The success of biotech and medtech companies relies on numerous factors, and notably on their capacity to attract high profile employees, independent board members and key opinion leaders. Collaborating with the right parties can considerably increase the credibility of a company or project by scientifically validating its drug candidates and other products, but also by providing reassurance on the ability of the team in place to make the project a success.
However, these high profile individuals are relatively rare compared to the number of biotech and medtech companies operating in an industry with worldwide competition. In addition, for employees, leaving big pharma or medtech companies for a risky entrepreneurial project often means leaving stability and comfort for a “pay cut.”
In this respect, incentives such as profit-sharing mechanisms allow biotech and medtech companies to offer potential significant gains in the case of a liquidity event (such as a sale or IPO). They also enable the interests of all parties involved (investors, founders, employees, board members and KOLs) to align toward increasing the equity value of the companies.
The French government has clearly indicated that it supports innovation and will take action in favor of startups. With respect to incentives, we have noticed some movement even though we still see a need for additional measures in the future.
Whereas stock options are disregarded by biotech and medtech companies (except for foreign employees) as they are expensive for the company and not tax efficient for beneficiaries, founders’ warrants (bons de souscription de parts de créateur d’entreprise or BSPCE) and free shares (attribution gratuite d’actions) are very common.
Recent changes in the legislation applicable to free shares and in the tax regime of capital gain have made incentive mechanisms much more attractive.
For a long time, free shares were seen as inflexible and expensive.
Vesting conditions on free shares were subject to legal constraints, providing that they could not be acquired before the end of a two-year acquisition period and be transferred before an additional two-year lock-up period. Where four years may have been compatible with the liquidity target at the beginning of a project, it may not have been the case at a later stage, and no vesting acceleration was legally possible. Since 2015, the acquisition and lock-up periods have been reduced to a global two-year period, which makes free shares more flexible.
In addition, the allocation of free shares was triggering, at the date of the allocation, a social contribution amounting to 30% of the value of the shares. Consequently, companies were liable for a significant amount of social contribution even though employees might have left their position before the end of the acquisition period and the free shares might have lapsed. Since 2015, social contribution is now due at the end of the acquisition period (i.e. when the free shares are vested) and reduced to 20% (with some limited deduction in favor of SMEs).
Even though this was seen as a major move in support of startups, the payment of this contribution nevertheless creates a significant cash issue in companies with zero or little revenue. The amount of the contribution also cannot be properly anticipated, as it remains uncertain since it is based on the value of the share at the date of acquisition, (i.e. at least one year after the grant, in high growth companies where the valuation can grow very quickly).
Free shares could be much more attractive if their legal regime provided for flexibility in term of vesting acceleration and if the social contribution regime applicable to SMEs was adjusted to take into account their financial and cash capacities (e.g. reduced rate or contribution calculated on the value of the shares at the time of the allocation with a deferred payment).
Founders’ Warrants (BSPCE)
Founders’ warrants are very often seen as the most appropriate incentive mechanism for biotech and medtech companies as they are tax efficient for the beneficiaries, free for the companies and very flexible in terms of vesting and allocation conditions. Even if the tax regime on capital gains and founders’ warrants has been aligned to the 30% “flat tax,” founders’ warrants remain attractive.
However, not every company or person contributing to biotech and medtech companies is eligible for founders’ warrants.
SMEs need to comply with several conditions in order to be eligible for founders’ warrants. In particular, until recently, companies resulting from the acquisition of a preexisting business and/or any restructuring were not eligible. This condition has been softened and nowadays these companies remain eligible if the initial companies meet all other eligibility conditions.
One condition remains an issue for biotech and medtech companies. Only companies where 25% of their share capital is held since their inception by natural persons (or by legal persons where 75% of the share capital is directly held by natural persons) are eligible for founders’ warrants. The calculation method neutralizes French investment funds and foreign “equivalent structures,” but the French tax administration does not recognize US limited partnerships and most foreign funds as “equivalent structures.” Consequently, French biotech and medtech companies which have recourse to international funding often lose their eligibility for founders’ warrants. Clarifying and extending the conditions to all investment funds, regardless of their structure, would avoid complex issues for these companies.
Although the list of potential beneficiaries of founders’ warrants was extended to employees and executive officers of subsidiaries, non-executive officers are still not eligible. Parliament is currently discussing extending founders’ warrants to board members, supervisory board and members of equivalent corporate bodies of simplified stock companies (sociétés par actions simplifiées). This would be an important step forward as it would enable French biotech and medtech companies to remunerate their independent board members more easily and within a secured tax mechanism.
If founders’ warrants remain the most attractive incentive mechanism for biotech and medtech companies, they would benefit from legal amendments extending their eligibility and taking into account their ecosystem – for example, the necessity to hire and incentivize independent board members, and the need for larger and more international fund raising.