University of California Berkeley
Regional Oral History Office University of California
The Bancroft Library Berkeley, California
The Program in the History of the Biological Sciences and Biotechnology
Fred A. Middleton
FIRST CHIEF FINANCIAL OFFICER AT GENENTECH, 1978-1984
With an Introduction by
Louis J. Lavigne, Jr.
Interviews Conducted by
Glenn E. Bugos, Ph.D.
in 2001
.
Copyright 2002 by The Regents of the University of California
Since 1 954 the Regional Oral History Office has been interviewing leading participants in or well-placed
witnesses to major events in the development of northern California, the West, and the nation. Oral
history is a method of collecting historical information through tape-recorded interviews between a
narrator with firsthand knowledge ofhistorically significant events and a well-informed interviewer, with
the goal of preserving substantive additions to the historical record. The tape recording is transcribed,
lightly edited for continuity and clarity, and reviewed by the interviewee. The corrected manuscript is
indexed, bound with photographs and illustrative materials, and placed in The Bancroft Library at the
University of California, Berkeley, and in other research collections for scholarly use. Because it is
primary material, oral history is not intended to present the final, verified, or complete narrative of
events. It is a spoken account, offered by the interviewee in response to questioning, and as such it is
reflective, partisan, deeply involved, and irreplaceable.
************************************
All uses of this manuscript are covered by a legal agreement between The
Regents of the University of California and Fred A. Middleton dated June 2002. The
manuscript is thereby made available for research purposes. All literary rights in the
manuscript, including the right to publish, are reserved to The Bancroft Library of the
University of California, Berkeley. No part of the manuscript may be quoted for
publication without the written permission of the Director of The Bancroft Library of
the University of California, Berkeley.
Requests for permission to quote for publication should be addressed to the
Regional Oral History Office, 486 Bancroft Library, Mail Code 6000, University of
California, Berkeley 94720-6000, and should include identification of the specific
passages to be quoted, anticipated use of the passages, and identification of the user.
The legal agreement with Fred A. Middleton requires that he be notified of the request
and allowed thirty days in which to respond.
It is recommended that this oral history be cited as follows:
Fred A. Middleton, "First
ChiefFinancial Officer at Genentech, 1978-1984"
an oral history conducted in 2001 by Glenn E. Bugos for the Regional Oral
History Office, The Bancroft Library, University of California, Berkeley,
2002.
Copy no. Jj.
Fred A. Middleton, 2001
Photograph courtesy ofSanderling Ventures
Cataloguing information
Fred A. Middleton (b. 1949) Corporate executive/venture capitalist
First ChiefFinancial Officer at Genentech, 1978-1984, 2002, viii, 267 pp.
Childhood in New Jersey; education in chemistry, business; early employment experiences in business
management, banking, and as financial and administrative officer for Genentech s first management
team; early growth of Genentech, Inc.; corporate financial strategies: raising venture capital, product
licensing, private placements, research and development partnerships, joint ventures, FIPCO [fully
integrated pharmaceutical company] plan, junior common stock; discussion of Genentech products
including insulin, growth hormone, gamma interferon, tissue plasminogen activator (tPA), enzymes;
Genentech s initial public offering; comments on Eugene Kleiner, Thomas Perkins, Cornelius Pettinga,
Robert Swanson, and others.
Introduction by Louis J. Lavigne, Executive Vice-President and Chief Financial Officer,
Genentech, Inc.
Interviewed in 2001 by Glenn E. Bugos for the Program in the History of the Biological Sciences
and Biotechnology, Regional Oral History Office, The Bancroft Library, University of
California, Berkeley.
TABLE OF CONTENTS-Fred A. Middleton
BIOTECHNOLOGY SERIES HISTORY by Sally Smith Hughes i
BIOTECHNOLOGY SERIES LIST iii
INTRODUCTION by Louis J. Lavigne, Jr. iv
INTERVIEW HISTORY by Glenn Bugos vi
BIOGRAPHICAL INFORMATION viii
I EDUCATION AND PRE-GENENTECH CAREER 1
Childhood and Interest in Science 1
Massachusetts Institute of Technology, 1967-1971
M.I.T. Biochemistry Course-Biology 7.05 3
M.LT. s Sloan School of Management and Harvard Business School 4
McKinsey & Company, Rooming with Swanson 5
Studebaker-Worthington, 1975-1977 6
McKinsey & Company Contacts 6
New York, 1975-1978
News of Swanson s Venturing and Genentech
Chase Manhattan Bank 9
H GENENTECH, INC. 10
Introduction to the Company 10
Founding the Genentech Management Team 10
Negotiation of Job Offer with Genentech 1 1
Swanson s Relationship with Kleiner & Perkins 13
My First Day on the Job-August 1 978 14
Middleton s Duties and Accomplishments 15
Early Rapid Growth 15
Automatic Conversion of Preferred Shares 16
Negotiations with Eli Lilly, Novo Nordisk, and Hoechst for Human Insulin 16
Job One as CFO: Raising Money-Lots of It 17
The R&D Partnership Financing Program 1 8
The Pay-As-You-Go Strategy 19
Operating Responsibilities
20
Joint Ventures
Leaving Genentech 21
Genentech in Historical Perspective 22
The FIPCO Plan
Corporate Strategy 22
Growth Hormone 23
Gamma Interferon and tPA 24
Blockbuster Drug vs. Broad Technological Platform 24
Genentech IPO 25
Buzz about Biotech 26
Tandem Computers as a Model 27
Picking Hambrecht & Quist 28
Swanson s Hesitance 28
Attempting a Sale to Big Pharma 29
Drafting the Prospectus 30
Examiner Interview and SEC Response 30
Roadshow Honeymoon 3 1
Pricing the Shares 3 1
Fluor Corporation and Trading Volatility 32
Underestimating Manufacturing Costs 33
Private Placements 34
Premium Market Capitalization 34
Down Market for Biotech: Cetus and Biogen 35
Biotech Analysts 36
Government Regulation 37
FDA Regulation 38
R&D Limited Partnerships 39
The Need for Clinical Trials 3 9
Getting Investment Banks to Sell R&D Partnerships 40
Returns to Investors 41
Third and Fourth Partnerships 42
End of R&D Partnerships 43
Morgan Stanley Research Venture Partners 43
Genentech Development Corporation 44
Risk and Expense of Clinical Trials 44
Partnership Holds the License 45
Getting Idea for R&D Partnerships 46
Legal Opinions 46
Historical Significance of R&D Partnerships 48
Joint Ventures: Genencor 48
Coming s Interest in Biotech 48
Fifty-Fifty Joint Venture 49
Enzyme Products for Nonmedical Applications 49
Resources from Genentech 50
Genentech Industrial Products Group 5 1
Other Joint Ventures and Their Significance 5 1
Agricultural Products 5 1
Choosing a Joint Venture Arrangement 52
HP Genenchem 53
Instrumentation in the Biotech Industry 53
Travenol Genentech Diagnostics 54
Diagnostics as a Distinct Business 55
Joint Venture Returns to Genentech 56
Prutech Research and Development Partnership 56
GLC Associates 57
Joint Ventures as Managerial Training Ground 58
Significance of Joint Ventures to Genentech 58
Junior Common Stock 59
Middleton s Innovation 59
Accounting Debates 60
Junior Stock Vesting 61
Proliferation of the Structure 62
Junior Stock as Employee Incentive 63
Benchmarks 63
In Corporate Partnerships 63
In Research Contracts 64
In Royalties 65
Flexibility to Walk 65
Monetary Value of Benchmarks 66
Profit Sharing 66
Relations between Contract Revenues and Royalties 66
Product Evaluation/Development Teams 67
Budgeting Process 68
TAPE GUIDE 69
APPENDICES 70
A. Biography and Curriculum Vitae 71
B. Sigma Chi (M.I.T.) Yearbook Photographs of Fred Middleton and Bob Swanson, 1968 74
C. Genentech, Inc., Sale of Series A Preferred Stock to the Lubrizol Corporation, 1979 75
D. Fred Middleton and Herbert Boyer in Switzerland, 1980 101
E. Amendment No. 2 to Form S-l Registration Statement submitted by Genentech to the
Securities and Exchange Commission, October 14, 1980 102
F. Purchase of Common Stock by Corning Glass Works and Formation of Genencor, Inc., 1982 153
G. Genentech Clinical Partners, Ltd., 1982 178
H. Genentech Clinical Partners U, 1983 241
I. Bob Swanson and Fred Middleton at Fred s 50* Birthday Party, 1 999 263
INDEX 264
1
BIOTECHNOLOGY SERIES HISTORY-Sally Smith Hughes, Ph.D.
Genesis of the Program in the History of the Biological Sciences and Biotechnology
In 1996 The Bancroft Library launched the Program in the History of the Biological Sciences and
Biotechnology. Bancroft has strong holdings in the history of the physical sciences-the papers of E.O.
Lawrence, Luis Alvarez, Edwin McMillan, and other campus figures in physics and chemistry, as well as
a number of related oral histories. Yet, although the university is located next to the greatest
concentration of biotechnology companies in the world, Bancroft had no coordinated program to
document the industry or its origins in academic biology.
When Charles Faulhaber arrived in 1 995 as Bancroft s director, he agreed on the need to
establish a Bancroft program to capture and preserve the collective memory and papers of university and
corporate scientists and the pioneers who created the biotechnology industry. Documenting and
preserving the history of a science and industry which influences virtually every field of the life sciences
and generates constant public interest and controversy is vital for a proper understanding of science and
business in the late twentieth and early twenty-first centuries.
The Bancroft Library is the ideal location to carry out this historical endeavor. It offers the
combination of experienced oral history and archival personnel and technical resources to execute a
coordinated oral history and archival program. It has an established oral history series in the biological
sciences, an archival division called the History of Science and Technology Program, and the expertise to
develop comprehensive records management plans to safeguard the archives of individuals and
businesses making significant contributions to molecular biology and biotechnology. It also has
longstanding cooperative arrangements with UC San Francisco and Stanford University, the other
research universities in the San Francisco Bay Area.
In April 1996, Daniel E. Koshland, Jr. provided seed money for a center at The Bancroft Library
for historical research on the biological sciences and biotechnology. And then, in early 2001, the
Program in the History of the Biological Sciences and Biotechnology was given great impetus by
Genentech s generous pledge to support documentation of the biotechnology industry.
Thanks to these generous gifts, Bancroft has been building an integrated collection of research
materials-oral history transcripts, personal papers, and archival collections related to the history of the
biological sciences and biotechnology in university and industry settings. A board composed of
distinguished figures in academia and industry advises on the direction of the oral history and archival
components. The Program s initial concentration is on the San Francisco Bay Area and northern
California. But its ultimate aim is to document the growth of molecular biology as an independent field
of the life sciences, and the subsequent revolution which established biotechnology as a key contribution
of American science and industry.
Oral History Process
The oral history methodology used in this program is that of the Regional Oral History Office,
founded in 1954 and producer of over 2,000 oral histories. The method consists of research in primary
and secondary sources; systematic recorded interviews; transcription, light editing by the interviewer,
and review and approval by the interviewee; library deposition of bound volumes of transcripts with table
of contents, introduction, interview history, and index; cataloging in UC Berkeley and national online
library networks; and publicity through ROHO news releases and announcements in scientific, medical,
and historical journals and newsletters and via the ROHO and UCSF Library Web pages.
Oral history as a historical technique has been faulted for its reliance on the vagaries of memory,
its distance from the events discussed, and its subjectivity. All three criticisms are valid; hence the
necessity for using oral history documents in conjunction with other sources in order to reach a
reasonable historical interpretation. Yet these acknowledged weaknesses of oral history, particularly its
subjectivity, are also its strength. Often individual perspectives provide information unobtainable
through more traditional sources. Oral history in skillful hands provides the context in which events
occur-the social, political, economic, and institutional forces which shape the course of events. It also
places a personal face on history which not only enlivens past events but also helps to explain how
individuals affect historical developments.
Emerging Themes
Although the oral history program is still in its initial phase, several themes are emerging. One is
"technology transfer," the complicated process by which scientific discovery moves from the university
laboratory to industry where it contributes to the manufacture of commercial products. The oral histories
show that this trajectory is seldom a linear process, but rather is influenced by institutional and personal
relationships, financial and political climate, and so on.
Another theme is the importance of personality in the conduct of science and business. These
oral histories testify to the fact that who you are, what you have and have not achieved, whom you know,
and how you relate have repercussions for the success or failure of an enterprise, whether scientific or
commercial. Oral history is probably better than any other methodology for documenting these personal
dimensions of history. Its vivid descriptions of personalities and events not only make history vital and
engaging, but also contribute to an understanding of why circumstances occurred in the manner they did.
Molecular biology and biotechnology are fields with high scientific and commercial stakes. As
one might expect, the oral histories reveal the complex interweaving of scientific, business, social, and
personal factors shaping these fields. The expectation is that the oral histories will serve as fertile ground
for research by present and future scholars interested in any number of different aspects of this rich and
fascinating history.
Location of the Oral Histories
Copies of the oral histories are available at the Bancroft, UCSF, and UCLA libraries. They also
may be purchased at cost through the Regional Oral History Office. Some of the oral histories, with
more to come, are available on The Bancroft Library s History of the Biological Sciences and
Biotechnology Website: http://bancroft.berkeley.edu/Biotech/.
Sally Smith Hughes, Ph.D.
Historian of Science
Regional Oral History Office
The Bancroft Library
University of California, Berkeley
October 2002
ir
rhe three criticisms leveled at oral history also apply in many cases to other types of
documentary sources.
Ill
October 2002
ORAL HISTORIES ON BIOTECHNOLOGY
Program in the History of the Biological Sciences and Biotechnology
Paul Berg, Ph.D., "A Stanford Professor s Career in Biochemistry, Science Politics, and the Biotechnology
Industry," 2000
Mary Betlach, Ph.D., "Early Cloning and Recombinant DNA Technology at Herbert W. Boyer s UCSF
Laboratory," 2002
Herbert W. Boyer, Ph.D., "Recombinant DNA Science at UCSF and Its Commercialization at Genentech," 2001
Thomas J. Kiley, "Genentech Legal Counsel and Vice President, 1976-1988, and Entrepreneur" 2002
Arthur Kornberg, M.D., "Biochemistry at Stanford, Biotechnology at DNAX," 1998
Fred A. Middleton, "First Chief Financial Officer at Genentech, 1978-1984," 2002
Thomas J. Perkins, "Kleiner Perkins, Venture Capital, and the Chairmanship of Genentech, 1976-1995," 2002
"Regional Characteristics of Biotechnology in the United States: Perspectives of Three Industry Insiders"
(Hugh D Andrade, David Holveck, and Edward Penhoet), 2001
Niels Reimers, "Stanford s Office of Technology Licensing and the Cohen/Boyer Cloning Patents," 1998
William J. Rutter, Ph.D., "The
Department of Biochemistry and the Molecular Approach to Biomedicine at
the University of California, San Francisco," 1998
Robert A. Swanson, "Co-founder, CEO, and Chairman of Genentech, 1976-1996," 2001
Oral histories in process:
Brook Byers
Stanley Cohen
Chiron Corporation
Roberto Crea
David Goeddel
Herbert Heyneker
Irving Johnson
Dennis Kleid
Arthur Levinson
G. Kirk Raab
William J. Rutter, vol. 2
Richard Scheller
Axel Ullrich
Keith R. Yamamoto
IV
INTRODUCTION-by Louis J. Lavigne, Jr.
Whether raising operating funds through R&D partnerships, championing our first IPOthe
hottest of its time-identifying and directing joint ventures, or simply ensuring that our budgets balanced,
Fred Middleton was Genentech s champion of finance during the critical early years of the company s
history. From 1978 to 1984, Fred rose from vice president of finance and administration to the
company s CFO (Chief Financial Officer) spot, completing more than $200 million in corporate
partnering and institutional funding transactions during his tenure.
He was an ideal match for Genentech in those early days. As a financier, he had a deep
understanding of the financial markets and a knack for raising funds through innovative ideas and
structures. As a student of science, he understood biotechnology and could easily explain it to just about
anyone.
Fred was the perfect complement to Genentech co-founder and CEO Robert A. Swanson. The
two had been friends since their Sigma Chi days at MIT, both pursuing their MBAs while earning their
undergraduate degrees in chemistry. And both shared a love for science, finance and entrepreneurial
management. Bob was a great visionary who could convince someone that they could do something that
seemed impossible, and Fred was someone who could take that vision and really make it happen from a
financial perspective. He would have many conversations about it, polish the idea, and then create
something workable and financially sound.
Fred s gift of gab went a long way toward building ongoing relationships with the financial
community. For Fred, the phone was a very important tool. He spent an enormous amount of time with
the receiver in his hand and had tremendous communication skills. He devoted most of his days to
talking with investment bankers and others on Wall Street, describing biotechnology in a way they d
understand and outlining the opportunities for explosive growth and returns.
Fred was a master in building critical relationships and communicating with different audiences
at different levels. He was a great inspiration in terms of how to build relationships on the outside the
amount of time and energy it takes to build relationships with investment bankers and people on the buy
and sell side of the financial community in order to have them truly understand your business.
I first met Fred in 1982 when I was interviewing for a position to build the operating side of
finance at Genentech. Already in that first meeting, I was struck by the fact that Fred was clearly
someone who had a very strong understanding of the financial markets and who recognized that cash is
king in terms of the development of a company. He made sure that the company was building a firm
foundation and had discipline-something young companies don t always have. With Bob, he focused
the company on making a profit at the earliest possible time and meeting scientific benchmarks linked to
revenues. He and Bob were committed to growing the business in a very careful, thoughtful way-always
preparing for a rainy day, raising money when we didn t need it at the time, and intent upon never getting
into a position of having to reduce headcount because the company got ahead of itself. That discipline is
a hallmark of Genentech and one of the things we have always carried forward in the development of the
business.
Even though Fred was this amazing financial powerhouse, he didn t always look the part. Fred
always wore a suit and tie and still does to this day, but he was constantly running around the office with
his shirttail hanging out of the back of his suit. He s quite tall, and clearly there was no shirt made that
could be tucked in by Fred and continue to stay in place during his hectic workdays. He got more and
more wrinkled and disheveled during the course of the day-to the continuous amusement of those of us
on his team.
Fred left Genentech in 1984 to become president of Morgan Stanley Ventures. He continues
today to combine his zest for science and flair for finance as general partner of Sanderling Ventures,
where he directs investments in early-stage biomedical companies. And, even after all his success, I
suspect he still has trouble with his shirttails.
Any student of finance who dreams of parlaying investors funds into successful companiesand
even creating brand new industrieswould do well to study Fred s inspiring story. Thanks to his ability
to, as he says, "go get the money," Fred made it possible to transform our scientists dreams into products
that extend, improve, and even save, people s lives. That s what I call an amazing return on anyone s
investment.
Louis J. Lavigne, Jr.
Executive Vice President and
Chief Financial Officer
Genentech, Inc.
South San Francisco, California
October, 2002
VI
INTERVIEW fflSTORY-Fred A. Middleton
The initial public offering of Genentech shares in October 1980 launched what was then the largest
first-day run up in a share price. It was a spectacular debut for the biotechnology industry and the one
corporate event many people remember about Genentech. Genentech is otherwise known for its pioneering
work in recombinant DNA, for bringing new drugs through approval and to market, and for ramping up mass
production of its products. Yet as innovative as Genentech was in its science, especially in its formative
years, Genentech was just as innovative in its corporate finance.
Fred Middleton, as Genentech s first chief financial officer, was instrumental in preparing the
company for that IPO. Middleton anchored all facets of Genentech s early corporate finance. Middleton
lays out the four key themes of Genentech s financial story on pages 17 to 21, then explores those themes in
greater detail throughout these interviews.
First, Genentech was constantly raising money, estimated at $450 million over the first seven years,
and at ever higher valuations. This included several closings of a Series A preferred stock prior to the IPO
(not then common practice) and several private placements after the IPO. These were unusual not only in
the types of corporate partners Genentech cultivated, but also because these private placements followed
upon one of the most successful public placements ever.
Second, Genentech adopted a pay-as-you-go philosophy, of always remaining profitable, even as a
start-up company, by having contract income exceed operating expenses. An important part of that story was
imposing budgeting and accounting controlsthrough product evaluation and development teamson a
loosely affiliated group of brilliant but unherdable scientists.
Third, Genentech pursued a FIPCO strategy. Genentech s first full generation of leaders decided to
become a fully-integrated pharmaceutical company. The easier path would be for Genentech to simply
license its intellectual property, sell itself as a research boutique, and live for the day it would be acquired by
big pharma. Rather, Genentech cultivated expertise in every business disciplinefinance, manufacturing,
sales, marketing, clinical, and research-and grow quickly into a self-sustaining company that brought cures
to patients. That was a bold stance at the time.
Fourth, Genentech constantly "benchmarked" by defining interim points toward the success of a
research effort and attaching a dollar amount to it. Not only was benchmarking an important part of
Genentech s relations with its licensees, but it also provided important internal metrics for progress.
Emerging from these three general themes that guided Middleton s work over his years at Genentech
were three specific financial instruments that Genentech invented to fuel its early growth.
First, Genentech was the first pharmaceuticals company to use research and development clinical
partnerships. As a general financial instrument these flourished only briefly, between 1980 and 1986. The
impact on Genentech of its three clinical R&D partnerships, though, was enormous. They funded key
clinical trials that Genentech likely could not have funded otherwise, isolated the risk of the trials, and
proved very profitable for Genentech investors.
Second, Genentech created various classes ofjunior common stock. Again, this type of stock
flourished only brieflybetween the years that founders shares disappeared and stock options grew more
common-but allowed Genentech to attract and retain, the world class scientists who worked there. Readers
will note that Tom Perkins, a leading venture capitalist and Genentech s founding chairman, also considers
Genentech s clinical partnerships and junior common stock to be financial inventions that not only drove
Genentech s early success but were widely copied.
Vll
Third, Genentech showed the biotechnology industry how to structure joint ventures. Genentech
started with a broad technology platform-essentially, the techniques of gene splicing and the practice of
expressing protein-which opened the prospects for it to pursue products in many areas. Indeed, within its
first decade, Genentech launched efforts in veterinary drugs, industrial enzymes, diagnostics and
instrumentation, but quickly spun those efforts into joint ventures. This allowed Genentech itself to focus on
therapeutic proteins for humans even while maintaining an equity stake in the technology it had developed.
Genentech s finance and legal staffs grew expert at forming joint ventures, which provided a model for
countless others, just as they grew expert at drafting the licensing agreements that became a standard
practice among biotechnology companies around the world.
In these interviews, Middletown does an expert job of describing the evolution of these financial
inventions as well as of explaining the broad sweep of Genentech s early financial history. Likely he has
told these stories before while coaching the executives of his portfolio companies in his current position with
Sanderling Ventures.
Middletown also adds some telling details to what we know about Genentech history. Bob Swanson
cultivated many friends, and Fred Middletown was among his earliest. Thus, this interview starts with some
intimate memories of friends sharing their dreams for their future careers. Middletown tells of how
Genentech explored an acquisition by Lilly just prior to its IPO. Middletown was the first person to author
the risk factors section in the filing documents for the IPO of a biotechnology company. Plus, Wall Street
analysts did not then know what questions to ask of biotechnology companies, and Middletown describes
how Genentech learned to communicate with the financial press.
We did three interviews during August 2001, at Middletown s office at Sanderling Ventures on Sand
Hill Road in Menlo Park. Middletown had in his office a complete set of bound volumes of the public
filings for the major transactions he oversaw while at Genentech. While these were all public documents,
they are not easily available. And while most of these documents were formal and legalistic, they provided
the precise dates, terms, and personalities involved in each transaction. He referred to them at times during
our interviews to verify his memory of details. Selected documents from these transaction volumes are
appended to this volume.
Winnie Lam, Middletown s assistant at Sanderling Ventures, was a great help in scheduling
meetings then guarding the door as we talked. Even then, as marked by the few tape interruptions, some of
Middletown s colleagues absolutely needed his signature before the close of business on those Friday
afternoons. Middletown invited the current chief financial officer of Genentech, Lou Lavigne, to write the
introduction to this volume. Genentech is a dramatically different company today then when Middletown
left it, in terms of its size, product portfolio, and corporate alliances. Yet Genentech remains an innovator in
corporate finance, as it remains an innovator in science, thanks to Lavigne and thanks to the standards
Middletown set in Genentech s formative years.
Glenn E. Hugos, Ph.D.
The Prologue Group
Redwood City, California
September 29, 2002
Regional Oral History Office viii University of California
Room 486 The Bancroft Library Berkeley, California 94720
BIOGRAPHICAL INFORMATION
(Please write clearly. Use black ink.)
Your full name fVcl A . A^n
Date of birth &>
"
2 ?- V?_Birthplace H t.nVfeu>n
j
Kj . T
Father s full name fracl A .
rf 44 lefrn
Occupation /Va^r /i-acl ( s (ts
FX<C.) Birthplace *^e.u
J*e-y
/
Mother s full name Caiyol B .
*
^cl
Occupation "g h. cji ( Scl,,J Tfitktr) Birthplace
Your spouse/partner C /. *3~- M idaf\e~tn
Occupation f^u.v$e. Birthplace v^ ma tea.
Your children *A J/a X
r"
Where did you grow up? Na\*> J <j
>-**? V>* m*
Present community
Education 13. S.
Occupation(s)
Areas of expertise 6 >
~t~<s<zk
+-Dio**e<iif+l
_/^ g to Co m/3gi>
rn-gniai. fr>**
Other interests or activities n
Organizations in which you are active
SIGNATURE 7^ * //IS***L-=- DATE:
INTERVIEW WITH FRED MEDDLETON
I EDUCATION AND PRE-GENENTECH CAREER
[Interview 1: August 3, 2001] ##
[Menlo Park, California]
Childhood and Interest in Science
Bugos: So why don t we start at the beginning. Where did you grow up? What did your parents do
for work? What got you interested in chemistry and finance? What got you pointed towards
M.I.T.?
Middleton: OK. A good set of questions. I was born in Morristown, New Jersey, June of 1949. Grew
up in New Jersey in the 1950s and early 1960s. My dad was in marketing and sales for the
Westinghouse Company. He commuted from the suburbs of New Jersey into New York City
for twelve, thirteen years. Then I moved around to a couple of other places while I was
growing up. My dad took a job in Washington with an import/export company, so we moved
to northern VirginiaFairfax, Virginiain 1 962 and lived there for two years. Then we
moved to Indiana, South Bend, Mishawaka actually, in 1964. He worked for Studebaker Car
Company there in their international consumer products operations.
When I was growing up I always had in interest in science and math; more science. I
entered science fair projects and things like that. Just always had an interest in the area. Did
pretty well in those subjects. I wouldn t say that I was a nerd, in terms ofjust having my
nose in the books. But I probably did a reasonable amount of extracurricular investigation in
the area. Did some reading, joined some clubs. Originally I went to high school in Indiana-
did the first three years in Mishawaka. In my senior year, my dad took another job in
London, England with the Singer Company.
So, unexpectedly I spent my senior year in high school in London, at the American
School in London. Which, initially, was a bit upsetting that I had to spend my senior year
in London but it ended up being an absolutely terrific experience. The American School in
London was a private school, a prep school, pretty much for the children of expats who were
over there for temporary tour of duty. Some of them were diplomats, some were in business,
## This symbol indicates that a tape or tape segment has begun or ended. A guide to the tapes
follows the transcript.
in finance. Maybe 10 or 20 percent were non-US citizens who wanted their kids to go to an
American college, so they were preparing them.
In London, I did well in school. Graduated number two in high school and had pretty
close to a perfect grade point average. Just had a general interest in science. I attended a
summer program at the University of London on various topics having to do with the
environment, cosmology, physics, and so forth~was pretty interested in pursuing a career as
a scientist initially, wasn t quite sure in what. I was thinking at the time maybe physics or
chemical engineering or something like that.
Massachusetts Institute of Technology. 1967-1971
Middleton: So when I applied to schools, I applied to scientific programs. Applied to M.I.T., Princeton,
Purdue, few other places. Really, my first choice was to go to M.I.T. I didn t apply to
Caltech. It was a smaller school and I didn t think I d get in. I got into M.I.T. I was hoping
I would but wasn t necessarily expecting to get in there. I did manage to do pretty well on
the SAT boards. I had done some work one summer for the dean of the school of science at
Notre Dame, and he was pretty good friends with some of the people at M.I.T. He wrote a
nice recommendation letter for me, and I suspect that if I was on the margin that might have
helped push me over. That s how I got there.
When I started out I didn t have any particular focuson biology or biochemistry or
molecular biology which sort of was the foundation of biotech. These areas were not hitting
their stride yet as technology in 1967. Biology was more about the classification of
organisms, and doing genetics in fruit flies.
The first pivotal thing that relates to Genentech was when I first went to Boston in the fall
of 1967, 1 had never been there before. I didn t do a college tour. People didn t do them so
much in those days like they do today. So I basically just flew to Boston and showed up. It
just so happened at the airport there were some M.I.T. upperclassmen who were there to
meet incoming freshmen and take them to the campus. So I met these two guys from the
Sigma Chi fraternity, Reid Marsh and Dave Kaiser who were from [Robert A.] Bob
Swanson s fraternity where he was already a member. They invited me to come over, have
breakfast, spend some time with them, and so forth. This occurrence was totally
serendipitous. I spent the first evening in the dorm, at East Campus, and then I moved my
stuff over to Sigma Chi. They have a rush week right when you show up at the school,
because they need the housing for incoming freshmen. They don t have enough room for
everybody, so about a third of the students choose to live in fraternities. They have the rush
week right at the beginning so people can decide where to live. I thought the system worked
pretty well, because living in the fraternity turned out to be a great thing for me. I think most
of the fraternities there were great living groups to support young freshmen who needed to
evolve into a tough and rigorous academic environment. M.I.T. was a very tough school my
freshman year, as it was not yet on a pass-fail system as it became later.
So serendipitously, I pledged the Sigma Chi fraternity, and my first roommate in
September 1967 was Bob Swanson. There were actually four of us in the room: Bob, me,
Dendy Young, a sophomore from Rhodesia, and Bob Lindgren, another freshman from
Illinois. Bob Swanson was my bunkmate. He was a junior at the time, a very friendly guy.
He gave tours on campus, as a part-time job, so he would show us freshmen around campus.
He was always very friendly to underclassmen, taught us the ropes, would get us dates, and
would draft us into house social events. So that s how I met Bob.
It turned out Bob was a chemistry major. He was the only chemistry major in the house.
There were ten members of my freshman pledge class. Most of them ended up going into
engineeringelectrical engineering, chemical engineering one went into math, a couple
went into management. I ended up in chemistry. In high school I really liked physics, but at
M.I.T. we were already doing special relativity by the second course, 8.02, and the physics
was all math, a mathematical science, not something you could physically touch, whereas
chemistry was more of a real physical science which I personally could relate to. There were
a lot of cookbook aspects to chemistry, doing experiments, a lot of lab work, but it was just
for me intuitively easier. That s about all I can say about it. Because Bob was the only other
chemistry major in the house, we developed a friendship. He would tell me about professors
and courses, and we d talk about areas of interest.
Bugos: But not chemical engineering?
Middleton: Not chemical engineering. I tried chemical engineering, and it had a lot of approximating
about tanks, pressure vessels, distillation towers, etc. I found it
pretty difficult, in that it was
not to my liking. I just did pure chemistry, the science of chemistry-doing lab work,
figuring out pathways for synthesis, understanding matter. When I look back at it, I would
have to say it was a pretty general educationa good general background in learning what
chemistry is and how it works.
M.I.T. Biochemistry CourseBiology 7.05
Middleton: One thing that did intrigue me- I was taking other courses. I did take some chemical
engineering courses, in terms of how you build a chemical plant or a refinery. I took some
courses in astronomy, in materials sciences, and I took some courses in biochemistry. There
was a course 7.05. It was called an introduction to biochemistry. About two-thirds of the
students in the class were graduate students. M.I.T. didn t have a medical school, but they
did a lot of medical research. The students who were planning to go to medical school took
this course. It was an extremely broad-based and rigorous survey course about biochemical
pathways, DNA, RNA, proteins, and the relationship to genetics. It had to do with the latest
trends in genetics, [tape interruption]
So the first introduction I had to genetics and biochemistry and the whole field of science
that resulted in Genentech was through this course which I found to be just an absolutely
fascinating course. One of the textbooks was James D. Watson s Molecular Biology ofthe
Gene, which was a mainstay textbook early on. You learned about E. coli and the genetic
code. This was in the mid-1960s, and the genetic code was just being deciphered. At this
point it was maybe two-thirds deciphered. I remember in the lectures some of this was very
logical in terms of how the proteins were made from codons, and so forth. There were still
some missing pieces in the puzzle at this time. They didn t exactly know what stopped the
synthesis, and how the promoters worked to start the synthesis. It was really the key link to
how chemistry related to biology. All biology is controlled by chemical processes. It could
take something I knew something about~chemistry~and relate it to living systems in what
was a total science, or a totally logical approach, though very early in its development. I
found it fascinating, to the point where I even considered going to medical school. It was
also a very tough course, a very competitive course, since there were many competitive
students in there going to medical school. Ultimately I decided not to go to medical school.
But at this point, in 1969, 1 could see that biochemistry was on a trajectory to becoming the
science of the future.
M.I.T. s Sloan School of Management and Harvard Business School
Middleton: While I was a chemistry major, I also enrolled in the Sloan School of Management, which
was the business school at M.I.T.-largely as a result of Bob s model. He had formed his
own strategy for getting a combined degreea bachelor s and a master s degreeby
combining an undergraduate program in chemistry and a graduate program in management.
The management program was a two-year course, but you could structure it in a way that if
you were done with all your chemistry requirements by the end of your junior year, you
could use your senior year as the first year of participation in the Sloan School. By year five
you would have completed the two-year program. You got everything done a year early.
That s what Bob did, he got his bachelor s then master s at Sloan. I subsequently decided in
my senior year, in the middle of my first year at Sloan, that it might be beneficial to go to
another university for business school assuming I got in. I applied to Harvard Business
School, in the middle of my first year at the Sloan School, and managed to get in. This
created a bit of a dilemma. They don t have any advanced placement to be able to receive
credit for courses already taken. You ve got to take all their courses, if you enroll, period.
And it s a case method approach, very different from M.I.T. It s an experiential way of
learning, whereas M.I.T. is more of a quantitative and rigorous approach-getting data, and
correlating data, developing conclusions. It s more data-driven, whereas the case study
method is more based on what I would describe as action scenarios based on a situation
analysis. You have some facts, this is the situation, now, what do you do about it?
So our academic paths diverged here a bit. After getting my degree at M.I.T., I decided to
go to Harvard Business School and went off and did that. Bob, when he was done with the
Sloan School went off into the venture capital business with Citicorp Venture Capital
Limited. Bob s story there is related in another oral history volume in this series.
2
2
See oral history of Robert A. Swanson, "Co-founder, CEO, and Chairman of Genentech, 1976-
1996," interviews conducted in 1996-1997 by Sally Smith Hughes, Regional Oral History Office, The
Bancroft Library, University of California, Berkeley, 2001.
