and 
business leadership and, of course, our entrepreneurs. I am confident 
we will achieve these aims and look to your leadership in making our 
entrepreneurial future again possible.
    Thank you.
                                 ______
                                 
                 PREPARED STATEMENT OF ELIZABETH MARCHI

         Founder and Fund Coordinator, Frontier Angel Fund, LLC
                             July 20, 2011

    Mr. Chairman, Distinguished Members of the Subcommittee, my name is 
Liz Conner Marchi and I am the Coordinator of the Frontier Angel Fund, 
Montana's first angel investment fund, a former economic development 
executive for Flathead County, the Coordinator for Innovate Montana and 
a business consultant with Northfork Strategies. I live on a working 
cattle ranch in the Mission Valley of Northwest Montana near Glacier 
National Park.
    I am honored to have the opportunity to speak before you today with 
a voice informed by 10 years of economic and business development work 
in Montana. I want to thank my fellow Montanan, Senator Jon Tester for 
extending this privilege to me. Prior to moving to Montana, I worked in 
economic development in North Carolina where I was a constituent of 
Senator Hagan.
    The most interesting people I have ever met live in rural America. 
Most of them are innovators and entrepreneurs, because they have had to 
be to survive. As my business partner at Northfork Strategies, Diane 
Smith, author of TheNewRural.Com says, ``When I worked in Washington, 
DC, I knew plenty of patent lawyers but not a single inventor. Within 
months of moving to Montana, I knew dozens of inventors but only one 
patent lawyer.'' This speaks volumes about the challenges and 
opportunities we face in America to retool an economy deeply impacted 
by globalization and technology.
    I want to speak to three issues that merit your attention if new 
jobs are to be created:

    Financial capital must be made available to entrepreneurs

    Innovation and discovery is everywhere

    Telecommunications infrastructure and regulatory policy are 
        critical to this effort

    Today's capital environment is very difficult for entrepreneurs. 
Before the recession, many entrepreneurs bootstrapped startups with 
personal credit cards. Banks once would just ask you to mortgage your 
house for a business loan. This, frankly, was a significant obstacle to 
entrepreneurship when the economy was good. In today's climate, it's 
hard to know what a house is worth, so lending on an existing asset is 
rare. Most bankers will tell you they are working for regulators today, 
not customers. Bank lending today is driven by cash flow. Most startups 
have no cash flow, and some don't have many liquid assets. Banks look 
at history. As a result, bank debt is a very unlikely source of capital 
for entrepreneurial ventures which rely on a forward looking 
opportunity.
    Angel investors look forward at the opportunity. In 2005, we 
initiated a conversation with a number of high net worth individuals 
who were living in Montana. In addition to investment capital, they had 
deep skills sets in starting and building successful businesses. In 
2006, the Frontier Angel Fund, LLC closed with 33 investors who put in 
$50,000 each to invest in early-stage businesses located in the region. 
What is an angel investor? An ``Accredited Investor'' that is the first 
``professional'' money in a business after family, friends and fools. I 
want to thank all of you responsible for the compromise on the 
Accredited Investor definition in the Dodd-Frank bill. Without the 
compromise, more than two thirds of potential angel investors in 
Montana could no longer be ``accredited.'' Angel investors differ from 
Venture Capitalists in that they are investing their own money, not 
other people's money. Most angels have a double bottom line: they want 
to make money but they also want to see their community or region 
prosper. Many angels are successful entrepreneurs and they share a real 
affinity for mentoring and coaching others. The estimated size of the 
angel and VC markets are roughly the same, $20-$30 billion annually. In 
2009 Venture Capital money went to 3,800 companies in the United States 
while angels invested in almost 56,000 companies. Two thirds of all VC 
investments were in California, Boston and New York and half of all 
States had only one or no VC deals. Angel investments happen in every 
State in America. \1\
---------------------------------------------------------------------------
     \1\ PricewaterhouseCoopers Money Tree Survey, 2006-2009 and 
Jeffrey Sohl, Center for Venture Research, University of New Hampshire, 
``The Angel Investor Market in 2007: Mixed Signs of Growth'', 2008.
---------------------------------------------------------------------------
    The Frontier Fund is easy to find--we have an online application 
process, we screen deal submissions every other month, and we meet in 
person every other month. We have looked at over 300 companies since 
inception and have investments in 10 regional startups, most of which 
have a proprietary product or service. Frontier Fund conducts a monthly 
call with 18 other groups in the inland Pacific Northwest to share 
investment opportunities and to learn from each other. Angels are very 
important, and we need more of them. In that regard, I would encourage 
your support of a Federal angel tax credit. And as you consider capital 
gains, think about the importance of that capital for angel investing.
    Included in my submission today is a map of angel groups in the 
U.S. provided by the Angel Capital Association of which the Frontier 
Angel Fund is a founding member. They are now in every State in the 
union. Compare that to Venture Capital which is concentrated on the 
east and west coasts. I would encourage your focus on ways to support 
the growth of angel networks and funds.
    Government policy and investment plays a critical role in enabling 
the kind of telecommunications infrastructure required for businesses 
to operate today. In last mile locations like Livingston, Montana 
(population 7,300), where entrepreneurs like Andrew Field with Printing 
for Less.com have developed sophisticated businesses printing platforms 
serving a global market, telecommunication infrastructure is critical. 
For his company, bandwidth and speed are lifelines. And in the case of 
PrintingforLess, which employs 160 highly trained workers, initial 
funding came from a Montana based early-stage seed fund, Glacier 
Venture Fund, and other local angels. Debt sources allowed the business 
to grow, but equity got it off the ground.
    Bandwidth supports scores of new enterprises throughout rural 
America. TeleTech, a customer contact center, located in Northwest 
Montana employs 900 people. Bandwidth and a trainable workforce 
attracted this company. Profitability keeps it in Montana. You can 
build and scale a technology based enterprise from anywhere if you have 
the right business model, employees, and pipes. Avail TVN, the largest 
provider of digital media services in North America, was born in 
Kalispell, Montana, in 2005. A team of technologists, guided by an 
experienced former corporate executive, built a company that last year 
had $150 million in revenue, employs over 100 with 20 in Kalispell. As 
an employee of Avail-TVN, a former University of Montana student from 
Belt, Montana (population 589), has a real chance at becoming wealthy 
through stock options if the company is sold or goes public. The 
initial seed funding for Avail came from local angels and a local rural 
telco. The local talent is as good as it gets, they just need the 
teaching and sophistication that comes from experience.
    Many of the programs designed here in Washington, DC, are built for 
clusters of industries. This doesn't translate well to rural 
innovators. A team in Montana is likely to include someone using open 
source software in Estonia working with software developers in Bozeman, 
Bigfork, and Arlee. It's a virtual community of interest, not 
necessarily a geographic one. We often get a one-size-fits-all 
approach, and it often doesn't fit for rural areas.
    Innovation and discovery are everywhere. But we must find better 
ways to connect capital to ideas and to entrepreneurs. This is the 
recipe for new jobs in all of America. Innovate Montana is a new 
initiative to not only tell our growing number of entrepreneurial 
success stories, but to build a virtual community of interest around 
businesses in IT, Cleantech, and Life Science. It's a low overhead 
collaboration led by CEO's in the private sector, Governor Schweitzer's 
Office of Economic Development, Tech Link, and the Tech Transfer 
offices of our Montana universities. Too much money, time, and energy 
is spent trying to create jobs without a business perspective in the 
mix.
    We need Federal policy that does all it can to minimize 
regulations, provide essential telecommunications infrastructure, 
encourage angels, provide real world business education and strategy to 
entrepreneurs, and doesn't lose site of the incredible talent and 
ambition that you find in rural America. Federal policy is often made 
in Washington, DC, where you have 11,000 residents per square mile. It 
doesn't always translate effectively to a place like Montana where we 
have 6.8 people per square mile.
    I have never regretted bringing my children to Montana to be 
educated there in public schools. In addition to a fine education, they 
have learned values like self-reliance, being thrifty and being 
innovative--all a part of the fabric of life in rural communities. We 
cherish our landscape and with your continued vigilance, rural America 
will be an important part of the path to economic prosperity and 
national renewal.
    Thank you.

