Most people don’t realize how much our government intrudes into every market. For example, I saw a drug company pitch recently. The company has a drug that helps cure cancer, and which may also have other life-promoting uses (I am obscuring non-essential details to protect the innocent). Let’s look at this company, to see how the capital and drug markets are both harmed by government interference.
Like all angel investor pitches, this was a closed meeting. Angel investment groups are not open to the public. They are exclusive clubs, restricted to Accredited Investors only. The Securities and Exchange Commission (SEC) defines several ways for an investor to be Accredited, but the two most important are: $1M net worth or $300K annual income.
Angel groups generally grow only by personal referrals, since it has not been possible to advertise to the general public (recent rule changes allow advertising in theory, but in practice I am not aware of any doing it). This SEC regulation further restricts the number of people who invest in startups. By clamping down on angel investing, the SEC reduces the capital available to startup companies.
The supposed purpose of these restrictions is to protect the non-accredited investors, which we’ll call the Plebian Investors, or Plebes for short.
Oh boy, are the Plebes “protected.”
Startups are legally forbidden from offering securities to Plebes (to invest in a company is to buy a security). Plebes are protected from being able to invest, from using their own judgment, and from allocating their portfolios as they wish. They are a government-created lower class, much like women were back before the right to own property and to vote. The government keeps them down. It’s for their own good, you understand.
Plebes can gamble, where loss of money is virtually certain. They are allowed to buy expensive toys, or even liquor. They may slack off at work and lose their jobs. They are even permitted to give their money away to a non-profit that is working on curing cancer.
What they are not allowed to do is invest their money in a startup with the hope of a return on a cancer cure. That is such a serious crime that… well… all manner of seriousness would erupt if Plebes could do that. It is unconscionable to even think it.
The SEC has a term for when a startup sells securities to a Plebe. George Orwell would be proud of this clever new linguistic development. The term is “securities fraud.” Even an honest entrepreneur, who carefully describes the nature of what he is selling, is automatically guilty of fraud if the buyer is a Plebe. He will get no sympathy from the public (including the Plebes!). They don’t understand that, in Newspeak, fraud does not mean, well, you know… actual fraud.
Now let’s get to our cancer drug. It was originally developed by another company. That first company spent a lot of time and money to prove that it’s safe. We investors were told that it has no significant side effects (I am not in a position to evaluate this, or other, medical claims that I raise in this article).
That first company, the developer of the drug, decided not to go forward. Thus a new company, the one that pitched to the angel investor group, bought the drug. The new company seeks to target a different disease process. Therefore the new company may have to do additional work to demonstrate safety, and especially efficacy, for the new application. That’s not the problem I’m discussing.
The problem is that the new company ought to be able to proceed from where the old one left off. It shouldn’t matter who did the clinical work, only that it was done. Unfortunately, safety, or at least the compliance file, is proprietary to the old company.
So the new company has to spend time and money to petition the Food and Drug Administration (FDA) to be able to take over the paperwork and status from the previous company. This is just to get back to the same place that the first company had been. It cannot just inherit it.
Let that sink in. As the SEC protects the Plebes, the FDA protects the Hapless Disease Sufferers, or the Sufferers for short. As the Plebes might waste their life savings gambling on a get-rich-quick scheme, the Sufferers might waste theirs on snake oil.
Oh boy, are the Sufferers “protected.”
The first line of defense of the Sufferers is an expensive and time-consuming compliance process. Drug companies are not to be given speedy access to profit off the Sufferers.
Let’s put this new cancer drug in perspective. According to the company pitch, there are currently no other drugs to cure the cancer that it targets. With mortality over 95%, people are dying right now. Thousands will die waiting, even if the company eventually slogs all the way through the drug approval process.
The company is seeking to raise money to cover the cost of compliance. It expects to need at least $10M, and it will probably need a lot more than that down the road. I choose not to invest, and I don’t know any other investor who did. The risks—particularly those created by the government—are too high.
It’s worth pausing at this point to say that if it were possible to put in, say, $500, on a long-shot bet that maybe the company will cure cancer and pay me back 100-fold, I would not hesitate. Many others would put in money too. Unfortunately, the government has blocked off this avenue.
A company is deemed public once it has 500 investors. No company in its right mind wants to go public today, certainly not before it has enough revenues to cover the costs of public company compliance. The Securities Act was expensive enough, but then they added Sarbanes-Oxley, and more recently Dodd-Frank. These regulations don’t make investing any safer, but they do make companies waste tens of millions of dollars (and management energy) on compliance.
This company, like any other startup, has to plan to be able to raise all the capital it will ever need, from fewer than 500 investors. Since sometimes the number of shareholders can rise spontaneously (if investors sell some of their shares), the effective limit is well under that.
If you need to raise $10M or more, then you clearly cannot accept small-fry investments of $500. The minimum investment is $10,000, or often higher. Faced with the choice of risking $10,000 on a long shot, I passed.
The financial side of this deal is not the worst part. Even if the drug works, it still faces a long, risky road to market. During that time, 95% of patients who could benefit from it will continue to die. In the end, the FDA might deny permission to sell the drug, dooming patients to nearly certain death.
The FDA is killing people.
Someone needs to ask what does unsafe mean—to a patient who faces nearly certain death? Suppose a drug had a 50% chance of causing a massive heart attack. If you had a 95% chance of dying from cancer, wouldn’t you take your chances with the heart attack? Is a patient really better off dying, because a drug that could save his life is not approved to be offered to him?
It costs $1 to make a dose of this cancer drug, but the company plans to sell it for $1,000. The time, cost, and uncertainty of compliance make this price both necessary and possible. It’s necessary to compensate investors for the huge risk they take. It’s possible, because the compliance is a sky-high barrier to keep competitors out of the market.
The FDA contributes to the high cost of medicine.
Every last aspect of this saga is perverse. Plebes are forced into the corral of investments deemed acceptable for lesser beings, such as the bonds issued by insolvent cities. Sufferers are forced into the corral of drugs deemed safe enough, without regard to their wishes or health.
Innovators are starved for capital. They are working to bring us new cures for deadly diseases. Unfortunately, most will not be funded even if their drugs have real promise. Thanks to the costs and delays of regulation, too many drugs just don’t merit investment.
The government is not protecting Plebes and Sufferers. It is creating them.