Under the United States tax code, a corporation may be registered as an S corporation (S-corp) or as a C corporation (C-corp).
A C-corp is typically a full corporation, with officers, stockholders, and not insignificantly, a degree of liability protection
for its investors. (If you buy a share in General Motors—a C-corp—you need not worry that a car owner will sue you if the
An S corporation, on the other hand, is designed to help launch new businesses. If profitable, the S-corp pays more tax than
a C-corp, and retained earnings, used to fuel business growth, are taxed to S-corp stockholders. However, the losses of an
S-corp, which are more likely in the start-up phase, also pass to the stockholders, who can use those losses to offset tax
liabilities. Most new companies begin as S corporations, then convert to C corporation status once profitability is achieved.
S-corp status is unlikely to be appropriate for biodefense spin-offs for two reasons. First, the likelihood of high liability,
in case the product develops problems, makes the protection of C-corp status more desirable. Second, S-corp status requires
that all stockholders be individuals. Because the typical spin-off has a mandatory contractual license to provide part of
its stock to a parent university, it cannot qualify as an S-corp.
As mentioned above, fools are knowledgeable investors with non-obvious motives, and one of those motives may be a desire to
benefit from the tax advantages of an S corporation. Faced with paying taxes on a profitable venture, the fool may wisely
opt to obtain shares in a high speculative venture. The foolish choice makes sense because the losses of a speculative S-corp
investment may cancel out the taxable profits from another investment; thus, the wise fool will readily pick up high-risk
start-up shares rather than pay the Internal Revenue Service. US tax laws, thus, encourage investment and help provide capital
to start-up companies.
However, a biodefense spin-off company typically has a high liability potential and a mandatory contractual licensing agreement
that disqualifies it from S-corp status. Therefore, it is unlikely to attract a knowledgeable fool as an investor. The biodefense
spin-off must look beyond the four Fs when seeking funding.
THREE FACTORS THAT OFFSET THE LOSS OF "FOUR F" FUNDING
Fortunately, three factors offset the loss of four F funding for biodefense start-up companies. First, the companies probably
benefited from pre-stage grant funding. Second, they are likely to be working on products that are in the public interest.
Third, they are typically farther along in the product development process and in the market definition process than are other,
more traditional start-ups. These three factors result in substantial advantages for spin-off companies attempting to secure
initial and growth funding.
As a spin-off, a new biodefense company is probably beginning with a patented or developed product initially funded by grants.
The organization, therefore, starts without the product development debt that hamstrings many new organizations. Even a new
local pizza restaurant must experiment with the right mix of cheese, sauce, crust, and toppings. For a spin-off, that research
and development phase has been independently funded before founding.
Because the product is in the public interest, the biodefense company has a greater likelihood of government and foundation
assistance than other companies might have. For example, the US military or the US government may pre-fund future orders or
provide grant funding for a company in the biodefense arena.3
Finally, the reality of a market made up of civilian or military authorities makes the spin-off an attractive investment for
a biomedical corporation; indeed, the appeal is far beyond that available to most new businesses. Many major biomedical companies
are actively looking for new developments; others are more passive but are open to discussions. And the model of funding product
development by investing in independent spin-offs is well established in the biomedical industry.
Given these advantages, biodefense spin-off companies have multiple funding options beyond the "four Fs" mentioned above.
These options include: government grants, foundation grants, investors, pre-sales funding, loans, and other sources, such
as licensing agreements. Spin-off companies can maximize funding success by pursuing a combination of the sources discussed
Although grants can be complex, and attached strings can consume a portion of funds and result in multiple frustrations, grants
carry two main advantages: No equity is sacrificed, and no debt is incurred.