ADDENDUM 1




































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ADDENDUM 4




                PREPARED STATEMENT OF ROBERT F. BARGATZE

     Executive Vice President, Chief Scientific Officer, LigoCyte 
                         Pharmaceuticals, Inc.
                             July 20, 2011

    Good morning Chairman Tester, Ranking Member Vitter, Members of the 
Committee, ladies, and gentlemen. My name is Robert Bargatze, and I am 
Executive Vice President and Chief Scientific Officer of LigoCyte 
Pharmaceuticals, Inc. I want to thank you for the opportunity to speak 
with you today about the unique hurdles to accessing capital that 
innovative biotech startups face. Make no mistake, biotechnology has 
incredible potential to unlock the secrets to curing devastating 
disease and helping people to live longer, healthier, and more 
productive lives, but the barriers that small biotech companies 
encounter on a daily basis raise some important questions: Would we 
rather see the next generation of breakthrough cures discovered by 
researchers in Bozeman or Beijing? Do we want the jobs associated with 
this groundbreaking science to go to workers in Missoula or Malaysia? 
If we want more scientific breakthroughs that allow us to enjoy a high 
quality of life--indeed, breakthroughs that save the lives of our loved 
ones--then shouldn't we put in place policies that encourage innovation 
through private investment?
    While the biotechnology industry faces significant challenges, we 
nonetheless have the ability to deliver the next generation of cures 
and treatments to the bedsides of patients who desperately need them 
while at the same time creating a healthier American economy. The 1.42 
million Americans directly employed by biotech are driven to treat and 
heal the world, but in order for them to be able to do that, Congress 
must remove the barriers to innovation that we face. Innovation in 
biotechnology leads to the medical breakthroughs that cure and treat 
devastating diseases like cancer and Alzheimer's and allow real people 
to see their grandkids graduate from college or walk their daughters 
down the aisle.
    The leash that holds our industry back from helping more people is, 
in large part, the devastating effect that a lack of access to 
necessary capital can have on growing biotech companies. Today, 
Congress has the opportunity to help speed lifesaving cures and 
treatments to patients by bolstering capital formation in our industry.
    My company, LigoCyte, is a private biopharmaceutical company based 
in Bozeman, Montana, that is developing innovative vaccine products 
based on our virus-like particle (VLP) platform. VLP technology 
provides antiviral protection without the complexity associated with 
live viruses. Our lead product candidate, a VLP-based vaccine designed 
to prevent gastroenteritis caused by norovirus, just completed a Phase 
I/II study which showed proof-of-principle in humans. I cofounded 
LigoCyte in 1998, and we currently have 38 employees.
    I am also the Chairman of the Montana BioScience Alliance, which 
fosters partnerships among the various biotech stakeholders in Montana 
in order to grow and sustain a globally competitive bioscience industry 
in our State. Our relationships with entrepreneurs, laboratories, 
hospitals, clinics, and universities allow Montana biotechnology 
companies to create high-quality jobs and economic opportunity for the 
people of Montana.
    When I cofounded LigoCyte in 1998, we were the quintessential small 
business. My four cofounders and I each gave the new company $5,000 to 
get things off the ground--our very first round of financing. With our 
startup funds, we bought kitchen cabinets from the home improvement 
store down the street and installed them ourselves, giving us our first 
laboratory shelves in our new workspace. Our location in the Advanced 
Technology Park near Montana State University put us in prime position 
to succeed, but we had no cash on hand past our initial personal 
investment. Our first contracts were for high content screening with 
large pharmaceutical companies like Merck and SmithKline to facilitate 
selection of lead product candidate anti-inflammatory drugs. These 
small revenue streams generated income to cover our overhead while we 
wrote our Small Business Innovation Research (SBIR) grant proposals.
    SBIR gave us the jumpstart we needed to move forward with our own 
projects. SBIR is targeted specifically at small, innovative companies 
like ours, and it was a key foundation of LigoCyte's success in 
Montana. Because of our SBIR grants, we could focus on our vaccines and 
make important progress in our research. We were able to leverage this 
progress into a contract to do biodefense vaccine development work for 
the Department of Defense (DoD). With our success on our DoD contract, 
we were finally able to get our first round of venture financing. 
Venture capital is the lifeblood of the biotechnology industry around 
the country, and our early partnerships with two small venture firms in 
the Rockies allowed us to fund Phase I clinical trials in our vaccine 
pipeline. The data from those trials was instrumental in getting buy-in 
from larger investors, which has pushed our research to where it is 
today. Four years ago, we attended the Montana Economic Development 
Summit, hosted by Montana Senator Max Baucus. We successfully presented 
our Phase I data there to Forward Ventures and subsequently met with 
several interested venture capital funds, including Fidelity 
BioVentures and those affiliated with the large biopharmaceutical 
companies MedImmune and Novartis. These relationships led to a $28 
million round of venture financing.
    We are currently entirely privately funded, with the exception of 
our ongoing contracts with the Department of Defense. As you can see, 
getting to this point was no easy task. Even as the Chief Scientific 
Officer, I always had to keep one eye open for financing opportunities 
to further our research. There is no ``beaten path'' for small 
companies like ours to follow. Instead, we have to break new ground, 
both in our science and in our search for funding. It is not a simple 
undertaking, and many companies are not as successful as LigoCyte has 
been. Their science might be just as groundbreaking as ours, but if the 
funding cards do not fall the right way the science hardly matters.
    As Chairman of the Montana BioScience Alliance, I have heard 
numerous stories of other biotech startups going through the same 
process that LigoCyte did. The first years of a private biotech consist 
of cobbling together funding from any source possible until a larger 
revenue stream opens up. LigoCyte was lucky enough to be researching 
vaccines, as our biodefense contract with the Department of Defense was 
an important financing milestone in our early development as a company. 
However, most startups do not have a pipeline that lends itself quite 
so easily to large biodefense contracts. Companies researching 
treatments for cardiovascular disease, the leading cause of death in 
the United States; diabetes, one of the fastest-growing ailments in the 
population; or cancer, the largest biotechnology research space, would 
get no interest from DoD, leaving them in an even weaker position when 
seeking venture capital financing.
    There are thousands of companies facing similar funding struggles 
throughout the United States, each one with molecules and product 