McKinsev & Company, Rooming with Swanson
Middleton: I went to Harvard for two years and developed a strong interest in finance and
entrepreneurial management. When I graduated in 1973, 1 ended up taking a job in San
Francisco with McKinsey & Company, the management consulting firm. Originally I
thought I d want to go into investment banking, but the right offers didn t materialize to be
of interest. I probably had a misimpression of what the investment banking world was all
about anyway, so I mjust as happy that I went to work for McKinsey, which I considered to
be a postgraduate education in business. Not having had any real business experience before
graduating from Harvard, the opportunity to consult on business problems with managers
and use problem solving skills, but learn firsthand how business organizations function and
how to influence themit was a pretty interesting undertaking as a way to start a business
career.
Where the interesting part of the story comes together again is that Bob had been working
at Citicorp in New York, by then for two years. He and Dave Arscott were going to be
opening a San Francisco office for Citibank Venture Capital in 1973. I was talking to him in
the spring when I was getting ready to graduate and go on to San Francisco. And he said he
was going there, and so we decided well, why don t we get a place together when we get out
there-that could be a lot of fun. We knew enough about each other to know we could stand
living together, [laughter]
Bugos: You had done it before.
Middleton: Right. As undergraduates at M.I.T. Bob was a little quirky in some respects. But he was a
good roommate, generally. He was clean, pretty organized, and a good arranger of social
events. So we came out initially, McKinsey had us set up in the place of one of the senior
engagement managerssomeone who had been transferred to Amsterdam and had a really
nice lease on a place out on Eighth Avenue that we just sort of picked up. It was a hell of a
deal, costing next to nothing. We paid a little bit of rent and got to live there for two or three
months. It was a nice place. So Bob and I roomed together there. And then we decided
we d like to get a place with a view of the Golden Gate Bridge, a two-bedroom place. Bob
had this whole strategy of going around and finding buildings he d like, putting a notice in
peoples mailboxes saying if you know of any places for rent please contact me. This
approach was taking forever to come to fruition. So we went out with agents, and it was
kind of funny how it worked. There was always something wrong with everything not quite
the right location, or parking wasn t very good. There were six or seven places that for one
reason or another he didn t like. I was getting kind of nervous because we were just about
running out of time on this other place. Finally I said, "OK, we ll try one more place. If I
like it I m going to take it, and you can go and find your own place."
One of the people in
my office, somebody with a family, was buying a home, and they had an apartment that was
really very nice. On Broadway, 2275 Broadway, on the third floor-had a beautiful view in
the front overlooking the bay and the Golden Gate Bridge, it had a two-car garage. It
basically had everything. We picked up that place for $450 a month in 1973. It became the
apartment where Genentech was conceived.
So we became roommates again, for about two-and-a-half years, from 1973 through
1975. Bob did his venture capital thing around the area. The venture capital industry was
maybe 1 percent the size it is today. This was very early in the scheme of things. It was
right after the founding of Intel. Bob did his deals, had his network of venture capital
friends, many whom I would meet. I had my assignments with McKinsey. I was gone a lot
of the time on assignments in Europe, in Canada, or in Hawaii. I decided by the fall of 1975
that I was kind of tired of traveling around. I didn t have any social life, was always
traveling to distant locations for consulting assignments, and it was just getting old after
two-and-a-half years. I used to do stuff with Bob. We d go hiking on the weekends up at
Mount Tamalpais, or up to Napa Valley for wine tasting (it s free!), or up to Stinson Beach,
or down to Santa Cruz. We had a lot of fun. Bob s a fun guy to be with because he was
very socially oriented. He loved to have a good time with friends, he s very light hearted
and easygoing. So that worked out well.
Studebaker-Worthington. 1975-1977
Middleton: By the fall of 1975, 1 had decided to leave McKinsey and I decided to get a job-probably in
finance, business development, or corporate strategy. I wanted to work somewhere where I
could develop some equity with an organization, some relationships in an organization, and
also have some stability in my social life. As it turned out I was on an assignment in New
York and was talking to a headhunter back there, and he presented to me an interesting
opportunity in business development as assistant to the chairman of the board of a company
called Studebaker-Worthington, which was a conglomerate. It was the same company my
father had worked for once, just a coincidence. When the Studebaker Car Company shut
down in the mid-1960s there were several businesses that got merged together. There was
an automotive parts company-basically it was a conglomerate of about twenty different
companies, of which there were twelve public subsidiaries. So the CEO was a wheeler-
dealer, bought and sold companies, took things public, bought them back again. To me, in
1975, this sounded like an MBA s "dream job"
in business development, buying and
selling companies, [tape interruption]
McKinsev & Company Contacts
Bugos: Before you leave McKinsey & Company, why did you go to the San Francisco office? I ask
that in part because that was recognized as a hotbed of managerial innovation within
McKinsey.
Middleton: McKinsey did a lot of recruiting at Harvard. At the time, I guess Harvard and Stanford were
their two favorite business schools. Wisely, in my view, they recruit from everywhere now.
It just so happened that when I interviewed with McKinseyand I interviewed with a lot of
places the office recruiter was a fellow named Ted Demosthenes, who happened to
interview me. San Francisco was the toughest office for a new MBA to get into. There were
five or six spots there, and people would really love to go there to work, as you can imagine,
because of the attraction of the city, and it s a great office with great people. The fact that I
got invited out to San Francisco for an interview was very flattering. The people I met there,
I really liked a lot. They had a lot of bragging rights. They were hiring the top guys, like the
guy who was number one in his class at Stanford Business School that year, Elaine Bowman.
They had a great bunch of people, who were also very nice people in addition to being smart
people. They were just a terrific group (all guys) my own age. No women at that point in
1973 had made partner at McKinsey.
My first officemate there was a graduate of Stanford Business School, Ted Hall, who
ultimately spent his whole career at McKinsey and just recently retired. He became the
managing director of the San Francisco office and became a guru on management. The
authors of the best-selling book, In Search ofExcellence, Bob Waterman and Tom Peters,
also both worked there. Tom Peters was an animated figure, but I think after he went into
private practice he became a bit of a showman. He was a very successful and bright man.
Don Larson and John Katzenbach were the managing partners. So it was a terrific
experience.
The hard part of it for me I think there were three of us who were single out of the new
recruits. The single guys were the ones who got shuttled off onto long-distance assignments
because arguably it was less onerous on their family life, and less costly for the firm to send
us on long assignments. That being said, they did go out of their way to be nice about it.
They always got you a place, always made sure you were taken care of in the local office that
you went to. It was a great experience, except that you weren t afforded any social life. If
you were dating somebody, by the time you came back six months later, she says "Well, I
assumed you were never going to call me again." So after three years of that you figure
you d like to settle down somewhere and have a life.
New York. 1975-1978
Middleton: So that s what I did in New York. That s where I met my wife. I had some friends there
from business school who I tuned in to. We did things together, they took me out. I ended
up getting fixed up by one of them. My wife Carole was a fix-up, a blind date, from the wife
of a friend of mine. So the "social
program" part of my move to New York worked out
pretty well. I must say I wasn t in a hurry to get married, but I did want to meet people and
develop some relationships. I didn t date that many people, maybe three or four people the
whole time I was there. And then by the spring of 1978, 1 got engaged.
News of Swanson s Venturing and Genentech ##
Middleton: While I lived in New York City in 1976 and 1977, Bob Swanson and I remained friends.
[tape interruption] He would visit me when he was in New York on some trip to meet with
his HQ at Citibank. Carole and I had some parties with friends, and Bob would occasionally
be in town to attend. At one charity fundraiser I attended, I won a weekend at the
presidential suite in the St. Regis Hotel. Of course, I was living in New York so it was no
big deal. But I also won with that a night at the Copacabana. So Carole and I decided to
8
turn this event into a party. The presidential suite is big enough to have a party in. I invited
Bob and asked if he wanted to come back. He said, "Yes." On that visit and some other
visits he told me he had decided to leave Citibank to go work with Kleiner Perkins.
He and Eugene Kleiner had developed a friendship over a deal called "Antex." It was a
failed deal, one of those interesting relationship things in life where people get to know each
other through the "creditors committee." They were liquidating the company. Bob had
convinced Eugene and his partner [Thomas J.] Tom Perkins to bring him on as an employee,
limited partner, do some deals. They had Jimmy Treybig and [John C.] Jack Loustaunou,
who were the founders of Tandem Computer there at the same time. Looking back, to my
understanding, all the deals that Kleiner & Perkins s first fund had invested in went bust
with the exception of the last two Tandem and Genentech, which were phenomenal
successes and more than offset everything else. So Tom and Gene were learning about
venture capital, making a lot of terrible investments, then finally at the end of their fund
getting it right with two phenomenal winners.
So when Bob went to work for Kleiner & Perkins, he started reading a lot about advances
in biochemistry (he and I were both chemistry majors at M.I.T.). He was learning about
genetic engineering and recombinant DNA, which were making news and scientific
headlines in the mid-1970s.
Bugos: But only out of his own interest?
Middleton: Yes. I think he was following his own interest. He was looking around for places to invest
and he was doing a lot of reading. Bob was a networking kind of guy. He d literally read
Scientific American. He read a 1975 article by [Stanley N.] Stan Cohen about recombinant
DNA.1
This article should be somewhere in this archive, because he told me it was
important. Bob was very careful, he spent a lot of time reading, a lot of time thinking.
Probably, someone like Tom Perkins thought, (my conjecture only) "Is this guy ever going to
come up with anything? It s taking him forever. What s going on?" Bob was systematically
going about understanding the technology, talking to some of the scientists, calling up the
people who wrote the articles. He cooked up this idea for a venture, after he met [Herbert
W.] Boyer. He was telling me about it. He didn t tell me all the details, but he said he had a
scheme to take DNA and the knowledge of molecular biology and package it in a microbe
and use it to produce insulin. A new way of making insulin. He asked me not to talk about it
with anybody because he was filing patents, and he was very secretive about it. And I was
thinking this was pretty interesting if it could really work.
Then he told me a little time after that that he decided to do this full time. "I m going to
be leaving Kleiner Perkins and doing this full time. And they re going to give me a little bit
of money to pursue this. Maybe. I ve decided this is a great opportunity." And I said "Well,
that s nice." And we had several more conversations. He told me he had some good
scientific results initially, and that he was really thinking about starting a company to pursue
the commercial aspects of this work. Initially it was kind of a research project. There was a
company named Genentech, but it was really just him and a telephone and a checkbook and
Stanley N. Cohen, "The
Manipulation of Genes," Scientific American 233 (July 1975): 24-33.
some researchers working at the City of Hope, the University of California at San Francisco,
and Caltech.
Chase Manhattan Bank
Middleton: At the time I was thinking, "Wouldn t it be nice to move back to California?" I had been in
New York for three years after Studebaker-Worthington-- I was there for two-and-a-half
years. Their career path was to move out to one of the subsidiaries in a financial job,
probably as a controller. And I interviewed for a couple of those jobs. One of them was in
Buffalo, New York, and it was at one of these old stodgy companies. I thought this was
really an unexciting career path. I decided to make another job change.
I took a job with Chase Manhattan Bank in corporate development and strategy working
for the CEO in a small planning group. The strategy work was interesting. There s only so
many businesses a bank can get into because they re heavily regulated, but I found
commercial banking to be a dull area. I had a decent job, I was making a good living, very
collegial. But I was kind of unsatisfied, not thinking that anything I was doing there would
really have much of an impact on the world. Whether I showed up for work or not probably
wouldn t really matter much to anybody.
10
GENENTECH, INC.
Introduction to the Company
Founding the Genentech Management Team
Middleton: In February 1978, Bob told me he was going to be building up a management team at
Genentech. He was looking for someone to run the company s financial and administrative
functions. You know, he had a very conventional view of businesses. It was almost
humorous if you think about it now. It was going to be him as the CEO. Then he hired a
head of manufacturing. He had the scientists already doing science. He needed to hire
someone out of industry to be the V.P. of manufacturing. And he had found that person-a
Ph.D. out of Squibb, Dr. Brian Sheehan. He was supposed to be able to grow vats of
bacteria~or yeast, I forget which microbe-which was the process historically used to make
antibiotics. This was going to be the same process needed to grow these genetically
engineered microbes that would be engineered to make human insulin. So Brian was
brought in. And somebody else to run marketing. There was nothing to market, of course,
but that was the way you conventionally organized a company, and this person could do
"marketing deals."
Then he needed someone to run finance and administration. He asked me if I knew of
anybody who might be interested, [laughter] It was kind of a leading question. So I said
"What about me?" Bob said, "Oh, you d be interested in that?" Like when the headhunter
calls up and asks "Do
you know of anyone who might be interested in this job?" [laughter]
And I thought, "Wow, this is pretty interesting. I don t understand if this thing is going to
work very well. But it d be nice to go back to California. Even if it s a total bust in a couple
years, I could do something else. I m not concerned about taking a risk at this point in my
career."
I knew he had spent a lot of time on it, and was a reasonably smart person. He also told
me he had received venture capital commitments for 4 million dollars, which was pretty
impressive. I came out and interviewed a very short list of people. Herb Boyer, Tom
Perkins, Brian Sheehan, and Bob. Bob, Herb, and Tom constituted the board of directors.
Brian Sheehan was the only other officer, V.P. of manufacturing, at the company. I seemed
to get along with everybody.
11
Negotiation of Job Offer with Genentech
Middleton: The negotiation on my job offer at Genentech in retrospect was humorous. I did the math
and everything. Bob said, "I
guess we ll offer you forty thousand dollars a year." I was
making thirty-eight thousand at Chase as a vice-president in 1978. And it was a startup
company, so I thought that was pretty reasonable. He said "We ll offer you forty thousand a
year because that s what I m making and I m the president and I can t
pay you more than
what I m making." I said, "That sounds logical."
He offered me five thousand shares. He
said "It doesn t sound like that s a lot, but we re gonna split the shares ten to one, then you ll
have fifty thousand shares." I did the math on this and it was about 1.25 percent of the
company. I thought, "Gee, that s pretty crummy. Here he has half the company and I get
1 .25 percent."
I was disappointed in the amount of stock, but I wanted the job. I talked with
some of my friends in venture capital. We went back and forth a couple of times. He said,
"My final offer is one hundred thousand shares, ten thousand at the time." He said, "If
you
don t accept this, I d like to part as friends, but this is my final offer." So I moped around a
little bit and said all right. And so that was the offer 2.5 percent of the company. So after
the ten for one stock split I was to receive one hundred thousand shares, vested over four
years.
Hugos: What had you been advised would be an acceptable offer?
Middleton: What I wanted was 5 percent. Bob told me was at this stage that would be way too much.
And I really didn t have a clue. Five percent didn t sound like a lot to me. Turns out one of
my roommates at Harvard was in the venture capital business, so I called him up. At the
time he was in northern Mississippi or somewhere, and I tracked him down. I said, here s
the job, and said I think I ought to be worth about 5 percent. One of the reasons I had this
perception was that Bob was a close friend, and our abilities were pretty much equal, in my
view. Scholastically I had gotten better grades than he did, maybe I was a bit smarter than he
was. That was kind of how I felt about it anyway. So how could there be such a huge
difference? I understand that he set it up and all, but still 5 percent was not a lot. Anyway, a
bigger number just was not in the cards. So I had been advised. I was trying to get 2 to 3
percent and he ended up giving me two. When I look back on it now, being in the venture
capital business myself, at the time it was a pretty fair offer for a top CFO candidate. That s
the most you would offer somebody in a venture-backed situation today. But at the time I
didn t really have the data. And of course, I didn t have a clue that the thing was going to
work out as well as it did. So that was how I got hired at Genentech.
When I returned to San Francisco in 1978, Bob was still living in the apartment at 2275
Broadway I had found for us in 1973. When I moved out of there and out to New York, he
took on Brook Byers as his roommate [laughter], who was the next guy to join Kleiner
Perkins after Bob left. Bob mumbled about how Brook was kind of messy. Not as neat and
tidy as me. Anyway, Brook moved out into his own place. So Bob was basically living there
alone, but he was acting as a hotel. Whenever he would have scientists in town or whenever
he d be recruiting, people would always be there staying with him. They d sleep on his
couch or in the extra bedroom. When I came out I sort of moved back into the
12
place too. I slept on the couch for a while. Then I moved over to Shelter Creek Apartments
in San Bruno, where the V.P. of manufacturing, Brian Sheehan, had lived for a while after
he had been hired. That s how I got to Genentech. That was 1978. Bob Swanson offered
me the job in April of 78 and I started work as Genentech s CFO on August 1, 1978. That
was my history with Bob, which goes back a long way, to 1967.
Bugos: So the party at the St. Regis was the first time that he mentioned to you that he was looking
at recombinant DNA? And what was the date of that?
Middleton: Let s see. I moved back to New York in November of 1975. That was in 1976. The
company was formally established in April of 76. Actually before the St. Regis party, we
had a dinner at a restaurant on the Upper East Side. I asked him what he was doing exactly.
What I was doing at Chase was pretty straightforward to talk about. What he was doing was
more interesting because it was very different. So he told me about the idea of making
genetically engineered insulin, and why that was an attractive market. He didn t tell me
much at all about the technology, except to say that you program the bacteria with the DNA
code. So I just sort of listened. I thought, if it works, it d be a good idea.
But I guess I was a little skeptical, as a lot of people were, believing that if this was such a
great idea, why haven t the big pharmaceutical companies been doing it.
They spend billions
of dollars a year on R&D each year. What s the probability that a handful of people, some
academics and some other people, could really do this kind of science without the kind of
research and development resources that you might need to put behind it? That was before I
understood the lesson that most innovation comes from small companies. It s what I believe
today.
Just an observation. For the first three or four years we had literally every pharma
company in the world traipsing through the place, hearing our presentation. We got to see
most every one of them, Eli Lilly, Johnson & Johnson, Hoechst, Novo. They obviously
thought this is a really big deal, what we ve got here. And obviously, they aren t doing it.
By then we had patents, and a few successes. This success here [points to a framed copy of
the San Francisco Chronicle with a headline "New Insulin for Diabetics"], I believe that
was in September of 1978. That was literally two months after I joined. So things were
pretty far along. There was a proof-of-concept molecule called somatostatin that was
expressed prior to insulin, and that worked. And they had to come up with a fusion protein
to make it long enough so it would precipitate out.
I got a little bit of comfort from talking with Herb Boyer, who I knew was a famous
scientist. Herb s a very easygoing guy. He projected a lot of confidence in being able to do
this work. The other thing that struck me was that he was a very poor scientist (monetarily
speaking) at the time, [laughter] He drove me around in this old Porsche that was rickety-
rackety. He was a warm person with long, curly hair, and a brown suede vest which he
always wore. So I thought Genentech would be a very big deal for him.
13
Swanson s Relationship with Kleiner & Perkins
Bugos: Can I ask you another thing about Bob? It s not clear what his relationship was with Kleiner
& Perkins in that December, January 1976 time period when he was forming this business
plan-whether he was actually on salary, or if Kleiner & Perkins had let him go, if he had any
expectations of getting back with them. And ultimately, his relationship was stronger with
Tom Perkins than with Eugene Kleiner. What do you know about all that?
Middleton: Tom Perkins told me that one of his biggest mistakes was in cutting Bob loose without a
salary. I don t think at the time he had a tremendous amount of confidence in Bob. Tom is a
man of action and a bit of an impetuous guy. Probably (my conjecture) he may have said
something like, "Fine, if this is what you want to do, great. When you have it together come
back and talk to us, and maybe we d like to put some money into it." He decided not to pay
him a salary, so Bob Was off on his own. Bob told me he collected some unemployment
compensation while he was doing it. Perkins would probably be the first to say that was a
bad move on his part. If he had continued to pay him while he was doing it, he could have
bridged the salary and some other things and converted that into more stock. Probably, Bob
would have been more favorably inclined to give him a better deal than he got.
Bob did get the thing pretty well financed on his own. Initially he got some money from
Kleiner Perkins, I think it was a surprisingly small amount, only two-hundred thousand
dollars. A small amount of money, even in 1976. I believe Kleiner Perkins put in a small
amount of money on the next venture round. The most they ever owned of the company was
about 20 percent. I think the fund, Kleiner & Perkins I, was about out of money; it was at its
end. Genentech may have been the very last investment that they made. But I also think
Tom thought Bob would need to come back to him for more money, and he could buy more
of it then. Instead Bob went out and raised money from Mayfield [Fund] and Inco [Venture
Capital Management]. There was a guy there whose name I don t remember-[Daniel
Adams] who was the lead investor on the second round. Then Kleiner Perkins put in a little
bit, but the valuations and terms were decided by these new investors.
That being said, Bob and I both had a tremendous amount of respect for Tom Perkins as a
highly visible promoter, marketer, strategist, and financier. I believe that Bob had a warmer
personal relationship with Eugene Kleiner, the other founding partner of Keiner Perkins
who s just a tremendously nice guy, an intuitive, very low key guy. And I think Bob felt that
if you needed to climb mountains, and you needed to go out and establish a beachhead
somewhere new, that Tom was the guy to lead the charge. He was capable and adept at
promoting and being a front man for the company. He was the chairman. I d have to say
that s all very true. He was a tremendous inspiration. He s also a high-profile guy. He
drives fancy cars, lives in a big house. Gene is low key. Tom had a think big, spend big,
make it big mentality, which was the mentality that Bob was interested in himself,
personally. And which he was inspiring everybody else to. There s one story I heard-Bob
was taking the founding scientists to Tom Perkins s house for dinner in Belvedere. It s a
pretty spectacular place. And he said to all the scientists, "See
guys, this is what we re
working towards. Right here." [laughs] I think the scientists were a bit surprised to hear
that, but they were impressed. It was all part of the dream at the time. "Yeah, right, when I
win the lottery," was probably what they thought. It was that type of impression.
Bugos:
14
Could he have come back? I think Bob had decided to leave venture capital. The way he
described it, he was tired of sitting on the sidelines; he wanted to be in the game. The
quarterback is in the game and running things. The coach is on the sidelines and doesn t get
quite the same thrill of victory as the guy throwing the passes. He wanted to be an
entrepreneur. I think he was a hell of a lot better entrepreneur than he ever would have been
as a venture capitalist. I m sure he would have been a fine venture capitalist, but he made a
tremendous entrepreneur. That s how his skill set really evolved. He made the choice, and
Perkins didn t really help him out a lot at first was my understanding.
So let s jump forward to August 1978. The venture capital rounds were concluded and
Lubrizol was the only placement to come after?
Middleton: Right. In April 1978, you can check the date, Bob raised a round of venture capital from the
Hillman family, Inco-Mayfield put in a little more money. It wasn t a lot of money. That
round was $3 to $4 million. I think the first round was around a million.
My First Day on the Job-August 1978
Middleton: The first day I was on the job, I showed up in my coat and tie. Bob and I were the only two
people in the company who ever wore a coat and tie, because we were former finance
people. He always believed it was the right image, but we had no expectations that any of
the scientists would dress like that. They dress however they want, and that was fine. Being
the finance guy, I had to deal with the bankers and was supposed to be a business guy, so I
wore a coat and tie. Never bothered me.
The first day I showed up on the job, this was in South San Francisco, 460 Point San
Bruno Boulevard, which is now called One DNA Way. It was the corner building of a
warehouse, with tilt-up building. Bob had this corner of the building staked out, a couple of
labs, three more offices, maybe four, one for himself, one for his finance guy, one for his
manufacturing guy, one for his marketing guy. Then there were two labs where all the
scientists were working. Then we also had a class HI containment facility which everyone
thought you were going to need to do recombinant DNA work. Then in the back he had an
organic chemistry lab.
First day I m on the job, a big truck rolls up to the loading dock in the back of the
warehouse. The truck driver comes in and says "I ve got all your lab supplies here, but
where s the guy to unload it? I drive the truck, but I don t unload it." There was supposed to
be somebody there from a different union to unload the truck. He either didn t show up or
some wires were crossed and we forgot to arrange for him to come. Bob said, "OK, we re all
going to unload the truck now." So first day, I m unloading the truck of all the lab supplies.
It brought home the whole concept of- [laughter] here you are in a startup company. Very
hands-on type of environment. If you don t do it, the truck s not going to get unloaded
today. Maybe the guy will drive away and you won t get your lab supplies. I though that
was wonderful symbolism. It s what it s like to be an entrepreneur. On the first day on the
job, you unload the truck.
15
The other thing that was very funny about the location~we were right next to a movie
distribution center with inventory. These tilt-ups contained a series of individual
warehouses. This guy next to us had all these old-fashioned, sixteen millimeter movie reels.
I think many were soft pomo. So you d go out the back of the Genentech door, which we
had all built up, and there s all these shelves with all these movies. That gave it a kind of
unsavory atmosphere. Genentech ended up cleaning all that stuff out and taking over the
whole building over the next three or four years. They got those original two buildings
which were originally warehouses. Over time they cleaned everybody else out of there and
turned them into biotechnology laboratories.
Middleton s Duties and Accomplishments
Early Rapid Growth
Bugos: So, spending money on the facilities-
Middleton: Was a very big deal.
Bugos: And something you would have been directly involved with?
##
Middleton: Yes. My initial job in 1978 was vice-president-finance and administration. I was
responsible for purchasing, human resources, facilities, finance and accounting, and also the
treasury function. Back in those days there were no personal computers, so people did the
general ledgers by hand, if you can believe that now. We had ten people involved in the
accounting function for payables, receivables, payroll, general ledger, and so on by 1981.
Today you could do it with two people.
Genentech was always building and growing. The six years that I was there the
headcount grew about a hundred percent a year. When I started it was obviously a small
number. At the end of the first year I was there, there were twelve people. The next year
twenty-four, the next year fifty. Then a hundred, then two hundred. When I left there were
about six hundred people, in late 84. All those people had to have a place to work, so we
were always building labs, building offices, leasing more space, trying to figure out how to
get more space, doing recruiting, negotiating relocation, and arranging employee benefits.
Working with the landlord, working with the facilities team, designing the labs, laying out
floor plans that was something else that was a big deal. Bob very much believed in the
group-think approach to designing facilities. You have a design, you d lay it down, everyone
would get involved, and everyone would tweak it. It would take a while. You wouldn t
quite know when the whole thing would get blessed. Then finally, you figure how much will
it cost and say, "Let s build it."
16
We had a good banking relationship with Bank of America. They leased us practically all
of our lab equipment. I don t know why the bank left this sector, but they re not around
anymore. But if you d need to buy any kind of hardware equipment centrifuges,
refrigerators, cooling bays, hoodsthey would lease all that stuff to us. We ended up with
probably 30 to 40 million dollars in leases over the five or six years I was there. I did all the
banking relationships, negotiated all the credit arrangements and leasing deals. After four
years, Bank of America Leasing sent me a gold-plated telephone hand-set cover (in plastic)
so I could really feel important! The Genentech finance department started with a single,
part-time outside accountant, then we hired some inside accountants and built up that
function.
Automatic Conversion of Preferred Shares
Middleton: On the financing side of things, Bob had very cleverly engineered for this preferred stock to
be sold-this was a good example of how he would focus on details, and Kleiner Perkins
wasn t so concerned with those details at the time. He had a provision whereby the preferred
stock would convert into common based on the passage of time, or based on raising so much
money. Which is not the way it s done by venture capitalists today. Today you have a series
A round, series B round, series C round, etc. He had just a series A round. The trick is that
if you re going to sell the business for not a huge amount of money around 25 to 50 million
dollars or maybe $10 million, you d really like all of the shares to be common shares so you
can divide up the proceeds equally between the common and preferred shareholders.
Otherwise the preferred stock gets a preferential cut of the proceeds. He designed the
preferred stock so it would convert by time and by revenues.
Bugos: Could I mention that I believe the provision that eventually kicked in was the one specifying
that Genentech had gross receipts of 2 million dollars in that fiscal year. In December of
1 979 I believe it converted.
Middleton: OK, that rings a bell. We did get that contract revenue from Lilly. That deal was signed in
1978, and more than $2 million in revenue was earned in 1979.
Negotiations with Eli Lilly, Novo Nordisk, and Hoechst for Human Insulin
Middleton: I participated in those negotiations, but they were pretty far along when I got there. I would
like to acknowledge the contributions of Tom Kiley who worked on them pretty much from
the beginning. Tom was outside counsel in the areas of intellectual property and contract
negotiations and he eventually joined the company. But he was working for Lyon & Lyon for
about the first two years that I was there. Neil [Cornelius] Pettinga, a senior vice-president,
was the chief negotiator for Lilly. I don t know that the company has ever disclosed those
terms. Under the terms of the contract they were supposed to be secret, even though by now
the royalties would have ended, the patents would have expired on human insulin (in 1999).
Competitively, it was very important to Lilly. They got such an unbelievably good
17
deal on it, in retrospect. They paid 3 million dollars in milestones and a high single digit royalty
(8 percent). They made billions of dollars on this deal. I remember Neil Pettinga was saying
"Oh, you guys are such tough negotiators." [laughter] He just complained and complained.
"Lilly
never paid so much for anything, blah, blah, blah." He was so upset at the terms, he
couldn t enjoy the toast. Swanson had gotten some champagne. He told me the next day it was a
bad omen-it was a bad omen for the relationship with Lilly-because the champagne was flat
when they opened it. That relationship put Genentech on the map. That was the idea. It was an
endorsement for a new technology by the leading producer of insulin in the world. It gave our
company overnight credibility in the commercial world. And the deal left Lilly s principal
worldwide competitors, Novo Nordisk and Hoechst, out of the market for human insulin.
It was a good product for Genentech to off-license, because it had major distribution and
pricing issues. It is truly amazing to think that the first producthuman insulin~to be
manufactured by recombinant DNA was a very low-priced product. It was not a thousand-
dollar-a-dose product. It sold at the drugstore for twelve dollars a dose or ten dollars a dose. So
they had to scale up to a pretty large scale to get the sort of margins they needed to make money
on it. That wasn t something that would have been easy for Genentech to do, even if they had
the money for it. So it was a good one to off-license, but Lilly ended up getting a tremendous
deal. At least Lilly had the foresight to do the deal before the announcement that Genentech had
succeeded in making human insulin with recombinant DNA technology, in September 1978.
I believe the company that really blew their opportunity was Novo. Swanson had approached
them first about a deal, and they basically said, "Come and see us after you prove it works." I
don t think Swanson ever talked to them again after that. They could have had it for Europe, and
they basically walked away from it they completely missed the opportunity. I later heard that
the research guys who turned their backs on this opportunity ended up getting fired in the end.
The arrogance of the German researchers from Hoechst was even worse. I remember the guys
from Hoechst came in and the research guy lectures us, "Well, we looked at this, and we don t
think it s ever going to work, for this reason and that reason." You kind of wonder. Why did
this guy travel halfway around the world from Germany to talk to us, to tell us that our
technology wasn t going to work? What was the point? The arrogance was incredible,
[laughter]
Job One as CFO: Raising Money Lots of It
Bugos: Let me ask you a broad question, to give some structure to the rest of the conversation. You
came in 1978 and left in 1984. Could you give me a synopsis of your career there, how your job
titles changed, how your actual responsibilities evolved, the things you were most proud of
accomplishing while you were there?
Middleton: I consider my main contributions to Genentech were threefold. First, I was heavily involved
in raising money for the company. I quarterbacked Genentech s IPO process in 1980
1
and
wrote much of the prospectus, with counsel s help. I d acknowledge Ken Guernsey s
significant help at Cooley Godward. I helped pick the bankers, helped raise a ton of money
1
Mike Johnson, "Behind Genentech s Decision to Go Public," San Francisco Chronicle, August
20, 1980.
18
for the company. This was not a sole effort. Obviously I had a great product to sell. Bob
was involved with it, Tom was involved with it, but I d have to say that I did the yeoman s
amount of work on it. Just like Kiley can take credit for a lot of the patent strategy, I feel I
can take a lot of credit for the financial strategy for the company. I did the Lubrizol deal,
which raised $10 million for them in private equity, and brought Don Murfin to the board,
and took the company to about a 60 million dollar valuation. The IPO in which we raised
$38.5 million, at a 262 million dollar valuation, in 1980, with H&Q [Hambrecht & Quist]
and Blyth Eastman Paine Webber. Subsequent to that we did several private placements, one
with Coming Glass to do Genencor1
,
which raised another $20 million. In 1982, Bob and I
traveled to Sweden and did a 20 million dollar placement with Swedish investors. Tom
Perkins, Bob, and I traveled to Japan to raise an 8 million dollar private placement with a
number of Japanese investors. This capital was raised to fund the infrastructure development
for manufacturing; to expand our product base and to get us into the making and selling
business.
The R&D Partnership Financing Program
Middleton: My second major financing contribution to the company, which I think involved a fair
amount of creativity, was the R&D partnership program. The big challenge for Genentech in
the early 1980s was what I d call bridging the cash valley. Look at the amount of money that
you had to spend in clinical trials and to build manufacturing. It was an enormous amount of
money, over $200 million we estimated. It was more than you could raise at the time in the
public markets. If you were to get it from large corporations, you d end up turning over the
products to them, and they would have gotten all the downstream benefit from making and
selling the product. Genentech wanted to get into the business of making and selling itself
and, so, needed to come up with a way to fund clinical trials on its own. I introduced the
notion of the clinical R&D partnership, which raised money through an external partnership,
which then contracted with the company to do the R&D, ended up owning the results of the
R&D, and then licensed the products back to the company in return for a royalty.
Now why would people be interested in that? At the time, in 1982, the tax laws
2
allowed
you to pass along the tax benefits of the R&D expenditures to investors. If you re an
investor, investing a hundred dollars into an R&D program, you were allowed to write off
that hundred dollars against your personal income. If you were in a 50 percent bracket or
higher, which a lot of people were in 1982, that meant that after taxes you were investing
fifty dollars. So if you were investing fifty dollars and you could earn a royalty of say ten
dollars every year, once the product was approved, then that was an annual cash on cash
return of 20 percent in this example. If it worked. What did Genentech get out of it? It got
total control over its clinical programs, the money to pay for them, and total ownership of the
product rights, in North America primarily, to be able to manufacture, market, and build a
pharmaceutical company!
See appendix F to this volume.
2
This financial benefit was subsequently eliminated by the Tax Reform Act of 1986, which did
away with most investor tax shelters. [F.M.]
19
The tPA partnership, which was done in 1983, raised a 34 million dollar partnership.
Genentech sold the rights in Europe to Boehringer Ingelheim; the rights in Japan were sold, I
believe, to Mitsubishi. So they were able to get that money into the company, as well, to
fund the clinical program. The clinical programs for tPA cost a lot more than $34 million,
but it was one piece of the puzzle that allowed them to keep tPA. tPA was the first big
product that Genentech introduced. It did not end up being a billion dollar product like we
hoped, but it was a several hundred million dollar product. It created a lot of excitement in
the medical community and certainly put them on the map commercially. We did the same
thing with growth hormone, which was the first product Genentech introduced with its own
salesforce in 1985. And gamma interferon, which is now having its second life through
InterMune Pharmaceuticals, a company which we (Sanderling Ventures) are the financiers
of. I m pleased it has a second coming there-having made an excellent return once it was
licensed away from Genentech. Through the R&D partnerships we raised about $125
million to fund the company s clinical programs and turn them into a commercial entity.
