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This is the third article in a Boston Business Journal series on the state of corporate philanthropic giving. Read our previous stories on what happens to corporate philanthropy when the company moves out of state, and gender diversity at corporate foundations.
At the intersection of patient advocacy and venture capital lives an idea known as venture philanthropy, and its role in life sciences investment is increasingly important.
The Cystic Fibrosis Foundation helped pioneer this model more than 20 years ago. Maryland-based CFF has focused on patient advocacy since its founding in 1955 and established a therapeutics arm in 2000. Soon after, it partnered with Boston’s Vertex Pharmaceuticals Inc. (Nasdaq: VRTX) to help engineer new drugs that would ultimately change the course of cystic fibrosis — and help make Vertex a multibillion-dollar company.
The royalties the foundation has received from that collaboration and others have since been reinvested into new research, giving rise to the idea of a “virtuous circle” in conquering diseases. Simply put, the model enables for-profit drug development through nonprofit means. Donors give to such organizations as CFF, which invests it in research to benefit an organization’s disease focus and patient population. That research eventually turns into new medicines, which generate returns that can fund new research.
Nonprofit investors maintain that despite their similarities to venture capital firms, there are key differences beyond the fundamental motive. Their resource allocation and the size of returns they typically receive — if they receive returns at all — can be very different from VCs.
But the model has drawbacks. The investments don’t always liquidate, effectively stopping the circle. Nonprofit investors must take care to avoid conflicts of interest. And while venture philanthropy firms can push forward drugs for certain diseases, they don’t control drug prices. Some patients end up “paying twice” — once in the form of a donation, then to buy the treatment.
“It’s a two-edged sword. There’s no doubt. There’s a tradeoff,” said MIT professor Andrew Lo, who runs the laboratory for financial engineering at MIT’s Sloan School of Management and co-authored a 2019 case study on the CFF. “It’s not always the case that patient advocates are aligned with drug manufacturers and, for that matter, the FDA.”
Venture philanthropy vs. venture capital
Between 2002 and 2017, according to a 2022 study published in the scientific journal Nature Biotechnology, philanthropic investments in the life sciences increased five-fold in the U.S., to $2.6 billion, outpacing the growth of investments from both industry and the federal government.
In Massachusetts, nonprofit life sciences investment has mostly increased since 2016, hitting a high of 14 deals in 2021, when investment reached $699.1 million according to data from PitchBook.
Most nonprofit investors say their funding sources are a mix of donations from top-dollar investors and other organizations. But venture philanthropy firms also benefit from returns on their investments, much like traditional venture capital.
“One of the problems with philanthropy ... there’s a mind-set of, ‘What do you do? You allocate money.’ It’s always check-writing, forever,” said Richard Lipkin, co-founder and board director of the Catalytic Impact Foundation (CIF). “The whole thing we’re trying to do is create this regenerative model.”
Few of the most active nonprofit investors in Massachusetts biotechs are forthcoming about their funding sources. Among the top 10 such investors between 2016 and March 2023, eight were required to file forms with the IRS, and only three disclosed their financial backers in annual tax filings reviewed by the Business Journal. The Kraft Foundation disclosed funds from Robert Kraft himself and the Kraft Group; the Bill & Melinda Gates Foundation listed donations from the estates and trusts of high-net-worth individuals; and the Cystic Fibrosis Foundation disclosed a handful of fundraising activities. But the rest said their funding sources were “NA” — not available.
Venture philanthropy ROI
Lipkin and his co-founder, Rachel Butler, started the CIF around 2015. Both science journalists turned venture capitalists, they’d grown tired of the limitations of venture capital, particularly VCs’ lack of interest in rare and orphan diseases, which have small potential market sizes. Lipkin and Butler said the foundation’s donors include family offices, other foundations, venture capitalists and fund managers. That appears to be the case for many nonprofit investors, according to the managers of these funds, although specifics are unclear from their tax forms. The Retinal Degeneration Fund, an investment fund of the Foundation Fighting Blindness, is heavily supported by the foundation’s founder, Gordon Gund. Likewise, the Alzheimer’s Drug Discovery Foundation is propped up by the Estée Lauder estate, which formed the organization in 1998 and donated $200 million to it just this year.
But the CIF, the RDF and the ADDF have also seen large returns on their investments in the form of exits — IPOs or acquisitions — among their portfolio companies, with rates of return that can rival those of traditional VCs.
The CIF has had four exits, with return rates as high as 6.7X. All told, CIF gained a 45% return on its investment portfolio between 2019 and the end of 2022, based on its most recent impact report.
The 6.7X return came from one of CIF’s very earliest investments, New York’s Applied Therapeutics Inc. (Nasdaq: APLT). The CIF invested $100,000 in an early round, Butler said, and within a year and a half, the company held a $40 million IPO. The following year, Applied held a second public offering at $143.4 million. After a lockup period, CIF sold $50,000 worth of stock, generating proceeds of around $335,000, which Butler says has since been reinvested into other projects.
“Our model allows us to invest where traditional VCs may not be able to, either because the company is too early in its development — the ‘valley of death’ — or because potential returns may be lower than what they need, due to smaller patient populations, or various other reasons,” Butler said. “We’re delighted when there are returns, and our goal is to create a cycle of returns that creates ‘impact in perpetuity.’ However, accelerating potentially life-saving innovation is at the center of what we do and why we do it.”