candidates that could change the face of modern medicine. Biotechnology 
may hold the answers to the medical problems that America faces, from 
the devastation of cancer and HIV/AIDS to the personal losses of 
Alzheimer's and Parkinson's to the spiraling costs of health care 
associated with diseases of epic proportions, such as Type 2 diabetes. 
Of the 118 scientifically novel drugs approved from 1998 to 2007, 48 
percent were discovered and/or developed by biotech companies. These 
revolutionary cures and treatments save lives, provide a higher quality 
of life, and reduce long-term health care costs. As Congress continues 
to look for ways to reduce our Nation's deficit, it is important that 
we remember the impact that innovative medicines can have on increasing 
overall health, especially by combating costly chronic diseases. These 
advances will save taxpayers money by decreasing the outlays necessary 
to care for our aging population.
    Additionally, the biotech industry is a thriving economic growth 
engine, directly employing 1.42 million Americans in high-quality jobs 
and indirectly supporting an additional 6.6 million workers. The 
average biotechnology employee makes $77,595 annually, far above the 
national average salary. President Obama has called for the United 
States to lead in the 21st century innovation economy, and 
biotechnology can be a key facet of our Nation's economic growth. 
Montana is among the leaders of this growth--the bioscience sector in 
our State spends more on R&D per capita than the bioscience sectors in 
all but 13 States.
    Despite these windows of opportunity, biotechnology research and 
development is often a difficult process. Bringing groundbreaking cures 
and treatments from bench to bedside is a long and arduous road, and 
small biotechnology companies are at the forefront of the effort. It 
takes an estimated 8 to 12 years for one of these breakthrough 
companies to bring a new medicine from discovery through Phase I, Phase 
II, and Phase III clinical trials and on to FDA approval of a product. 
The entire endeavor costs between $800 million and $1.2 billion. Due to 
this capital-intensive process, biotechnology companies lacking 
research and development funds turn to private sector investors and 
collaborative agreements to finance the early stages of development.
    However, the current economic climate has made private investment 
dollars extremely elusive. In 2010, venture capital fundraising endured 
its fourth straight year of decline and its worst since 2003. 
Biotechnology received just $2 billion in venture funding, a 27 percent 
drop from its share in 2009. Even worse, the biggest fall was seen in 
initial venture rounds, which are the most critical for early-stage 
companies. Series A deals last year brought in just over half of what 
they did in 2009. Decreasing up-front investment could mean cures and 
treatments being shelved in labs across the Nation and ultimately not 
reaching patients. Generally, venture capitalists are challenged by 
significantly reduced capital flowing into their funds on the front end 
and are having to hold their investments longer before exiting due to 
the weakness of the public markets. This has led to venture funds 
deploying capital differently than in the past, to biotech's 
disadvantage.
    Montana startups are at a particular disadvantage due to the dearth 
of venture capital firms in and around our State. Although the Montana 
BioScience Alliance has taken steps to increase university 
partnerships, find firms that specialize in biotech construction and 
intellectual property protection, and propel scientific and management 
expertise to Montana companies, it remains the case that funding 
sources are few and far between among the Rocky Mountains. In fact, 
Senator Baucus's Economic Development Summit is one of the only 
efficient ways for startup biotechnology companies in our State to 
connect with venture capitalists. Small biotech companies in Montana 
are almost all private and are largely reliant on SBIR and other 
Government programs like the Therapeutic Discovery Project (TDP). 
However, Government funding combined with investment from a company's 
founders is not enough to pilot a clinical study or investigate 
potential new treatments. The high cost and long development period 
associated with bringing a new medicine to market make private capital 
necessary, often in the form of angel investors and venture 
capitalists. LigoCyte has been fortunate thus far, but the high-risk 
nature of biotech development and the gloomy economic climate have made 
investors reluctant.
    The shift in the economy has also harmed companies like mine that 
already have venture financing. Historically, venture capitalists 
receive a return on their investment when a company goes public through 
an initial public offering (IPO). The cash raised through the IPO would 
provide an exit for these early investors as well as provide the 
capital to fund expensive Phase II and Phase III trials at the company. 
However, the IPO market is essentially closed at the moment. From 2004 
to 2007, the United States had an average of 34 IPOs in biotechnology 
per year. In 2010, there were only seventeen. Although the funding 
level of biotech IPOs is increasing from its recession-induced nadir, 
this progress has been made almost entirely by larger, more mature 
companies. The two largest transactions in the industry last year were 
completed by a company in Phase III trials and a next-generation 
sequencing company that was already generating revenue. The weak demand 
for these public offerings for smaller companies is restricting access 
to capital. This then hampers critical research, forces companies to 
stay private for longer, and depresses valuations of later-stage 
venture rounds.
    As U.S. biotech companies face financial uncertainty, other 
countries are increasing their investments and enacting intellectual 
property protections to encourage their own biotech growth. The United 
States still holds its place as the leader in global biotechnology 
patents thanks to our large head start, but China and India rank first 
and second in biotech patent growth. These emerging powers are heavily 
investing in science, and particularly in biotechnology. Meanwhile, the 
U.S. has fallen to 20th out of 23 countries in new biotech patent 
applications. A recent survey conducted by BIO found that nearly a 
third of small biotech companies have been approached to move their R&D 
operations offshore, and CEOs named China and India as two prime 
destinations. Furthermore, since 2008, trouble in the IPO market has 
decreased the number of public biotech companies in the U.S. from 394 
to just 302, a 23 percent drop. Meanwhile, China's biotech IPO market 
continues to grow--in 2010, thirty-three bioscience IPOs in China 
raised $5.9 billion, an increase of 47 percent over 2009. The venture 
capital and private equity market is thriving in China as well, 
increasing funding levels by over 200 percent in the past 2 years. 
Meanwhile, companies here in the United States struggle to find funding 
from any number of sources, not all of which prove fruitful. In 
Montana, we have found that novel financing sources are few and far 
between, and innovation capital is dwindling. It is imperative that 
financing is robust and available to encourage continued biotech 
innovation in the U.S., enhance American competitiveness on the global 
stage, and ensure that the United States maintains a healthy and 
growing innovation economy.