The same strategy was copied by all the other biotech companies--Amgen did Amgen
Clinical Partners and got G-CSF [granulocyte colony-stimulating factor] through. George
Rathmann, the founder of Amgen, would say he did this because Fred Middleton and Bob
Swanson did one at Genentech. Biogen did one, Cetus did one, everybody did one to
conduct their own clinical trials for product development.
Bugos: And the third principal contribution you made was?
The Pay-As-You-Go Strategy
Middleton: I would consider my third major contribution to be Genentech s corporate financial strategy.
And the corporate strategy had to do with designing an approach that would allow investors
to put a high valuation on the company. What I reasoned there, and what I convinced Bob to
do This was going to be an expensive business to get into. We could lose a lot of money.
But we had a very broad technology. If we could sell off parts of it through corporate deals,
we would be paying as we go, so that we always are profitable. Investors will feel much
more comfortable with this approach than if we are losing a lot of money each year. The
conventional wisdom at the time was that it was too expensive for a new company to get into
the pharmaceutical business. It was just too expensive and it just couldn t be done. People
were highly skeptical. What we managed to do with our corporate financial strategy was to
make Genentech always profitable. It was profitable when it went public, it was profitable
for the next five years. Pretty much every quarter. I look back at this and think this is an
absolutely phenomenal accomplishment. I wouldn t try to do it again. Fortunately, today
investors don t require this kind of financial discipline in a startup company. I think it s
impossible to do again. This was at a time when we were spending enormous amounts on
facilities, on hiring, on clinical trials. One of the advantages of the R&D partnerships is that
the way they are accounted for is as revenue, so they come in as contract revenue.
Somebody looking at an income statement can seethis company didn t make a lot of
money, it made four cents a share. But they have a ton of R&D, and it s all being paid for by
corporate partners and R&D partnerships. So these guys don t need to raise any equity.
Shareholders come out really well because the equity dollars are being preserved, and the
equity owners will own all the profits from these great biotech products when they are
marketed in the future!
20
What is not true now, but was true from about 1980 to 1988, Genentech s first eight years
as a public company, is that Genentech s valuation was way more than anybody else in the
industry because of this strategy. Everybody else was losing money. We were making
money. So investors felt these guys must know how to operate a business. Investors would
think, we don t know whether Biogen or Cetus is going to be around in three years because
they lost a ton of money last year and are using up their cash reserves funding these losses.
Maybe they won t be able to raise any more money from investors and maybe they ll have to
shut down. So I believe the pay-as-you-go strategy was one of my major accomplishments. I
don t know that the same strategy would be necessary today, but it worked well then.
Because we had such a high value, we were able to go out and raise fairly large sums of
capital in the public markets-several hundred million dollars worth. So those are the three
things I consider my important contributions.
Operating Responsibilities
Bugos: So the next part of my question is what, on a day-to-day level, what actually were you doing?
There was administration in your title, corporate development. Again in broad terms, then
we ll go back over details.
Middleton: OK. My initial title was vice president of finance and administration. It covered the
financing that I talked about which was really the creative part of what I was doing, and the
most demanding part. On the operating side it included human resources, which was
managed initially by Fred Ruffin. It included the controllership and financial reporting
function, which was managed by Patricia McGrath, who was actually a classmate of mine
from business school and joined us as controller. It included the treasury function, which
was managed by Shirley Clayton, who also handled investor relations, the banking, and
dealing with Wall Street on a day-to-day basis. Shirley was the vice-president who joined us
from Bank of America, our commercial bankers. It included purchasing and facilities, which
was managed by Dave Pfaff, who joined us from Barnes-Hind Pharmaceuticals. At one
point I had ninety-five people reporting to me which, for somebody who hadn t had any
management experience three years before, was pretty demanding. The people who I hired
were more experienced managers in terms of day-to-day management than I was, really, so it
worked out fine.
Around 1982, we concluded we should divide up some of these functions. So we created
an administrative function that took the facilities and the purchasing and the HR, and a lot of
the control functions, and organized them together. Then I became CFO, vice president of
finance and corporate development. I was working mostly on big deals for the company and
financings on Wall Street. As I tell people, there were only three people who Bob would
allow to talk to the media-there was me, Shirley, and him. Nobody else could say anything,
[laughter] Fortunately, I had an ability to remember everything that went out on every press
release, so I could always craft together a story based on what I already knew was public
information rather than saying something that I shouldn t say. Generally it went pretty well.
We had good relations with Wall Street, and developed a good following as a public
company.
21
Joint Ventures
Hugos: From 82 to 84 was the time when most of the joint ventures got going. Would the joint
ventures have been part of your purview as well?
Middleton: I worked on a lot of them, as part of a team. We did a number of deals in Japan. Bob
Byrnes, V.P. of marketing, worked on those, and Tom Kiley. We did a number of deals in
agriculture, in industrial-we did some things with Lubrizol. Baxter Travenol Genentech
Diagnostics~that was one that didn t work out. I was on that board. Genencor was one I
participated heavily in, where we spun off all the industrial applications of the technology.
That was a company I founded and am still working with those guys today, like [Robert E.]
Bob Leach. That was a wonderful relationship, with Coming. The former CEO of Coming,
Amory Houghton, became a United States congressman. He used to be on the Genentech
board.
I was the corporate secretary for Genentech for a number of years and went to most of the
board meetings. I got to rub shoulders with most of the board members-Dave Packard of
Hewlett-Packard, Dave Tappan, the CEO of Fluor Corporation, Don Murfin from Lubrizol,
Amory Houghton, the CEO of Coming. Bob put together a good board. By 1984 1 was more
focused on the deals and the joint ventures.
Leaving Genentech
Middleton: To get to the end of the story. I had done everything at Genentech, after six years, that I
could imagine a finance person doing in a career. Genentech was an incredible opportunity
for me. Since I wasn t really in the line of succession-Bob was roughly my age and we were
good friends-I decided to give Wall Street a try. Through the Genentech R&D partnership
program, I had become a leading expert on this type of financing vehicle, and several of the
large investment banks were interested in setting up investment groups to do R&D financing.
I received offers from Paine Webber (Genentech s banker) and Morgan Stanley. I decided to
accept a position as president of Morgan Stanley Ventures. We put together a fund to do
R&D partnership financing. That s why I left Genentech. Not because I didn t think it s a
great company, but because the skill set that I had developed seemed to be a skill set that I
could leverage on Wall Street. And I had always wanted to work on Wall Street. I tried
working there for two or three years then decided that was enough.
Bugos: So that was in New York?
Middleton: Actually, it was in San Francisco. They wanted me to move to New York, but I said I wasn t
interested in going there (again). So, they set me up in the San Francisco office.
22
Genentech in Historical Perspective
Bugos: OK. Let me ask one more general question. That is to think as a historian. Looking back
from your subsequent experience in starting biotech companies and seeing the industry
evolve, what would you see as the Genentech model for the industry? What sort of patterns
did Genentech set that other companies have followed? Or, what was unique about
Genentech?
Middleton: OK. I ll give you my short answer. This came from Bob and from the original management
team; Bob deserves the lion s share of the credit. First of all, the legacy they set-it was
doing high-quality science in an industrial setting. Which sounds a little Pollyannaish, but it
really means world-class science. The people there are world class scientists. They can
participate in scientific meetings, they can publish papers, they are the best at what they can
do, they are highly regarded. Even today-one of the great accomplishments in the post-
Roche-acquisition yearsthey have preserved this culture. They do have, still, the most
productive R&D organization in biotech. People just don t consider Amgen to be in the
same league, even though they re a great company. So excellence, which means recruiting
excellent scientists, allowing them to publish, allowing them to prosper, creating the right
environment. The fact that Art Levinson is leading the organization today, having come out
of that organization, is a tremendous tribute to the legacy that was left. People are motivated
by money and adventure, but a good scientist is motivated more by doing a good job, and by
the motivation to produce worthy health care products. People there have a mission to do
that, beyond the money. Call it the corporate mission to do good, to create valuable
therapies, medicines.
I think hiring really good people is also a good legacy. "Don t be afraid of hiring people
better than you,"
Bob would always say that. Creating that excellence in recruitment. They
always try to get the best people in any given area. That would be my view of what they
have left in terms of a legacy. It s a legacy that survived even an acquisition. As long as
they keep that engine going; I don t think they re running out of gas. They re going strong.
The FIPCO Plan
Corporate Strategy
Bugos: Good. Thanks. Then let s go back to 1978. The business plan for December 1978, from my
understanding, was the first time that Genentech talked about becoming a FIPCO~a Forward
Integrated Pharmaceutical Company. Were you part of that discussion?
Middleton: Oh, absolutely. That was a part of the corporate strategy. I talked about the strategy of
financing. But the other part of it was the FIPCO strategic plan. That was internal stuff.
The FIPCO1
plan I worked heavily on.
##
By FIPCO, Fred Middleton means a fully integrated pharmaceutical company.
23
Middleton: We looked at some models. We looked at Syntex. We determined that all it takes is one
really great product to get you on the map, and then the valuations that you achieve can be
pretty spectacular for your shareholders. Then you create the engine to generate the profits to
reinvest in R&D, and so on. You can go on and develop a franchise in the marketplace.
The other thing was that if you look at the valuation of the company, and you look for
people s expectations, people were really expecting big things, though they didn t really
know how we were going to do it. If you project out, if you look at what the company is
valued at today, and what you have to do ten years from now or five years from now to
justify that, people were really expecting us to become a FEPCO. Because there s no other
way that you could justify the kind of valuation that we had. [laughter] It was like the high
road and the low road. People were betting on the high road. There was no low road. You
could find one, but then you d just be creating disappointment. The road for us was the high
road. People had high expectations for us, and we did for ourselves. We had to figure out
how to achieve the high road.
Bugos: Were there other companies that were taking that low road?
Middleton: In my opinion, Biogen took the low road in the 1970s and 80s. They licensed all of their
products. At one point they were our financial equal, and technologically. They had a huge
number of big name scientists associated with them. But they licensed all their products.
They licensed interferon, they licensed insulin, and they licensed hepatitis there s nothing
left for them to sell. At the time, they were selling off everything to have enough money to
keep going. Ten years down the road they were collecting royalties, but they weren t making
and selling anything. At that point [James L.] Jim Vincent decided "Gee, we should really
have some products of our own. We should be making and selling. Then maybe this
company will have a future." He eventually turned it into a FIPCO. They ended up
belatedly pursuing the strategy.
Growth Hormone
Bugos: In terms of developing the FIPCO strategy, did you compare and contrast the Lilly and Kabi
deals with Genentech? With Lilly you essentially outlicensed everything; with Kabi you
kept the majority of the rights.
Middleton: Yes. The strategy theregrowth hormone was perceived to be a product that we could take
to the market ourselves. It was also perceived by people to be a very small product. Nobody
believed, at the time we went public, that growth hormone was going to be more than a 30
million dollar a year product. You can look at the projections to see. We saw something
called constitutionally delayed short stature, which we thought could be a much larger
patient population than just hypopituitary dwarves. The analysts and doctors all said "We
don t see that. That s all a pipe dream." It turned out to be as big a product as tPA, in the
end, at several hundred million a year. But the number of pediatric endocrinologists who
prescribe it are relatively few. It s a product that sells for a lot of money-ten, twelve
thousand dollars a year. Ten, fifteen thousand patients, relatively small patient population.
Not really a great alternative to it. Lilly got into that business as well, so there ended up
24
being some competition. But Genentech focused on that and said "This is a good first
product for us." So the FIPCO strategy then was achieved through the use of the R&D
partnership.
Gamma Interferon and tPA
Middleton: The next big product was actually perceived to be gamma interferon, but unfortunately the
clinical trials for that on cancer didn t work out. It never quite lived up to peoples
expectations. That was a product in search of a therapy. It turned out being very small for
Genentech, where they never did more than $5 or $6 million a year on that, because it just
got approved for a tiny little indication, and as a cancer drug it didn t work.
But tPA was right down the center of the bowling alley. You put that in dogs with
clogged arteries, and it cleaned them out like that, [snaps fingers] It was really easy to see
that it was going to work. It was like Drano. [laughter] We had a package when we sold the
deal, where we had a picture of the dog before and after the tPA therapy, you could see in
just an hour that the arteries were cleaned up. That was one we were sure we wanted to
keep. There was nobody who had any thrombolitic therapy at the time. There was
streptokinase which was making a little bit of noise, but tPA ended up coming out as the
superior product there. Those were the two products that got us into the FEPCO strategy-
growth hormone and tPA, which was the first big product to be marketed in 1 986. The
unfortunate thing there was that people thought it would be a billion dollar plus product and
it never got to more than $300 million or so. [tape interruption]
Blockbuster Drug vs. Broad Technological Platform
Bugos: In conjunction with the FIPCO idea Genentech had a broad technological platform, so
broad that you later needed to develop your joint venture strategy. A lot of biotech
companies today pronounce that they have a broad technological platform even if they are
pushing one product. So your FIPCO strategy was built on this idea that you can have one
blockbuster product, at least big enough to justify the formation of the marketing force, but
at the same time you have this broad technological platform from which you can develop
many products. Did you see those two as inconsistent?
Middleton: They are both realities. What the broad platform allowed you to do was to outlicense a lot of
stuff. The way that Genentech functioned, from a revenue perspective, from 1979 to 1986
when it started to generate enough product revenues to make a profit, was-there was a lot of
stuff, a lot of creative minds. You can use recombinant DNA for industrial applications.
You can use it to make enzymes, so we did the Corning deal (Genencor). We did deals on
albumin and all sorts of other products that weren t central to our strategy.
We had our core five product programs. We tried to keep the five best ones. We would
look at all aspects of them. Does it make sense to get into manufacturing and marketing
them? When the pricing came out on tPA, it was premium pricing, over two thousand
Bugos:
25
dollars a dose, which was a huge price. Insulin wouldn t have been a good product at ten or
twelve dollars a dose. So we had a very broad product platform, but that was used to
generate the corporate deals which then funded the clinical trials and other programs for
Genentech s own products.
The industrial stuff all got licensed away, and eventually spun off. We used to have an
agricultural division which actually reported to me for a short period of time. That all got
sold to Ciba-Geigy for $45 to $50 million, so we could do something else with that money.
Even in pharmaceuticals, we got rid of some Pharmaceuticals. The neurosciences they got
out of because it s not central to their focus anymore. They got out of gamma interferon
because it was for an infectious disease, and they re not in the infectious disease business.
They re focused more now on cardiology, endocrinology, cancer. So biotech companies
today do focus more. Genentech s technology truly was one of the broadest technologies
I ve ever seen. And there were other people who were chipping away at parts of it as well.
When Cetus went publicwith a lot of hubris they tried to make the pitch that they re
going to be the industrial biotech company because that s a much bigger market than
Pharmaceuticals. Pharmaceuticals was maybe a three-billion-dollar-a-year market, but the
industrial market for this stuff was maybe forty billion a year. "So we re going to end up
being ten times bigger than Genentech." They actually said that on their roadshow. It s a
bunch of hooey. But there were people pursuing different aspects of the technology.
Brian Sheehan and Bob Byrnes were also on board when you developed the FIPCO strategy.
Did having good people like that on board lead Genentech to do the FIPCO strategy or did
Bob simply have this idea that to pursue a FIPCO strategy we needed to find people like
these?
Middleton: I d say it evolved. We didn t know what all the products were when we started out. When I
started there there were only two products being worked oninsulin and growth hormone.
Bugos: Not interferon?
Middleton: We were initially late on the interferons. Biogen had a start on interferons, and beat us to the
punch, but Genentech had a strong program. Turned out there were multiple interferons.
People didn t know that at the time. Turned out we discovered all these different kinds of
interferons. [David V.] Dave Goeddel was so focused on those. He discovered all these
subsets of interferon: "Well, this is an antiviral, and this is an antiviral, but it can t be the
right one because the sequence doesn t match what s published. So he kept going on it and
in reality he discovered all these new classes of compounds, which ended up being
Genentech s play in the sector did a deal with Roche in 1980.
It was a strategy to take these low hanging fruit and sell them off so that you can keep the
gems that we had a chance to develop on our own. We missed a couple. We missed
Epo[gen]. We could have had that one. It was on our screen. I forget the reason it was
overlooked. There was some researcher making the rounds with it. George Rathmann
picked him up, got the patent filed, and figured that one out. Nobody thought that artificial
red blood cells would be that big a market. He figured it out a lot better than we did.
Nobody at the time thought
that Epo would be bigger than tPA, for example. It was way bigger than tPA. But at the
time, "Something that cures heart attacks, boy!" Epo s something that s very broad,
26
and it s chronic. You only take tPA once, or twice, but you don t take it all the time. So it s
the difference between chronic and acute therapy. If you took tPA once a month it d be a
two billion dollars a year product, (laughs) But of course you don t do that.
Bugos: Why don t we end here for today?
Middleton: OK.
Genentech IPO
[Interview 2: August 22, 2001] ##
Bugos: I d ask today if we can focus on two main topics, the history leading up to the Genentech
IPO and as much detail as we can cover on the research and development limited
partnerships. The usual elements of the IPO story that I ve discovered are: the
recapitalization, which meant that everyone was going at the IPO with common stock; the
development of the Series B restricted shares for consultants and employees; what it took to
write the risk factors into the prospectus since this was an entirely new and unknown
industry; the alleged violations of the quiet period; the road shows; and how you decided
upon the share price. Could you touch upon those things as you convey the story?
Middleton: There s a lot of topics there. A fascinating few years of history. Last time we talked about
the private equity financing of the company, which was the Series A preferred stock rounds.
The financings with Kleiner Perkins, Mayfield, Wilmington Securities, Inco, and then with
Lubrizol. The Lubrizol deal was done in June of 1979. By 1979 the company had signed
several important contracts-one with Eli Lilly for the development of human insulin, one
with Hoffmann-La Roche in 79 or 80 for the development of alpha and beta interferon, and
one with Kabi for the development of human growth hormone.
Buzz about Biotech
Middleton: There was starting to be quite a bit of buzz about genetic engineering and interest in a
technology that would allow you to use genes to make commercially useful products that
might lead to whole new classes of drugs, whole new classes of natural compounds, foods,
industrial products, and so forth. It was a little like the early days of the Internet.
Programming life forms and using the machinery of life to produce chemicals that were very
complex, but found in nature, seemed to offer boundless horizons to the pharmaceutical and
agricultural industries. There was a fair number of articles that were published in Science,
both technical articles and review articles, and in the public press, in the New York Times,
Chemical and Engineering News.
The very first conference was held on biotechnology around September or October of
1979. It was put on by E.F. Hutton in New York. This is where the phrase biotechnology
27
was actually coined by E.F. Mutton s analyst, Nelson Schneider. Prior to that it was known
as gene-splicing or genetic engineering. Biotechnology became the vernacular. The industry
in 1979 consisted of only four companies who were invited: Genentech, Biogen, Cetus, and
Genex. Genex was working on industrial products and failed pretty early on. Biogen and
Cetus and Genentech became the early stories of the industry.
Late in 1979, Tom Perkins pushed the idea of a public offering. Although the technology
was young, and we were early on in the development of products, there was enough interest
in the public to get a public offering done. This was a foreign concept at the time. While we
had a couple million dollars in revenue--! think it was $3.5 million in revenues in 1979-there
were no product revenues or profits generated from products. Whether or not you could take
a company public that didn t have product revenue, didn t have commercialized products,
and didn t have significant profits, was an unknown. In the mid to late seventies, if
companies went public, they had revenues and earnings. You d have at least $10 million in
revenues and at least a million dollars in profit, then maybe you could have one of the small
high-tech underwriters take you public.
At the time the only real high-tech underwriters in San Francisco were Hambrecht &
Quist-Hambrecht & Quist was actually an investor in Genentech but a very small firm at the
time-and the old Robertson, Colman, Siebel, and Weisel, the predecessor to Robertson
Stephens and Montgomery Securities. Tom Perkins had a close relationship with [William
R.] Bill Hambrecht and George Quist, who was alive at the time. They talked about moving
ahead with an IPO. Perkins had an interest in liquidity. His early fund was finished at that
point. It was out of money, and he wanted to raise another fund-Kleiner Perkins H, maybe
Kleiner Perkins Caufield & Byers I. As I mentioned last time, Kleiner Perkins had two
major successful deals out of their first fund-Tandem Computers and Genentech.
Tandem Computers as a Model
Middleton: Tandem Computers went public in 1979, about a year before we did. Jimmy Treybig and
Jack Loustaunou, the founders of Tandem, used to work in a similar capacity with Kleiner
Perkins as had Bob Swanson. Sort of an employee, limited partner. They worked on a deal,
spun it off, and ran it. With Gene Kleiner and Tom Perkins s introduction, Bob Swanson
and I went down to visit with Jimmy Treybig, who was the CEO, and Jack Loustaunou, who
was the CFO. Jack was a very colorful guy. Retired soon after that, became a piano player,
had a wonderful apartment in Paris. Their IPO had been successful, raised a fair amount of
money, and it had been a large holding for Kleiner Perkins. They were looking to doing
something similar with Genentech. But there was still an unknown about the kind of
business we were. Tandem Computers was a fault-tolerant computer system that actually
generated revenues and earnings a reasonably conventional high-tech company. It was
taken public by C.E. Unterberg, Towbin, so [Thomas I.] Tommy Unterberg was one of the
parties that got introduced to us.
28
Picking Hambrecht & Quist
Middleton: In late 79, early 80, Perkins brought down several bankers. Tommy Unterberg of
Unterberg, Towbin came down, started to pitch us on how we would create a story to take
Genentech public. Bob didn t really take to him. He thought they were a little bit
promotionally oriented. Bob was a pretty conservative guy. We were all interested in
creating a company for the long term, not just to make a quick buck in the stock market. Bill
Hambrecht came down. Bob actually knew Bill Hambrecht, but Tom and Bill were more
contemporaries. Bill is a very likable guy and had a good balance of intellect, perspective,
objectivity, creativity. He seemed like a natural to work with. He really didn t have a clue
as to what gene-splicing was all about, and he d be the first to tell you that. He even said at
one point, Hambrecht & Quist will invest fifty thousand dollars even in something it doesn t
understand- [laughter] -referring to Genentech.
We took him on a tour of the newly opened facility at 460 Point San Bruno Boulevard.
We had a very colorful fermenter that was acquired from one of the pharmaceutical
companies back east, with all these different colored valves and pipes and dials. And then
we had several wet labs where people were doing gene-splicing experiments with centrifuges
and cooling and warming rooms. So Bill politely went around, saw the tour. Tom Perkins
asked him, "So Bill, what do you think of this operation?" Bill sort of looked around the
room for a moment, perplexed, not knowing what to say. Then he said, "Well, it looks like
$100 million to me!" [laughter] [in terms ofvaluation] Everybody broke up laughing
because that was all he had to say to get the deal for Hambrecht & Quist.
So Bob and I, with agreement from Tom and Herb, felt that Hambrecht & Quist would be
a great firm to work with for an IPO. Then we were interested in finding a big name firm on
Wall Street. We went around talking to firms, a number of whom I knew from my previous
jobs. We ended up selecting Blyth Eastman Paine Webber. Blyth had a tradition, in
California, as a big corporate firm. Gene Kleiner made that introduction to Bud Coyle,
whom he knew. Bud Coyle had worked on the seed financing for Fairchild Semiconductor.
Kleiner was the V.P. of manufacturing at Fairchild. Another interesting tidbit is that Arthur
Rock (the famous venture capitalist who financed Intel and Apple Computer) used to work
for Bud Coyle as an associate and did the actual phone calls which got Fairchild and later
Intel financed. He became the richest individual shareholder in Intel. So we started talking
with firms.
Swanson s Hesitance
Middleton: Bob had trouble getting comfortable with the idea of doing an IPO. Early on in 1980 the
company had a board meeting. Tom was pushing hard for an IPO: "I want you to know that
the timing is perfect. All the planets are lined up. Are we ready to go on this?" Bob said,
"I ve thought a lot about this decision to go ahead with an IPO. I think we ll be ready in
about a year, ready to begin working on our IPO." Tom had a fit. He thought he had it all
positioned, and ready to go. Bob was thinking a year out into the future; Tom was clearly
thinking next month. I remember he took a pencil and threw it down on the table and said
29
"That s the most ridiculous thing I ever heard. Why don t I just sell all my stock and resign
from the board. I think we ought to put this to a vote right now." It was Tom and Herb and
Bob in the room- a three-man board. I was attending as secretary. Tom asked Herb Boyer:
"Herb, how are you going to vote on this IPO thing?" Herb didn t quite know what to say,
then said, "Well, I always vote with my friends." [laughter] That kind of broke the ice and
everyone started laughing. It was a very political thing to say. They had an animated
discussion. Eventually, Bob came around to the idea of pursuing the IPO.
Attempting a Sale to Big Pharma
Middleton: Two other important events led up to the IPO. With the investors looking for liquidity, Tom
Perkins was pushing the notion of selling the company to big pharma~who really had the
resources, had the people, had the development capability to take this exciting technology
and commercialize it. With a little firm like Genentech-with fairly novice management who
had never developed a pharmaceutical product before, without the big money you would
need to do a clinical and development program-maybe the way to go was to sell the
company. So we met with Johnson & Johnson, who sent out their president. It was a very
friendly meeting. We floated the trial balloon that for around 80 million dollars we could
have a discussion. They essentially didn t respond because I don t think they had a clue as
to what to do with this technology-certainly didn t know what it was worth. They couldn t
fit it into a Band-Aid mold.
Bugos: Did you give them the 80 million dollar figure?
Middleton: Yes. We threw it out, but they never responded. We had a subsequent meeting with Eli
Lilly who was the licensee on the insulin. Again, Perkins chaired the meeting. This was in
Indianapolis. [Richard D.] Dick Wood was the CEO, the mystical head of Lilly, and a
conservative, high-brow guy. I presented and the other management folks presented to the
Lilly managers Gene Step, Neil Pettinga, Dick Wood. We floated a 100 million dollar
figure there. We figured insulin was a go. Lilly had those royalty and contractual
obligations, they could buy their way out of that. Plus they would get all these other
products-growth hormone, interferon, a number of other things. They didn t move ahead
either, though we had several discussions with their business development people after that
meeting. I think it was one of the worse decisions they ever made. They paid out hundreds
of millions of dollars in royalties to Genentech only on insulin alone. But their mentality
was "Not Invented Here." If we were to take a hundred million dollars and put it into our
own research labs at Lilly we could get a much better return on product development than
spending it to buy this new technology. Plus, we can go out and license this technology from
a bunch of other companies. So, that deal didn t fly.
Big pharma just wasn t going to be able to get their arms around this-partly as a result of
the not-invented-here factor, partly that it was too new and too different to be able to value.
It became clear that if we were going to create some liquidity for our investors and raise
some money that the public offering really was the best route. We reached that conclusion
by May or June of 1980.
30
Drafting the Prospectus
Middleton: We started drafting a prospectus, around June of 1980. It was filed in [looks at S-l on his
desk] August, September. The objective was to raise $20 to $30 million for development.
We didn t know all of the things we would be spending it on. We selected Hambrecht &
Quist and Bud Coyle at Paine Webber Blyth Eastman Dillon merged with Paine Webber
after our deal. Bud came out of retirement, schmoozed us all really well. He was a
delightful man, hadn t done a deal in a while. The thinking was to file a prospectus and see
if investors have enough interest to put in the money. We ought to be able to achieve a
valuation north of a hundred million. That was better than any buyout offer we didn t get.
The banker thought we could do that and sell 20 to 30 million dollars worth of stock.
The other thing Perkins pushed hard on~and let me add that he was definitely right on-
was that being first mover would have a significant advantage. Being the first company to
come out in a new hot area would really excite investors. He thought it was important to
come out ahead of Cetus, ahead of Biogen, ahead of Genex. All those firms did go public
after our deal. We filed, in July or August, and it did create a lot of interest. Here was this
new technology, here was this new company. There were pictures in the prospectus that
showed genetically engineered products in a bottle. No one had even imagined that. A lot of
people were skeptical, doubted that it was even real: "It s probably just talcum powder that
they put in a bottle." Well, the lawyers and the SEC don t let you do stuff like that, but
that s what a lot of people thought. We showed people photographs of microbes swelling up
with manufactured protein. Some were skeptical that it was real. But many more were truly
amazed.
Examiner Interview and SEC Response
Middleton: The media picked this up and developed it into a frenzy. I did the interview for the
Examiner. I must say no one properly tutored me in the behavior of the quiet period. My
understanding was that you were allowed to talk to the media so long as your comments were
limited to anything that was in the prospectus. Since I had written the prospectus, I knew
what was in the prospectus. So I answered questions. They wanted to come down and take
some pictures of the company, so we let them do that. We had several good pieces of media
in the past. What I hadn t realized is that they went back into the archives and pulled out
stuff on the company that was previously in the media, but was not in the prospectus, such as
a quote by Bob Swanson that in five years we ll be a hundred million dollar company and
profitable. There were some financial goals. Those goals and some previous facts and
figures were picked up and attributed to Bob as though he was making those statements in
the current time. When this article came out we were dumbfounded with all of the stuff that
they had put into it that went way beyond just answering questions about the prospectus.
That s what got us into hot water with the SEC~the so-called gun-jumping claim. Some
of our friendly competitors sent this information along to the SEC. Because of all the stories
31
in the media, the SEC thought we were out there actively hyping the deal. Other than this
one interview, we hadn t talked to the media at all. The only reason we talked to them then
was because it was in response to our filing. We put out a press release that we were filing
an S-l and this was in response to that press release. In retrospect we shouldn t have said
anything. The SEC sent us a letter saying they were going to refer these activities to the
enforcement division: "We re going to put your filing into hiatus for a couple of weeks to
see how things develop." That was pretty ominous. Maybe the deal just got killed. Maybe
I ll be out of a job in two weeks. I was the obvious fall guy if things had gone wrong,
because it was my picture and my interview in the paper.
We had hired Lee Benton and Bruce Mann, who also represented Kleiner Perkins and
who had good contacts at the SEC. We went back to talk to them. Several memos were
prepared about all of the contact we had had with the media. About the naivete of
management- We had behaved appropriately, with one exception. We hadn t been guilty of
trying to hype and promote the deal. Ultimately, the SEC relented and let us go ahead with
our roadshow. They were going to take up our filing for active review; they weren t going to
put it on ice anymore.
Roadshow Honeymoon
Middleton: So we did the roadshow in September of 1980. The response was overwhelming
everywhere. People just listened and gaped. Herb got up and told a joke and did his tricks
with the pop beads showing how recombinant DNA works. I don t know if that little toy is
around somewhere. Basically, we had a little clear plastic box with pop beads in it the baby
toys that popped together. It was supposed to represent a bacterium. He took out the beads
and showed how you spliced genes together. A very simplistic little model. The fact that a
UCSF professor was up there explaining it had everyone mesmerized. I gave the talk on the
financial side, Bob gave the talk on the strategy, Herb gave the talk on the technology. It
was pretty elementary. Every time we asked for questions there weren t any. People didn t
know what to ask. There were no experts, there were no analysts. Everybody was just
amazed.
The other point that was interesting was that Bob Swanson got married in early
SeptemberSeptember third or fourth. He ended up taking his wife (Judy) on the roadshow.
He went over a couple days early and she sort of rode around with us. It was a combination
roadshow/honeymoon.
Pricing the Shares
Middleton: The filing range on the prospectus- Initially, we were looking at twenty dollars a share.
Because of the extreme interest, the bankers said we could probably name our price. But we
don t want to be too greedy. We want to do what s fair, we want to do what s right. So we
put a wide filing range of twenty-five to thirty dollars a share in the prospectus. Sold a
32
million shares to raise our 25 to 30 million bucks. Sounds great. In 1980 that was a lot of
money. It s worth about five times that today.
Then we had the pricing committee set up, which was Bob and Tom, and one of the other
directors, Don Murfin. I participated in it. One of the bankers, John Dakin, who was the
partner and head of the syndicate department at Hambrecht & Quist, said "We ve never seen
interest like this before."
##
Middleton: He said "We don t even take calls anymore about Genentech. We know that if we answer
the phone, or call them back and start talking about the Genentech deal, they re only going to
be disappointed. They re only going to be mad at you for not getting shares or more shares.
So we re not even calling them back anymore."
So how do you price this deal? Bill said we could price it at whatever we want. People
will buy it. It s an incredible statement. We were advised by counsel that we shouldn t go
more than five dollars outside of the range without having to refile. It s a regulatory
consideration. One of the things we could have done, which we didn t think to do at the
time, was to sell more shares. So we priced the deal at $35. It opened the next day at $82,
went to $89, closed at about $71.50 the first day. That was the "Genentech Jolts Wall
Street"
story, [points to a framed copy of the San Francisco Chronicle with that banner
headline]. It was the hottest deal in ten or fifteen years and held the record for the hottest
deal for quite a while.
I always like to tell people we raised $35 million in capital and $35 million in goodwill,
(laughter) Even to this day, everybody who got some shares on the Genentech offering will
tell you about it. I used to run into people who would say, "My
broker gave me fifty shares
of Genentech on the offering. He sold it right away and made me a thousand bucks. That
was such a great experience. I m finally glad to have a chance to meet you guys."
So I think
we really did raise $35 million in goodwill. It would have been nice to get that $35 million
in the company, but we did eventually. Briefly, that s the story of the IPO.
Bugos: OK. On the stock price issue. After that the stock settled for a year around that EPO price,
which made everyone think you were actually precise in figuring out how to value it.
Middleton: Yes. What happened was it went up to about seventy-one and then it slowly settled down. It
came down into the fifties, forties, then stayed in the high thirties. The bankers told us you d
like to see the price go to a 15 to 20 percent premium. Then after the offering, everyone
would be happy. Your investors would be happy, your company would be happy, and you
create a positive environment for trading in the stock.
Fluor Corporation and Trading Volatility
Middleton: Genentech stock was highly volatile because there weren t that many shares outstanding.
We were subject to a lockup, a ninety-day lock, meaning the insiders couldn t sell. Then
33
there was a lot of skepticism about people dumping shares people like Boyer, Swanson,
Lubrizol, and Kleiner Perkins. With Kleiner Perkins, people understood that they were a
venture fund and they were going to distribute their stock. But investors were a little worried
that there were only a million shares out there trading and another five million shares that
could be dumped on the market by people who didn t have any money. It didn t matter to
them if they sold it at forty or twenty-they d still sell it to create a little cash for themselves.
One of the ways we dealt with that- We had a corporate investor, Fluor Corporation.
They had actually offered to buy the whole public offering. They were interested in the
plants that would be built to make genetically engineered products. They had identified our
sector as a strategically important future area for engineering and construction. Anyway,
they couldn t participate in the offering, but we told them after the offering that they could
probably buy stock from the holders before it was put onto the market. They offered to buy
up to 15 million dollars worth of stock at forty dollars a share. That was a little over the
market price. Actually, they made that offer when the stock was at trading at forty-four,
forty-five. And we said "Why would we sell it to you at forty when it s at forty-four in the
market?" They said "It s not going to be at forty for long if you start selling it. So forty is
our price. Take it or leave it." We decided it s worth doing something here.
We went around to everybody in management, including Boyer and Swanson and some of
our institutional investors. Lubrizol didn t want to sell any of their stock. Management
didn t sell a lot. Some people sold maybe 10 percent of their position. We were able to
shake loose all of the shares that were likely to be shaken loose and sell them to Fluor.
