Employee share incentives in recent Biotech IPOs

We have again surveyed employee share plan arrangements as disclosed in company admission documents and prospectuses for biotech companies. Our survey covers documents issued between January and June 2007.

Although there were nine "admissions" there were no main list IPOs in this period, and only three of those were true IPOs in the sense of companies entering the quoted markets for the first time. These were Neuropharm (which is developing drugs for developmental and degenerative disorders), Epistem (which is commercialising adult stem cell research) and China Medical System Holdings (a pharmaceutical company operating in China). Other companies produced documents for different reasons.

The IPO market for biotechs is clearly subdued and that has no doubt led to interest in other areas for raising money, including large licensing deals and exits. However, we are talking to several companies who are considering IPOs later this year and so it may well be that there could be a quick upturn in the number of companies coming to the market in the next six months - although recent overall market sentiment does not look positive.

Although only three “admissions” in our survey can be termed IPOs, we have also decided to draw on the documents produced by the other companies for the purposes of our review. This is partly to compensate for what would otherwise be a very small survey, but also because these documents contain reasonably full information on the company, giving a useful insight into current features and trends in biotech company employee share scheme practice.

The following are points to note:

• Between January and the end of June 2007, nine quoted companies produced relevant documents - BBI Holdings, China Medical System Holdings, Epistem, Genemedix, Maelor, Neuropharm, Northwest Biotherapeutics, Sinclair Pharma and Vectura.

• Only three in the list were true floats or IPOs – China Medical System Holdings, Epistem Holdings and Neuropharm.

• Documents were produced by other companies for various reasons. Northwest Biotherapeutics, which had already been listed on NASDAQ, was coming to London to raise new money and to set up London trading. Sinclair Pharma moved from AIM to the main list and Euronext (and Vectura has also recently followed it to the main list). Genemedix moved from the main market to AIM, and Vectura, BBI and Maelor produced admission documents in connection with their major acquisitions of Innovata, Theratase and Acorus respectively.

• The companies are heavy users of option arrangements - whereas listed companies in general are still moving towards arrangements where individuals receive free shares. The exception is China Medical System Holdings, where no option scheme is in place at present. Offering options to Chinese residents is full of legal and exchange control difficulties, but even so, the company says it is considering doing so in the future.

• All companies apart from China Medical System Holdings (which does not have a UK trade and so is ineligible to grant EMI options) and Genemedix disclose they have used EMI options, although some are now too large to grant further options. Where further EMI options are being granted, since most of these companies are specially established holding companies of groups, they will have been relieved that a late concession by the Revenue inserting holding companies. This was agreed by the Revenue after intervention by various industry participants as to legislation on this year’s Finance Act, including CMS Cameron McKenna.

• Dilution limits are in several cases higher than the ABI guideline of 10%. Sinclair Pharma and BBI are permitted to use up to 15% for employee share schemes. Maelor reports that it can go up to 12.5% in the future. Vectura and Neuropharm adhere to the 10% norm. Last year, biotech companies obtained the commitment of the investment community to listen carefully to requests to relax pre-emption protections and it will be interesting to see if this change filters through into greater relaxations for employee share scheme arrangements.

• Non-executive directors hold/can receive options in Maelor, Vectura and Sinclair Pharma, as did consultants in Sinclair Pharma pre-IPO. Again, this goes against the general trend for quoted companies as directors holding options are not normally considered “independent” for corporate governance purposes.

• In terms of performance conditions which must normally be met before options can be exercised (and which are often only applied to post-IPO grants), these can be quite specific to particular development and commercialisation targets (e.g. in the case of a certain percentage of the Neuropharm options). However, the most common measure is TSR (total shareholder return). Some companies do not disclose or, more likely, do not have targets. Earnings targets do not normally feature in the biotech sector where profits are usually some way down the line and so earnings would be too long-term a goal for the purposes of options, but BBI Holdings is a notable exception.

• As befits what is now one of the largest UK biotech companies, Vectura is the only company to have taken advantage of Revenue-approved all-employee arrangements. It has both the Sharesave plan (under which employees can save up to £250 per month and receive shares at the end of the savings period acquired using the savings monies) and the Share Incentive Plan under which a variety of relatively small awards can be made. Epistem has said, however, that it is planning to use its Sharesave plan in the future.

• Interestingly, Sinclair Pharma appear to have taken advantage of a new type of plan under which only the rise in value in shares is received (as under an option arrangement) but the gain is taxed as a more favourable capital gain rather than as income. This plan involves the use of an employee trust and relatively complicated joint ownership arrangements. Concerns still remain that this scheme is susceptible to Revenue challenge and the risk of a change of law. It is not really appropriate for profitable companies, but as biotech companies are generally not tax profitable, this last point is of less concern for this sector.