Modifications to Current Federal Programs Impacting Innovative Biotech 
        Companies
    Congress and the Administration have taken some notable steps to 
help companies facing these financial struggles. By providing funding 
to innovative companies and incentivizing investment in small 
businesses, certain programs have proven invaluable to companies like 
mine. However, Congress can increase the impact of these important 
programs by making modifications to ensure that they have the largest 
possible effect on innovation.

Small Business Innovation Research (SBIR) Program
    As I have already mentioned, SBIR was a potent lifeline for 
LigoCyte during our early stages of development. The SBIR program is 
structured so that 2.5 percent of all Federal R&D grant monies are 
reserved for small business applicants. These funds provide critical 
seed money to new business innovators like the biotech startups in 
Montana. However, the eligibility rules for small businesses to qualify 
for SBIR have excluded biotech companies since 2003. In particular, the 
size standard limits eligibility to companies that are majority owned 
and controlled by individuals who are U.S. citizens (or resident 
aliens). While the congressional intent of this definition was to keep 
funding in the United States, the Small Business Administration (SBA) 
has interpreted it differently. In 2001, after LigoCyte had already 
received our SBIR grants, the SBA Office of Hearings and Appeals ruled 
that the definition of ``individuals'' only applied to ``natural 
persons,'' and not to entities such as venture capitals funds, pension 
funds, or corporations. In 2003, SBA specifically applied this ruling 
to biotechnology companies funded by venture capitalists. This 
effectively barred venture-backed companies from receiving SBIR funds, 
a drastic change from the program's implementation since 1982.
    In order for biotechnology companies to be successful, they must 
tap into venture capital funding. LigoCyte, for instance, meets 
virtually every definition of the ``small, high-tech, innovative'' 
businesses that SBIR purports to help; however, we are not currently 
eligible for SBIR grants because we are majority owned by venture 
capital companies. Other companies like LigoCyte that are not as far 
along the development pathway have been similarly barred from the 
program. I have seen the impact the SBIR program has had on the 
biotechnology industry, not only by fostering the growth of fledgling 
companies during some of the most challenging times in their business 
cycles, but also by enhancing the advancement of important cures and 
treatments to the marketplace. However, the current rules have 
inhibited the growth and survival of small private biotechnology 
companies due to the inability of venture-backed companies to 
participate in the SBIR program. I believe that Congress should restore 
SBIR eligibility to majority venture-backed companies in order to truly 
incentivize breakthrough innovation.