When we announced that deal the stock initially went to forty, but then it went back up when
people realized there wasn t going to be a big overhang of shares dumped onto the market,
because these guys at Fluor have bought them up. So that was a good way of dealing with
the aftermarket.
Underestimatine Manufacturing Costs
Middleton: The other thing we realized soon after the public offering was that with the green shoe [the 1
percent oversubscription], we had raised about 38.5 million dollars. That seemed like a lot
of money, but we were just completing our feasibility study on the first plant that we would
be building to manufacture products~a place for growth hormone and tPA, and we were
thinking gamma interferon because we had a supply contract with Roche. Fluor was helping
us with this project, and we had hired [William D.] Bill Young from Eli Lilly. He had been
in charge of their plant development program for human insulin. The Lilly people were mad
as hell that we hired him, and they wouldn t let us near their place after that. He was doing a
study that showed just to build the basic infrastructure for this plant it was going to cost
somewhere between $35 and $40 million. That s without all the equipment in it. In one
shot, we had a use of proceeds for a hundred percent of the all the money we had just raised.
34
Private Placements
Middleton: We realized we d need a lot more money than we had just raised. That s when we went on
to do several other deals. We did a 20 million dollar joint venture deal with Corning Glass.
We did a joint venture called Genencor. Then Coming, to cement that deal, which they were
very interested in, gave us $20 million for an equity investment.
Bugos: Which went directly into Genentech?
Middleton: Which went into Genentech, right. We also did a private placement with a group of Swedish
institutions, where we raised another $20 million. And with a group of Japanese institutions,
we raised another eight. This was all after the IPO, between 1980 and 1982. The market
was not really great then. It was not strong enough for us to be doing a follow on, so we did
these private placements. That was a little nerve-wracking. Here you had the hottest deal in
history, and a year later the bankers thought the timing wasn t right to go back and raise
more money in the public market.
Bugos: Did you actually do the Japanese placement at a down financing? I calculate that at thirty-
one dollars a share whereas the Swedish and Corning placements were at thirty-five.
Middleton: Yes. It was down a little bit, but it was restricted stock. We insisted with Corning that
thirty-five was a minimum. With the Japanese deal, we ended up having to price it on the
average trading market. They couldn t figure out any other way of doing it, but they were
locked up for a year or two, and they got 144 stock. We didn t like the pricing formula, but
we figured having the relationships with the Japanese investors in the long run was more
important, because it was a big market for biotech. In fact, the company did several hundred
dollars worth of deals in Japan. So it was a good decision, but it was kind of a down round.
At the time, people didn t really know what the Japanese investors paid. It wasn t disclosed.
The formula was disclosed but the price wasn t. So nobody knew that we sold the stock for
less than thirty-five.
Bugos: And these were all equity deals. You didn t consider debt or convertible shares?
Middleton: No. It was too early for that. They were all straight equity deals, straight common stock.
Bob liked to do plain vanilla deals. They weren t preferred stock deals, they weren t
convertible debt deals.
Premium Market Capitalization
Bugos: Just dilution that you had to worry about?
Middleton: Yes, just dilution. While we were doing these equity deals we were also doing some very large
corporate deals. The Roche deal in 1980 had quite a few significant milestone payments for
the alpha and beta interferon project. We did a deal with Mitsubishi for something like 50
million dollars. There were deals with Daiichi Seiyaku and Kyowa Hakko.
35
We d sell the product three times. We d sell it in Europe, we d sell it in the US, and we d
sell it in Japan. We could sell it for about three times what it cost to develop, just because
people were interested in getting access to it. The company was actually profitable, based on
these corporate deals, from 1980 until about 1986. This was quite an accomplishment because
we were the only company that was profitable, by far. This helped create a real premium price
for Genentech in the market. We were marginally profitable, but our market cap was between
five and ten times our nearest competitors market cap. And we were able to maintain that
market cap that whole time. We were viewed as a much higher quality company because we
were able to manage an income statement and a balance sheet. People weren t concerned
about us taking a lot of stock dilution, because we were very careful in the stock deals we did.
The company didn t do a single follow-on offering until 84 or 85, quite a while after the IPO.
I wasn t there anymore. It was because of the R&D partnerships.
Down Market for Biotech: Cetus and Biogen
Bugos: Before we start that-one reason the biotech market was down in the year following your IPO
was because other companies, particularly Cetus, had spectacular offerings. Spectacular mostly
because they came after you. Cetus and Biogen were not as well managed and there was some
concern that they might not last. Was that part of Perkins s thinking in wanting you to get to
market first?
Middleton: Yes, I think it was. And you re basically correct. It sort of backfired in that regard. Our deal
was so hot, so successful, and in such short supply. It created a huge afterdraft, an opportunity
to take other companies out.
Cetus came along, with Unterberg, Towbin as the underwriter. Tommy Unterberg was
really pissed that he missed the opportunity to take Genentech public, so he started working
right away on the Cetus deal. I guess [Michael S.] Ostrach in The Partners talks about
Genentech, though he was at Cetus subsequently. Cetus had put together a litany of
arguments, one of which was that they were interested in industrial biotech: "The industrial
market is a 30 billion dollar market, the pharmaceutical market is only a 3 billion dollar
market, so Cetus offers ten times the opportunities to investors that Genentech offers." Plus,
"We
got more people, we got more Ph.D.s, we d been around longer, we got more Nobel
laureates on our board." The reality is that their technology was not anywhere near as
advanced. Their staff wasn t in the mainstream of what biotech was working towards. But
investors couldn t figure this out. So Cetus went out and raised over 100 million dollars based
on this pitch-sold five million shares rather than a million, at about twelve bucks. It gave
them a huge war chest. They had another $20, $30 million in the bank as a result of some
deals they had done with big oil companies. So overnight they had $140 million in the bank.
We had $50, $60 million in the bank. They were a threat. But investors didn t make money on
that IPO. They were under water almost immediately, and I don t know if investors ever made
money on the Cetus IPO.
Cetus had creamed the market in terms of absorbing all the available capital. Then Biogen
went out. They had a reasonably good technical story. They had a couple of good managers
36
they had brought in, plus Wally [Walter] Gilbert. They managed to get their deal done. Their
deal was not a real hot deal. I think they raised $30 or $40 million. They were probably the
worst managed of the companies, because they had huge losses and an unmanageable
corporate structure. But they had good technology.
The Cetus management was guilty mostly of overpromotion. They were promising what the
market wanted, without really having the goods. Subsequently, management there was fired.
This did create disappointment that made it hard for biotech companies. That was one of the
reasons why we had to go and do these private placements and corporate deals.
We had less cash in the bank, but we were doing more corporate deals at a better rate,
getting good values for the sale and licensing of our technology. And remaining profitable
every quarter, doing a good job on investor relations, and we were doing a good job explaining
our story. "Measure us on these benchmarks. Come back at the end of the year. This is what
we got done against those benchmarks. These are our benchmarks for next year."
Then we
started to create a track record that people could follow. They couldn t really follow our
revenues and earnings, because they weren t completely related to our product progress. They
were related to deals. But investors started to think that this is an interesting pipeline. Any
one of these things hits and this is going to be a hugely successful investment. From about
1980 to 1985, Genentech developed a really good shareholder base of institutional support
with a premium value. Everyone who had bought stock in all these deals, whether they were
the private placements or the public offerings, had a pretty good gain. Everybody was
convinced they could make a pretty good return in the future as well. People were saying there
was Genentech and everybody else, in terms of market value. That changed when tPA turned
out to be a smaller product than was hoped, and when Amgen succeeded with erythropoietin
and G-CSF, which were both billion dollar products. Just based on pure revenues and earnings
Amgen became the most valuable biotech company.
Biotech Analysts
Bugos: Were there analysts working in that early period in biotech whose judgments would stand the
test of time, who were writing good reports, understanding the bigger story?
Middleton: The very first Genentech analyst was David MacCallum. One of the reasons for selecting an
investment banker is to have a good analyst. Dave MacCallum was the pharmaceutical analyst
at Blyth Eastman Dillon, I think from Mitchell Hutchins. He s still on Wall Street today; he s
a veteran. He s been head of health care banking at H&Q, UBS Warburg, and Salomon Smith
Barney. After his first visit to Genentech in 1980, he got it. He said "This is really interesting.
If you re able to make pharmaceutical products with this technology, you can create a company
worth several billions dollars. I see how you can do it." He was able to look out five or ten
years and see a scenario that made sense to him. We had an immediate rapport with him.
The analyst at Hambrecht & Quist was Annette Campbell-White, who was a newly hired
analyst. She s a venture capitalist today. She has her own firm called MedVenrure
Associates. We still co-invest with her. A brilliant lady. A strong-willed lady. She didn t
37
always hit it off with Bob, but she and I got along great. She asked tough questions; Bob
didn t take too kindly to people asking tough questions. He liked people who would hear it the
way he wanted to tell it. But she did a nice job as well. Those were really the first two biotech
analysts. David MacCallum s reports have definitely held the test of time.
Government Regulation
Bugos: Let me ask another broad contextual question that gets back to how you wrote the S-l, and
specifically the risk factors in there. More specifically, government regulation. At this point,
from the academic scientist perspective, there was a lot of debate over whether biotechnology
should be owned by private corporations at all, but the finance people don t seem at all to be
affected by that more theoretical debate. Diamond v. Chakrabarty was allowed just prior to
your IPO, so how important were patents? And finally, the fear of genetic engineering. I
assume part of the reason you needed to spend so much, unexpectedly, on your facility was
because class HI containment was still required. So what s the story about government
regulation and whether you d be able to pursue your business plan?
Middleton: A lot of those things were uncertainties. The Chakrabarty decision demonstrated that you
could get patents on novel life forms, and predated the IPO. We had enough evidence for
people to believe that we could get proprietary rights to technology. Actually getting the
patents, and the extent of those patents was still a risk factor.
The academic controversy was largely ending. The recombinant DNA controversy goes
back to the early seventieswhether you should do genetic engineering at all, whether bringing
new life forms into existence was a good idea. It s similar to the stem cell controversy today.
In my view, you weren t really creating new life forms, you were creating modified life forms
that were much weaker, but could make the products you wanted to make. It was microbe
slave labor, that s how I would describe it.
(laughter) You let them out of a fermenter and
they die. They re spending most of their energy doing something which is non-productive for
the microbe itself.
Bugos: Boyer was focused on quasi-synthetic DNA-part natural recombinant, part synthesized DNA.
Did that help you avoid that whole controversy?
Middleton: Yes, it did. There was a recombinant DNA advisory committee and an NTH committee. The
furor was settling out. They could have passed laws to prohibit work in this area, and that was
the big concernthat they would. They didn t. Boyer and Swanson spent some time as
lobbyists trying to convince politicians to do the right thing. They got an audience with
[Senator] Edward Kennedy and a few others. They headed off legislation to outlaw the
technology. That would have stopped Genentech in its tracks. That risk was gone by 1977 or
so. It was no longer a real political risk after that. There was still the perceived regulation by
the NTH, which you can read about in the risk factors which I just pulled up here, [looks at the
1980 S-l] It had to be done in the right ways. You had an NIH ethical, scientific review.
38
FDA Regulation
Middleton: Then, of course, the FDA process had to do with the regulation of drugs; how you make them,
are they safe, and do they work. There was a very big regulatory risk-whether a small
company could have successfully dealt with all these things to get a product approved. It
turned out to be a bigger risk factor than management thought it would be at the time.
Genentech had a fair amount of trouble with the FDA in its early days. With growth hormone,
the trials went on a year longer than what we had originally hoped they would. The reviewer
there was very tough and there was a lot of argument back and forth with Swanson and our
regulatory people.
With tPA, the same thing. At the advisory committee meeting there was some internal
political haggling over whether it was a biologic or a new drug. We had done this great
clinical trial which showed that it dissolved clots, then the panel and the FDA debated whether
dissolving clots was a basis for therapeutic approval. Maybe it should be a decrease in
mortality; that s the real goal if you re treating heart attack victims. It s not whether you re
dissolving clots and restoring blood flow but: "Are
you increasing their life span?"
It s a
totally different clinical trial than what we had done. Most people thought, including the
clinical manager, that if you can open up an artery that s blocked in the middle of a heart attack
that it would essentially bring a person back to life. He can get up and go home. That is an
indication of a successful drug. But the expert, outside advisors to the FDA advisory board
didn t agree with that. We almost got into a shouting match over this. The company got shot
down. It took another twelve to eighteen months of politicking at the FDA-backroom
discussion~to work this all out. The company s approval was delayed about a year.
The risk factors associated with regulation were quite serious and continue to be. It was
particularly difficult because we were the first ones through, and we didn t have any
experience in working with the FDA. And the FDA didn t have much experience in reviewing
recombinant drugs.
Bugos: You were doing all your initial new drug applications yourself?
Middleton: Well, we had consultants, but there weren t CROs like there are today-clinical research
organizations. We were just naive. The big drug companies had close relationships with the
reviewers, they go to meetings, talk to them continuously, take them out to lunch. They know
how they think. We were showing up in Washington, for the first time, with the guidebook,
learning how to fill out the forms. People in Washington, being bureaucratic, being skeptical
of this small company from California-took a very tough and somewhat adversarial position
with us. Their attitude probably was "We re going to show these kids a thing or two about
what you have to know to get a drug approved in this country." [laughter] All that s changed
in the succeeding years. The FDA works pretty well with small companies today.
##
39
Middleton: The other risk factors that were important here was the amount of capital the company would
need, that it would take a while for the company to achieve profitability. The capital
requirements to support R&D and get into manufacturing might be beyond the ability of the
company to finance. Those did turn out to be significant items-trie host of financing vehicles
that needed to be created to provide that capital, until the acquisition, or investment, by
Hoffmann-La Roche in Genentech, which brought close to a billion dollars into the company.
The Genentech deal with Roche was the last deal it ever had to do to raise money. It never had
to raise money again after that, did not have to subject itself to the fundraising vagaries of the
public markets. That was ten years after the IPO. But while I was there, as CFO, I worked on
a lot of different approaches to raising money. That leads us into the R&D partnerships.
R&D Limited Partnerships
The Need for Clinical Trials
Bugos: Yes. Why don t you tell us about how the clinical partnerships were conceived, the laws that
preceded it, how they came and went.
Middleton: I described earlier the IPO, and the several private placements we did with large corporate
investors in the US and internationally. There was still a big need to fund clinical trials. In
order to be a successful FlPCO-fully integrated pharmaceutical company~you have to be able
to pay for and manage clinical trials. This was clearly something that was the purview of big
pharma, like Eli Lilly, Hoffmann-La Roche, Schering-Plough, Pfizer, Merck. Syntex was
maybe the last new pharmaceutical company that was started, and that was successful, based
on birth control drugs. You had to have the people to manage the clinical trials, but you also
had to have the money. The big companies were not going to give you the money to do the
clinical trials for products that you planned to market yourself. They would only pay for the
clinical trials for the products that you had agreed to license to them. The only way to build a
company long term is to be able to make and sell your own products. You have to do your
own clinical trials to get to that point.
Genentech had three or four new products. It was working on growth hormone, interferon,
tPA, and several other molecules. Those clinical programs were estimated to cost as much as
150 to 200 million dollars. That was a massive amount of money compared with even the $35
million that we raised in the IPO. We had product deals on these compounds with different
companies, primarily for international rights. But in the US market we would have to run our
own clinical trials.
The idea of the R&D clinical partnerships was born. The first R&D partnerships were done
on technology-based companiesin semiconductors. The IRS had determined that under the
tax code, and there were several court cases on this, that if an investor entered into a
partnership that spent money on R&D, then the tax deductions associated with the R&D
expenditures could be passed through to investors, so that the investor could take the deduction
on his personal income tax form. That was just the way the tax law worked in the seventies.
40
The notion of the R&D partnership was: get the money in from the investors, spend it on
R&D, the investors take the deduction. Then if something came out of the R&D, split the
fruits of that harvest between the investors and the company interested in commercializing the
product. There were several ways of doing that. One of the ways was for a royalty on the
product. For a pharmaceutical product, you could have a 5 or 10 percent royalty. If the
product did maybe $250 million a year, average success, a 10 percent royalty is 25 million
dollars a year. Maybe you raised 50 million dollars on that partnership, so you re getting a 50
percent cash flow return per year, for every year that that product is generating a royalty, plus
you re getting your original tax deduction. That was the concept.
So I was thinking, there are a lot people who are interested in this technology, a lot of
doctors. Doctors make a good living, they re in a high income tax bracket. When we started,
the tax rates were something like 70 percent at the marginal rate, then they went down to 50
percent at the marginal rate. Even at 50 percent, if you can deduct a hundred thousand dollars
and save fifty thousand dollars, that s a huge tax savings. Why not sell this to high net worth
individuals? Tax shelters were a fairly big business, and you could get the tax shelter benefit
and still play on the upside benefit of biotech if the product was successful. Doctors were
familiar with-in the example of tPA-cardiologists were familiar with this new product and
can make some judgment about whether it s going to work. They talk to their friends. They
say this is the best thing we ve seen in a long time Maybe they ll buy it up. We put pretty
detailed projections in this document, and maybe they d make a 6, 7 percent royally for fifteen
years.
Getting Investment Banks to Sell R&D Partnerships
Middleton: We took this idea to Blyth Eastman Paine Webber and Hambrecht & Quist. A totally novel
concept. They had never marketed one of these before to anyone. Other firms had, these two
firms had not. Merrill Lynch had done one with Gene Amdahl. Paine Webber had not done
R&D partnerships, but they had sold tax shelters. They had a tax shelter department. The
biggest tax shelter investments were real estate, oil and gas, and leveraged leasing. Most of .
those were tax driven. R&D partnerships were really more investment driven. You look at
what you re going to get out of it. The tax benefit is a leverage factor. If you re going to earn
a 20 percent tax flow return, then with the tax deduction thrown in, that 20 percent becomes 40
percent because you re only working on half the investment base.
So Paine Webber agreed to take it on, as did Hambrecht & Quist, although they did so very
reluctantly. "We ve never marketed one of these before, and we don t really know what to do
with it."
Anyway, Tom Perkins twisted their arm and they came into the deal. Tom, very
much to his credit, said for the very first R&D partnership we marketed, "I m going to buy a
million dollars of this for myself because I think it s such a great investment." He stood up
and said this in front of a bunch of brokers who were out to visit the company. That really got
people excited.
Initially we tried to sell it to institutions. The institutions liked the story, they liked the
company, so they went out and bought the stock, [laughter] So the stock, during our roadshow
in 1982, went from about thirty-two up to forty-six. "Wow, this is a great story, a great
41
product. But we can t buy an R&D partnership. That s not the kind of security that we invest
in." So they bought the stock. Then people started thinking we ought to have a stock offering,
but if we announce that we re going to have a stock offering then the stock will go down again.
The deal wasn t selling very well on the basis of a royalty, because it was an unknown vehicle.
Then Paine Webber came up with the idea of, "Let s sell this to high net worth individuals,
investor by investor." That means you have to go out and meet with them, take a bunch of
doctors to dinner, explain why this is a good investment so they can make up their own mind.
The whole management team marketed the first R&D partnership, Genentech Clinical Partners
I, which was for gamma interferon and human growth hormone.
The other thing we decided to do, to sweeten the deal, was throwing in some warrants on
Genentech stock. We debated about whether it should be stock or warrants. I thought that
getting the royalties plus the warrants was too rich a deal, because you were assured of getting
a ride on both. My argument was to give investors a choice. They could take either the stock
or the royalties. These partnerships all had a buyout. The company has an option to buy the
technology back. The consideration paid for the buyout is the royalty stream or whatever other
consideration is negotiated. So it seemed to me that it was a better deal to offer them one or
the other. If the stock price was up by four times they could make four times the money at the
time of the buyout in three yearsapproximately three years; it depends on when the results of
the technology were completed, [tape interruption]
Returns to Investors
Middleton: So when the deal didn t initially sell, we put in the stock alternative. In the case of Clinical
Partners I, for a fifty thousand dollar unit, you got your choice of either a product royalty for
twelve or fifteen years, a 5 to 7 percent royalty on growth hormone and gamma interferon. Or
fifteen hundred shares of stock, which was worth about fifty thousand dollars in 1982. And so
if the stock went up four to five times, you get a buyout worth two hundred to two hundred and
fifty thousand, plus you got the initial write-off of fifty thousand dollars. It turns out that the
stock did go up about five times, and Genentech did cash out the R&D partnership for all
stock. Actually, it went up a little less than that, and they offered people additional shares if
they would cash out so that they could get rid of the royalty obligation. Investors in Clinical
Partners I made about five times on their moneyfor the fifty thousand they put in they got two
hundred and fifty thousand in stock. On the basis of a twenty-five thousand after-tax
investment, that was a ten times return on their investment. So that turned out to be a great
deal for everybody.
Genentech Clinical Partners n was raised a year later, in 1983. We raised 34 million
dollars to fund tPA, which was the third product that Genentech took into the clinic on its
own. Same deal there. You could take a royalty or, in that case, a thousand shares of stock.
Because the stock had gone up in a year, they only had to offer a thousand shares rather
than fifteen hundred shares. That thousand shares of stock, by the time this deal was ready
to be bought out, was worth about two hundred thousand dollars. So four times the fifty
thousand dollar unit, or eight times an after-tax cost of twenty-five thousand dollars. These
two partnership deals which totaled about 90 million dollars of investment-returned an
42
average of four to five times, 350 to 400 million dollars to investors. Right about the time
Genentech was introducing tPA into the market in 1986 or 1987, they bought out the R&D
partnership.
Third and Fourth Partnerships
Bugos: How did the third one do?
Middleton: The third one was done just after I left, [laughter] They did two more R&D partnerships.
Investors made money on all of them, is my understanding. The third R&D partnership was
for tumor necrosis factor [TNF], which was a product for cancer. Very toxic material. The
problem was that it was too toxic to give to patients. The company decided to buy back the
technology for a nominal amount of money. We had switched over the structure to offer a
combination of royalties plus warrants. My understanding is that investors made one-and-a-
half times their money by virtue of the fact that the warrants were in the money. Then
Genentech bought the technology back. The partnership was about 50 million dollars, and I
think Genentech paid them $15 million, so they got some cash back plus the value of the
warrants.
The fourth partnership was on CD4 for the treatment of AIDS. It also didn t have
tremendous efficacy. It didn t work as a product. But the investors got their money back by
virtue of the stock appreciation, as well as through the warrants. I don t know the exact
returns on the last two because I wasn t with the company when those two were done.
Bugos: They were structured the same and their returns were dependent upon the success of the
product?
Middleton: In those cases, they got the royalties plus a warrant. In the first two deals you had a choice.
You could take the royalties or you could take the stock. In the latter two deals you get the
royalty and you got warrants on the shares. There were accounting and tax reasons why it
was advantageous to shift to warrants, so it was a different structure.
Bugos: And in terms of returns to the company?
Middleton: Through all those R&D partnerships they raised something like 200 million dollars. It
allowed them to fund the clinical trials for five products, three of which were successful
commercially. Growth hormone and tPA were the principal source of product sales for the
company from 1985 until 1990, which was the time the company got bought~60 percent for
$2.1 billion. Investors tend to value companies in the pharmaceutical industry between six
and ten times revenues. So it was a tremendous way to finance products and successfully
build a FIPCO.
43
End of R&D Partnerships
Middleton: The Tax Reform Act eliminated the ability of investors to deduct R&D expenses on their
personal returns. So the R&D partnership was killed by Congress in 1986. There was no
advantage any longer to forming a partnership to take a tax write-off. As a quid pro quo for
the elimination of all those tax shelters, the marginal tax rates went down. There was less
desire for people to buy tax shelter investments.
Morgan Stanley Research Venture Partners
Middleton: After leaving Genentech in 1984, 1 managed an R&D fund for Morgan Stanley, which I
raised in 1984~about a 40 million dollar fund. We did ten deals, three of which were pretty
successful: IDEC [Pharmaceuticals], Silicon Graphics, and Genetic Systems. Two of those
involved funding clinical trials. One involved funding product development of a chip set
that was used in Silicon Graphics computers. That was the last institutional fund that was
raised. Returns were OK; they weren t fantastic. IDEC and Silicon Graphics were great
long-term investments, and Genetic Systems was brought by Bristol Myers at a profit.
There really was no advantage to using this structure any longer because the tax advantages
were gone. You might as well finance just using straight equity.
What was the fund called?
It was called Morgan Stanley Research Venture Partners.
And Midvest?
Bugos:
Middleton:
Bugos:
Middleton: When I left Morgan Stanley, Midvest was the name for my own venture activities.
Bugos: OK, so when you raised the Morgan Stanley fund, that meant that you sold these
partnerships to high net worth individuals?
Middleton: It was a pooled fund. It was the evolution of this concept to a blind pool. There was lots of
tax and legal advice that we needed. Rather than taking these deals and selling them to
people, we created a pool of capital. We wanted to do $100 million, but we only got forty.
We take the cash and go out and do these R&D funding transactions. They pass through all
the R&D expenditures, to investors, who get a market basket of projects. There will be
some royalties, there will be some warrants, there will be some buyouts for cash. Sort of
like a venture fund.
44
Genentech Development Corporation
Hugos: OK. Genentech Development Corporation was created to manage the clinical partnerships.
I assume these high net worth individuals were limited partners, that they were fairly silent
on telling Genentech how to pursue its work.
Middleton: Genentech Development Corporation was the general partner. The structure is laid out here
[refers to the prospectus for Genentech Clinical Partners]
1
.
Basically, Genentech
Development Corporation, which I was president of, was a subsidiary of Genentech. It was
set up to be the corporate general partner for these entities. Genentech Development Corp.
had the responsibility for administering the partnership, but it was basically a holding
company. The investors came in as limited partners.
Then there were a series of contracts. The partnership contracted with Genentech
research labs to do the research. They would give Genentech the money as it would come
in, Genentech would perform the research on a best efforts basis-doing the clinical
research, getting the products ready, getting them into the clinic. Then the partnership
would own the rights to these products. If Genentech was ready to commercialize, then
Genentech had an option to license these technologies from the partnership that paid for
them and owned them. Genentech would sell the drugs for maybe a hundred dollars, then
pass back eight dollars of that as a royalty to the investors and keep the rest. So Genentech
became a FIPCO. They controlled the manufacturing and the marketing and the profits
from the drugs. And they just had to pay investors a royalty for the money that they put up.
Risk and Expense of Clinical Trials
Bugos: Why was it for clinical trials? Could Genentech have done the same thing at the more basic
end of the research spectrum?
Middleton: The answer is yes. You could have, but the pay-off would have been a lot further into the
future. There were some basic research partnerships done, but one of the rules for the tax
deduction was that the R&D had to be pursuant to a commercial purpose. If you re just
doing research, and there s no product coming out of it, it s a little harder to show that it s
pursuant to a commercial purpose. You do the clinical trial, then at the end of the trials you
know if you have a commercial product. If you have a commercial product, then you can
start paying a consideration. If you re doing basic research, you get into a clinical trial, but
you still don t have any revenue that you can compensate investors with. You have to do
another two or three years worth of work. That s why we thought it was ideally suited to a
clinical trial.
Bugos: It isolated that particular risk?
Middleton: Right, which is a really big risk. It s a huge risk because when you start a clinical trial you
have to finish it. A clinical trial is $30, $40 million. You either hit oil or you hit a dry hole,
[laughter] You are sharing risk. The latter two did hit dry holes-TNF and CD4. But
See appendix G to this volume.
Bugos:
45
when these two hit a dry hole, it didn t bankrupt the company. If the company had spent all
of its cash on a clinical trial, had nothing left, and it was a dry hole, the company would
have been out of business, because it wouldn t have been able to raise any more money. So
it was like a giant oil drilling project. They hit two pretty good gushers here, one smaller
one, and because these worked out so nice, investors were willing to put in more money for
the next two. Investors came out whole on those. They didn t lose money. But the era was
over on these by 1986.
In addition to forecasting the revenues for the product, did you forecast the amount that the
clinical trial would cost? There are differing amounts raised by each partnership. Was the
partnership limited in the amount that it could raise?
Middleton: Yes. There s a whole provision in here on what happens if you don t have enough money.
If the trial was going well, the company would have an incentive to pick up the remainder
of the funding, which it did. Genentech did not get tPA approved for a 34 million dollar
clinical trial. They ended up spending three times that amount because of the delays and
everything. But it was clear by then that the product was going to be successful, so they
were able to get money from other sources.
With this one [points to binder for Genentech Clinical Partners I], the 55 million dollars
was probably enough to finish the clinical trials for growth hormone and gamma interferon.
But Genentech sponsored other clinical trials on gamma interferon after this was over.
Partnership Holds the License ##
Bugos: One question, on ownership, specifically. Did a patent transfer, for a specific disease
indication, to the partnership? Explain again the intellectual property, and what you mean
that the partnership owned the product.
Middleton: Basically, it s a license. Read the summary. That s the easiest way to understand it. [reads
from Genentech Clinical Partners I prospectus]
1
"The
partnership will hold a license for the
manufacture and sale of tPA in the United States using recombinant technology developed
by Genentech, blah, blah, blah." They owned the rights, all the rights that Genentech had,
they had the license to. Then Genentech had an option to get the rights back. So the license
was a holding pattern. It was a little bit like collateral for the money that the investors put
up. If Genentech did not exercise its options, or did not fulfill its obligations under the
contract, then the partnership had the right to take the product and sell it to somebody else.
That s the quid pro quo. They also did a license like that in Japan and in Europe, which
they might have used to fund the shortfall in the American clinical trial.
I m curious to see what the projections were on tPA here. To see how close we were,
[reads the prospectus] Not bad. It says $275, $280 million. I think we did that. Projecting
revenues ten years out is not an easy business. It looks like the projections for growth
hormone and tPA were pretty accurate. The returns to investors were really based on those
projections. It could be more, it could be less, but that s why it worked out to what investors
See appendix G to this volume.
46
were expecting. Gamma interferon did not become a big product under Genentech. It s going
to be a big product under InterMune Pharmaceuticals, who subsequently licensed it.
Getting Idea for R&D Partnerships
Bugos: Going all the back to the beginning-Bob Swanson read Scientific American to come up with
his idea for recombinant DNA. Where did you get your Eureka insight for these partnerships?
Middleton: I was at a financial meeting, put on by Coopers & Lybrand in San Jose, and I met Gene
Amdahl and his CFO. They talked about this deal to found Trilogy, to build this three
dimensional chip that was going to have huge amounts of processing power. The thing didn t
work. It was a total bomb. But Gene Amdahl had a big name-he was the scientist behind the
IBM 360. Then he founded Amdahl Computer. Rather than take venture capital-he might
have gotten 5 million dollars for half the company-he convinced Merrill Lynch to put up 50
million dollars through an R&D partnership. Because it was not an equity instrument, he
could still maintain control of the company, which was very appealing to him. He and his
CFO did this deal and set it up like an R&D partnership for the development of Trilogy. I
looked at that.
We were doing a lot of R&D, and there was this big funding valley sometimes called a
J-curve. To become a FIPCO the amount of money you had to spend for clinical trials could
kill you. I got this idea to use this vehicle and presented it to management. We had an off-
site meeting in Silverado, the country club near Napa. It was just after the IPO, 1980/1981.
Everybody was there, and we had a brainstorming session on some of the ways we can raise
money. Tom Perkins said we can take out a loan. There s obviously more equity. Then I
introduced this concept of R&D partnerships, gave a little presentation on it. Initially people
were kind of skeptical. Then, when it became clear we had to explore all the avenues for
raising money, Swanson said, "Let s give this a shot. Talk to the bankers and see if you can
convince them to do it." I worked on them. Bud Coyle introduced me to Stephen Evans-
Freke who was a banker at Paine Webber. He subsequently set up Paine Webber
Development Corporation which did a bunch of these. Stephen and Paine Weber did the most
in the industry. He did the ones for Amgen, Centocor, for all the big guys-though this was
the first one. We gave him the idea, and then we did some together.
Legal Opinions
Bugos: Who on the legal side was helping you structure the contracts?
Middleton: Davis Polk & Wardwell. They did most of the legal work on these. They are a New York-
based firm. They were the experts. They gave tax opinions on two aspects: the deducibility
of the R&D expense for investors, and the tax treatment for the buyout, which was long-term
capital gains. So we got that benefit on the back end and the deduction on the front end. So
their tax opinion was really important.
47
Hugos: Did you have to beef up the treasury function to deal with the taxes, or was that all handled
elsewhere?
Middleton: The tax structure was handled by the lawyers. The treatment to Genentech was pretty
straightforward. The money that came into Genentech was under an R&D contract, so it s
just revenue. We had lots of tax loss carry-forwards anyway, so we weren t really paying any
taxes for a while. The other side of the coin was Genentech spent 450 million dollars to get
the products back, then they got to deduct the cost of those shares from their tax return. It
was all a paper transaction, to give the investors the shares. They had to issue the number of
shares that were specified in the contracts.
Historical Significance of R&D Partnerships
Bugos: One more question, then I ll let you go. These partnerships took advantage of a tax situation
that just happened to arise twenty years ago. But in terms of the larger impact of these R&D
partnerships on the development of the industry, or venture capital, or whatever, how do you
place these in the bigger picture?
Middleton: R&D partnerships were the mechanism that allowed biotech companies to become FIPCOs.
That s the big picture. Look at who used them, everybody who developed the big products
early on. Amgen used them, Genentech used them, Biogen used them, Cetus used them for
IL-1 [interleukin-1], Centocor used them for Centorex, and Genzyme used them. The only
one that didn t use it was Chiron; I m not quite sure why they didn t. Though they merged
with Cetus, and they got the benefit of IL-2 [interleukin-2] which was developed with an
R&D partnership, there was some thinking that no one could become a pharmaceutical
company, because they couldn t afford to pay for the clinical trials without having revenue to
generate the profits to pay for the R&D and trials. So this really got the industry going.
When these R&D partnerships went away in the late 1980s a lot of people started thinking
that maybe the right strategy is to not become a FIPCO anymore. Then something else
happened. Investors no longer expected companies to operate at a profit or a break-even
prior to getting an FDA-approved product. They also expressed a willingness to put in more
money during the startup phase. Genentech raised a very small amount of money~$4 million
in venture capital; $10 million from a corporate partner; $35 million in an IPO. Today, you d
raise $200 or $300 million under those same parameters. Today you d use equity capital.
And if the markets are good, they can raise the capital and afford to pay for these clinical
trials. If the markets are bad they can t.
The R&D partnerships allowed the first generation of biotech companies to become
FIPCOs. The ones that are the biggest companies today in the industry.
Bugos: Thank you very much.
48
Hugos:
Joint Ventures: Genencor
[Interview 3: August 31, 2001] ##
In our third interview, I m hoping we can start with the joint venture strategy of Genentech,
focusing on the formation of Genencor in the spring of 1982~the strategy you followed in
setting that up, your relationship with Coming, your personal role in setting it up and serving
on the board of directors, and how this joint venture structured the others that came after.
