02.25.11

"Bringing Biotechnology to Market through Federal Contracts"
Written with contributions by Zach Toth

The economic downturn has forced many companies to look for ways to increase revenues or decrease costs. For the biotech industry, such economic conditions create additional risk and have a major impact on a company’s ability to obtain venture capital, initiate public stock offerings, and secure loans due to its high-risk/high-reward nature. Many biotechnology companies have looked at the Federal Government as a source of additional funding to supplement the other sources of funding.

Biotechnology companies are in a unique situation because they require substantial investment to generate new products and without adequate funding will have difficulty maintaining enough capital to fund ongoing operations. Traditional funding sources become less reliable as economic conditions declineso biotech companies have increasingly turned to funding from contracts or grants from the Federal government.

While contracting with the Federal Government may appear attractive, it is not a funding source that is good for all companies. Each company needs to approach Federal contract and grant opportunities with caution and understand that with Federal taxpayer money comes additional compliance, public reporting and accounting oversight that must be adhered to.

Some biotech companies have been pursuing Federal dollars for the first time with little regard for the additional administrative burdens that will follow post-award. Such companies will have a difficult transition as they deal with the Government demands for its internal control and cost accounting compliance with Federal Acquisition Regulation (FAR). Companies that adequately prepare themselves for a pending contract or grant award can effectively mitigate the administrative and audit risk related to the compliance nuances involved with Federal Government contracting.

Why Go Gov

Many biotech companies are still in the product development stage and are not able to generate revenue through commercial sales of its products or services. They currently survive due to the generous amount of venture capital being committed to them, but this source of funding is not a long term solution. The Government potentially provides another viable source for obtaining additional funding to develop and produce its product.

According to usaspending.gov, in FY2010 Federal spending on grants and contracts was approximately $997.2 B; out of this the Department of Health and Human Services (DHHS) spent $388.8 B. Biotechnology companies should see the 39% DHHS share in Federal spending as a significant opportunity to fund business operations and increase revenue. It is important to note that biotech companies tend to fall into a further niche market regarding research and development. Within DHHS, the Biomedical Advanced Research and Development Authority (BARDA) has issued numerous solicitations and awarded multiple contracts related to research and development over the past few years. These awards can be used to fund individual research and development projects that a company knows will benefit the American public. However, the Government imposes additional constraints and requirements that must be strictly adhered to if Federal money is obtained.

Show Me the Money

There are many publically available resources that companies can utilize to determine what Government opportunities are out there. By monitoring these resources, a company should be able to identify opportunities that suit its current business model, products, and service offerings. These opportunities could potentially result in revenues, or at least provide funds that cover certain costs for years to come.

Besides the sources below, word of mouth and conversations with agency personnel can help ensure that your company is one of the first companies to hear about ensuing opportunities before it is announced. Attending industry events, Government sponsored events and talking with industry experts will give you the upper-hand when it comes to being prepared and ready to act fast when solicitations are issued.

• FedBizOpps is a website dedicated to publically announcing contract and grant opportunities. The website, www.fbo.gov, is constantly updated with pending opportunities, contract amendments, and award decisions. It is a great place to find everything you need to know about upcoming opportunities.
• For small businesses, www.sba.gov/contractingopportunities/index.html, is a good resource to keep abreast of contracts/grants that have been set aside for small business concerns and possible partnering opportunities with large contractors.
• The General Service Administration (GSA) administers the Federal Supply Schedule (FSS), which is also a way that healthcare service and product providers can sell to the Federal Government. For more information regarding how to apply for a GSA schedule, go to www.gsaadvantage.gov.
• www.recovery.gov is primarily designed to give taxpayers user-friendly tools to track Recovery funds – how and where they are spent – in the form of charts, graphs, and maps. It also offers the public an opportunity to report suspected fraud, waste, or abuse related to Recovery funding.
• www.grants.gov was established as a governmental resource named the E-grants Initiative and acts as a central storehouse for information on over 1,000 grant programs and provides access to approximately $500 B in annual awards. Grant programs are generally open during a specific time of the year and organizations propose based on the grant topic.

What Makes Biotech Companies Unique

When it comes to Government contracting, biotech companies have a few characteristics that make them unique. First, biotech companies rely heavily on research and development. The company must spend millions of dollars to fully develop a product before it is ready to be sold to the Government or in commercial markets. The majority of start-up biotech companies are small during the initial years of operation. As a result, many of these companies concentrate on a single product or product line and fully dedicate efforts to it. Such a narrow range of products makes the number of possible Federal opportunities relatively small compared to other industries.

Second, biotech companies often take a product from the initial research and development to manufacturing and distribution. This characteristic makes bidding on Government contracts, administering such contracts, and contract performance more difficult than other companies that focus on a single function, such as IT support providers or engineering services, or a single part of product development such as manufacturing. The biotech company’s proposal often encompasses all the Federal regulations that affect Government contractors from the beginning to the end of the product. Certainly the inherent risks are much greater for contract performance.