Therapeutic Discovery Project (TDP)
    Another program which has helped LigoCyte and other small 
biotechnology companies is the Therapeutic Discovery Project (TDP). 
Last March, Congress enacted this important tax credit program designed 
to stimulate investment in biotechnology research and development. 
Under this program, small biotech companies received a much-needed 
infusion of capital to advance their innovative therapeutic projects 
while creating and sustaining high-paying, high-quality American jobs.
    In total, the Therapeutic Discovery Project awarded $1 billion in 
grants and tax credits to nearly 3,000 companies with fewer than 250 
employees each. These small companies were eligible to be reimbursed 
for up to 50 percent of their qualified investment in activities like 
hiring researchers and conducting clinical trials. The impact of this 
funding was felt across the American biotech industry, as companies in 
47 States received awards. The average company received just over 
$200,000, an important shot in the arm in these rough economic times.
    LigoCyte received two awards under TDP, both for the maximum amount 
of $244,479. Our nearly $500,000 TDP allotment has been a valuable 
resource to our company. As a result of this funding, we were able to 
hire one new researcher and keep the rest of our 44 workers employed at 
salaries that reflects the hard work they put in. The cash influx that 
TDP provided also helped us advance our research. One of our grants was 
for our VLP-based norovirus vaccine which, as I have mentioned, 
recently showed proof-of-principle in a Phase I/II trial. Additionally, 
we received a grant for another candidate in our pipeline, a VLP-based 
vaccine to prevent respiratory disease.
    The infusion of capital for small biotech companies provided by the 
Therapeutic Discovery Project is an essential incentive for companies 
to keep their research and development, manufacturing, and operations 
here in the United States. The critical funding will also accelerate 
the movement of cures and treatments to patients who need them. This 
program was a step in the right direction by Congress to invest in 
growing the U.S. biotech industry to keep pace with our global 
competitors. Given the imbalance between the extraordinarily high 
demand by small biotech companies and the limited pool of funds, I hope 
that Congress will extend and expand this oversubscribed program and 
assist more American companies in pursuing life-saving scientific 
breakthroughs and supporting American jobs.

Financial Services Capital Formation Proposals
    The breadth of the financing problem in the biotechnology industry 
calls for comprehensive solutions to ease capital formation, involving 
both tax and financial services policy. In addition to the difficult 
financing landscape and struggling public markets, growing biotech 
companies also face regulatory burdens which further hinder capital 
formation in our industry. Making changes to regulations which 
unintentionally harm the biotech industry would free companies to focus 
their efforts on their innovative scientific research rather than 
complex reporting and compliance. I believe that changes to Sarbanes-
Oxley Section 404(b), SEC Rule 12b-2, SEC Regulation A, and the SEC 
reporting standard could provide great benefit to groundbreaking 
biotechnology companies.

Sarbanes-Oxley Section 404(b) (Financial Reporting)
    The Sarbanes-Oxley Act (SOX) was enacted to protect investors by 
bringing greater transparency to public companies. While the financial 
reporting requirements in SOX continue to provide this important 
service, Section 404(b) imposes a disproportionately negative cost 
burden on smaller public companies.
    The biotechnology sector is especially disadvantaged by the 
compliance burden of Section 404(b) due to the unique nature of our 
industry. The long, capital-intensive development period intrinsic to 
biotechnology often causes companies to have a relatively high market 
capitalization (caused by multiple rounds of venture financing prior to 
going public) but little-to-no revenue. Therefore, many biotech 
companies facing their first few years on the public market are forced 
to divert funds from scientific research and development to Section 
404(b) compliance. The opportunity cost of this compliance can prove 
damaging, resulting in already limited resources being driven away from 
a company's search for cures and treatments.
    Further, the true value of biotech companies is found in 
nonfinancial disclosures such as clinical trial milestone results, FDA 
approvals, and patent status. Investors often make decisions based on 
these development milestones rather than the financial statements 
mandated by Section 404(b). Thus, the financial statements required do 
not provide much insight for potential investors, meaning that the high 
costs of compliance far outweigh its benefits.
    Section 989G of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act is an important acknowledgment by Congress that Section 
404(b) of Sarbanes-Oxley is not an appropriate requirement for many 
small reporting companies. Dodd-Frank sets a permanent exemption from 
Section 404(b) for companies with a public float below $75 million; 
however, this is too narrow in practicality and must be raised. In 
2006, the SEC Small Business Advisory Board recommended that the 
permanent exemption be extended to companies with public floats less 
than $700 million. The Advisory Board's proposed ceiling would allow 
small innovative companies to focus on speeding cures and treatments to 
patients rather than SOX compliance.
    The Advisory Board also realized that public float alone does not 
fully portray the complexity and risk associated with a reporting 
company, and suggested a revenue test to paint a fuller picture. 
Revenue should be a critical consideration when determining the 
appropriateness of Section 404(b) compliance, along with public float. 
The addition of a revenue test would better serve the congressional 
intent behind Sarbanes-Oxley by reflecting the truly small nature of 
companies with little or no product revenue. Public companies with a 
public float below $700 million and with product revenue below $100 
million should be permanently exempt from Section 404(b), allowing them 
to focus on their critical research and development.