Middleton: OK, the joint venture strategy at Genentech- Recombinant DNA technology and genetic
engineering technology affected many different markets and products. There was a lot of
interest-not only from people in the pharmaceutical industry but also in the chemicals
industry, the materials industry, the diagnostics industry-as to how molecular biology and
recombinant DNA would impact their business. Also in the equipment manufacturing
industry, since a lot of research lab equipment and a lot of production equipment is used. We
saw there was an opportunity for Genentech to enter into a series of partnerships with
companies that were outside our stream of central interest. We determined pretty early that
Pharmaceuticals was the highest value-added use of molecular biology. Genetic engineering,
after all, has to do with genes and living systems, therapies of treating disease, and
mechanisms of diseases, and so forth.
The other reason Genentech was interested in the joint venture strategy was that it was a
way to derive value from different applications of the technology without having to invest
significant funds ourselves. Our partners could invest the funds. It was a way to derive
income for the parent company to support our own development activities in Pharmaceuticals
and health care.
Coming s Interest in Biotech
Middleton: So we began discussions in 1981, 1982 with Coming. Corning had a business in diagnostics
and in biological sciences. They were trying to figure out how to get involved in
biotechnology. They were interested in working with one of the major new companies to set
up a vehicle for consolidating their own activities creating a critical mass structure. They
talked to a lot of the new companies in the industry-Cetus, Biogen, and others-and liked
Genentech the best. We started talking about how to work together. Corning has a wonderful
group of managers. It s an older aristocratic company because the Houghton family has for
many years run the company. Corning, New York is a company town. They started in glass
and moved into high tech-biological sciences and health care on the one hand, and more
recently information technology and telecommunications and fiber optics on the other hand.
49
Fifty-Fifty Joint Venture
Middleton: Coming had a history of doing joint ventures. They also had a philosophy on doing joint
ventures: a joint venture is a true partnership, meaning an equal partnership, like a marriage.
Both partners had to be perceived as equal both in terms of their contribution and their
ongoing roles. If one partner was no longer pulling its weight then the other should take over.
They believed only in fifty-fifty joint ventures. They believed each partner should contribute
equal amounts of technology and dollars.
The dollars part was a problem for Genentech because we didn t have a lot of money. The
way we got around that was by having Corning invest 20 million dollars in Genentech as a
direct investment in the company-they purchased 20 million dollars worth of stock~and then
we were committed over time-over five or ten years~to contribute up to 20 million dollars in
the venture. And we could make in-kind contributions of equipment and research, and they
gave us credit for that.
We set up a board of directors, with four members of Genentech on the board and four
members from Corning on the board. The joint venture was run by Bob Leach, who was
CEO, and who came out of Coming. It was located in South San Francisco. I served as a
Genentech director.
Enzyme Products for Nonmedical Applications
Middleton: The business purpose of Genencor was to develop recombinant DNA applications in non-
pharmaceutical areas, looking primarily at the production of enzymes used in the production
of foods. Enzymes were used in the production of cheese and wines and various foodstuffs,
and in processing paper, for example. Another major application was the use of enzymes in
laundry detergent. Procter & Gamble ended up being a very large customer.
There were some traditional enzyme companies in the world-Novo Nordisk, Gist
Brocades in Holland-who had enzyme production systems based on conventional technology
and conventional organisms. With recombinant DNA you had the ability to amplify the
production of enzymes. Enzymes are just proteins. Just like Genentech s recombinant drugs
are proteins, enzymes are proteins too. [tape interruption]
Starting in 1982, their board would meet frequently, about every two months. Most of the
scientific value added came out of Genentech. Genencor recruited their own staff, but there
were several scientists from Genentech, including Herb Heyneker who joined Genencor as
director of research. Under Bob Leach they developed several successful commercial
programs. Generally, it took longer in that area because the value added on the individual
products is lower. The selling price of enzymes is less than the selling price of
Pharmaceuticals. And the consumers are very conservative.
Genencor became a very successful company. It s one of the largest biotech companies
in the world that s focused on non-pharmaceutical areas. They ve brought in capital from
50
new partners, including Eastman Kodak and Cultor, a Finnish firm, and today they re a
publicly-traded company.
Both Corning and Genentech were satisfied. Both companies ended up divesting their
stakes for a profit because Genencor s business was no longer central to the long-term
strategic interests of either Genentech or Corning. It became a successful business
enterprise in its own right.
Bugos: How important was production? This venture came at a time when Genentech was already
making huge investments in new production facilities. Did Coming really expect this to be
a manufacturing enterprise?
Middleton: Not really. Genencor had an enzyme manufacturing capability~a small capability that they
acquired from Rohm & Haas, I believe in Pennsylvania. This was a traditional enzyme
plant. The reason for buying it was to get experience in running it. It was a break-even
business, an existing business, not used for these genetically engineered enzymes. By the
time Genencor was ready to supply enzymes to Procter & Gamble and to the cheese
companies, it did have to make a major capital investment. Those investments were made
by some of the newer strategic partners, like Kodak. This was after my involvement there.
They did build some large production facilities.
They started off tolling the manufacturing, meaning they hired out someone else s
facility. I believe they used Abbott s facility near Chicago, initially. One of the nice things
about enzymes is that they don t have the same stringent quality control criteria that a
pharmaceutical would have. So you can use systems that are a little more generic in nature.
You can use fermenters that may have been used for other things. So Genencor was able to
delay capital investment in the production side of the business. Ultimately, the production
side of the business did require a good bit of money.
Resources from Genentech
Bugos: And in terms of allocation of resources from Genentech, could employees of their own free
will decide to go to Genencor?
Middleton: Yes, though that was a question. Bob Swanson was very concerned about Genencor
sucking away some of the top people. There weren t that many people who left. It was a
good opportunity for some Genentech people to get in on the ground floor of a new
company. Genencor did have a stock plan; 10 percent of the company was set aside for
employees. There were people who had moved beyond their specific roles at Genentech
and needed to move on to other opportunities. Most of the employees were recruited from
outside of Genentech. There were four or five people who joined from Coming who were
good people, but they had kind of become orphans at Corning because Coming wasn t
getting into this business on their own. One of the reasons for basing it in California was to
create the sizzle and appeal of a young startup in biotech. That was part of the draw in
attracting top scientists. That strategy worked pretty well.
51
Genentech Industrial Products Group
Bugos: Was there an active enzyme research effort at Genentech before Corning approached you?
Middleton: We had an industrial products group which included enzymes and industrial chemicals-like
looking at recombinant DNA for the production of rubber. That was headed up by Gary
Steele on the business development side, and [Reinaldo H.] Ray Gomez on the research
side. Genencor was an outgrowth of that group. The realization of industrial products was
through the joint ventures.
Bugos: So new product development for diversifying no longer was done within Genentech?
Middleton: Business development still had a function. At one point it was divided into three areas-
pharmaceuticals, agriculture, and industrial products. Industrial products was the first to
disband, then agriculture. Doing these joint ventures was a pretty creative way of realizing
the value of these different initiatives, taking the cost of them and putting it off the balance
sheet.
Bugos: Was there much debate within Genentech on whether to spin these off and focus on
Pharmaceuticals?
Middleton: No. Even look in the original plan. You have to focus on the job you want to get done,
otherwise you don t get anything done. A lot of companies get indigestion. Genentech
certainly was undertaking a broad variety of things at that time. We focused on
Pharmaceuticals, and we also focused on specific Pharmaceuticals evaluating those within
the families of pharmaceuticals available for us to work on.
Other Joint Ventures and Their Significance
Agricultural Products
Bugos: You mentioned agriculture, and later there was a joint venture devoted to agricultural
products. But at that time you were developing bovine interferon and growth hormones
without a joint venture.
Middleton: There were several programs devoted to agriculture. There was one with Monsanto for
somatotropin which, subsequently, Monsanto invested a lot of money in. This is growth
hormone for cows and pigs. It became somewhat controversial. When you give it to cows
it basically improves the quantity of milk, so it had an economic impact on farmers. That
was a very big effort early on at Genentech.
Another effort was for bovine interferon, which was for shipping disease. It was to
protect animals from getting a flu, basically respiratory trauma, while being shipped on rail
52
cars to market. A large percentage of animals get sick, lose weight, or die. Bovine
interferon was an internal program. It was funded by an outside group called Granada,
which was a Texas-based R&D partnership. It was like an R&D partnership but funded by
a single partner who took the write-offs and would get part of the royalties on the back end.
Middleton: The agricultural program ultimately was sold to Ciba-Geigy for 45 to 50 million dollars
around 1985. There was a group in Genentech who wanted to develop those products in
house, a group that came out of the Eli Lilly Blanco Division, which was then Lilly s
agricultural products division.
But Swanson and the board decided that this was not something central to our business.
Agricultural markets are generally slow to develop. Farmers take a while to make up their
minds, the products are lower margin, and there s a lot of testing involved. So after four
years of working on it, Genentech decided it was better left to a larger company already in
the agricultural chemicals business. And getting 45 million dollars in cash is not bad if you
have other things to do with it. So the agricultural business got sold and the business
development people dispersed.
Choosing a Joint Venture Arrangement
Bugos: Having seen the biotech industry develop, you know that alliances are important for any
young biotech company. With Genencor, why did you decide to do the joint venture that
specific corporate governance structure-when you could have done a license agreement, a
research and development contract, or any other type of alliance vehicle? Why a JV?
Middleton: The main reason we did a JV was because of Corning. They had the most successful track
record of any company doing JVs. Coming wasn t interested in licensing the technology
from us, because they didn t have the know-how to develop it on their own. Another reason
you do a corporate joint venture instead of a license is that a joint venture can target an
entire field. We knew that some industrial enzymes were exciting to work on, but we didn t
know all the enzymes.
Everybody realized this was a new business opportunity that would require a new
business organization and a new set of people. In neither of the parent companies was their
expertise in marketing enzymes, or manufacturing enzymes, or even determining which
enzymes to develop. That had to be sorted through. That s why you did a joint venture.
Genencor was the most successful of the Genentech joint venture companies. That was
a function of the strong commitments of the parents. The joint venture itself had a good
management team, the freedom to determine a strategy and execute it, and adequate
funding. Also, Genentech fairly liberally shared all its technology. The field was outside
of Pharmaceuticals, so the technology transfer was very good.
53
HP Genenchem
Bugos: Then why don t we contrast that with the other joint ventures.
Middleton: OK. There was one called HP [Hewlett-Packard] Genenchem. One of the big opportunities
in biotech was in making instruments to be used by the industry-for example, DNA
synthesizers, DNA analyzers, sequencers, protein synthesizers, protein sequencers. These
machines did techniques that were done by hand, historically, in the lab. The first
Genentech genes were synthesized by organic chemists, one step at a time. So the
engineers of the world figured out ways to automate the production and analysis of genes
with the appropriate robotics, materials handling, sample handling, and charting. It was the
marriage of computers and chemistry. Applied Biosystems was the first company in this
field, and ultimately the most successful company.
David Packard was on our board of directors. Hewlett-Packard was in the
instrumentation for medical products business, today through Agilentit s no longer part of
HP. Back in those days, they thought they ought to have a piece of this action, too, by
working exclusively with Genentech on the design and development of instrumentation to
be used by biotech scientists.
The result was HP Genenchem. Their engineers would come over and follow the
scientists around, discuss the customers needs, and determine what opportunities there
were to automate things. Here you had an engineer on the one side and the customer on the
other side. Since Genentech had the biggest R&D effort in genetic engineering, they were
the ideal company to go to school on.
This was a joint venture company, but Hewlett-Packard had a majority interest.
Ultimately, after the engineers were done learning what they could by following the
scientists around, it would become a Hewlett-Packard-owned entity. They would make
automation equipment of use to Genentech but also sold to other people in the industry.
There wasn t a lot of management structure to HP Genenchem. There was some money
less than 10 million dollars-that went to Genentech from HP. Some products did come out
of it, but they were somewhat modest. I don t know enough about HP s product line today
to tell you which products were derived from the HP Genenchem venture.
Instrumentation in the Biotech Industry
Bugos: Cetus was founded on a technology that robotically scanned petri dishes. Did their effort
prompt you to find someone to develop better automation for you?
Middleton: Not really. That was kind of a dead-end product. That served a different purpose, though
this general area of robotics, screening, has come back into the forefront several times.
High-throughput screening, systems for managing multiple combinatorial chemistry,
screening very large numbers of samples-that s all come back in the forefront several
timesnow through Celera Genomics. The whole genomics revolution is based on large
54
quantities of materials handling. But Cetus didn t have a real advantage there as far as
biotech was concerned. They did have one laboratory technology that did turn out to be
very important later on, called PCR [polymerase chain reaction].
m
Middleton: PCR was invented by Cetus-an outstanding analytical technique. It identified segments of
DNA which could then be cloned for making products. They were paid several hundred
million dollars for that by Roche who bought it when Cetus was divided up and sold to
Chiron. The PCR piece went to Roche.
Instrumentation has continued to be an important part of this industry. There have been
several generations of plays in instrumentation. Molecular Devices was another company.
The former head of business development in the industrial applications area, Gary Steele,
went on to become CEO of that company. Molecular Devices developed tools for biotech
companies for manufacturing, using sampling, testing, and quality control.
Bugos: Did the formation of HP Genenchem affect your relationships with your instruments
suppliers? Did you have a lot of instrumentation suppliers?
Middleton: Yes. We bought from a lot of companies, from Applied Biosystems. I don t think it
affected our relationships, because Genentech was a big customer. We didn t publicize it
widely. HP Genenchem never turned out to be a real problem for anybody.
Bugos: Was it a problem, within Genentech, in terms of allocating resources and manpower to the
effort?
Middleton: No. There was a board of directors, and maybe a coordinating committee. They would talk
about areas of opportunity, and then the engineers would follow the scientists around and
figure out how to automate something. So the money we got there was really gravy. We
were never planning on making much money out of this. To the extent we can automate
something, we can do it more efficiently, it costs us less, and it makes the research go
quicker. That was the principal advantage to Genentech.
Travenol Genentech Diagnostics
Bugos: OK. What came next?
Middleton: Travenol Genentech Diagnostics. That was between us and Baxter-it used to be called
Baxter Travenol. This joint venture was done at a very high level. [Vemon R.] Vem
Loucks, the CEO of Baxter, was introduced to us by [Sanford R.] Sandy Robertson of
Robertson Stephens. Baxter was more in the hospital solutions business; supplying
solutions, diagnostics, and all kinds of equipment and catalog items to hospitals.
Historically, they had been a technology-based company, but they had become more of a
manufacturing and supply company than an R&D company. Vern Loucks came out and
met with us several times, and we came up with an idea.
Bugos:
55
One advantage of recombinant DNA is for diagnostics. For every therapeutic you come
up with, you can imagine a diagnostic to be able to measure the level of the drug or protein
in the blood, or the antigen or the microbe or the virus that you re trying to treat. There was
also the possibility of producing monoclonal antibodies using recombinant DNA.
Vem had some traditional diagnostics-like sticks with solution in them. You mix the
solution back and forth and it changes color and tells you something about the condition of
the blood. They had a business that did maybe $20 million in revenues, total. But prices
were coming down, and they were trying to decide whether to fish or cut bait on the
diagnostic business. They decided to try to make something out of it.
They agreed to form a joint venture with us~fifty-fifty. We gave this joint venture the
rights to all of our diagnostics technology which, in theory, should be pretty valuable. They
would throw in their existing diagnostics business, and they agreed to fund it for the first
three years. They agreed to put in 10 to 15 million dollars. Some Genentech people were
assigned to this, and they had some good ideas, initially.
But the joint venture didn t work, primarily because some of the key Genentech people
left. It was unfortunate. The other reason was that this subsidiarythat Baxter had given to
the joint venture-started to lose money. Their diagnostics business was really tanking.
Genentech had to incur more losses, which it wasn t counting on. So Swanson went back to
Vem Loucks and said "We want out of this thing. You can take it all back." I was only
involved in that joint venture, personally, for less than nine months. I negotiated putting it
together. We probably got $10 to $15 million out of it, but two or three years later it was
unwound. Their business was really tanking.
How important was that venture as an opportunity for scientists to pursue monoclonal
antibodies, which was not something done inside Genentech otherwise?
Middleton: It was pretty important. It should have been an excellent vehicle to pursue monoclonal
antibodies but, unfortunately, the level of staffing never reached critical mass. Especially
no first-class scientists. A medical person was on the board. There was a general manager
from the Travenol Diagnostics division who became the scapegoat for the whole thing. But
he didn t really have much technology to offer. He was just pumping out diagnostics with
no capability to develop new products. Their R&D was focused on existing products. It
was just a bad marriage. I think they were expecting Genentech to develop new products to
save their bacon. But it just never got to that point of development.
Diagnostics as a Distinct Business
Bugos: When you talk about the close coupling between therapeutics and diagnostics, it wasn t
close enough that Genentech would have developed diagnostics on its own?
Middleton: I think diagnostics was really a separate business. They re sold through diagnostic testing
labs and the technology changes very quickly. Every two years you might get a new
diagnostic test that does something just a little better. Somebody else has a patent on it; they
56
make a killing for a while. Some diagnostics tests have been monopolized by some of the
largest companies. And this is an industry that s consolidated and consolidated. Coming
had a clinical diagnostics business which they subsequently sold. It s a tough business to
make money in-particularly for a small company. It ends up being more of a marketing
game then a technology game. We could have developed diagnostics, but it would have been
a diversion from our main business. So we decided to joint venture diagnostics, to get
leverage from outside parties. It would have been terrific if we had joint ventured with
Abbott Laboratories, but Baxter wasn t the right partner.
Joint Venture Returns to Genentech
Bugos: When you say the losses began to pass through to Genentech-there was no liability barrier
between the joint venture and Genentech?
Middleton: There was a liability barrier, but we owned half of the venture. You have to consolidate
losses just on a pass-through basis from a subsidiary. And that wasn t something Swanson
wanted to do. This may show up on some of the statements, [tape interruption]
I m looking at the 1987 annual report here, on page thirty-five under note one "related
party transactions." It points out the impact of the some of these joint ventures. In 1985,
Genentech received $32.3 million of revenues from these joint ventures, which included
Genencor, HP Genenchem, and Travenol Genentech Diagnostics. They received $30.7
million in 1986, then in 1987 it dropped to $6.4 million.
Again, Genentech was able to tap into these joint ventures as a source of cash to support
its R&D efforts prior to the major uptick in its own product revenues, which by 1987 had
kicked in with both growth hormone and IPA. Product sales in 1987 were $141 million, up
from $43 million the previous year, and only $5 million the year before that. So the joint
ventures were able to help Genentech make the transition in earnings from contract research
with affiliates to its own product sales. That was an important part of the strategy.
PruTech Research and Development Partnership
Bugos: One more joint venture happened during your time there, and that was with Lubrizol for the
production of vitamin C. Were there others?
Middleton: No. There was PruTech, which worked on rubber, but that was more of a contract research
program. The idea there was to make the rubber precursor found in rubber plants. PruTech
was a British-based venture capital organization. They were funding this project more as a
high-risk venture, and we received revenues for doing the research. There was some success,
but that never got commercialized. They lost interest in it and just stopped funding it.
57
GLC Associates
Middleton: GLC Associates, which was the Lubrizol venture to make vitamin C, was just starting up at
the time I was leaving. Lubrizol basically made additives, lubricants. It was a petroleum-
based specialty chemical company, and one of the early investors in Genentech. They put 10
million dollars into the company in 1979 and became one of the largest shareholders. They
were very interested in the application of biotech to make specialty chemicals, though the
technology was a bit too early. And in chemicals, the value added is much lower, and to
make tank car quantities of chemicals is a bit beyond the scope of biology, even today.
Ethanol came along for a while. But vitamin C was a useful chemical, so they worked on
that.
I don t really know what happened to the venture. There was an anti-trust suit in the early
1990s on the manufacture of vitamin C. There was price collusion between Hoffmann- La
Roche and three or four other companies. Lubrizol wasn t part of that. To my knowledge
they never commercialized the technology. They probably sold it to one of the vitamin
manufacturers.
Bugos: When you got the 10 million dollar private placement from Lubrizol years earlier, there was
some indication that Genentech would continue to explore possibilities for developing
products together.
Middleton: Exactly. This was one of them. They were interested in an option on industrial chemical
applications of the technology-that was a loosely written agreement, but we cooperated.
Don Murfin attended all the board meetings; we explored a number of different types of
chemical applications. They were pretty slow in moving this to fruition, but eventually we
settled on vitamin C as something that would be a useful industrial chemical. But the
biological systems were just too far afield from the large-scale procedures that are done in
chemical plants. The technology never got to the point where it could have a significant
impact on their business. Needless to say, they made a lot of money on Genentech as an
investment, [laughter]
Bugos: Again the question of the allocation of resources. Was it a drain on Genentech in terms of
the scientists or production capability to participate in this joint venture?
Middleton: No. This was probably a one- or two-person effort. To work on a project like this-where
you re looking at a chemical pathway in a microorganism-that doesn t require a lot of
scientists. You need to go sequentially through a series of steps. That can only be done by
one or two people. It doesn t help to have twenty people working on it simultaneously. So it
was not a significant consumer of science talent.
58
Joint Ventures as Managerial Training Ground
Bugos: What about as a consumer of legal talent. Did you have someone helping you set up these
JVs? You re almost doing it in an assembly-line fashion.
Middleton: Yes, we had our very able legal staff. [Thomas D.] Tom Kiley, general counsel, then Brian
Cunningham after him. They both were involved with these JVs. We also had Lee Benton
at Cooley Godward. He participated with me on the Genencor joint venture, Tom was also
heavily involved in that one. I was primarily the finance person and the deal person on the
JVs. Then people like [Michael J.] Mike Ross on the scientific side, Ray Gomez from the
industrial side, Gary Steele from the business development side, [William H.] Bill Rastetter
from business development. All of these people went on to become CEOs of other
companies, [laughter] All, with the exception of Tom Kiley. So it s a pretty illustrious
group. So it was a good training ground.
Significance of Joint Ventures to Genentech
Bugos: So in addition to creating future CEOs, in the long run, in the big picture, what did the JVs
mean to Genentech and to the industry as a whole?
Middleton: I would say three things. First of all, the joint ventures were a good way to take a very broad
technology that affected many aspects of business and industry-health care, diagnostics,
industrial products, foods~and pursue applications of the technology in each of those areas
with partners who knew those businesses.
The other thing it did was provide resources back to Genentech, which I alluded to in the
annual report, to fund the development of its pharmaceuticals business. They were big
numbers. Probably over 100 million dollars came back from these joint ventures over five or
six years. So that was an important part of the strategy of building a big company that was
able to sustain itself.
Number three was that a number of these joint ventures found their way into the
mainstream of their industries. Certainly enzymes are made and designed using molecular
biology today. Certainly vitamins can be produced using genetic technology today.
Certainly the instrumentation business has continued to grow and be driven by the
biotechnology revolution. Those have become big businesses.
Their time has come and gone. JVs are no longer a critical part of Genentech. They
filled an important niche at that point in time. They also indicated the very broad interest
which existed in American industry in biotech, by the major players-Hewlett-Packard,
Corning, Lubrizol, Baxter Travenol. All were interested in getting a foothold in this new
industry. Partnering with Genentech was their vehicle for doing it. Certainly other
companies had joint ventures too, but Genentech had more encompassing joint ventures. So
that s my take on joint ventures.
59
Junior Common Stock
Middleton s Innovation
Bugos: Let s shift focus a little bit. The other thing I wanted to discuss was the junior stock, the
employee stock option plans, the restricted series B and C shares, and the earnings
convertible shares.
Middleton: OK. This is something I can take credit for. It was an idea I came up with-an idea that has
unfortunately come and gone. The basic idea is that when you have a new venture you can
sell people founders stock. You let them participate at a very low price, before you go
public, and it s a big incentive. It s the reason you re able to get people to leave large
corporations, stable secure environments, and take a risk on making the big money. And the
way that s largely done is that common stock is sold at a penny, ten cents. Preferred stock,
which is sold to investors and has preferences on liquidation, is sold at maybe ten or twenty
times the amount that the common stock is sold for. The common stock may be sold, or it
may be given as options, but either way the employee has a call on the value between the ten
cents and the ten dollars. So there s a very large incentive.
However, once a company goes public, the preferred stock goes away. You have one
class of stock, common stock. The employees get that big bump-up at the time of the public
offering. Generally employee shares are subject to vesting over four or five years, so they
get vested, they get the big bump up, they can cash out or hold. But they have made their
venture play at that point. They can continue to get options in the public company, but they
don t quite have the same leverage on the upside that they once had.
I looked at all this and tried to figure out a way of creating this incentive for new
employees and management in a company that is already public. Companies continue to be
risky. They only difference at Genentech was that we used to be a private company without
products and now we re a public company without products, [laughter] Is the risk really that
much less to an employee coming in? My thought was that you can come up withjunior
common stock that has the same relationship to common stock that the common stock once
had to the preferred stock. By making this junior common stock available to employees you
can create the upside for them again.
Now, what is junior common stock? It s a class of stock that is only sold to employees. It
has no value, no trading market, no liquidity, no redemption value. It only obtains its value if
the company achieves certain milestones-revenues, earnings, and other things, like
acquisition.
So you re a public company with no products. Someday you hope to have a
product on the market doing revenues of $ 1 00 million or more. That may be a long
time and it may be a huge risk. And the only way we can get to $100 million is to
have a product of our own~we can t do it through contract research. But I can buy
some of the stock today and hold it for five years, and if we manage to get the
product through the clinical trials, through the FDA, manage to build the sales force,
manage to sell it, then the junior common stock, also called earnings convertible or
60
restricted stock, would convert into common. It would convert up, just like the common
stock converted up to the preferred stock price when you went public. That s why this was
created. We recreated the incentive for employees-to buy cheap stock that would convert
based on the future success of high risk events off into the future.
We ran this by our accounting firm, Ernst & Young. We calculated there s a 10 percent
probability of this happening in the coming year, maybe a 30 percent probability of this
happening in five years. You can discount all the values back. We got valuations from
investment banks which defined the fair market value at which the shares could be sold.
##
Bugos: So these different types of stock-the restricted B and C, and the earnings convertible-were
all part of this class ofjunior stock?
Middleton: Yes. It had several names, but it came to be known generically as junior common stock.
Some lawyer gave it that name. It s a good name.
And there was a class of this stock available right before the IPO, because generally right
before the IPO your common stock tracks up to your preferred stock price. The idea was to
continue to give people an opportunity to make a ten times return. So if the stock is at $35,
the restricted stock at $3.50 can become $35, and hopefully the $35 soon became $70. And
the $3. 50 became $70. So you ve made twenty times on your money. That is a big
incentive for any employee and creates the same kind of risk-reward opportunity that a
startup venture creates in attracting a new employee. And because of the long time frames
involved and the kind of talent that we had to hire, we thought this was a very important
incentive mechanism to have. We used it for about three or four years.
Accounting Debates
Middleton: The real issue was, from an accounting standpoint, how should this gain be treated? Is
it compensation expense or is it a balance sheet and equity issue? If you re selling the
stock at $3.50 and then it s converting at $35, is the difference between the $3.50 and
the $35 compensation expense? Or do you account for it as the sale of a class of stock
at $3.50 and then there s no further impact on the income statement? Just like par value
and paid-in capital. Once you have par value and paid-in capital on a balance sheet, it
doesn t change because the stock price goes up. This was the issue.
These plans became all the rage. There were probably two hundred of them. The SEC
found one that they particularly didn t like. One of the milestones that that company had
put in was an IPO. Then the junior stock would convert from its low price into common
stock. The SEC thought that should be compensation expense. After all, doing an IPO is
not a highly contingent event. It doesn t connote any specific progress, just that you can
sell stock to the public. That s not really a true milestone, in my view, of business success.
61
The Financial Accounting Standards Board was directed by the SEC to look at this.
They came out with a ruling that we argued strongly againstthat these things would have
to be accounted for as compensation expense. That made them untenable. Every year you
had to take a compensation expense based on where your stock price was and the
difference between that and how many shares vested for each employee. That meant that
your compensation expense could be all over the map in any given year. Nobody could
manage an income statement effectively.
The other monkey in the works was how the IRS would look at it. If it was
compensation expense to the company, maybe it would be compensation to the employee
also. The employee would have to pay taxes on it as ordinary income when the conversion
event occurred. That was the big hammer out there.
I visited the SEC over this. The chief accountant there said that he wanted these to go
away. They would come up with a pronouncement that after some date they would no
longer accept the accounting for these kinds of plans. He said "I ll give you three months
to clean everything up. You can sell all the stock you need to sell and you won t be
penalized. But after that we re not going to allow it anymore." So we sold all the
remaining stock in our plan to employees and recruited people. Then they came out with a
white paper that said after such a date we re going to require that these junior common
stock plans be accounted for as compensation expense. So there was an administrative
death to the idea. After that it became too unworkable. It became a variable compensation
plan.
I was arguing that stock options aren t accounted for as compensation. They clearly
have value when you give them to somebody. They have the Black-Scholes value and the
value between the exercise price and the market price. And the accountants said, "We
agree with you. Someday they ll have to account for options." And they have been
working on that issue over the last three or four years.
Unfortunately, the junior stock died. There were a lot of people who benefitted from it
from a wealth creation standpoint. It was very useful to Genentech in being able to recruit,
retain, and reward high-potential scientists and managers in the 1979 to 1984 time period.
Bugos: How many people got the stock?
Middleton: A few hundred. When I left there were six hundred people; probably two-thirds of them
had it. Probably four hundred people, then. We probably issued a couple million shares of
it. At maybe forty dollars a share, we probably issued 80 to 100 million dollars of it.
That s a fair amount. If you go back and look in the annual reports, which I ll do right
now. [tape interruption]
Junior Stock Vesting
Middleton: One of the advantages of this plan is that the board of directors could set important strategic
goals for the company upon the achievement of which the management would be rewarded
by the conversion of the junior common stock into common stock. The series C restricted
Bugos:
62
stock, which was issued in May of 1981 and 1982, said that when the company achieved
revenues of $40 million and earnings of S4 million, or upon the merger or sale of the
company, the restricted stock would convert into common stock. In 1981, Genentech had
revenues of about $20 millionit was $8 million the previous year and had earnings of half
a million. So, those criteria would have been met two or three years after the plan was
written.
Let s look at the 1982 annual report. In 1982, there was an additional class ofjunior
common stock which was called earnings convertible stock. It converted when management
achieved a net income of 20 million dollars, or at least $1.33 cents per share. That was at a
time when net income was $625,000. So going from a net income of $625,000 and $28
million in revenues in 1982 to a net income of $20 million that s a pretty significant
increase. The company would have achieved that in 1985, 1986 three or four years later.
But it would only have done that with a significant product introduction. That s the
important thing. For management to have been rewarded with this junior common stock, it
would have had to have successfully navigated a product through the clinical trials, through
the FDA, into the marketplace and generating $100 million in revenues in order to make net
income of 20 million dollars. So I think it was a pretty fair model for the board to use as an
incentive for management. The accounting treatment killed it.
So the values of the junior shares are set at 10 percent of the trading price of the common
shares?
Middleton: Yes. And it had essentially no redemption rights. One-tenth of a vote, one-tenth of a
dividend right. It was one-tenth of everything basically.
Proliferation of the Structure
Bugos: The legal structure for this type of stock- Where would this have been laid out? And I ask
that in part to learn how other companies would have learned about this particular
innovation.
Middleton: It was set up through Cooley Godward. Lee Benton and I worked on it.
Companies would
have learned about it because stock plans are approved in proxy statements and stock plans
are filed as exhibits to SEC documents. Plus, lawyers talk a lot to each other. And they have
other clients and think it might be a good idea for them. It proliferated largely through
Cooley Godward and by getting publicly filed documents from the SEC. My guess is that
there were as many as two hundred plans out there and at that point the SEC became
concerned about them. They were catching on like wildfire.
Bugos: Did companies come to you, asking you how to set them up?
Middleton: Oh, yes-I had a lot of people talk to me. But once they had the document it wasn t all that
hard to understand. And lawyers tend to give more advice on those sorts of things than
63
CFOs. We were planning on writing an article about it for the Harvard Business Review but
scuttled that when the plans were killed.
Junior Stock as Employee Incentive
Middleton: To us it seemed like a completely legitimate way to go, and I still think it is intellectually. If
you buy off on the common stock and preferred stock model, then there s no way you can t
buy off on the convertible restricted stock into common stock model. There s no reason
intellectually. And that was our model. There s no reason you can t create a class of stock
with one-tenth the value of the publicly traded stock. There s no reason at all. It just has to
do with how the establishment wants to report earnings as a convention.
It s no different than selling a warrant on your stock. A warrant might sell for one-tenth
the value of the common, it s just that the warrant is triggered by a change in the price of the
publicly traded stock ,
and the junior common attains its value by the achievement of actual,
fundamental financial goals of the company.
Bugos: How did the employees take to this? Did they understand what you were trying to do?
Middleton: The employees loved it. It doesn t take a genius to understand: "I can buy stock at $3.50
and the publicly traded stock is trading at $35. If I achieve my goals over the next three to
four years, if I successfully introduce a product and see the earnings go from $600,000 a year
to $20 million a year, then the value of my restricted stock has gone from $3.50 to $35 or
even higher. That s attractive. I ve made a lot of money."
To me it s a lot fairer than giving somebody stock options, because with options you
might have done all those things and the stock still didn t go up. Maybe you did a great job
getting your product to market; you got your stock options at thirty five and the stock is still
at thirty five. You didn t get rewarded for doing a good job because of the stock market.
That s not exactly a fair system.
Benchmarks
In Corporate Partnerships
Bugos: It strikes me as being very similar to the benchmarking agreements that you had with your
major corporate partners. Was Genentech always a company that was forecasting, always
benchmarking its progress and thinking of its performance as something that can be
measured and predicted?
Middleton: We were a company that always had some carrots out there. It s an interesting observation.
There were benchmarks in the stock plan. There were benchmarks in the contracts, research
64
benchmarks. There were benchmarks in the royalty payments. So as we continued to do a
good job, these economic benefits would kick in. Most people don t mind paying you for
success. That s the model Genentech used, and why they were so successful. As success
kicked in, the rewards were greater over time.
Bugos: What is remarkable is that this was a new industry, these were new products, manufactured
in a new way. And somebody, presumably you, had to figure out what that reward system is
going to be based on and what the future value of these products will be.
Middleton: Starting in 1981, 1982, when we were just barely starting with our clinical trials for growth
hormone, we had never taken a product through clinical trials before, had never taken a
product through the FDA before, and had no marketing and sales force at all. The idea of
doing all that and generating $20 million in profits in three or four years that was a big goal.
That was a huge goal. That s why I think it was a fair incentive. People got a big reward if
they got it done, but it had never been done before. There should be a big reward, [laughter]
Conventional wisdom at the time was that you cannot build a new pharmaceutical
company. It s too hard, costs too much money, takes too long, the expertise needed is too
great. Sitting here now, I d have to say that we didn t know then whether it would be
possible or not until we actually did it.
In Research Contracts
Bugos: So let s talk about the benchmarks in the licensing agreements. How did you structure
those? What were your models?
Middleton: The idea of the benchmarks is pretty basic. Let s take the insulin deal with Lilly. I m not
going to remember all the details. A lot of people didn t think this was possible at allusing
genetically engineered microbes to make pharmaceutical products. So sitting opposite Lilly,
they re saying "We think this a really great idea, but we don t think you can do it at all.