Entering the Government Contracts Arena

Government contracts can provide a biotech company with opportunities to lessen the stress of obtaining capital for funding ongoing operations. It may also reduce the risk to other funding sources that no longer have the entire financial burden of getting a product to market. While the stress of obtaining capital can be reduced, the administrative efforts related to Government contracts are far greater than in the commercial market. Many companies that are new to Federal Government contracting, especially small companies, make several mistakes when entering the Federal contracting arena. The following are some common areas where mistakes are made:

• Submitting a Proposal: In order to win a Government contract, companies need to ensure that they are fully responsive to all requirements set forth in the Government’s solicitation and comply with regulations that govern the acquisition process. Submitting a proposal to the U.S. Government is much more cumbersome then vying for commercial contracts. The purpose of FAR is to ensure that contracting officers attempt to receive the “best value” for any good or service procured. As a result, the Government often requires substantially more detail regarding cost and pricing estimates, technical approach, and past performance proof than commercial organizations.
  
  To win contracts, companies must establish and follow a proposal process that is consistent with Federal requirements. The proposal process should establish estimating techniques that can be constantly applied when pricing all contracts and grants. This includes establishing indirect rates, understand the cost associated with each labor category, and seeking the best value from subcontractors and consultants.
  
  A company’s indirect rates are essential in estimating contract costs and profitability and should be used to price each project. Maintaining a compliant rate structure that is easy to administer can be a key factor in successful Government contracting and differs from normal commercial business practices.
  
  Estimating costs is important because Government contractors are required to account for and bill costs in the same manner that the contract was estimated. Additionally, compliance with the Cost Accounting Standards (CAS) can come into effect as companies grow in size and can further increase the importance of maintaining sound and consistent accounting practices.
   
• Processes: Small companies have processes and internal controls (i.e. approvals) in place with regards to running their business, but usually these are not adequately documented and may not be entirely appropriate for the increased revenues generated from Government contracts or grants. As a result, companies need to review and formally document all processes and internal controls utilized as they are awarded Government contracts and transition to becoming Government contractors. In addition to documenting current processes, the company should also review and develop processes that encourage compliance with Federal regulations. A lack of written processes can result in increased scrutiny by a Government auditor, which can possibly increase the length of time to complete a Government audit and create stress for company personnel.
   
• “Major Systems”: Many companies wait until after receiving their first Federal contract before they implement processes and systems necessary to perform on Federal contracts. Companies should develop and implement the required “major systems” of Federal contracting prior to contract award, including accounting, timekeeping, estimating, purchasing (procurement), and billing. Early development of these systems provides the contractor with the capability to obtain contract awards in a more timely fashion. To maintain a proactive approach, many companies engage a third-party to conduct an adequacy audit of the systems to determine if the systems are operating effectively and in compliance with Federal regulations.
  • Timekeeping System: The timekeeping system is one of the major systems that typically differs for Federal contracts as opposed to commercial work. While many commercial biotech companies do not have elaborate timekeeping systems in place to assign hours worked to specific projects, Federal regulations require the contractor to track costs incurred by contract, including labor hours and costs. As a result, companies new to Federal contracting should assess their current timekeeping practices and ensure that employee timekeeping properly assigns labor costs to appropriate projects.
     
  • Job Cost Accounting: In addition to assigning labor costs to projects, contractors are required to track direct costs for each contract separately from other contracts. Job cost accounting is a requirement that commercial biotech companies may not be familiar with when they are awarded their first Federal contract. Several accounting systems, such as Deltek Costpoint, have job cost accounting functions that assist Government contractors in achieving this compliance requirement.
     
  • Purchasing (Procurement): The Government places significant emphasis on ensuring that Government contractors have a purchasing (procurement) system in place that maximizes benefit and provides the best value to the Government. A few examples of how Government contractors can achieve this objective include maximizing the use of competition, selecting vendors/subcontractors that provide supplies/services timely, and documenting all efforts involved in the procurement process. Maintaining documentation should be a focal point for all Government contractors.
     
• Additional Systems: Contractors should be aware of some additional systems that may be required by a Government contract. These systems are designed to assist contractors in monitoring contract performance and may not specifically need to be fully implemented until after contract award. However, additional required systems required by specific contracts should be considered by contractors when obtaining Federal contracts. Examples of additional systems are an earned value management system (EVMS), which enables the contractor to monitor project progress in an objective manner and Government Property systems, which ensure that the products developed under the contract are appropriately documented and secured.
   
• Additional Government Reporting: For Government contractors, there are reporting requirements for prime and subcontractors awards over $25,000. For many such companies, there may also be total compensation reporting for its top executives. For cost type work, a company is required to complete an incurred cost submission that is subject to audit.
   
• Support for Government System Audits: For many contracts, especially large cost-reimbursable contracts, the Government will conduct audits to assess the adequacy of the company’s major systems (as previously described). These audits can occur during pre-award, post-award, during contract performance, or a combination thereof. Contractors should note that special attention is paid to the company’s accounting system, specifically the ability to perform job cost accounting. An “inadequate” opinion issued by the Government could lead to a delay in contract award, start of contract performance, or in some instances, no contract award for the company. Contractors can obtain an independent, third-party opinion of their accounting system to demonstrate to the Government that they are being proactive.
   