SEC Rule 12b-2 (Filing Status Definitions)
    Amending the filing status definitions found in SEC Rule 12b-2 
would be another way to reduce the 404(b) compliance burden on small 
innovative companies.
    SEC Rule 12b-2 establishes three distinct classifications by which 
companies determine their filing status: large accelerated filers--
companies with a public float of more than $700 million; accelerated 
filers--those with a public float of more than $75 million but less 
than $700 million; and nonaccelerated filers--companies with a public 
float of less than $75 million (known as smaller reporting companies).
    Because a particular filing status carries with it onerous 
regulatory duties and compliance costs (such as compliance with SOX 
Section 404(b)), finding a method of designation that fairly captures a 
company's profile is essential. While using public float as a primary 
metric for determining filing status is a good first step, it fails to 
take into account other relevant factors that more accurately measure 
the size and complexity of certain industries or categories of 
companies. The biotechnology industry provides a telling example.
    Biotech companies often have a relatively large public float 
because of the potential of the groundbreaking cures and treatments 
they are developing. However, as I have discussed, the extended R&D 
timeline that we face calls for a long-term commitment and considerable 
private funding. During the long development period, small biotech 
companies commonly have no revenue or operate at a loss. If revenue was 
taken into account in determining filing status, then companies with 
little to no revenue but a high public float could avoid the financial 
burdens of certain auditing requirements with which larger, more 
established companies must comply. Revising the definition of smaller 
reporting companies to include a revenue component would reflect the 
true nature of startup biotechnology companies and allow them to focus 
on their groundbreaking science.
    Additionally, the current quantitative metrics for determining 
filer status under Rule 12b-2 also need revision. The definitions of 
filer status were created to offer unique classifications based on 
filer characteristics and determine the breadth of regulatory 
compliance to which filers must adhere. As I have mentioned, the 
markers are currently set at $75 million and $700 million, dividing 
filers into three groups. When these definitions were set, they 
provided an accurate depiction of the groups above and below the 
markers. Since then, however, the market has continued to evolve and 
these markers have become outdated. In particular, the $75 million 
public float cap for smaller reporting companies does not match current 
market conditions. I believe that a $250 million cap for nonaccelerated 
filers would group companies with common characteristics together, as 
the rule originally intended to do, rather than split them at the 
outdated $75 million point.

SEC Regulation A (Direct Public Offerings)
    Regulation A, adopted by the SEC pursuant to Section 3(b) of the 
Securities Act of 1933, was created to provide smaller companies with a 
mechanism for capital formation with streamlined offering and 
disclosure requirements. Updating it to match today's market conditions 
could provide an important funding source for small biotechnology 
companies.
    Regulation A allows companies to conduct a direct public offering 
valued at less than $5 million while not burdening them with the 
disclosure requirements traditionally associated with public offerings. 
The idea behind Regulation A was to give companies which would benefit 
from a $5 million influx (i.e., small companies in need of capital 
formation) an opportunity to access the public markets without weighing 
them down through onerous reporting requirements.
    However, the $5 million offering amount has not been adjusted to 
fit the realities of the current market and Regulation A is not used by 
small companies today. The current threshold was set in 1980 and is not 
indexed to inflation, pushing Regulation A into virtual obsolescence. 
As it stands, a direct public offering of just $5 million does not 
allow for a large enough capital influx for companies to justify the 
time and expense necessary to satisfy even the relaxed offering and 
disclosure requirements.
    I believe that Regulation A could have a positive impact for small 
biotechnology companies if its eligibility threshold was increased from 
$5 million to $50 million while maintaining the same disclosure 
requirements. This increase would allow companies to raise more capital 
from their direct public offering while still restricting the relaxed 
disclosure requirements to small, emerging companies. Regulation A 
reform could provide a valuable funding alternative for small biotech 
startups, giving them access to the public markets at an earlier stage 
in their growth cycle and allowing them to raise valuable innovation 
capital.

SEC Reporting Standard (Shareholder Limit)
    Although SEC policies like Rule 12b-2 and Regulation A are designed 
to monitor public companies, the agency also keeps tabs on private 
companies when they reach a certain size. Modifying the SEC's public 
reporting standard would prevent small private biotechnology companies 
from getting unnecessarily burdened by shareholder regulations.
    Once a private company has 500 shareholders, it must begin to 
disclose its financial statements publicly. Biotechnology companies are 
particularly affected by this 500 shareholder rule due to our 
industry's growth cycle trends and compensation practices. As I have 
mentioned, the IPO market is essentially closed to biotechnology, 
leading many companies to choose to remain private for at least 10 
years before going onto the public market. This long time frame can 
easily result in a company having more than 500 current and former 
employees, most of whom have received stock options as part of their 
compensation package. Under the SEC's shareholder limit, a company with 
over 500 former employees holding stock, even if it had relatively few 
current employees, would trigger the public reporting requirements. 
Exempting employees from any shareholder limit is a minimum necessary 
measure to ensure growth-stage biotech companies are able to hire the 
best available employees and compensate them with equity interests, 
allowing them to realize the financial upside of a company's success.
    Also, including accredited investors in the private company 
shareholder count does not serve the intended purpose of protecting 
retail investors. The SEC recognizes that accredited investors are a 
unique class that does not require the same level of protection as 
other investors. By including them in the 500 shareholder limit, 
growth-stage private companies are forced to rely primarily on 
institutional investors because they need to maximize funding without 
triggering the limit. This excludes retail investors, who the SEC was 
originally trying to protect, from taking part in this process.
    Additionally, increasing the shareholder limit from 500 to 1,000 
would relieve small biotech companies from unnecessary costs and 
burdens as they continue to grow. As it stands, the limit encumbers 
capital formation by forcing companies to focus their investor base on 
large institutional investors at the expense of smaller ones that have 
been the backbone of our industry. Further, it hinders a company's 
ability to compensate its employees with equity interests and 
negatively affects the liquidity of its shares. Increasing the 
shareholder limit and exempting employees and accredited investors from 
the count are measures that, together, would remove significant 
financing burdens from small, growing companies.