We re not going to pay you 30 million dollars, because we don t know if this technology is
worth that or not."
They say they ll pay us $3 million; we say we want $30 million. So the
compromise is: "If we are successful in various steps along the way, one step at a time, you
will pay us numbers that add up to our $30 million. If we achieve every step, and five years
from now, when you have a product you are selling, we will have gotten the $30 million that
this is worth."
Typically, there are some research benchmarks: product yield, the amount of protein per
milliliter of fermentation broth, percentages of the cell that has the protein you want, making
the first gram or first ten milligrams of a pure product, delivering to them the protocol for
manufacturing a batch of this material, filing an IND [Investigational New Drug
Application], getting permission from the FDA to start a Phase n clinical trial, getting human
results from a Phase n clinical trial that are positive, starting a Phase in clinical trial, getting
data from the Phase HI trial that s statistically significant, filing an NDA [New Drug
Application], getting FDA approval. Everything I told you there is a basis for a benchmark,
and all of those benchmarks were used by Genentech in various of its contracts. The partner
65
will argue for making the benchmark payments bigger and bigger in the later years when
there s more certainty and less risk on their part.
In Royalties
Middleton: There s also benchmarks having to do with royalties. If this is a 200 million dollar product,
it ought to be paid at a 6 percent royalty. But if it s a 500 million dollar product, then we
ought to get a 10 percent royalty. So you have a stepped royalty structure. It starts at one
level. The big company argues that we have to pay all the overhead, we have to pay our
sales force, we have to pay for our marketing campaign. We have to pay that whether it s a
$200 million or a 500 million dollar product. We re not going to know that at the
beginning, but we still have to spend all that money up front. Then they acknowledge that if
it s a 500 million dollar product, that they re making a lot more money for each incremental
dollar of sales, so they ll pay you 10 percent rather than 6 percent.
Flexibility to Walk
Middleton: The other thing that s important about these deals is that it gives the large company the
ability to walk at any point-which is a big advantage. Big companies like flexibility. Their
budgets change, their priorities change, their strategies change, their management changes.
Maybe three years into this they re not interested in this business anymore. So they don t
want to spend any more money on it. So they walk. And they give it back to you. The
ability to walk with limited downside is a good thing from a big company standpoint. They
don t want to be obligated to spend another ten years on research. So the other feature of the
milestone arrangement is-you pay us the milestones for as far as we ve gone, but you re not
obligated to go any further. If you don t go any further, it s over. A lot of companies do
this. The benchmarks help large companies work with small companies in a way that they re
comfortable. They re willing to pay for success. And they have the flexibility to walk away.
And it s outsourcing of R&D. Usually they have very large R&D budgets, but they re
managing portfolios of things. In any given year the portfolio may be rich or it may be light.
If it s light they may want to go forward with more of these programs; if it s rich maybe they
want to cut them back. Having that kind of flexibility is important. Virtually all biotech
companies do these kind of deals.
Of course, they re calculated in the so-called "bio-dollars." Which means companies add
them all up and show them as one number. They say it s a 50 million dollar deal, but that s
only information of limited use. Of the 50 million dollar deal, they may get one million this
year and $49 million in five years when they get FDA approval. There s a lot of room in
between, [laughter]
66
Monetary Value of Benchmarks
Bugos: And how do you negotiate the value of reaching those benchmarks? Is it always related to
costs and expenses? Or is it always that you want to be paid earlier, and they want to pay you
later?
Middleton: It s partially related to cost. It s mostly related to value. It s a value proposition. Up front,
there s usually a research contract component. Usually there s some part of the project that
you can work on contract-the molecular biology, or the chemical synthesis, or the animal
models. You want to get some dollars from a corporate sponsor to fund those research
activities. It s a direct cost. You say: "I m going to have six researchers and they re going
to work on this for three years and it s going to cost me an average of $250 thousand per
researcher per year, so I want 4.5 million dollars for that."
Profit Sharing
Middleton: One other place cost comes into it-if you have a profit sharing deal on the back end, you
might agree to split the profits fifty-fifty.
m
Middleton: Profit sharing is a good way to do deals, but you have to be able to do the accounting to
determine what the profits are. Typically, a large company will market the product, and
since they have a huge amount of costs in that sales force and advertising programs how
much of that gets allocated to a product is a big issue. If they allocate all of it then you re
not going to have any profits. So you asked about basing things on actual costs. That would
be based on actual costs, but there s a negotiation over how much of that cost should show
up on your P&L [profit and loss statement] for your profit sharing.
Relations between Contract Revenues and Royalties
Bugos: Was there always a relationship between contract revenues and royalties? In other words,
did you consider these benchmark payments to be advances against royalties?
Middleton: No. Inmost cases there s three separate parts to a deal. There s the R&D piece. You re
going to get paid to do this research, so you have certain responsibilities. Second piece is the
milestone piece. That s really the incentive piece. You achieve clinical success,
manufacturing success, how much extra do you get? These are the $5 million, 10 million
dollar milestones-realty license fees, but they call them milestone payments. The third
element of the deal is, upon commercialization, how are you going to be compensated for
that success. Most commonly it s a royalty-a percentage of sales~or it could be a profit
67
share. Or it could be co-promotion, co-marketing. You sell X, you get to keep the profits on
that, we sell Y, we get to keep the profits on that.
Bugos: And these deals were mostly with non-U.S. companies for licenses outside the U.S.?
Middleton: No. It was both with U.S. companies and non-U.S. companies. Some companies wanted the
world, so we licensed them the world. Back then, though, it was easier to divide up the
world. Give one company rights to Europe, another to Japan, [tape interruption]
Product Evaluation/Development Teams
Bugos: So the final set of questions-the product evaluation teams and the management issues those
evoked, all revolving around the future value of a product. How did those function? What
was your role in them?
Middleton: One of the biggest resource allocation and strategic planning questions was: Now that we
have all these joint ventures to take care of the non-pharmaceutical stuff, what about the
pharmaceutical stuff? Which products should we spend our resources on? The resources
that we had worked so hard to get from all these deals. This is the strategy question leading
to how we get to the product development teams.
We concluded that we should have our top five list. We prioritized all of our products. If
you look at the business plans you ll see them listed from top to bottom. We decided we
could not focus on more than five. Some were near term, some were far off. They all had
good IP-intellectual property protection. They all had pretty clear clinical targets, that is,
end points that could be measured in the clinic. They all were products that we had the right
to make and sell ourselves; that allowed the FIPCO model. They all had a pretty good
probability of success. So we boiled all our potential products down to five.
The product development teams- Genentech started to get bigger. At this time there
were four hundred, five hundred people. We had a fairly conventional management
hierarchy~a manufacturing organization, a marketing organization, finance organization,
business development, and so forth. But developing these products took us across those and
the many scientific areas-molecular biology, organic chemistry, preclinical testing in animal
models, clinical management, regulatory, process science which figures out how to
manufacture things, then manufacturing. So we really used a matrix organization structure.
The product development managers-someone like Mark Levin, an early product
development team leader, or Chuck Hoyne-they would be the product champions across the
matrix, bringing together the focus and the attention of all the sciences. Each one was
managing a product pipeline all the way through. To be on it was a pretty big responsibility
and a pretty big honor. We took people from each of the disciplines, and they had to manage
it across the whole thing. Every two years or so we d review the responsibilities. Maybe it
would become a clinical priority, so then the product development team leader would
become a clinical person. And the person from R&D would go back and do something else.
So these jobs rotated around.
68
There were several groups. The product evaluation team was more of an R&D
management team that selected the products. The product development team actually
managed the process after the selection had been made.
Budgeting Process
Bugos: What was the role of finance in all this?
Middleton: To come up with as much money as they said they needed (laughter). That was our role in it.
Bugos: You didn t question how they spent it?
Middleton: We had an active budgeting process. It was a bottoms-up process. Everything would be
added up, and it would always be twice as much as what we could do. The management
committee and Swanson would beat it up and say "We re not doing this, we re not doing
that, we re going to kill this project." They d send it back down and tell them to take
another cut at it. We d go back and forth a couple of times. All the time there were new
ideas coming out of R&D, vying to be in the top tier status. Products would die. [tape
interruption]
Certainly the products that were being funded by our R&D limited partnerships would be
in the top five. Then there was a second tier-six through ten-of products that were always
vying to get into the first tier. So there was a good backup behind them. It was a very rich
pipeline.
One of the benefits of having a strong R&D person like Art Levinson in there running the
company is that he can weigh the pros and cons of these product opportunities. It s always a
fight for resources. Even when you re a bigger company, you re limited by your earnings.
You can t
spend everything you have in the bank. You have to earn money for your
shareholders. They expect that.
Back then, basically we d look at what it would cost us to do what we want to do. Then
we d say we need $30 million in corporate deals, $50 million in equity. The business
development guys would go seek the corporate deals. I d go do the financial and equity
deals, and go get the money. That would be my goal. That was my contribution.
Bugos: Thank you very much.
Transcribed by The Prologue Group
Final Typed by Kathleen Zvanovec-Higbee
69
TAPE GUIDE--Fred Middleton
Interview 1 :
August 3, 2001
Tape 1, Side A 1
Tape l.SideB
Tape 2, Side A 15
Tape 2, Side B 22
Interview 2: August 22, 2001
Tape 3, Side A 26
Tape 3, Side B 32
Tape 4, Side A 38
Tape 4, Side B 45
Interview 3: August 31, 2001
Tape 5, Side A 48
Tape 5, Side B 54
Tape 6, Side A 60
Tape 6, Side B 66
70
APPENDICES
A. Biography and Curriculum Vitae 71
B. Fraternity Photographs of Fred Middleton and Bob Swanson, 1968 74
C. Genentech, Inc., Sale of Series A Preferred Stock to the Lubrizol Corporation, 1979 75
D. Fred Middleton and Herbert Boyer in Switzerland, 1980 101
E. Amendment No. 2 to Form S-l Registration Statement submitted by Genentech
to the Securities and Exchange Commission, October 14, 1980 102
F. Purchase of Common Stock by Coming Glass Works and Formation of 1 982
Genencor, Inc., 153
G. Genentech Clinical Partners, Ltd., 1982 178
H. Genentech Clinical Partners H, 1983 241
I. Bob Swanson and Fred Middleton at Fred s 50
th
Birthday Party, 1999 263
71
APPENDIX A
Biography
Fred A. Middleton
Sanderling
2730 Sand Hill Road, Suite 200
Memo Park, CA 94025
Phone: 650-854-9855
Fred Middleton has over twenty years experience in the biotechnology and biomedical industries in both
corporate management and as an institutional investor. Mr. Middleton joined Dr. McNeil in late 1987 as a
General Partner at Sanderling. Since 1987, Mr. Middleton has focused on venture capital investments in
the corporate development of early-stage biomedical companies at Sanderling, serving as a founder,
management team member and director of numerous start-up ventures in the Sanderling portfolios. Over
the last several years, he has played active management roles at a number of Sanderling companies,
including service as the Chief Executive Officer of Vical, DepoTech, Acea, Desmos, and Stereotaxis.
Mr. Middleton began his career as a consultant for McKinsey & Company s San Francisco office and was
also a Vice President of Chase Manhattan Bank in New York. In 1978, Mr. Middleton joined the founders
of biotechnology pioneer Genentech, Inc. to become part of the original management team, and served as
Vice President of Finance, Administration, Corporate Development, as well as Chief Financial Officer.
While at Genentech, Mr. Middleton completed over $200 million in corporate partnering and institutional
funding transactions, including the Company s initial public offering in 1980.
In 1 984, Mr. Middleton founded Morgan Stanley Ventures, serving as managing general partner of an
institutional fund raised to sponsor R&D funding arrangements of leading technology companies in the
biomedical sciences and information technology fields.
Mr. Middleton earned a B.S. in chemistry from the Massachusetts Institute of Technology in 1971 and an
M.B.A. with distinction from Harvard Business School in 1973.
72
Curriculum Vitaefor Fred A. Middle-ton page - 1
CURRICULUM yiTAE
Fred A. Middleton, MBA
2730 Sand Hill Road, Suite 200, Menlo Park, CA 94025 (650) 854-9855 finiddleton@sanderling.com
PROFESSIONAL EXPERIENCE:
1 987 to present SANDERLING VENTURES
General Partner - Mr. Middleton joined Dr. Robert G. McNeil in 1987 to found Middleton-McNeil
Associates, L.P., the General Partner for the Sanderling Funds. At Sanderling, Mr. Middleton has
played a key role as a founder, management team member and/or director of many Sanderling portfolio
companies including CoCensys, DepoTech, Desmos, Genteric, Novatrix, Regeneron and Vical. Mr.
Middleton works closely with the Sanderling portfolio companies in strategic planning, fund raising,
business development, and positioning the company for growth
1 984 - 1 986 MORGAN STANLEY VENTURES
President and Managing General Partner - Mr. Middleton was a founder of Morgan Stanley
Ventures, establishing the firm s office in San Francisco, recruiting staff, and raising $40 million fund
to sponsor R&D funding arrangements at high technology companies. Under his direction in 1985 and
1986, the fund evaluated over 330 investment proposals and completed five investments, including two
with biotechnology companies in 1985 and 1986.
1978 - 1984 GENENTECH, INC.
Vice President Finance, Administration, Corporate Development and Chief Financial Officer -
Mr. Middleton joined Genentech as the eighth employee in 1978 with responsibilities for business
planning, finance, human resources, facilities and corporate venture activities. He completed over
$200 million in funding transactions for Genentech, including several corporate and institutional
private placements and the company s successful initial public offering in 1980. He negotiated
contracts to fund research, formed several corporate joint ventures, and completed numerous corporate
partnering transactions. In 1982, he conceived and established Genentech Development Corporation,
serving as its President, to raise $89 million in R&D partnership funding to sponsor clinical trials for
human growth hormone, gamma interferon, and t-PA. By January 1987, these partnerships had paid
out to investors $450 million in common stock distributions, representing the most successful R&D
partnership program completed by a company.
1977-1978 CHASE BANK
Vice President, Planning and Corporate Development -
Responsibilities included strategic planning
for the International, Real Estate, and Information Service Groups.
1975 - 1977 STUPESAKER WORTfflNGTON
Assistant to the Chairman and CEO - Assisted in corporate development, strategic planning and
mergers and acquisitions.
73
1973-1975
Curriculum Vitaefor Fred A, Middleton page - 2
McKINSEY & COMPANY
Consultant - Completion of assignments in strategic planning, investment analysis, and
mergers/acquisitions for clients in the petroleum, chemical, and natural resources industries.
PROFESSIONAL AFFILIATIONS:
As of September 2000, Mr. Middleton serves as a director of the following portfolio companies:
Regeneron Pharmaceuticals, Inc.
Novatrix, Inc.
Stereotaxis, Inc.
Cardionet
Genteric, Inc.
Cythera, Inc.
EDUCATION:
1971
1973
B.S.
Chemistry
M.B.A. with Distinction
Massachusetts Institute of Technology
Cambridge, Massachusetts
Harvard Business School
Boston, Massachusetts
74 APPENDIX B
ZEIGLER 9. REID MARSH E RICHARD I. KARASH ROLF BRAUCHLER EDWARD A. SEYKOTA JOHN L. WYATT
iQTATQH OON1UL "0 CONiUL OUAI1T
PETER & MAYBECK KENNETH P. MORSE LANCE E. HAN3CHE JOHN f. WALTERS
1 3 C
<v+\ "U * V-
ALAN L. DAVIS BRUCE R. DONATH ROBERTA. SWANSON JAMES A- SCNWARZROCK
D. WAYNE WENSER J. RALPH COLE ALBERT C. MEYERtR JOHN S. WURTS JR. THOMAS 0. UN8ER GARY K. STI MAC
EDWARD M. DONIE PHILIP C. ABBOTT FRED A. MIDOLETON JR. DAVID R. OUTRIGHT ROBERT E. LINDGREN RICHARD A. AKEMANN
APPENDIX C
GENENTECH, INC.
Sale of Series A
Preferred Stock
To
The Lubrizol
Corporation
1979
76
PREFERRED STOCK PURCHASE AGREEMENT
This Preferred Stock Purchase Agreement (the "Agreement")
is made as of the 28th day of August, 1979, by and between
GENENTECH, INC., a California corporation (the "Company")
and THE LUBRIZOL CORPORATION, an Ohio corporation (the
"Investor" ) .
In consideration of the mutual promises, covenants and
conditions hereinafter set forth, the parties hereto mutually
agree as follows:
1. Purchase and Sale of Preferred Stock.
1.1 Authorization of Sale of Preferred Stock.
The Company has created a series of 90,000 of the 100,000
shares of its $0.02 par value Preferred Stock ("Preferred
Stock") entitled Series A Preferred Stock (the "Series A
Preferred Stock"), the rights, preferences and privileges of
which are as set forth in paragraph (c) of Article FIFTH of
the Articles of Incorporation of the Company, a copy of
which is attached hereto as Exhibit A. An aggregate of
61,371 shares of the Series A Preferred Stock has previously
been issued and sold by the Company. The Company has autho
rized the sale of 25,000 shares of Series A Preferred Stock,
(the "Shares") to the Investor. Subject to the terms and
conditions of this Agreement, the Investor agrees to purchase,
and the Company agrees to sell and issue, the Shares at the
Closing (as defined below) for an aggregate purchase price
of ten million dollars ($10,000,000) in cash.-
1.2 Closing. The purchase and sale of the Shares
shall take place at the offices of Cooley, Godward, Castro,
Huddleson & Tatum, One Maritime Plaza, 20th Floor, San
Francisco, California 94111, on September 13, 1979, or at
such other time and place as the Company and the Investor
mutually agree upon in writing (which time and place are
hereinafter referred to as the "Closing"). At the Closing
the Company shall deliver to the Investor a certificate
representing the Shares against delivery to the Company by
the Investor of cash, a wire transfer or a certified or bank
cashier s check in San Francisco Clearing House funds in the
amount of the purchase price for the Shares.
2. Representations and Warranties of the Company.
The Company hereby represents and warrants to the Investor
that:
77
2.1 Incorporation and Qualification to do Business;
subsidiaries. The Company is a corporation duly organized
and validiy existing and in good standing under the laws of
the State of California and has all requisite corporate
power and authority to carry on its business as now conducted.
The Company has no subsidiaries.
2.2 Capitalization .
(a) The authorized capital of the Company
consists of 100,000 shares of Preferred Stock, $0.02 par
value per share, of which 61,371 shares are issued and
outstanding, and 10,000,000 shares of Common Stock $0.02 par
value per share, of which 758,976 shares are issued and
outstanding.
(b) Of the 100,000 authorized shares of
Preferred Stock, 90,000 shares have been designated Series A
Preferred Stock with the rights, preferences and privileges
set forth in paragraph (c) of Article FIFTH of the Articles
of Incorporation of the Company. Each presently outstanding
share of Series A Preferred Stock is entitled to be converted
into ten (10) shares of Common Stock.
(c) Attached hereto as Exhibit B is a list
of each person who holds 1,000 or more shares of Series A i
Preferred Stock or 10,000 or more shares of Common Stock.
(d) There are no options, warrants, con
version privileges or other rights presently outstanding to
purchase any of the authorized but unissued stock of the
Company, except the conversion privilege in the Series A
Preferred Stock presently outstanding and the options granted
under the Company s Non-Qualified Stock Option Plan referred
to below. The Company has adopted a Stock Purchase Plan
under which a maximum of 150,000 shares of Common Stock may
be issued to employees and consultants at prices of not less
than $.30 per share. To date, a total of 140,226 shares of
Common Stock have been issued under the Stock Purchase Plan.
In addition, a total of 9,750 shares have been authorized
for issuance under the Stock Purchase Plan. The Company has
also adopted a Non-Qualified Stock Option Plan under which
options to purchase a maximum of 150,000 shares of Common
Stock may be granted. To date, options exercisable for the
purchase of 4,000 shares have been granted under the Non-
Qualified Stock Option Plan.
2.
(e) There are no preemptive, subscription or
similar rights to purchase new issuances of the Company s
stock.
(f) All outstanding Common Stock and Pre
ferred Stock have been issued in compliance with all applicable
federal and state securities laws and have been validly
issued and are fully paid and nonassessable.
2.3 Authorization . All corporate action on the
part of the Company, its officers and directors necessary
for the authorization, execution, delivery and performance
of all obligations of the Company under this Agreement and
for the authorization, issuance and delivery of the Shares
and the Common Stock into which the Shares are convertible
has been or shall be taken prior to the Closing, and this
Agreement, when executed and delivered, shall constitute a
valid and legally binding obligation of the Company, enforce
able in accordance with its terms, except as limited by
applicable bankruptcy, insolvency, reorganization, moratorium,
or other laws of general application relating to or affecting
enforcement of creditors 1
rights, and except to the extent
that the enforceability of the indemnification provisions in
subparagraph 8.9 of this Agreement may be limited by appli
cable laws.
r i
2.4 Validity of Shares . The Shares, when issued,
sold and delivered in accordance with the terms of this
Agreement for the consideration expressed herein, and the
Common Stock into which the Shares are convertible when
issued upon conversion of the Shares, shall be duly and
validly issued, fully paid and nonassessable. The Investor
will receive good and marketable title to the Shares free
and clear of any mortgage, pledge, lien, charge or other
encumbrance caused or created by the Company, subject,
however, to restrictions upon transfer under this Agreement
and any applicable federal and state securities laws.
2.5 Governmental Consents . All consents, approvals,
orders, authorizations or registration, qualification,
designation, declaration or filing with any federal or state
governmental authority on the part of the Company required
in connection with the consummation of the transactions
contemplated herein shall have been obtained prior to, and
be effective as of, the Closing.
2.6 Proprietary Agreements . Each of the employees
of the Company has executed proprietary information and
confidentiality agreements in substantially the form previ
ously provided to the Investor, and the Company intends to
have all of its future employees who have access to the
3.
79
technology of the Company execute similar proprietary infor
mation and confidentiality agreements .
2.7 Compliance with Other Instruments . The
Company is not in violation of any provisions of its Articles
of Incorporation or By-laws, or, in any material respect, of
any agreement to which the Company is a party or by which
its property or business is affected, or any California or
federal (or to the best of its knowledge, any other) judgment,
writ, decree, order, statute, rule or governmental regulation
applicable to the Company; the execution, delivery and
performance of this Agreement will not result in any such
violation or be in conflict with or constitute a default
under any such provision; and there is no such provision
which materially adversely affects the business, operations,
affairs, prospects or condition (financial or otherwise) of
the Company or its property or assets.
2.8 Misleading Statements. No representation or
warranty by the Company in this Agreement or any statement
or certificate furnished or to be furnished to the Investor
pursuant hereto or in connection with the transactions con
templated hereby contains or will contain any untrue state
ment of a material fact or omits or will omit to state a
material fact necessary to make the statements therein not
misleading. The material which has been presented <to the ,
Investor by the Company has been prepared in a good faith
effort to describe the Company s proposed products, the
anticipated market therefor, and the Company s projected
growth, and the Company is not aware of any material mis
leading statements or omissions therein.
2.9 Litigation. There is no action, proceeding
or investigation pending (or, to the best of the knowledge
and belief of the Company, any basis therefor or any threat
thereof) which questions the validity of this Agreement or
which might reasonably be expected to result, either indi
vidually or in the aggregate, in any material adverse change
in the assets, condition (financial or otherwise), affairs,
or prospects of the Company.
2.10 Patents, Trademarks . To the best , of the
Company s knowledge, the Company has sufficient right, title
and ownership of all patents, information, proprietary
rights and processes or is able to obtain on reasonable
terms all permits, licenses and other authority, necessary
for the lawful conduct of the business as proposed by the
4.
Company. In this connection, the Investor has been informed
by the Company of pending applications for patents by
Stanford University and the University of California with
respect to certain matters encompassed within the business
of the Company and the status of license negotiations with
Stanford University with respect to the Stanford University
applications, and of the existence of a patent with respect
to a possible product of the Company and the status of the
Company s investigation of the coverage thereof. The Investor
also understands that the pace of development in the Company s
field of endeavor is very rapid and that the Company s
competitors may have made or may be making patentable inven
tions. With the foregoing exceptions, the Company is not
aware of any patents or proprietary rights or processes held
or owned by persons other than the Company which may conflict
with the lawful conduct of the Company s business as presently
proposed.
2.11 No Conflicting Agreements . No officer,
director or employee of the Company is obligated under any
contract or other agreement, or subject to any judgment,
decree or order of any court or administrative agency which
would conflict with his obligation to use his best efforts
to promote the interests of the Company or with the conduct
of the Company s business as proposed by the Company.
Neither the execution nor delivery of this Agreemerit, nor
the carrying on by any officer, director or employee of the
Company s business as an officer, director or employee will
conflict with or result in a breach of or constitute a
default under any contract or agreement under which any
officer, director or employee is obligated.
2.12 Finder s Fee. The Company will not be obli
gated for any finder s fee or commission in connection with
this transaction.
2.13 Financial Statements . The Company has pre
viously furnished to the Investor a Balance Sheet/ as of
December 31, 1978, and Statements of Operations and of
Changes in Financial Position, both for the year ended
December 31, 1978, as audited and reported on by Arthur
Young & Company, Independent Public Accountants. The Company
has also furnished to the Investor an unaudited Balance
Sheet, as of June 30, 1979, and unaudited Statements of
5.
81
terations and of Changes in Financial Position, both for
he six month period ended June 30, 1979. Such statements
are in accordance with the books and records of the Company
and have been prepared in accordance with generally accepted
accounting principles consistently followed throughout the
periods indicated. Such statements fairly present the
financial condition of the Company at the date of each such
I! statement and the results of its operations for the periods
Sr /specified therein (subject, in the case of unaudited finan-
?Jf^cial statements, to year-end audit adjustments). The Company
^ maintains a standard system of accounting established and
^;; :
administered in accordance with generally accepted accounting
>;
principles.
:
":
2.14 No Material Adverse Changes . Since June 30,
;
A: 1979, neither the business nor the properties, condition
;
(financial or otherwise), affairs or assets of the Company
have been materially adversely affected in any way.
2.15 Title to Property; Liens . The Company has
good and marketable title to all its properties and assets,
including the properties and assets reflected in the Balance
Sheet as at June 30, 1979, referred to in subparagraph 2.13,
except the properties disposed of since such date in the
ordinary course of business, and has good title to all its
leasehold estates, in each case subject to no mortgage,
pledge, lien, charge or encumbrance other than as disclosed
in such Balance Sheet.
2.16 Taxes . The Company has filed all United
States income tax returns and all state and municipal tax
returns which are required to be filed by it and has paid or
made provision for the payment of all taxes which have
become due pursuant to said returns or pursuant to any
assessment received by it except such taxes, if any, as are
being contested in good faith, as to which adequate reserves
have been provided.
2.17 Use of Proceeds . The Company intends to use
the net proceeds of the sale of Shares hereunder, after
payment of expenses, to construct and equip new laboratory
facilities and for working capital.
2.18 Legislation. The Company is not aware of any
pending legislation which would prevent it from carrying on
its business or materially adversely affect the business,
properties, condition (financial or otherwise), affairs or
assets of the Company.
82
2.19 Technology. Except as set forth on Exhibit C
the Company is not a party to and neither it nor any
of- its property is bound by any contract, license, commitment
; or other agreement that recognizes or grants in or to any
third party any right, title or interest in or to any patents,
proprietary rights, technology or processes owned or developed
by the Company or its employees (as employees of the Company).
; . 3 . Representations and Warranties of the Investor.
The Investor represents and warrants to the Company as
f- follows :
3.1 Authorization . This Agreement when executed
and delivered by the Investor will constitute a valid and
legally binding obligation of the Investor, enforceable in
accordance with its terms, except as limited by applicable
bankruptcy, insolvency, reorganization, moratorium or other
laws of general application relating to or affecting enforce
ment of creditors rights and except to the extent that the
enforceability of the indemnification provisions in subpara-
graph 8.9 of this Agreement may be limited by applicable
laws.
3.2 Finder s Fee. The Investor will not be
obligated for any finder s fee or commission in connection
with this transaction.
3.3 Business Plan Material. The Investor acknowl
edges that it has read the material presented to it by the
Company, that it has interviewed the officers, and directors
of the Company concerning the Company and that it has received
all the information it considers necessary or appropriate
for deciding whether to purchase the Shares hereunder.
4. California Commissioner of Corporations ; SEC.
4.1 Corporate Securities Law. THE SALE OF THE
SECURITIES WHICH ARE- THE SUBJECT OF THIS AGREEMENT HAS NOT
BEEN QUALIFIED WITH THE COMMISSIONER OF CORPORATIONS OF THE
STATE OF CALIFORNIA AND THE ISSUANCE OF SUCH SECURITIES OR
THE PAYMENT OR RECEIPT OF ANY PART OF THE CONSIDERATION
THEREFOR PRIOR TO SUCH QUALIFICATION IS UNLAWFUL. THE
RIGHTS OF ALL PARTIES TO THIS AGREEMENT ARE EXPRESSLY
CONDITIONED UPON SUCH QUALIFICATION BEING OBTAINED.
4.2 Investment Representation. The Investor
acknowledges that it is aware that the Shares being sold
7.
83
hereunder have not been registered under the Securities Act
of 1933, as amended. In this connection, the Investor
represents and warrants to the Company that it is acquiring
the Shares for investment and not with a view to or for sale
in connection with any distribution thereof (or of Common
Stock issuable upon conversion of the Shares) or with any
present intention of selling any of the aforementioned
securities in connection with a distribution and it does not
presently have reason to anticipate any change in circum
stances or any particular occasion or event which would
cause it to distribute any of the aforementioned securities.
The Investor shall execute and deliver at or prior to the
Closing a letter in the form attached hereto as Exhibit D
confirming this investment representation.
4.3 Restricted Securities. The Investor under
stands that the securities it is purchasing hereunder are
characterized as "Restricted Securities" under the Federal
securities laws inasmuch as they are being acquired from the
Company in a transaction not involving a public offering and
that under such laws and applicable regulations the Shares
may be resold without registration under the Securities Act
of 1933, as amended, only in certain limited sets of circum
stances .
4.4 Legends . It is understood that the certi- ,
ficates evidencing the Shares (and any Common Stock issuable
upon conversion thereof) may bear one or all of the following
legends :
(a) "These securities have not been regis
tered under the Securities Act of 1933. They may not be
sold, offered for sale, pledged or hypothecated in the
absence of an effective registration statement as to the
securities under said Act or an opinion of counsel satisfac
tory to the company that such registration is not required.";
and
(b) Any legend required by the California
Commissioner of Corporations.
5. Conditions of the Investor s Obligations at Closing,
The obligations of the Investor under subparagraph 1.1 of
this Agreement are subject to the fulfillment at or before
the Closing of each of the following conditions:
5.1 Representations and Warranties . The repre
sentations and warranties contained in paragraph 2 hereof
8.
84
foall be true on and as of the Closing, with the same force
d effect as though such representations and warranties had
een made on and as of the Closing.
5.2 Performance. The Company shall have performed
d complied with all agreements and conditions contained
required to be performed or complied with by it on or
;J3efore the Closing.
<:&-
. 5.3 Compliance Certificate. There shall have
been delivered to the Investor a certificate, dated the date
of Closing, signed by the Company s President or any Vice
President certifying ,
that the conditions specified in sub-
paragraphs 5.1 and 5. 2 have been fulfilled.
5.4 Opinion of Counsel. The Investor shall have
received from Messrs. Cooley, Godward, Castro, Huddleson &
Tatum, counsel for the Company, their opinion, dated the
date of Closing, in form and substance satisfactory to the
Investor, to the effect that:
(a) The Company is a corporation duly organ
ized, validly existing and in good standing under the laws
of the State of California, and has adequate corporate power
and authority to execute the Agreement and to consummate the
transactions contemplated thereby. r ,
(b) The Agreement has been duly authorized
by the Company and duly executed and delivered by an autho
rized officer of the Company and constitutes a legal, valid
and binding obligation of the Company and, subject to bank
ruptcy and other laws of general application affecting the
rights and remedies of creditors, is enforceable in accord
ance with its terms, except insofar as the enforceability of
the indemnification provisions in subparagraph 8.9 hereof
may be limited by law.
(c) The authorized capital of the Company
consists of 100,000 shares of Preferred Stock, $0. 02 par
value per share, of which 61,371 shares are issued and
outstanding, and 10,000,000 shares of Common Stock, $0.02
par value per share, of which 758,976 shares are Issued and
outstanding. The outstanding shares of Preferred Stock and
Common Stock have been duly and validly issued and are fully
paid and nonassessable. To the best of their knowledge,
there are no options, warrants, conversion privileges or
other rights presently outstanding to purchase any of the
9.
85
brized but unissued stock of the Company, except options
isable for the purchase of 4,000 shares of Common Stock
anted under the Company s Non-Qualified Stock Option Plan,
& conversion privilege in the Series A Preferred Stock
flresently outstanding, and except to the extent that the
gliding purchases of 9,750 shares of Common Stock under the
^Sipany s Stock Purchase Plan constitute such a right; there
no preemptive, subscription or similar rights to purchase
ew issuances of the Company s stock; and all outstanding
preferred Stock and Common Stock have been issued in compliance
*
th all applicable federal and state securities laws.
(d) The issuance and sale of the Shares
"
pursuant to this Agreement and the issuance upon conversion
v?;bf the Shares of the Common Stock into which the Shares are
^convertible have been duly authorized by all necessary
Corporate action of the Company, and upon issuance, sale and
Delivery for the consideration expressed in the Agreement,
the Shares shall be duly and validly issued, fully paid and
nonassessable, and upon conversion of the Shares into such
Common Stock, such Common Stock will be duly and validly
issued, fully paid and nonassessable. The Investor will
receive good and marketable title to the Shares, free and
clear of any mortgage, pledge, lien, charge or other encum- .
brance caused or created by the Company, subject, however,
to restrictions upon transfer under this Agreement and any
applicable federal and state securities laws.
(e) All authorizations, approvals, permits
or consents, if any, of any governmental authority or
regulatory body of the United States or of any state neces
sary or required on the part of the Company in connection
with the lawful issuance and sale of the Shares pursuant to
the Agreement have been duly obtained by the Company and the
Company has complied with any and all applicable provisions
of law requiring any designation, declaration, filing,
registration or qualification with any federal or state
governmental authority in connection with such offer, issu
ance, sale or delivery.
(f) The offer, issuance, sale and delivery
of the Shares under the circumstances contemplated by the
Agreement constitute an exempted transaction under the
Securities Act of 1933, as presently in effect, and regis
tration thereunder of the Shares is not presently required.
(g) To the best of their knowledge there is
no action, proceeding or investigation pending which ques
tions the validity of the Agreement or which might result,
10.
86
either individually or in the aggregate, in any material
adverse change in the assets, condition (financial or other
wise), affairs or prospects of the Company.
6. _
Conditions of the Company s Obligations at Closing.
The obligations of the Company under subparagraph 1.1 of
this Agreement are subject to the fulfillment at or before
the Closing of each of the following conditions:
6.1 Warranties True on the Closing Date. The
representations and warranties of the Investor contained in
paragraph 3 hereof shall be true on and as of the Closing
with the same force and effect as though such representations
and warranties had been made on and as of the Closing.
