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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 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

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 

KAY HAGAN, North Carolina 

TIM JOHNSON, South Dakota 

ROGER F. WICKER, Mississippi 

MIKE JOHANNS, Nebraska 

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)

(1) 

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 

2 

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 

3 

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 ‘‘Jcurve’’—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 laterstage 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 

4 

news is that this result is hollow—as the new firms that are largely being formed today are sole proprietorships as opposed to jobcreating 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. 

5 

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 definiVerDate Nov 24 2008 10:32 Apr 26, 2012 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\07-20 DISTILLER\72011.TXT JASON
6 

tion, 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. 

7 

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 

8 

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. 

9 

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. 

10 

Senator VITTER. OK. Thank you. 

Mr. ZOLLER. I would also argue that in the case of SarbanesOxley 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 

11 

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 

12 

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 

13 

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 SarbanesOxley. 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 

14 

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 talkVerDate Nov 24 2008 10:32 Apr 26, 2012 Jkt 048080 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\07-20 DISTILLER\72011.TXT JASON
15 

ing 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 earlystage 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 

16 

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. 

17 

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 

18 

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. 

19 

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 

20 

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 buildto-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-tosell 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 compaVerDate Nov 24 2008 10:32 Apr 26, 2012 Jkt 048080 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\07-20 DISTILLER\72011.TXT JASON
21 

nies 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? 

22 

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 re ́sume ́s 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 

23 

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:] 

24 

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 laterstage 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. 

25 

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, earlystage 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 

26 

1PricewaterhouseCoopers 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. 

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

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 CapVerDate Nov 24 2008 10:32 Apr 26, 2012 Jkt 048080 PO 00000 Frm 00030 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\07-20 DISTILLER\72011.TXT JASON
27 

ital 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 selfreliance, 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. 

28 

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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 viruslike particle (VLP) platform. VLP technology provides antiviral protection without 

the complexity associated with live viruses. Our lead product candidate, a VLPbased 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 

57 

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, 

58 

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. 

59 

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. 

60 

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 

61 

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 

62 

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 venturebacked 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 

63 

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 

64 

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. 

65 

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 startups 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 preVerDate Nov 24 2008 10:32 Apr 26, 2012 Jkt 048080 PO 00000 Frm 00069 Fmt 6602 Sfmt 6602 L:\HEARINGS 2011\07-20 DISTILLER\72011.TXT JASON
66 

vent 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.