The Foundation Fighting Blindness’ Retinal Degeneration Fund (RDF) has had two exits, according to managing director Rusty Kelley. One of those was Vedere Bio Inc., the Atlas Venture startup that was scooped up by Novartis AG (NYSE: NVS) less than two years after it was founded. The RDF had gotten in while Vedere was still in stealth, investing around $3 million. When Novartis acquired Vedere, it paid $150 million upfront, generating a 4X return for the RDF.
The organization could still reap benefits from the acquisition, since Novartis has promised up to $130 million more if Vedere hits certain milestones.
“A 4X return in our space, the venture space, is good,” Kelley said. “We know firms who are averaging 8X to 10X, which is outstanding. But generally speaking, in the VC world, if you’re above 2X, I think you’re doing fine.”
Howard Fillit, co-founder and chief science officer of the Alzheimer’s Drug Discovery Foundation (ADDF), estimates that his organization has gotten more than $30 million in returns on investment over the last five to 10 years.
“That’s not the main reason we’re in business,” Fillit said. “That’s a secondary benefit. When we get those returns, they’re just turned right around, back into more research.”
How venture philanthropy uses proceeds
For charitable organizations, the use of proceeds is different than in venture capital, Fillit explained. When the ADDF invests in a company, that money is earmarked for a specific project, he said. It can’t be used for anything else — not rent, not CEO salary, not legal expenses.
“We do operate like a venture capital firm,” Fillit said. “Now, by IRS law or regulation, our investments have to be driven by our mission, and the science has to come first. Any profit that we get from our investments is secondary to the goal of advancing the mission.”
Internally, the venture philanthropy–pioneering CFF is developing what it calls “venture philanthropy 2.0,” according to chief investment officer Jack Mahler.
In the last three years, the CFF has launched two partnerships with Boston-area venture capital firms. A project with the Longwood Fund involves $20 million from the CFF to establish a cystic fibrosis-focused incubator, through which the CFF can fund Longwood portfolio companies at the seed stage. The CFF is also a limited partner in Longwood’s fifth early-stage biotech fund.
A second partnership with Cambridge’s Flagship Pioneering — the firm behind Moderna Inc. (Nasdaq: MRNA) — involves up to $110 million from the CFF to develop new treatments for cystic fibrosis at Flagship-founded companies, starting with gene-editing startup Tessera Therapeutics.
The CFF is also forming its own business development team, which had three people as of August.
“The model that we had created, which very much resulted in companies coming to us, needed to be evolved,” Mahler said. “The key thing we realized was, we needed to go out and act like a venture capitalist and ... find the companies that were working on the most promising treatments.”
Avoiding conflicts of interest
Venture philanthropy firms don’t all invest in new research the same way. The RDF prefers to take an equity stake, although the organization has given out grants in the past, said Kelley. The CIF typically takes equity as well, and it sometimes continues to hold a stake in companies that have had an exit, including Applied Therapeutics post-IPO.
“The goal is to turn it over as much as possible, but there is this balance,” Lipkin said. “We’re not here to be traders. We’re here to be investors… not just be people who drop the company.”
The ADDF “sometimes” takes equity, Fillit says, but prefers convertible notes (short-term debt) with interest that allows the organization to make money back even without an exit.
Then there are royalty agreements. The CFF typically takes a royalty interest on any future revenues of a product, which was done through its drug development organization, Cystic Fibrosis Foundation Therapeutics Inc. (CFFT), until CFFT’s operations were rolled into the foundation in 2018. If a drug starts generating royalty returns, the CFF can quickly liquidate that money.
In the case of Vertex, CFFT sold its future royalties in 2014 for $3.3 billion, which had the added benefit of removing any potential conflicts of interest with the Boston pharma.
Lo, the MIT professor, said the issue of conflicts of interest “is a serious one.”
“Having an equity interest can sometimes create more of a conflict of interest, because now, the value you’re holding is directly proportional to the success of this other company," he said. "It’s not as directly related to the success of your patients. With the royalty, the more patients that get treated, the more you’re going to be able to earn, and therefore you can take that money and plow it back to supporting patients in a very direct way.”
When Kalydeco, Vertex’s first cystic fibrosis drug, was approved in 2012, it was listed for around $300,000 per year, per patient. The royalty sale meant the CFF wasn’t tied up in Vertex’s commercial operations. However, some still argued that many of the patients who had advocated for, and invested in, the development of the drug could not afford it.
Nonprofit organizations have to play by for-profit rules if they want to operate as venture investors. From Lo’s perspective, it’s a Faustian bargain. Asking companies for concessions on drug prices as a condition of investment is a nonstarter. In fact, he’s heard of a few organizations that have asked and gotten “pretty flat nos.” (Lo declined to name specific examples.)
“If you restrain the capitalistic urges, not surprisingly, you’re going to get less motivation from the private sector to take on these challenges,” Lo said. “You can’t afford to agree to restricting prices to anything other than what the market will bear.”
Maya Shavit contributed research to this story.
This article was reported through a fellowship supported by the Lilly Endowment and administered by the Chronicle of Philanthropy to expand coverage of philanthropy and nonprofits. The Boston Business Journal is solely responsible for all content.