6.2 California Commissioner p_f Corporations . The
Company shall have received a permit from the Commissioner
of Corporations of the State of California qualifying the
offer and sale of the Shares pursuant to this Agreement.
6.3 Investment Representation . The Company shall
have received from the Investor an executed investment
letter in the form of Exhibit D hereto.
7. Financial Statements . So long as the Investor
holds not less than 10,000 of the Shares being purchased
hereunder (or an equivalent amount of Common Stock), the
Company agrees to deliver to such Investor:
7.1 Annual Report . As soon as practicable after
the end of each fiscal year and in any event within 120 days
thereafter, a consolidated balance sheet of the Company as
at the end of such fiscal year, a consolidated statement of
income and surplus, and a consolidated statement of sources
and applications of funds of the Company for such year,
prepared in accordance with generally accepted accounting
principles consistently applied and setting forth in each
case in comparative form the figures for the previous fiscal
year, all in reasonable detail and certified by independent
public accountants of recognized national standing selected
by the Company.
7.2 Quarterly Reports . As soon as practicable
after the end of each of the first three quarterly fiscal
periods in each fiscal year and in any event within 60 days
thereafter, a consolidated balance sheet of the Company as
at the end of such period, a consolidated statement of
11.
87
lirnie and surplus and a consolidated statement of sources
^applications of funds of the Company for such period and
the case of the second and third quarterly periods) for
period from the beginning of the current fiscal year to
end of such quarterly period, all in reasonable detail
I certified, subject to changes resulting from year-end
ludit adjustments, by the principal financial or accounting
||ffiCer of the Company.
*& 8 - Registration Rights . The Company covenants and
atgrees as fo 1 1 ows : .
8.1 Requests for Registration. If the Company
shall receive at any time after four (4) years from, and
: within eight (8) years after, the Closing a written request
-
from the Investor to file a registration statement under the
Securities Act of 1933, as amended (the "Act"), or a similar
document pursuant to any other statute then in effect corres
ponding to the Act, covering the registration of not less
than 100,000 shares of Common Stock issued upon conversion
of the Shares (such shares of Common Stock are referred to
as the "Shares" in this paragraph 8), the Company shall use
its best efforts to cause such Shares to be registered under
the Act. The Company is obligated, however, to effect only
one such registration pursuant to this subparagraph 8.1.
Any request for registration under this subparagraph 8.1 \
must be for a firmly underwritten public offering managed by
an underwriter or underwriters of recognized national stand
ing reasonably acceptable to the Company. The Investor
expressly agrees that any holders of Common Stock of the
Company designated by the Company shall also be entitled to
include shares of their Common Stock in such underwriting
and registration in such quantity, if any, as would not, in
the opinion of the managing underwriter(s) , materially
adversely affect the distribution of such Shares, and no
reduction in the number of Shares of the Investor requested
to be included therein shall be made as a result of any such
inclusion.
8.2 Company Registration. If at any time within
eight (8) years after the Closing the Company proposes to
register any of its Common Stock under the Act on Form S-l,
S-7 or S-16 or any form equivalent thereto adopted by the
Securities and Exchange Commission ("SEC"), in connection
with the public offering of such Common Stock solely for
cash, the Company shall, each such time, give the Investor
written notice of said determination. Upon the written
12.
88
of the Investor given within twenty (20) days after
of any such notice from the Company (which request
l state the intended method of disposition of any of the
res proposed to be sold by it), the Company shall use its
_ efforts to cause to be registered, under the Act, such
ares as the Investor requests be registered.
8.3 Obligations of the Company. Whenever required
der subparagraph 8.1 or 8.2 to use its best efforts to
feet the registration of any of the Shares, the Company
all, as expeditiously as reasonably possible:
(a) Prepare and file with the SEC a Regis-
ation Statement with respect to such Shares and use its
st efforts to cause such Registration Statement to become
d remain effective;
(b) Prepare and file with the SEC such
endments and supplements to such Registration Statement
the prospectus used in connection therewith as may be
:
-lecessary to comply with the provisions of the Act with
respect to the disposition of all securities covered by such
ftegistration Statement;
(c) Furnish to the Investor such numbers of
.copies of a prospectus, including a preliminary prospectus,
in conformity with the requirements of the Act, and such
other documents as it may reasonably request in order to
facilitate the disposition of Shares owned by it.
(d) Use its best efforts to register and
qualify the securities covered by such Registration State
ment under such other securities or Blue Sky laws of such
jurisdictions as shall be reasonably appropriate for the
distribution of the securities covered by the Registration
Statement, provided that the Company shall not be required
in connection therewith or as a condition thereto to qualify
to do business or to file a general consent to service of
.
process in any such states or jurisdictions, and further
provided that (anything herein to the contrary notwith
standing with respect to the bearing of expenses) if any
jurisdiction in which the securities shall be qualified
shall require that expenses incurred in connection with the
qualification therein of the securities be borne by selling
shareholders, then such expenses shall be payable by selling
shareholders pro rata, to the extent required by such
jurisdiction; provided, however, that in connection with any
13.
89
proposed registration intended to permit an offering of any
securities from time to time (i.e., a so-called "shelf
registration" ) , the Company shall in no event be obligated
to cause any such registration to remain effective for more
than ninety (90) days.
8.4 Furnish Information. It shall be a condition
precedent to the obligations of the Company to take any
action pursuant to this paragraph 8 that the Investor shall
furnish to the Company such information regarding it, the
Shares, held by it and the intended method of disposition
thereof as the Company shall reasonably request and as shall
be required in connection with the action to be taken by the
Company.
8.5 Expenses of Demand Registration. All expenses
incurred in connection with a registration pursuant to
subparagraph 8.1, including without limitation all regis
tration and qualification fees, printers and accounting
fees, and fees and disbursements of counsel for the Company,
shall be borne by the Company, including the reasonable fees
and disbursements (not exceeding $20,000) of one counsel for
the Investor; provided, however, that the Company shall not
be required to pay for any expenses of any registration
proceeding begun pursuant to subparagraph 8.1 if the request
therefor is subsequently withdrawn by the Investor, ,
unless ,
the Investor agrees to forfeit its right to^ a demand regis
tration pursuant to subparagraph 8.1 hereof. Any excess fees
and disbursements of counsel for the Investor and any expenses
of any registration proceeding begun pursuant to subparagraph
8.1 if the request therefor is subsequently withdrawn by the
Investor (unless the Investor agrees to forfeit its/ right to
a demand registration pursuant to subparagraph 8.1 hereof)
shall be borne by the Investor.
\
8.6 Company Registration Expenses . In the case
of any registration effected pursuant to subparagraph 8.2,
the Investor and the holders of any other shares of the
Company s Common Stock being included in such registration
shall bear, any additional registration and qualification
fees and expenses, additional costs and disbursements of
counsel for the Company and the fees of counsel for the
selling shareholders which result from the inclusion of
shares held by the Investor and other selling shareholders
in such registration, with such additional expenses of the
registration being borne by all such selling shareholders
pro rata on the basis of the number of shares of Common
14.
90
iijock of such shareholders so registered. In the event some
o"
the securities being registered are or may become convert
ible into shares of the Company s Common Stock, they will be
deemed to have been converted for the purpose of allocating
tich expenses.
,
i 8.7 Underwriting Requirements . In connection
with any offering involving an underwriting of shares being
issued by the Company, the Company shall not be required
under subparagraph 8.2 to include any of the Investor s
Shares therein or in the registration unless the Investor
accepts the terms of the underwriting as agreed upon between
the Company and the underwriters selected by it, and then
only in such quantity as would not, in the opinion of the
managing underwriter(s) , materially adversely affect the
distribution of securities by the Company. If the total
number of shares of stock which all such selling shareholders
of the Company request to be included in such offering
exceeds the number of such shares which the managing under
writer (s) reasonably believes would not materially adversely
affect the distribution of such securities, the Company
shall only be required to include in the offering and in the
registration so many of the shares of stock of the selling
shareholders as the managing underwriter(s) believes would
not materially adversely affect the distribution of such
securities (the shares so included to be apportioned pro
rata among the selling shareholders according to the total
number of shares of Common Stock owned [or which could be
acquired by conversion of other securities convertible into
Common Stock] by said selling shareholders, or in such other
proportions as shall mutually be agreed to by such selling
shareholders ) , provided that no such reduction shall be made
with respect to any securities offered by the Company for
its own account.
8.8 Delay of Registration. The Investor shall
not have any right to take any action to restrain, enjoin or
otherwise delay any such registration as the result of any
controversy which might arise with respect to the interpre
tation or implementation of this paragraph 8 .
8.9 Indemnification. In the event any of the
Shares are included in a Registration Statement under this
paragraph 8:
(a) To the extent permitted by law, the
Company will indemnify and hold harmless the Investor, any
15.
91
underwriter (as defined in the Act) for it, and each person,
iif any, who controls such underwriter within the meaning of
"section
15 of the Act, against any losses, claims, damages,
costs/ expenses or liabilities whatsoever, joint or several,
to which they may become subject under the Act or otherwise,
insofar as such losses, claims, damages, costs, expenses or
liabilities whatsoever (or action in respect thereof) arise
out of or are based upon any untrue or alleged untrue state
ment- of any material fact contained in such Registration
Statement, including any preliminary prospectus or final
prospectus contained therein or any amendments or supple
ments thereto, or arise out of or are based upon the omission
or alleged omission to state therein a material fact required
to be stated therein, or necessary to make the statements
therein not misleading; and will reimburse the Investor,
such underwriter or controlling person for any legal or
other expenses reasonably incurred by them in connection
with investigating, preparing or defending any such loss,
claim, damage, cost, expense, liability or action; provided,
however, that the indemnity agreement contained in this
subparagraph 8. 9 (a) shall not apply to amounts paid in
settlement of any such loss, claim, damage, cost, expense,
liability or action if such settlement is effected without
the consent of the Company (which consent shall not be
unreasonably withheld) nor shall the Company be liable in ,
any such case for any such loss, claim, damage, cost, expense,
liability or action to the extent that it arises out of or
is based upon an untrue statement or alleged untrue statement
or omission or alleged omission made in connection with such
Registration Statement, preliminary prospectus, final
prospectus, or amendments or supplements thereto, in reliance
upon and in conformity with written information furnished by
the Investor, such underwriter or controlling person expressly
for use in such Registration Statement, preliminary prospectus,
final prospectus, or amendments or supplements thereto.
(b) To the extent permitted by law, the
Investor will indemnify and hold harmless the Company, each
of its directors, each of its officers who have signed such
Registration Statement, each person, if any, who controls
the Company within the meaning of Section 15 of the Act, and
any underwriter for the Company (within the meaning of the
Act) against any losses, claims, damages, costs, expenses or
liabilities whatsoever to which the Company or any such
director, officer, controlling person or underwriter may
become subject, under the Act or otherwise, insofar as such
losses, claims, damages, costs, expenses or liabilities
16.
92
(or actions in respect thereto) arise out of or
ate -based upon any untrue or alleged untrue statement of any
tiiiierial fact contained in such Registration Statement,
ffeiuding any preliminary prospectus or final prospectus
.contained therein or any amendments or supplements thereto,
oil arise out of or based upon the omission or alleged omission
t$Estate therein a material fact required to be stated
therein or necessary to make the statements therein not
misleading, in each case to the extent, but only to the
extent, that such untrue statement or alleged untrue state
ment or omission or alleged omission was made in such Regis-
.tration Statement, preliminary prospectus, or amendments or
supplements thereto, in reliance upon and in conformity with
written information furnished by the Investor expressly for
use in such Registration Statement, preliminary prospectus ,
final prospectus, or amendments or supplements thereto; and
the Investor will reimburse any legal or other expenses
reasonably incurred by the Company or any such director,
officer, controlling person or underwriter in connection
with investigating, preparing or defending any such loss,
claim, damage, liability or action.
(c) Promptly after receipt by an indemnified
party under this subparagraph 8.9 of notice of the commence
ment of any action, such indemnified party will, if a claim
in respect thereof is to be made against an indemnifying
party under this subparagraph 8.9, notify the indemnifying
party in writing of the commencement thereof and the indem
nifying party shall have the right to participate in, and,
to the extent the indemnifying party so desires, jointly
with any other indemnifying party similarly noticed, to
assume the defense thereof with counsel mutually satisfactory
to the parties. The failure to notify an indemnifying party
promptly of the commencement of any such action, if prejudicial
to his ability to defend such action, shall relieve such
indemnifying party of any liability to the indemnified party
under this subparagraph 8.9 but the omission so to notify
the indemnifying party will not relieve him of any liability
which he may have to any indemnified party otherwise than
under this subparagraph 8.9.
8.10 No-Action Letter; Letter or Opinion of Counsel
in Lieu of Registration. If the Company shall have obtained
from the Securities and Exchange Commission a "no-action"
letter in which the Commission has indicated that it will
take no action if the Investor disposes of the Shares covered
by any request made under subparagraph 8.1 or 8.2 hereof in
17.
93
pinner in which it proposes to dispose of the Shares
\ided in such request, or if in the opinion of counsel
e Company, concurred in by counsel for the Investor,
f|h concurrence shall not be unreasonably withheld, no
^Ltration under the Act is required in connection with
disposition, the Company need not comply with such
a .est or requests; provided, however, that the Company
gfaali not be so relieved of its obligations under this
h 8 unless the aforementioned "no-action" letter or
of counsel for the Company shall have been mailed by
to the Investor within forty- five (45) days
Company s receipt of their request or requests.
i
8.11 Reports Under Securities Exchange Act of
1934. The Company agrees to use its best efforts to register
under Section 12 (g) of the Securities Exchange Act of 1934,
-ats4^amended, not later than ninety (90) days after the
effective date of the first registration on Form S-l or any
form equivalent thereto covering an underwritten public
offering filed by the Company and thereafter (i) to use its
best efforts to file with the SEC in a timely manner all
reports and other documents required to be filed by an
issuer of securities registered under the Securities Exchange
Act of 1934, as amended, and (ii) so long as the Investor
owns in excess of 25,000 of the Shares (or an equivalent
amount of Series A Preferred Stock), to use its bes efforts
to furnish the Investor upon its request a written statement
by the Company that it has complied with the reporting
requirements under such rule or regulation, a copy of the
most recent annual or quarterly report of the, Company and
such other reports or documents so filed by the Company as
the Investor may reasonably request in order to obtain the
benefit of any rule or regulation of the SEC which may
permit it to sell securities to the public without regis
tration.
8.12 Transfer o_f Registration Rights. The regis
tration rights of the Investor under this paragraph 8 may be
transferred to any transferee who acquires at least 100,000
of the Shares (or an equivalent amount of Series A Preferred
Stock); provided, that the Company is given written notice
by the Investor at the time of such transfer stating the
name and address of the transferee and identifying the
Shares with respect to which the rights under this paragraph 8
are being assigned; provided, further, that the registration
rights of the Investor under subparagraph 8.1 may only be
transferred to a transferee who is acceptable to the Company,
which acceptance shall not be unreasonably withheld.
18
94
9. Survival of Warranties . The warranties and repre-
ions of the Company contained in or made pursuant to
Agreement shall survive the execution and delivery of
Agreement and the Closing Date hereunder, and the same
expire and be of no further force or effect upon the
liration of one (1) year from the date hereof (hereinafter
relerred to as the "expiration date"). Nothing in this
paragraph 9 shall, however, be construed to change or extend
the date at which such warranties and representations are
deemed to have been made to any date other than the date of
this Agreement and the Closing Date nor to foreclose any
demand, assertion or claim by any party hereto for indemni
fication in respect of a claimed breach of any warranty or
representation if such demand, claim or assertion is made on
or, before the expiration date pursuant to this Agreement,
even though the amount of such demand, assertion or claim
cannot be ascertained until after the expiration date.
10. Expenses .
Except as provided elsewhere herein,
the Company and the Investor will each pay their own expenses
(including legal expenses) in connection with the trans
actions contemplated by this Agreement.
11. Inspection. So long as the Investor holds not
less than 10,000 of the Shares (or an equivalent amount of
Common Stock), the Company agrees to permit any authorized ,
representatives of the Investor, at such Investor s expense
and upon advance notice, to visit and inspect any of the
properties of the Company, including its books of account,
and to take extracts therefrom, and to discuss its affairs,
finances and accounts with its officers, at all such reason
able times and as often as may be reasonably requested;
provided, however, that the Company shall not be required at
any time to disclose (i) any manufacturing or trade secret
or secret process, or any information or data classified by
the United States government, or (ii) other data the disclo
sure of which the Board of Directors of the Company reason
ably believes may adversely affect the business of the
Company by reason of other investments the Investor may have
at the time.
12. Lubrizol s Investment. The Investor has repre
sented to the Company that it is purchasing the Shares
hereunder as an investment and not with the intention of
acquiring the Company or making the Company a subsidiary of
the investor. Except with respect to the 13,880 shares of
Series A Preferred Stock (and/or any Common Stock into which
such Series A Preferred Stock is converted) held by INCO
19,
95
trities Corporation, the Investor hereby agrees that
er it, nor anyone acting on its behalf, shall solicit
sale of, or offer to buy, any equity securities of the
any from any of the Company s security holders without
prior approval of the Company. In the event the Investor
ryes any unsolicited offer, the Investor will notify the
iny in advance of making any purchase.
13 . Representative on the Company s Board of Direc-
. Effective at the Company s next Annual Meeting of
fftlreholders , and so long thereafter as the Investor holds
ilp;-
less than 25,000 of the Shares (or an equivalent amount
&f;
:Common Stock into which Shares have been converted), the
bmpany agrees to use its best efforts to cause and maintain
election to its Board of Directors of a mutually accept-
representative of the Investor.
V
14 . Miscellaneous .
14.1 Agreement is_ Entire Contract. This Agreement
constitutes the entire contract between the parties hereto
and no party shall be liable or bound to the other in any
manner by any warranties, representations, guaranties or
covenants except as specifically set forth herein. The
terms and conditions of this Agreement shall inure to the
benefit of and be binding upon the respective successors and1
assigns of the parties hereto (including, without limitation,
any wholly-owned subsidiary of the Investor to which the
Investor may assign the Shares (or equivalent Common Stock)
and its rights under this Agreement). Nothing in this
Agreement, express or implied, is intended to confer upon
any party, other than the parties hereto, and their respective
successors and assigns, any right, remedies, obligations or
liabilities under or by reason of this Agreement, except as
expressly provided herein.
14.2 Governing Law. This Agreement shall be
governed by and construed under the laws of the State of
California as applied to contracts between California resi
dents entered into and to be performed entirely within
California.
14.3 Counterparts . This Agreement may be executed
in two or more counterparts, each of which shall be deemed
an original, but all of which together shall constitute one
and the same instrument.
20.
96
14.4 Titles and Stab titles. The titles of the
s and subparagraphs of this Agreement are not to be
ired in construing this Agreement.
14.5 Notices .
Any notice required or permitted
Jer shall be given in writing and shall be deemed
Lvely given upon personal delivery or upon deposit in
il ted States Post Office, by registered or certified
-addressed to a party at its address hereinafter shown
Hits signature or at such other address as such party
signate by ten (10) days advance written notice to
xer party.
lament
14.6 Amendments and Waivers .
Any term of this
may be amended and the observance of any term
may be waived (either generally or in a particular
;|M|/tance and either retroactively or prospectively) with the
"en consent of the Company and the holders of more than
f the Shares sold hereunder (and/or Common Stock into
:fa Shares have been converted).
*
IN WITNESS WHEREOF, the parties hereto have executed
this Agreement as of the day and year hereinabove first
written .
THE LUBRLZOL CORPORATION
460 Pt. San Bruno Blvd. 29400 Lakeland BlvdL
South San Francisco, CA 94080 Wickliffe, OH 44092
21.
97
GENENTECH, INC.
460 POINT SAN BRUNO BOULEVARD
SOUTH SAN FRANCISCO, CALIFORNIA 94080
(415) 9524123
August 28, 1979
The Lubrizol Corporation
29400 Lakeland Boulevard
Wickliffe, OH 44029
Gentlemen :
In connection with your purchase of 25,000 shares
of our Series A Preferred Stock, you have indicated your interest
in exploring with us the possibility of cooperative efforts in
the development and manufacture, through the use of our tech
nology, of products and/or processes in the field of industrial
chemicals. We are similarly interested in such a joint effort.
As a result, we are willing to agree with you as follows, so
long as you own, or any wholly-owned subsidiary of yours owns,
your 25,000 shares of Series A Preferred Stock (or an equivalent
amount of Common Stock issued upon conversion thereof) :
1. We. will meet and discuss with your represent-
atives the possible application of our tech
nology to the development and manufacture of
industrial chemicals in which you are interested.
Our purpose would be to identify several industrial
chemicals on which we can collaborate. Such
collaboration would take place pursuant to written
agreements mutually acceptable to both parties
and would be upon terms substantially similar to
those we enter into with our other customers.
; 2. Furthermore, in situations in which we have
developed a product or process in the field
of industrial chemicals on our own, and not
under contract with any customer, and we decide
to contract with a customer for its manufacture
;
; -:I... and/or marketing rather than manufacturing or
marketing it on our own, we will contact you to
determine your interest in the project and, if
you are interested, will negotiate in good faith
with you in an attempt to arrive at a mutually
acceptable commercial arrangement, prior to
negotiating an agreement with any third party.
98
The Lubrizol Corporation
1
August 28, 1979
Page Two
3. Neither of the preceding two paragraphs shall be
interpreted to place any restraint on: .
(a) Genentech s ability to develop on
its own, or under contract with a customer,
any product or process in the field of
industrial chemicals; and/or
(b) Genentech s ability to develop,
manufacture and/or market any product or
process outside the field of industrial
chemicals.
You agree to respect the confidentiality of any
information you may learn from us as a result of our discussions
pursuant to this agreement including, without limitation, any
thing you may learn with respect to the plans , intentions ,
products and processes of our other customers.
If you are in agreement with the foregoing, please so
indicate by executing this letter in the space provided below.
i
Sincerely,
s>^~**^
Robert A. Swanson
President
Accepted and agreed to :
THE LUBRIZOL CORPORATION
99
BANKOF AMERICA
~rc \ 7
... <_
k <
LFB
SAN ANTONIO BRANCH
September 13, 1979
Fred Middleton
|>P
:
Vice President-Finance
g Genentech, Inc.
Point San Bruno Blvd.
g South San Francisco, GA 94080
.
Dear Fred,
If--
This will confirm that we received today for Genentech s
account a wire for $10,000,000. from Bank of America of
Hew York, by order of Lubrizol Corporation*
Enclosed is the duplicate deposit slip for your records.
Sincerely,
Shirley Liu Clayton
Assistant Vice President
ec: Cooley Godward et al,
Attn: Lee Benton
1 Maritime Plaza
San Francisco, CA 94111
OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION 384 SOUTH SAN ANTONIO ROAD MOUNTAIN VIEW. CALIFORNIA 94040
100
^ V*l"
*
"-^iW.?
1
^^* Wii* ,*^>*", iv :
*
H"-*T7-" ij<
^*f:"** *V * i* *"vr
" l4i*"
H - ^Vf*
"
l^r
"
*
101
APPENDIX D
Fred Middleton and Herbert Boyer take a break for a beer and a cigar at the outside cafe in the Baur au Lac Hotel
in Zurich, Switzerland in September 1980 during Genentech s IPO investor roadshow tour of Europe.
102
As filed with the Securities and Exchange Commission on October 14, 1980.
APPENDIX E
Registration No. 2-68864
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 2
to
Form S-l
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
GENENTECH, INC.
(Exact name of registrant as specified in charter)
460 Point San Bruno Boulevard
South San Francisco, California 94080
(415) 952-0123
(Address of principal executive offices)
FRED A. MIDDLETON
Vice President Finance & Administration
GENENTECH, INC.
460 Point San Bruno Boulevard
South San Francisco, California 94080
(415) 952-0123
(Name and address of agent for service)
LEE F. BENTON, ESQ.
COOLEY, GODWABD, CASTRO,
HUDDLESON & TATOM
One Maritime Plaza, 20th Floor
San Francisco, California 94111
(415) 981-5252
Copy to:
BRUCE ALAN MANN, ESQ.
PILLSBUHY, MADISON & SOTRO
P.O. Box 7880
San Francisco, California 94120
(415) 983-1061
Approximate date of commencement of proposed sale to the public:
As soon as possible after this Registration Statement becomes effective.
This Registration Statement shall hereafter become effective in accordance with the provisions
Section 8(a) of the Securities Act of 1933.
103
GENENTECH, INC.
Cross-Reference Sheet
Item Number and Heading Prospectus Heading
1. Distribution Spread Cover Page
2. Plan of Distribution Cover Page; Underwriting
3. Use of Proceeds to Registrant Use of Proceeds
4. Sales Otherwise than for Cash Inapplicable
5. Capital Structure Capitalization
6. Summary of Operations Statement of Operations
7. Organization of Registrant The Company
8. Parents of Registrant Certain Shareholders
9. Description of Business The Company; Business:
Use of Proceeds
10. Properties Business Properties
11. Organization Within 5 Years Certain Transactions
12. Legal Proceedings .
Inapplicable
13. Capital Stock Being Registered Description of Capital Stock
Common Stock
14. Long-Term Debt Being Registered Inapplicable
15. Other Securities Being Registered Inapplicable
16. Directors and Executive Officers Management
17. Management Remuneration and Transactions Management Remuneration;
Certain Transactions;
Certain Shareholders
18. Security Ownership of Certain Beneficial Holders and Manage
ment Certain Shareholders
19. Financial Statements Financial Statements
20. Brokerage Allocation Inapplicable
104
s> S
mS.
is 5 <"
sS -== S
;
s s ~ :
;5|1 1
i.* 5-""
ffjj
*5 *-* *"
M =3
>
E *"
CJ"
^
ro u. S
E
|e:s
Genentech, Inc.
PRELIMINARY PROSPECTUS DATED OCTOBER 14, 1980
1,000,000 SHARES
COMMON STOCK
All the shares of Common Stock offered hereby are being sold by Genentech, Inc. ( the "Company"
or "Genentech").
Prior to this offering, there has been no public market for the Common Stock of the Company.
See "Underwriting" for information relating to the method of determining the initial public offering
price.
The Common Stock offered hereby involves a HIGH DEGREE OF RISK. See "Risk Factors"
for information with respect to the Company s short operating history, uncertainty of financial results
and capital needs and other risk factors.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
in E = .2
EB
CO "
(1) See "Underwriting"
for information relating to indemnification of the Underwriters, shares
reserved for sale to certain persons and other matters.
(2) Before deducting expenses payable by the Company estimated at $435,000.
i
g-jf (3) Assuming full exercise of the 30-day option granted by the Company to the Underwriters
[ ^-^ to purchase, on the same terms, up to an additional 100,000 shares to cover any over-allotments. See
I Ji 55 "Underwriting."
!
3 S Tne shares are offered by the several Underwriters when, as and if issued by the Company and
|
!
S 2, accepted by the Underwriters and subject to their right to reject orders in whole or in part. It is
: 3 S expected that delivery of the shares will be made on or about October 21, 1980.
i 1 1 1 BLYTH EASTMAN PAINE WEBBER
INCORPORATED
5~l i
""
*- trJ L^
"
3
HAMBRECHT&QUIST
The date of this Prospectus is October 14, 1980
105
PROSPECTUS SUMMARY
The information below should be read in conjunction with the detailed information and
financial statements appearing elsewhere in this Prospectus.
The Company
Genentech, Inc. develops and produces products with commercial potential using
genetically engineered microorganisms created by means of recombinant DNA technology or
"gene splicing." Since inception in 1976, Genentech has applied genetic engineering techniques
developed by it and others to produce a variety of important health care products, including
human insulin, human growth hormone and human interferon. Other applications of the Com
pany s technology under development include the industrial and agricultural fields.
The Offering
Common Stock offered by the Company 1,000,000 Shares(l)
Common Stock outstanding after the offering .
7,472,102 Shares(l)
Use of Proceeds For capital expenditures and to increase work
ing capital for product research and devel
opment and clinical programs.
Proposed NASDAQ symbol GENE
(1) Does not include up to 100,000 shares which may be sold to the Underwriters to cover
over-allotments.
Risk Factors
See "Risk Factors" with respect to the reasons why purchase of the securities offered hereby
is speculative and should be carefully considered, including the Company s short operating
history, uncertainty of financial results and capital needs and other factors. See "Shares Eligible
for Future Sale" for the possible adverse impact on the market for the Common Stock of shares
available for sale after the offering, and see "Dilution" for the immediate dilution in net tangible
book value per share to be incurred by new investors.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT
OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF
THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT
OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED,
MAY BE DISCONTINUED AT ANY TIME.
106
PROSPECTUS SUMMARY (Continued)
Selected Financial Information
April 7, 1976 to
December 31, -
1976
Year Ended December 31,
1977
Revenues $
Income (loss) before extraor
dinary item
Extraordinary item(l)
Net income ( loss ) . .
Earnings (loss) per common
share and common equiv
alent share(2):
Income (loss) before ex
traordinary item
Extraordinary item
Net income ( loss ) . .
1,171 $ 26,335
(88,601) (426,481)
1978
$ 856,335
(373,286)
$(.04)
$(.04)
$(.17) $(.14)
(.17) $(.14)
1979
$3,405,804
81,536
34,800
$.01
$.01
$.02
Six Months Ended
June 30,
1979
(Unaudited)
$1,190,600
6,069
2,500
1980
83,461,330
51,802
29,000
$
$
June 30, 1980
$.01
$.01
Actual
Working Capital $ 9,520,736
Total Assets 14,173,296
Total Long-Term Obligations 56,212
Shareholders Equity 11,257,075
As Ad)usted(3)
$41,835,736
46,488,296
56,212
43,572,075
(1) Income tax reduction from carryforward of prior years losses.
(2) See Note (d) of Notes to Statement of Operations.
(3) Adjusted to reflect completion of the offering (assuming non-exercise of the Under
writers over-allotment option), but not application of proceeds for planned capital expenditures.
( See "Use of Proceeds." )
107
THE COMPANY
Genentech, Inc. develops and produces products with commercial potential vising genetically
engineered microorganisms created by means of recombinant DNA technology or "gene splicing."
Since inception in 1976, the Company has applied genetic engineering techniques developed by it and
others to produce a variety of important health care products, including human insulin, human growth
hormone and human interferon. Other applications of Genentech s technology under development
include the industrial and agricultural fields.
Genentech believes recombinant DNA and related technologies will make possible the pro
duction of many new and valuable products, and will provide significant commercial advantages
over current methods of production for existing products. From its inception, Genentech s strategy
has been to .develop an organization capable of developing, manufacturing and marketing its present
and future products.
The Company has entered into a number of long-term commercial arrangements with major
corporations under which the Company develops specific products. These agreements provide for
a variety of manufacturing and marketing arrangements. The Company expects to derive revenues
from these arrangements and also expects to derive a substantial portion of its future revenues from
direct Company sales of independently developed products to end users.
Genentech was incorporated in California on April 7, 1976. Its principal offices, laboratories
and manufacturing facilities are located at 460 Point San Bruno Boulevard, South San Francisco,
California 94080, and its telephone number is (415) 952-0123.
BISK FACTORS
The following factors should be carefully considered in evaluating the Company and its business
before purchasing the shares offered by this Prospectus:
1.
Early Development Stage of the Company. The Company was organized in April 1976 and
announced the development of its first product using recombinant DNA technology in 1977. Although
the Company expects to receive most of its long-term revenues from direct product sales and royalty
income, its revenues to date have been limited to payments under product development contracts,
interest and other income. Substantially all contract revenues to date have been received under
contracts providing for fixed and benchmark payments which continue only until the end of the
development period, after which payments are dependent on sales of the products developed. Until
the Company or its contract customers have received required government approvals and have
successfully marketed these products, which may not occur until a number of years after successful
completion of product development, the Company may be unable to fund its operating expenses
solely from revenues received under these contracts and from other sources. Thus, the Company s
ability to finance its operations without borrowing money or selling additional securities, as well as its
future profitability, will depend on the success of the Company in developing products which can be
manufactured and sold on a profitable basis by the Company itself or by its contract customers.
Although the Company is currently providing product to contract customers, no product sales have yet
been made to end users. At June 30, 1980 the Company had an accumulated deficit of approximately
$691,000, and it is possible that additional losses may occur in the future. (See "Business-")
108
2. Uncertainty of Financial Results and Capital Needs. Because the receipt and timing of a
significant portion of the payments under the Company s product development contracts are tied
to the achievement of performance "benchmarks," which cannot be predicted with certainty, there
nay be substantial fluctuations in the Company s revenues and profitability on a quarterly basis.
Furthermore, in addition to expending substantial funds in its on-going product research and develop
ment programs, Genentech expects to expend substantial sums in the near future in pursuit of reg
ulatory clearances, Substantial expenditures will also be made in continuing to build the Company s
manufacturing and marketing capabilities. There can be no assurance that the Company will derive
sufficient revenues from current sources to fund these expenditures.
3. Regulation by Government Agencies. The Company and its contract customers plan to
manufacture and sell many products which require regulatory approval. In particular, the Company s
health care products are subject to approval, prior to marketing, by the Food and Drug Administration
("FDA")
in the United States and comparable agencies in foreign countries. The process of obtaining
FDA and corresponding foreign approvals can be costly and time consuming, and there can be no
assurance that such approval will be granted to the Company or its contract customers. The Company
has adopted a policy "of
voluntary compliance with guidelines promulgated by the National Institutes
of Health ("Nlti") covering the conduct of recornbinant DNA activities. Pursuant to this policy,
the Company. ^eb the approval of the NIH prior to scaled^up manufacture of its products. To date,
the Company has received NIH approval for scaled-up manufacture of all of its announced products,
but there can be no assurance as to the future availability of such approval. The extent of adverse
government regulation which might arise from future legislative or administrative action is not cur
rently known. (See "Business Government Regulation.")
4. Proprietary Technology. The Company has filed applications for a large number of U.S.
and foreign patents based on inventions made in the pursuit of developing its technology. The
Company expects to be issued patents in the future, although there can be no assurance as to the
breadth or the degree of protection which these patents, if issued, will afford the Company. In
addition to the Company, universities and other public and private concerns have filed patent appli
cations and may be issued patents on inventions or otherwise possess proprietary rights to technology
useful to the Company. The extent to which the Company may be required to license such patents or
other proprietary rights, and the cost and availability of such licenses, are presently unknown. In
addition, the Company intends to rely to an extent on unpatented proprietary kaowhow. However,
there can be no assurance that others will not independently develop such know-how or otherwise
obtain access to the Company s know-how or plasmids or microorganisms embodying that knowhow.
(See "Business
Troprietary Technology Patents and Trade Secrets.")
5. Competition. The Company was the first to demonstrate the use of recornbinant DNA
technology to produce a product with commercial potential, and believes it is currently a leader in the
commercial application of the technology. However, the Company expects competition to become
more intense in the future. Many large pharmaceutical and chemical companies have announced
their entry into the eld, and with their extensive research and development, marketing, financial
and human resources they are capable of providing significant long-term competition. Large pharma
ceutical companies ha.ve had significantly greater experience than the Company in undertaking clinical
programs for obtaining FDA approval and in the marketing of their products. In addition, a number
of other companies have entered the field, and more may be expected to do so in the future.