• Contract Review and Understanding: Key personnel should review the contract terms and conditions of each contract in order to fully understand the importance of company processes, such as proper recording of time and expenses. Also, key personnel need to fully understand the contract pricing structure proposed to determine specific elements of costs that may be charged direct or indirect to each contract. Review of contract pricing provides insight for key personnel to the indirect rate structure proposed and all direct and indirect costs estimated.

Contract is Awarded – What’s Next?

Receiving a contract or grant award from the Federal Government should always be viewed as a positive event, since these programs provide companies with the financial means to conduct research and potentially deliver a product or service. However, many companies, including biotech companies, are faced with the question of “What do we do now that we’ve won the award?” The following observations and suggestions should be considered by new Government contractors as they begin performance on their first Government contract:

• The Government is adamant on ensuring that Government contractors are monitoring progress, timeline, and cost on every contract. Company personnel must be aware of the Federal requirements to actively monitor activities on each contract. Also, management must make sure that personnel are aware of the contract-specific requirements related to project management.
   
• Companies new to Government contracting need to adequately prepare personnel for the nuances that accompany Federal contracts. After the contract award, company must ensure that key personnel attend training to gain an understanding of regulations and additional compliance requirements that pertain to its Federal contract. Key personnel that require training include both indirectly charged support employees (i.e., accounting) and directly charged employees (i.e., scientists) because Federal regulations govern the activities of all personnel involved in Federal contracting.
   
• Contractors that develop the major systems in anticipation of contract award proactively mitigate many of the risks associated with Federal compliance. Conversely, companies that did not develop the major systems prior to contract award could face many potential compliance risks. Consequently, such companies need to develop the systems quickly and accurately, in order to obtain an “adequate” opinion in the event that the Government performs a review of the company’s systems. A Government finding of “inadequate” for a major system may create some serious issues for a company and may delay cash flow or even cause the Government funding to be discontinued. The following are the initial systems that the Government typically reviews:
  • Billing/Invoicing: One particular system that companies new to Government contracting should pay attention to is the billing/invoicing process. Every Government contract outlines the frequency and level of necessary documentation to be included with each bill. Government contracts require more detail for invoices that many commercial invoices, specifically outlining amounts by individual cost element. Cost elements include but are not limited to labor, travel, materials, subcontractors, equipment, consultants, and indirect expenses.
     
  • Accounting System and Indirect Rates: The Government requires that a Government contractor have an adequate accounting system for Government contracts that adequately identifies and segregates direct and indirect costs. Specifically, the Government requires the accounting for and reporting of indirect cost rates that comply with FAR Part 31. While commercial companies can calculate indirect rates in order to price projects, Government contractors are required to maintain calculations of indirect rates and use these rates in pricing proposals, assigning indirect costs to projects, and monitoring costs in future periods. Biotech companies who perform work for DHHS must abide by compliance requirements supplemental to FAR found in the Health and Human Services Acquisition Regulation (HHSAR). Indirect rates will need to be calculated during the proposal submission process, but must also be monitored and recalculated throughout the period of contract performance.
     
• Government contractors should continually monitor technical performance and financial performance to ensure that the risks associated with overruns related to cost and anticipated deliverance of products/services are mitigated.
   
• A positive relationship with the Contracting Officer can significantly lessen the stress of being a Government contractor. Companies should not be afraid when meeting with a Contracting Officer to discuss the contract timeline and expectations. Proactive communication with the Contracting Officer can help the contractor maintain reasonable and achievable expectations during contract performance. Communication with the Contracting Officer should be thought of as an opportunity to form a strong business relationship, not a stress-causing event.

Intellectual Property and Government Contracts

Biotech companies that consider entering the Government contracts arena raise questions regarding intellectual property. Intellectual property (IP) and patent rights are major reasons that biotech companies conduct business. As a result, the Government typically addresses these concerns by allowing the company to retain the IP, but granting the Government rights access to patents. A common misconception by companies not performing on Government contracts is that the Government will obtain all rights to a patent since the Government funded the project that resulted in the patent. Prior to signing a contract, the company’s legal counsel should conduct a review of all contract terms and conditions to ensure that IP will be retained by the contractor. Engaging outside expertise from law firms specializing in Government procurement law is strongly encouraged.

What Now?

Government contracts can provide opportunities for a biotech company to obtain funding, build revenue, and mitigate the risks associated with operating solely on venture capital money, while maintaining the biotech company’s vision of developing and retaining ownership of IP. Government contracts and grants may assist a biotech company in speeding up the completion of a product or technology, getting the finished product to the market sooner, and increasing the value of the company as an acquisition target. Biotech companies new to Government contracting must be aware of the compliance requirements associated with Government contracting and proactively seek ways to mitigate compliance risks.

To enter the Federal marketplace, companies need to identify which Government Agency could use its product and focus on upcoming solicitations and awards. Companies need to become an active member in the Federal community, either through events, seminars, agency open houses etc. Dedicated resources and a focused approach is necessary to truly succeed.

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