New Tax Proposals Encouraging Private Biotech Company Investment
    While modifications to onerous regulations would provide key 
improvements to the biotechnology investment environment, Congress has 
the opportunity to enact new incentives that could open new sources of 
capital for small biotechs. Though this Subcommittee does not have 
jurisdiction over tax issues, I would like to take this opportunity to 
highlight a few tax policies that could be valuable in incentivizing 
private investment. There are a number of new proposals, including the 
modifications to IRC Section 1202, the House-passed Small Business 
Early Stage Investment Program, an angel investor tax credit, and 
partnership structures to support high-risk innovative industries, 
which could incentivize biotechnology investment.

Reduced Capital Gains Rate for Sale of Qualified Small Business Stock 
        (IRC Section 1202)
    Congress has striven to aid startup companies by providing 
investors in qualified small businesses preferential capital gains tax 
treatment on the return on their investments. Section 1202 of the 
Internal Revenue Code covers this reduced capital gains tax and defines 
the small businesses that are eligible for preferential treatment.
    Congress's original intent in enacting Section 1202 was to 
stimulate investment in small businesses. President Obama and the 111th 
Congress further emphasized the importance of small business investment 
by enacting a law temporarily allowing 100 percent of gains from the 
sale of qualified small business stock to be excluded from capital 
gains taxation. Thus, investors in qualified small businesses are 
eligible for a zero percent capital gains rate on their sale of certain 
qualified stock through the end of 2011. However, despite Congress's 
support for stimulating investment in small and start-up businesses, 
Section 1202, which defines the qualified small business stock eligible 
for an exclusion from capital gains taxation, is too limited and 
presents technical challenges which investors in small innovative 
companies are unable to overcome. Among other challenges, Section 1202 
employs a test in which a corporation's gross assets must be less than 
$50 million immediately before and after the stock is issued in order 
to be eligible for preferred capital gains treatment. When intellectual 
property (IP) is incorporated as an asset, small biotech companies are 
almost always over the $50 million limit. The high value of our IP 
belies the fact that our emerging companies are small businesses that 
need support if they are going to continue to work toward important 
medical breakthroughs.
    As I have mentioned, venture capital funding is very limited in 
Montana, so incentives for further investment in our industry are much 
needed. Modifications to the small business stock rules under Section 
1202 so that they more accurately represent the State of innovative 
small businesses in America could provide a critical capital infusion 
for small biotechs.

Small Business Early-Stage Investment Program
    Last year, the House of Representatives took action to assist 
early-stage venture-backed businesses like those in the biotechnology 
industry. In June, it passed the Small Business Early-Stage Investment 
Program as a part of the Small Business Lending Fund Act of 2010. This 
program would provide $1 billion in matching funds for venture capital 
investments in certain industries, including life sciences. These funds 
would serve as matching dollars for venture capitalists that have 
already raised an equivalent amount of capital from private sector 
sources. The Government would essentially double the seed financing for 
venture capitalists who are investing in biotech startups.
    In order to participate, an investment company like a venture fund 
would have to submit a business plan describing its investment strategy 
in early-stage small businesses in targeted industries, information 
about the expertise of the management team, and the likelihood of 
success and profitability. A participating investment company would 
have to make all of its investments in small business concerns, 50 
percent of which would have to be early-stage small businesses, defined 
as domestic businesses with less than $15 million in gross annual sales 
revenues for the previous 3 years. If a venture group qualified, it 
would use its grant from the SBA to double its investment in an early-
stage small business.
    Under the program, the SBA's grants would be treated the same as 
investments by other limited partners in an investment fund, except 
that the SBA would not receive any control or voting rights with 
respect to the early-stage small business. Ideally, over time, the 
SBA's investment program would become self-sustaining as funds from 
successful small businesses were repaid into a revolving fund. This 
would allow the SBA to continue to provide matching grants for venture 
capitalists to extend lifelines to even more early-stage high tech 
companies.
    This legislation has the potential to significantly increase the 
flow of capital into small, early-stage biotechnology companies. In 
turn, it would give biotech startups the opportunity to conduct their 
groundbreaking research to find cures and treatments for patients while 
providing high-paying jobs for American workers.

Angel Investor Tax Credit
    Congress could look to the States for examples of how to spur 
biotech innovation. Over 20 States have implemented angel investor tax 
credit programs, in which individual taxpayers are incentivized to 
invest in small innovative businesses like mine. While Montana does not 
have an angel investor tax credit program, angel investors continue to 
play a significant role in early-stage financing of our small 
biotechnology companies. A Federal angel tax credit program would 
encourage additional financing from these valuable investors during a 
biotech's seed stage of development.
    Angel investors are the main source of capital for about 50,000 
companies each year in the United States, but that number could 
decrease significantly unless action is taken to promote investment and 
minimize risk. Many States have recognized the importance of angel 
investors and implemented tax credit programs reimbursing angels for 25 
percent to 50 percent of their qualified investments in biotechnology 
startups and other small businesses. This investment by the States 
makes clear the important impact that innovation can have on the 
national level. It is imperative that Congress look at measures the 
Federal Government could take that would spur seed investing vital to 
the beginning of the research and development process.

R&D Partnership Structures
    Congress's support for biotechnology is critical in this uncertain 
economic climate. Historically, Congress has provided tax incentives to 
high-risk industries as a means of encouraging investment in new 
endeavors which it deems important. Research and development in the 
biotechnology industry is an extremely high-risk undertaking with 
substantial start-up costs, a lengthy time period, and the possibility 
that the technology will not be commercially viable. Biotech companies 
face hurdles in finding and developing new resources and diversifying 
risk while also expending substantial financial resources on research 
and development before successful FDA approval.
    Allowing investors in high-risk biotech startups to take advantage 
of tax benefits accumulated during the long development process would 
create a powerful incentive structure for private investment in this 
often uncertain industry. By permitting biotech companies to drop their 
R&D projects into joint ventures with investors to pass through their 
tax benefits, R&D partnership structures would provide key early 
funding for startup biotechs while also keeping investors engaged. As 
Congress looks to maintain U.S. competitiveness in the global economy 
and lead the effort to cure and treat diseases, it should look to tax 
incentives that encourage investment despite the high-risk nature of 
the biotechnology industry.

Closing Remarks
    The U.S. biotechnology industry remains committed to developing a 
healthier American economy, creating high-quality jobs in every State, 
and improving the lives of all Americans. Additionally, the medical 
breakthroughs happening in labs across the country could unlock the 
secrets to curing the devastating diseases that affect all of our 
families. While I am appreciative of the steps Congress has taken to 
support and inspire biotechnology breakthroughs, further investment is 
needed if the United States is to hold its place as a leader in 
creating new medicines and cures. While there is no single solution to 
the challenges facing our industry, the portfolio of options I have 
presented will help startup biotech companies in Montana and across the 
Nation weather the current economic storm and continue working toward 
delivering the next generation of medical breakthroughs--and, one day, 
cures--to patients who need them.

        RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN
                    FROM ROBERT F. BARGATZE

Q.1. Dr. Bargatze, your testimony discussed the rounds of 
financing that your firm undertook as it grew.
    Is it common for early-stage firms like yours to seek 
financing from investors such as angel networks, venture funds, 
and high-net worth individuals?

A.1. Yes, from my experience here in Montana this is a commonly 
shared path to early-stage company financing for raising 
private capital. For the majority of biotechnology companies 
that are without any product revenue, the significant capital 
requirements necessitate fundraising through a combination of 
angel investors and venture capital firms. Additionally, we and 
other Montana start-ups have taken significant advantage of 
SBIR/STTR and DOD contracts to advance our research and 
development efforts. Being nondilute these funds have allowed 
for founders and early-stage investors to suffer less dilution 
of ownership. Additionally, these Government sources of 
nondilutive capital made up the lion's share of financing that 
enabled LigoCyte's acquisition of a large $28M round of venture 
funding that has facilitated our later Phase human clinical 
trials.

Q.2. If so, do these types of investors typically make up the 
majority of shareholders in an early-stage firm?

A.2. In addition to founders and employees--yes, this would 
represent a typical majority of early and midstage firms.

Q.3. I understand that proposals have been advanced that would 
increase the 500 shareholder cap under Section 12(g) of the 
Securities and Exchange Act to 1,000 shareholders. I am aware 
of at least one such proposal that should also exempt 
accredited investors and employees from the shareholder count.
    If the shareholders in an early-stage firms are typically 
accredited investors and employees, couldn't this exemption 
result in a substantial ``phantom increase'' in the 12(g) 
requirement?

A.3. While it is true that exempting employees and accredited 
investors from the proposed 1,000 private shareholder limit 
effectually redefines the limit to 1,000 retail shareholders, 
exempting employees from any shareholder limit is critical. 
Including employees in the count does not serve the intended 
goal to protect investors in privately held companies, but 
rather it limits a privately held company's ability to seek 
investor financing of any kind due to employee compensation 
practices.
    Because many such companies are emerging, growth-stage 
entities, the full financial success has yet to be realized. 
Without large (or any) revenues, companies often reward 
valuable talent with stock options so that employees can 
realize the financial upside of the company, versus doling out 
hefty salaries at a time when the company has little to no 
product revenue.
    Companies within industries with long growth cycles--such 
as biotech--are particularly burdened. They see many employees 
come and go in the 10-plus years it often takes to ready for 
the public markets. One can see how quickly and easily a 
company could hit the shareholder cap with employees, alone. 
These restrictions prevent companies from hiring and 
compensating the best talent, prevent companies from raising 
the outside capital they need from private investors, and shut 
out the retail investors that would otherwise choose to 
participate in the growth of exciting private companies.
    Including accredited investors in the shareholder count has 
a similar effect: companies are forced to focus only on the 
largest and most qualified investors, due to the cap. 
Therefore, once again, retail investors are crowded out. 
Excluding retail investors altogether was not the original 
intention behind the private company shareholder limit.
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