As a result, the Company expects competition to become more intense in the development of new
109
products, exploitation of markets and recruiting of scientific, technical and managerial personnel.
(See "Business Competition.")
6.
Technological Change. Technological developments are expected to continue at a rapid
pace in the Company s industry. Although the Company has announced the development of more
products using recombinant DNA technology than any other company, the successful development
of the Company s products will be dependent upon its ability to continue on the leading edge of
this technology and its ability to attract and retain scientific and technical personnel.
7. Possible Volatility of Share Price. Because of the foregoing factors, the market price of
the Company s Common Stock may be highly volatile. Announcement of new product develop
ments by the Company or its competitors, third party claims, irrespective of their merit, to rights in
the Company s technology or future public concern as to the commercial feasibility or safety of
recombinant DNA technology may have a significant impact on the market price of the Company s
shares.
SHARES ELIGIBLE FOR FUTURE SALE
Beginning 90 days after the date of this Prospectus, shareholders holding approximately 3,400,000
shares of Common Stock may be eligible to sell shares in the public market pursuant to Rule 144
under the Securities Act of 1933. In general, under Rule 144 a person (or persons whose shares are
aggregated) who has beneficially owned his or her shares for at least two years, including persons
who may be deemed "affiliates" of the Company as the term "affiliate" is defined under the Act,
would be entitled to sell within any three-month period a number of shares that does not exceed
the greater of 1% of the outstanding shares of the Company s Common Stock (approximately 74,700
shares based on 7,472,102 shares to be outstanding after the offering, assuming the non-exercise of
the Underwriters over-allotment option ) or the average weekly trading volume in the over-the-counter
market during the four calendar weeks preceding such sale. A person (or persons whose shares are
aggregated) who is not deemed an "affiliate" of the Company and who has beneficially owned his
or her shares for at least three years would be entitled to sell such shares under Rule 144 without
regard to the volume limitations described above. In addition, as of the date of this Prospectus
shareholders holding approximately 1,250,000 shares of Common Stock may be eligible to sell such
shares in the public market without regard to the restrictions imposed by Rule 144. The holders
of approximately 1,220,000 of these shares have agreed not to sell shares in the public market until
90 days after the date of this Prospectus without the consent of the Underwriters. (See "Description
of Capital Stock Outstanding Registration Rights"
for a discussion of registration rights of certain
holders of the Company s Common Stock.)
Prior to this offering there has been no market for the Common Stock of the Company and no
precise predictions can be made as to the effect, if any, that market sales of shares or the availability
of shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of
substantial amounts of the Common Stock of the Company in the public market could adversely
impact prevailing market prices.
DILUTION
As of June 30, 1980, the net tangible book value of the Company s Common Stock was $11,156,433,
or $1.72 per share. Giving effect to the offering at a public offering price of $35.00 per share, the
pro forma net tangible book value of the Company at June 30, 1980 would have been $43,471,433, or
$5.82 per share of Common Stock, representing an immediate increase in net tangible book value
6
110
of $4.10 per share to present holders of Common Stock and an immediate dilution of $29.18 per
share to new investors. The following table illustrates this per share dilution:
Public offering price( 1) $35.00
Net tangible book value of Common Stock, before offer
ing^) $1.72
Increase attributable to payments by new investors 4.10
Net tangible book value of Common Stock, after offering . . 5.82
Dilution to new investors(S) $29.18
(1) Offering price before deduction of underwriting discounts and offering expenses.
(
2 )
Net tangible book value per share of Common Stock is determined by dividing the number
of shares of Common Stock outstanding into the tangible net worth of the Company ( tangible assets
less liabilities) allocable to the Company s Common Stock upon liquidation. No net tangible book
value has been allocated to the Series B Restricted Stock because the Common Stock is entitled to a
liquidation preference of at least $10 per share, which at June 30, 1980 exceeded the total net tangible
book value of the Company. Giving effect to conversion of the 201,750 shares of Series B Restricted
Stock outstanding on September 30, 1980, the net tangible book value of the Company s Common Stock
on June 30, 1980 would have been $1.67 per share and the dilution to new investors would have been
$29.33 per share.
(
3 ) "Dilution" is determined by subtracting net tangible book value per share after the offering
from the amount of cash paid by a new investor for a share of Common Stock.
The following table summarizes the difference between the number of shares of Common Stock
purchased from the Company, the total consideration paid and the average price per share paid by
the investors purchasing new shares and by existing shareholders:
Percent Average
of Price
Total Per
Shares of Percent Share of
Shares Common of Total Common
Purchased Stock Consideration Consideration Stock
New investors 1,000,000 13.4% $35,000,000 74.5% $35.00
Existing shareholders 6,472,102 86.6 11,987,133 25.5% $ 1.85
Total 7,472.102 100.0% $46,987,133 100.0% $ 6.29
The above computations assume no exercise of the Underwriters over-allotment option.
The 7,472,102 shares of Common Stock which will be outstanding upon the completion of the
offering may be increased by conversion of all outstanding shares of Series B Restricted Stock upon
the happening of any of the conversion events specified therein. (See "Description of Capital Stock
Series B Restricted Stock.") As of September 30, 1980 there were 201,750 shares of Series B
Restricted Stock outstanding. Assuming the conversion of all such Series B Restricted Stock, which
was originally issued for an aggregate price of $256,500 (an average of $1.27 per share), the number
of outstanding shares of Common Stock would be increased to 7,673,852. Thus, the 1,000,000 shares
of Common Stock offered hereby would represent approximately 13.0% of such outstanding Common
Stock with an aggregate cost of $35,000,000, or $35.00 per share, while the remaining shares would
represent approximately 87.0% of such outstanding Common Stock with an aggregate cost of
$12,243,633, or $1.83 per share.
Ill
See "Management Employee Stock Plan" for a description of the Company s
Employee Stock
Plan, under which the Company has reserved 400.000 shares of Common Stock for issuance to
employees of the Company, which issuances may involve additional dilution to holders of Common
Stock.
USE OF PROCEEDS
The net proceeds from the sale of 1,000,000 shares of Common Stock by the Company are
estimated at $32,315,000 ($35,590,000 if the Underwriters over-allotment option is exercised in full).
Of such net proceeds, approximately $18 million will be used for the Company s capital expenditure
programs. The Company presently intends to acquire and develop facilities having a cost of approxi
mately $14 million and to acquire equipment having a cost of approximately $4 million in the next
18 months. The remainder of the net proceeds of the offering (approximately $14,315,000), as
well as the Company s current resources of approximately $10 million, will be used as working
capital. Uses of working capital will include product research and development which the Company
undertakes on its own behalf (see "Business Research and Development"), clinical testing pro
grams (see "Business Clinical Programs") and the financing of inventories and receivables as the
Company s manufacturing and marketing activities develop. Because neither the cost nor timing of
future research and development and clinical programs nor the extent to which such programs may
ultimately be funded by the Company s current and future contract customers has been finalized,
the Company has not allocated working capital among the various components identified above.
Other methods of financing the Company s capital expenditures, including mortgage or lease
financing, may be utilized if available to the Company at an attractive cost. In the past, the Company
has made a practice of using lease financing for equipment purchases (see Note 3 of Notes to
Financial Statements) and may continue to do so in the future. To the extent such financing is used,
proceeds will be reallocated from capital expenditures to working capital. It is anticipated that the
proceeds from the offering, together with the Company s present resources, will satisfy the Company s
cash requirements for at least the next 18 months. Because of the funding alternatives available to the
Company, it is not possible to predict with certainty the ctate by which the proceeds will be utilized.
Pending such uses the proceeds will be invested in short-term investments.
The following chart illustrates the anticipated uses of the net proceeds of the offering:
$4.0 Million
Equipment
$14.0 Million
Land, Building
Construction
$14.3 Million
Working
Capital
Research & Development
Clinical Testing
Inventories
Receivables
Other
112
DIVIDENDS AND DIVIDEND RESTRICTIONS
The Company has never paid a dividend on its Common Stock and it currently intends to retain
all earnings for use in its business. Accordingly, it is anticipated that dividends will not be paid to
holders of Common Stock in the foreseeable future. In addition, under its current lease lines with
B.A. Leasing Corporation, an affiliate of Bank of America N.T. & S.A., the Company may not pay
any cash dividends without the prior consent of B.A. Leasing Corporation. (See Note 3 of Notes to
Financial Statements. )
CAHTAUZATION
The following presentation sets forth the capitalization of the
and at that date giving effect to the sale of the Common Stock
exercise of the Underwriters over-allotment option):
Current portion of lease-purchase obligations(l)
Long-term portion of lease-purchase obligations(l)
Shareholders Equity:
Preferred Stock, $.02 par value, 2,000,000 shares authorized,
no shares outstanding . . . !
Common Stock, $.02 par value, 18,000,000 shares authorized,
6,472,102 shares outstanding, 7,472,102 shares outstanding
after the offering(2)
Series B Restricted Stock, $.02 par value, 2,000,000 shares
authorized, 152,000 shares outstanding(3)
Capital in excess of par value
Notes receivable from sale of stock
Deficit
Total Shareholders Equity
Total Capitalization
Company as of June 30, 1980,
offered hereby (assuming non-
OuUtanding
$ 20,885
$ 56,212
Giving Effect to
the Offering
$ 20,885
$ 56,212
129,442
3,040
11,974,889
(159,066)
(691.230)
11,257,075
$11,313,287
149,442
3,040
44,269,889
(159,066)
(691,230)
43,572,075
(1) See Note 2 of Notes to Financial Statements for a description of the Company s obligations
under lease-purchase agreements.
(2) Does not include 400,000 shares reserved for issuance under the Company s Employee
Stock Plan, which was adopted by the Board of Directors and shareholders in August 1980.
(3) Excludes 248,000 additional shares reserved for issuance under the Company s Series B
Restricted Stock Purchase Plan. Of the 248,000 reserved shares, 49,750 shares have been issued
subsequent to June 30, 1980.
See "Business Properties" and Notes 2 and 3 of Notes to Financial Statements for a description
of the Company s obligations under leases.
113
GENENTECH, INC.
STATEMENT OF OPERATIONS
The following statement of operations for the period from April 7, 1976 (date of incorporation) through
December 31, 1976, and for each of the three years in the period ended December 31, 1979 and for the six-month
period ended June 30, 1980 has been examined by Arthur Young & Company, certified public accountants,
whose report with respect thereto appears elsewhere in this Prospectus. The information for the six months
ended June 30, 1979 is unaudited but includes all adjustments (consisting only of normal recurring accruals)
which the Company considers necessary for a fair presentation of the results of operations for that period. The
information for the six-month period ended June 30, 1980 is not necessarily indicative of the operating results
for the entire year. This statement should be read in conjunction with other financial statements and notes
thereto appearing elsewhere herein.
Period from
April 7, 1976
( date of incor-
Year Ended December 31,
Six Months Ended
June 30,
1976 1977
Revenues:
Contracts(a) $
Interest
Other(b)
Total revenues
Costs and expenses, principally
research and development
costs(a) (c)
Income (loss) before taxes and
extraordinary item
Provision for income taxes (
a )
. .
Income (loss) before extraordi
nary item
Extraordinary item benefits de
rived from utilization of oper
ating loss carryforward
Net income ( loss )
. . . .
Earnings (loss) per common
share and common equiva
lent share: (d)
Income (loss) before extraor
dinary item
Extraordinary item
Net income (loss) ...
Weighted average number of
shares used in computing earn
ings (loss) per common and
common equivalent share ....
_ $ $
1,171
1,171
26,335
26,335
1978
796,500
56,598
3,237
1979
$2,581,600
524,204
300,000
1979
(Unaudited)
$1,142,054
48,546
1980
$2,692,630
768,700
856,335 3,405,804 1,190,600 3,461,330
89,772 452,816 1,229,621 3.277,968 1,181,181 3,372,528
(88,601) (426,481) (373,286)
(88,601) (426,481) (373,286) 81,536
34,800
6,069
2,500
51,802
29,000
.$(88,601) $(426,481) $ (373,286) $ 116,336 $ 8,569 $ 80,802
$(.17) $(.14) $.01
.01
S S.01
$(.04) $(.17) $(.14) $.02 $ S.01
2,176,000 2,482,520 2,624,332 5.767.574 5,425.365 6.489,321
See accompanying notes.
10
114
I
NOTES TO STATEMENT OF OPERATIONS
(Information for the six-month period ended June 30, 1979 is unaudited)
(a) See Note 1 of Notes to Financial Statements for summary of significant accounting policies;
Note 4 for a discussion of contract revenues; and Note 6 for the provision for income taxes.
Genentech is engaged in the development of microorganisms capable of producing products
with commercial potential and the eventual production and sale of such products. To date, the principal
activity and source of revenue has been research and product development pursuant to contracts with
customers.
(b) Other income in 1979 consisted of a $300,000 one-time payment to the Company in return
for a release of certain claims to a small equity interest in, in exchange for information and assist
ance in connection with the formation of, Biogen S.A., a non-affiliated concern. (See "Certain
Transactions.")
(c) In 1980, a payment of $350,000 was made to the Regents of the University of California in
connection with a restructuring of the Company s obligations arising from funded research. (See
."Business Research and Development.")
(d) Earnings (loss) per common share (and, in 1979, common equivalent share) calculations
are based on the weighted average number of shares outstanding. The Series B Restricted Stock
is not included as a common stock equivalent for purposes of such calculations because such
stock is only contingently convertible into Common Stock. The calculations included 2,746,508
equivalent shares for convertible preferred stock in the year ended December 31, 1979 and 2,454,840
such shares in the six-month period ended June 30, 1979. Common shares for conversion of preferred
shares were not included in the loss per share calculations for the period from April 7, 1976 ( date of
incorporation) to December 31, 1976 and for the years ended December 31, 1977 and 1978 since
their inclusion would have been anti-dilutive.
Per share amounts give effect to a ten-for-one common stock split in March 1978 and a four-
for-one common stock conversion in January 1980.
The Company has paid no dividends.
11
115
MANAGEMENTS DISCUSSION AND ANALYSIS OF THE
STATEMENT OF OPERATIONS
General
Due to its rapid growth, the Company has undergone significant changes from inception in
1976 through June 30, 1980.
Contract revenues were first received in 1978. In each subsequent period, contract revenues
have increased due to the addition of new contracts and achievement of contract benchmarks
which generate additional payments.
Although revenues from all sources exceeded expenses during 1979 and the first six months
of 1980, the Company had an accumulated deficit of approximately $691,000 at June 30, 1980.
To date, the Company has not received revenues from product sales and therefore no cost of
goods sold has been recorded. Increases in each period in costs and expenses, principally research
and development, are attributable to three key factors: an increase in the number of employees,
an increase in the volume of research supplies purchased and an expansion of the Company s
facilities.
Six Months Ended June 30, 1980 Compared to Six Months Ended June 30, 1979
Contract revenues increased approximately $1.6 million (136%) in the first six months of 1980
( under seven contracts )
over the comparable period of 1979 ( under four contracts )
due to achieve
ment of certain contract benchmarks and an increase in periodic payments recognized as revenue
under development contracts.
Interest income increased approximately $720,000 (1483%) in the first six months of 1980
over the comparable period of 1979 because of an increase in cash and short-term investments
resulting from a sale of stock in September 1979 and high interest rates during early 1980.
Costs and expenses increased approximately $2.2 million (186%) in the first six months of
1980 compared with the first six months of 1979 principally because of expansion of the Company s
work force, an increase in the number of research and development projects undertaken, expansion
of leased work space and additions to equipment operating leases. Costs and expenses in the
first six months of 1980 included a $350,000 payment to the Regents of the University of California
in connection with a restructuring of the Company s obligations arising from funded research. (See
"Business Research and Development.")
1979 Compared to 1978
Contract revenues for 1979 (under six contracts) increased approximately $1.8 million (224%)
over 1978 (under three contracts). Increases in contract revenues resulted from increases in bench
mark and periodic payments under contracts with certain new and existing customers.
Interest income increased approximately $468,000 (826%) in 1979 over 1978 due to an increase
in cash from a sale of stock in September 1979 and increased contract revenues. In 1979, other
revenues consisted of a $300,000 one-time payment to the Company in return for a release of
certain claims to a small equity interest in, in exchange for information and assistance in connection
with the formation of, Biogen S.A., a non-aflBliated concern. (See "Certain Transactions.")
Costs and expenses increased by approximately $2 million ( 167% )
due principally to an increase
in the number of employees, an increase in the volume of research supplies purchased and an expan
sion of facilities.
12
116
13
nized revenue under three development contracts.
s
y
117
BUSINESS
Genentech was formed in April 1976 upon the premise that advances in recombinant DNA,
gene synthesis and molecular biology made possible the development of a new technology which
could produce a wide variety of valuable substances with health care, industrial, agricultural and
other applications. The Company was the first to demonstrate, using recombinant DNA technology,
the genetic engineering of microorganisms which can make products with commercial potential.
In 1977 the Company successfully demonstrated the microbial production of the brain hormone
somatostatin.
Genentech believes recombinant DNA technology will make possible the production of many new
products, as well as result in significant commercial advantages over current methods of production
of existing products. In particular cases, the advantages over current methods of production may
include the ability to produce substantially unlimited quantities of products which are currently in
short supply, medically useful substances which are essentially identical in composition to those
produced by the human body, products at a substantially reduced cost over current methods of
production, medical products which are safer than those presently available, and products utilizing
raw material sources which may be more plentiful and less expensive than those presently used.
The Company s initial product development strategy has been targeted toward developing those
products which capitalize on the advantages of gene splicing technology over current methods of
production. Genentech has selected the health care field as the initial thrust of its product develop
ment strategy because it offers the opportunity to pursue valuable products which are biologically
active in relatively small quantities. The selection of the Company s initial health care products
was based on such factors as existence of established markets, technical feasibility, relative
cost of product development, market potential, availability of competitive products, ease of market
penetration and prospects for relatively prompt regulatory approvals. Genentech has engineered
microorganisms to produce a number of medically important proteins: somatostatin (in 1977),
human insulin (in 1978), human growth hormone (in 1979), thymosin alpha-1 (in 1979), human
proinsulin (in 19SO), human leukocyte interferon (in 1980) and human fibroblast interferon (in 1980).
(See "Products.") The Company s development program also includes applications in agricultural
and industrial markets.
At present, Genentech or its licensees are producing human insulin, human growth hormone,
thymosin alpha-1 and human interferon in sufficient quantities for on-going preclinical animal testing
programs and, in the case of human insulin, human clinical trials. Clinical programs are necessary
for these products as they may not be marketed prior to completion of human clinical trials and
receipt of required regulatory approvals. (See "Clinical Programs" and "Government Regulation.")
Technology Background
The cell is the biological unit of life. The simplest organism consists of a single cell which
reproduces itself by dividing. Each cell is complete with its own system of biochemical reactions
for maintenance of its life processes.
All cells contain DNA ( deoxyribonucleic acid), a complex molecule containing all of the
information necessary to govern a cell s biological processes. The information content of DNA is
derived from the sequential arrangement of four types of chemical building blocks. The information
contained in these sequences of building blocks is translated into biochemical products through the
14
118
"genetic code." Thus, DNA acts as a kind of computer tape which is "read"
by the cell s biological
machinery to direct its operation. Short sections of DNA which direct a specific function are called
"genes"
and each gene codes for the production of a specific protein, enzyme, hormone or other
complex chemical required for a cell s biological processes.
In addition to providing a "blueprint"
for the cell s functions, DNA has the capacity to duplicate
itself so that when the cell divides, each resulting cell will be a copy of the original and will perform
identical biological functions. Single-celled microorganisms such as those used by the Company
can reproduce themselves every 20 to 30 minutes.
Science has recently progressed to the point at which scientists are able to manipulate DNA
successfully for research or commercial purposes. Advances which led to this level of progress have
included key developments involving the ability to synthesize DNA with organic chemistry techniques,
the ability to determine the sequences of DNA, the deciphering of the "genetic code" and the
development of "gene splicing" techniques. "Gene splicing" involves the enzymatic cutting and
assembly at the molecular level of DNA fragments from different sources into a larger fragment
capable of being introduced into a microorganism.
Genentech Technology
The "gene splicing" techniques employed by Genentech are the result of recent scientific
advances in molecular biology made by Genentech and others in the research community. A key
factor in the successful development of a commercial technology has been the ability to insert seg
ments of DNA containing specific genetic information, through what is commonly known as "recombin-
ant DNA" or "gene splicing,"
into microorganisms which then are able to produce desired biochemical
products. Genetic engineering of a microorganism is only one step, however, in developing a com
mercially viable process for the production of desired substances. Many additional sophisticated
technical skills are necessary to build a useful technology. These include organic chemistry, protein
chemistry, biology, microbiology, fermentation, purification and process development engineering
(by which the genetically engineered microorganism is made capable of optimal production of the
desired substance). The Company has developed the complementary skills and capabilities necessary
to genetically engineer microorganisms and to obtain commercial quantities of products from them.
Although many of the individual techniques, processes and substances utilized by the Company
are proprietary, the general procedures used in the Company s processes are as follows. First, DNA
with a desired coding sequence is derived from the isolation and purification of genetic material
from biological sources, such as animal tissues, or synthesized by techniques of organic chemistry.
In many situations both sources are needed.
The DNA obtained in this manner, when specially tailored, becomes the basic "gene" containing
the genetic information to "code" for the production of a desired product, such as interferon or
human insulin. To this gene are assembled other pieces of DNA which contain the control signals
or "instructions" to program the cell to manufacture the product coded for by the gene. The DNA
segments are next precisely aligned and stitched into a circular piece of DNA called a "plasmid."
The plasmids containing the "stitched"
genetic information are inserted into microorganisms,
which then assimilate the newly encoded genetic information into their cellular makeup. Using their
normal protein making machinery, the cells translate the information contained in each plasmid into
the desired product.
15
119-
Once a single microorganism containing the correct "genetic code" has been engineered and
identified, it will divide and pass on to its offspring the same information contained in the parent
cell. Then, using "fermentation"
techniques similar to those used in the production of antibiotics, large
populations of genetically engineered microorganisms can be grown to produce the desired product.
These "microbial factories" are capable of producing new products using their "spliced"
DNA
as a source of genetic instructions. Genentech operates its own fermentation facilities for the scaled-up
growth of recombinant microorganisms, and maintains a staff of fermentation specialists who operate
these facilities.
As a next step, the Company "harvests" the genetically engineered microorganisms and isolates
the desired product through a series of separation and purification techniques. The Company operates
facilities for undertaking the preparation of purified product obtained by these methods, and employs
protein chemists and development scientists to manage that preparation. Once a purified health care
product is available, it can be tested in animal preclinical programs to determine pharmacological
activity, efficacy and toxicity. The Company employs a group of scientists to undertake the biological
testing of its products. Following an animal preclinical testing program and receipt of regulatory
approvals, a product enters human clinical testing. (See "Clinical Programs" and "Marketing.")
Research and Development
Genentech has undertaken a broad product research and development program. Genentech s
scientists have published their work in leading scientific journals, including Science, Nature and the
Proceedings of the National Academy of Sciences.
Substantially all of the Company s operating expenses to date have been related to the develop
ment of products either on its own behalf or under contracts with customers. Revenues recognized
under development contracts have been sufficient to fund approximately 70% of the Company s
total costs and expenses from inception to June 30, 1980. Genentech anticipates that expenses related
to product research and development will continue to constitute a major portion of operating expenses
as the Company maintains an active research program to develop new products.
Genentech has on-going research and development programs aimed at developing potential
products for useyin pharmaceutical, agricultural and industrial applications. Among these are hor
mones, vaccines, blood products, immune-response stimulants, anti-virals, enzymes and various other
biochemicals. These products are at various stages of development. Some are being pursued under
product development contracts with customers, while others are being pursued independently by
the Company. It is Genentech s policy not to disclose the nature of specific projects prior to the
successful demonstration of a product with commercial potential.
Genentech conducts most of its product research and development activities at its own premises.
It has also funded and will continue to fund research at universities and private research organiza
tions. Such funded research is generally done under arrangements which give Genentech the right,
ordinarily exclusively, to commercialize the results of the research, for which Genentech undertakes
to pay a royalty to the research institution. In this manner, Genentech has thus far incurred royalty
obligations with respect to certain of its products to two unaffiliated institutions, the University of
California and the City of Hope National Medical Center, each under contract since 1976. Herbert W.
Boyer, an officer and director of the Company, is a member of the University of California faculty
(See "Management"). In June 1980, Genentech restructured its relationship with the University of
California. (See Note (c) of Notes to Statement of Operations.) Genentech has agreed to pay each
16
120
of the two institutions royalties on sales of human insulin, human growth hormone and somatostatin,
when made by it or its licensees. After August 1981, the Company s royalty obligation to-the City of
Hope is contingent upon the existence of one or more patents arising from the funded research
which would, but for Genentech s ownership of the patent(s), be infringed by die activities under
lying the royalty payment. Genentech has made application for a number of patents as a result of
the City of Hope research. Certain of diese have since been granted in a number of countries outside
the United States. The Company s royalty obligations to the University of California are not con
tingent upon the grant of any associated patent.
Products
Genentech has publicly announced its development of six products with commercial potential:
somatostatin, human insulin and proinsulin, human growth hormone, thymosin alpha-1, human leuko
cyte interferon and human fibroblast interferon.
Somatostaiin. In 1977, Genentech produced somatostatin using a genetically engineered micro
organism. This achievement represented the first production of a protein with commercial potential
by means of recombinant DNA technology. Somatostatin, a hormone initially isolated from the
brain and presently used by medical researchers, was selected by the Company as a demonstration
product to show that its technology was commercially feasible. Somatostatin, currently available
in relatively small quantities from synthetic peptide manufacturers, is an inhibitory hormone which
affects the secretion of other hormones such as insulin and human growth hormone. It is currently
of interest to medical researchers who are evaluating its activity for several clinical applications,
including treatment of diabetes, gastroesophageal bleeding and certain hormonal disorders. Genentech
is evaluating plans to manufacture somatostatin for sale to the medical research market. Currently,
the Company is engaged in the process development and scale-up procedures necessary for the
production of commercially saleable quantities of somatostatin. Several parties have indicated an
interest in the purchase of somatostatin from the Company, but Genentech has made no contractual
arrangements for the commercial application of this product.
Human Insulin and Proinsulin. In 1978, Genentech engineered microorganisms capable of
being used in the production of human insulin identical to that produced by the human body. Insulin
is a hormone which is produced in the body by the pancreas gland and is utilized in the metabolism
of sugars and carbohydrates. The inability of the body to produce or utilize its own source of insulin
results in a disorder known as diabetes. Currently diabetes requiring insulin is treated with animal
insulin generally obtained from the pancreas glands of cows and pigs. Pancreas glands from animals
are a byproduct of meat production and are, therefore, dependent upon the quantity of animals
slaughtered for food consumption. Insulin obtained from animal sources is chemically different from
human insulin and causes allergic reactions in some people. Genentech has also demonstrated the
production of human proinsulin from a genetically engineered microorganism. Proinsulin, although
not a therapeutic product itself, is a precursor molecule to insulin which may offer an economically
attractive alternative route to the production of insulin.
In August 1978, the Company entered into a long-term agreement with Eli Lilly and Company
("Lilly")
to manufacture and market human insulin developed by the Company. Lilly has received
exclusive worldwide rights from Genentech to manufacture and market human insulin made using the
Company s technology in return for the payment of royalties on product sales. Lilly, currently a
leading manufacturer of animal-produced insulin, offered Genentech the best potential for rapidly
17
121
Introducing this product. Since reaching agreement, Genentech and Lilly have been engaged in a
joint program to scale-up production of human insulin. In July 1980, Lilly announced that it had
started construction of manufacturing facilities to produce human insulin using recombinant DNA
technology. In addition, Lilly announced that it had begun its clinical testing program on humans in
the United Kingdom following preclinical animal and laboratory testing.
Human Growth Hormone. In 1979, Genentech announced the successful development of a
genetically engineered microorganism capable of producing human growth hormone. Human growth
hormone is produced by the pituitary gland and affects normal body growth of bones and tissue during
the growth years. A deficiency of human growth hormone may result in a disorder known as
hypopituitary dwarfism. This form of dwarfism is currently treated by administering human growth
hormone obtained from pituitaries removed from cadavers. Due to the limited availability of these
tissues, there is a worldwide shortage of this hormone, and many cases of dwarfism are either
insufficiently treated or not treated at all. Human growth hormone is under scientific investigation for
potential applications in addition to the treatment of dwarfism.
In August 1978, the Company entered into a long-term agreement with KabiGen AB ("Kabi"),
an
affiliate of AB Kabi, currently the world s largest supplier of human growth hormone, which gives
Kabi the right to manufacture and market human growth hormone produced with the Company s
technology throughout the world in return for the payment of royalties on product sales. Under this
agreement, Genentech also has the right to supply a percentage of Kabi s marketing needs, and also
retains the non-exclusive right to market the product in the United States and Canada.
Human growth hormone is currently undergoing preclinical testing in animals by both Genentech
and Kabi. Genentech plans to commence its own human clinical program in the United States in 1981.
Thymosin Alpha-1. In 1979, Genentech produced thymosin alpha-l from a genetically engi
neered microorganism. Thymosin alpha-l, a hormone isolated from the thymus gland, is believed to
have an immune-response stimulating effect. Preparations of chemically synthesized thymosin alpha-l
are undergoing clinical trials sponsored by the National Cancer Institute in the treatment of certain
types of brain and lung cancer. Genentech does not participate in these programs. To date, the Com
pany has not contracted with any third party regarding the commercial development of thymosin
alpha-l. Genentech is presently pursuing its own preclinical animal testing program, and is evaluating
plans to enter its own human clinical program for thymosin alpha-l in 1981. The ultimate therapeutic
value or market potential of thymosin alpha-l cannot be predicted at this time.
Leukocyte and Fibroblast Interferon, In 1980, Genentech announced that it had produced two
types of interferon, human leukocyte and human fibroblast, from genetically engineered micro
organisms. Interferon, a protein produced in the body, appears to inhibit the multiplication of viruses
and proliferative cell growth, and is being widely evaluated by investigators. Human leukocyte and
human fibroblast interferons obtained from blood cells and tissue cultures are currently undergoing
human clinical testing within the United States in programs sponsored by the American Cancer Society
and the National Cancer Institute. These trials are being undertaken on a number of different types of
cancer as well as on different types of viral diseases. These tests show promising but currently incon
clusive results, believed by Genentech and others to be due in large part to the extremely limited
quantities of interferon available to date and the relative impurity of certain of the materials-
employed in the trials.
Human leukocyte interferon is currently obtained from leukocyte or white blood cells available
from blood banks, and human fibroblast interferon is currently obtained from tissue cultures of human
18
122
connective tissue. The Company believes, based on its production process, that the manufacture of
interferon using genetically engineered microorganisms will offer a vastly improved source of supply
and reduction in cost over currently available methods. Human interferons produced by the Company s
microorganisms differ in certain respects from interferons derived from blood cells and tissue
culture. Limited non-clinical studies conducted by the Company have so far failed to reveal any
resulting difference in activity. An increased supply of human interferon should greatly assist in
determining efficacy in the many clinical applications currently under study.
In January 1980, the Company entered into a joint development contract with Hoffmann-La
Roche Inc. ("Roche")
to produce commercial quantities of interferon for the therapeutic market.
Under this agreement, in return for payment of royalties on product sales, Roche receives worldwide
exclusive marketing rights. Genentech has the right to supply Roche with a percentage of Roche s
marketing requirements. Currently, interferon produced by Genentech is being preclinically tested in
animals, and Genentech and Roche have announced plans to produce sufficient quantities of interferon
for human clinical trials in 1981.
The Company has been made aware of a claim stated by the University of California against
Roche alleging unauthorized use of certain materials in connection with its interferon project with
the Company. Roche has asserted that its conduct in regard to the materials was proper and has
filed an action against the University and certain of its employees seeking a judgment to that effect.
Counsel for the University has stated that its claim against Roche will be extended to the Company,
in which case Roche has agreed to indemnify the Company against any money judgment the
Company might incur. Lyon & Lyon, patent counsel to the Company, has expressed the opinion
that there is no reasonable likelihood that the Company will be subject to injunctive relief in the
event of litigation against it. The Company cannot predict whether its future income from interferon
sales would be adversely affected if a claim were established against Roche.
Manufacturing
Genentech operates its own manufacturing facilities to scale-up the production of its products
and to manufacture commercial quantities. Techniques for optimizing fermentation and for sepa
ration and purification of products from recombinant microorganisms have been developed by the
Company. In some cases, Genentech will use its manufacturing facilities to produce products for
sale to customers. In other cases it will use the facilities for purposes of demonstrating that a
commercial process has been achieved so it can be licensed to others who will manufacture product
for sale. The Company believes the productive capacity of its present manufacturing facilities is
adequate for its current needs. However, the Company presently has plans to expand its manu
facturing facilities to accommodate anticipated future requirements (see "Use of Proceeds" and
"Business Properties" ) .
Genentech s manufacturing activities generally involve the fermentation of recombinant organisms
in amounts greater than 10 liters, a scale which it seeks permission to exceed from the National
Institutes of Health ("NIH") upon recommendation of the NIH s Recombinant DNA Advisory
Committee. Genentech has received NIH approval for scaled-up manufacture of somatostatin,
human insulin and human proinsulin, human growth hormone, thymosin alpha-1, human leukocyte
interferon and human fibroblast interferon. (See "Government Regulation.")
Although certain of the Company s equipment is specially designed to meet the Company s
specifications, most of the equipment necessary for the Company s production process is commonly
19
123
available from vendors. Fermentation equipment is used by manufacturers of antibiotics and other
pharmaceutical products. In general, the same fermentation equipment may be used to manufacture
any of Genentech s products.
All manufacturing techniques and facilities used for the production of products for clinical
programs or for sale must be operated in conforrmmce with Good Manufacturing Practices_the. Food
and Drug Administration ("FDA") regulations governing production of pharmaceutical products.
Clinical Programs
In order to obtain the approval of the FDA in the United States and comparable agencies in
foreign countries, and prior to the marketing of pharmaceutical products to be administered to
humans, Genentech or its contract customers must undertake preclinical testing programs on animals
and clinical testing programs on humans sufficient to establish product safety and efficacy. Genen
tech is
currently evaluating plans for its own preclinical and clinical programs for human growth
hormone and thymosin alpha-1. The commencement of a human clinical program in the United
Kingdom for human insulin was announced by Lilly in July 19SO. The animal preclinical and human
clinical programs for human interferon will be undertaken by Roche. Although medical researchers
outside the Company have indicated the desire to purchase somatostatin from the Company for
clinical research, Genentech does not currently plan to undertake its own preclinical or clinical
program for somatostatin.
Human growth hormone, thymosin alpha-1 and human interferon are presently being preclini-
cally tested in animals by the Company or its contract customers. It is anticipated that Investiga-
tional New Drug Applications will be filed to seek permission to begin human clinical testing programs
in the United States for these products in late 1980 or early 1981. The length, complexity and cost of
each of these human clinical programs depends to a large degree on the characteristics of the product
being evaluated, the relative lack of alternative drags on the market, the existence or not of side effects
and the potential long-term effects of the therapeutic agents involved.
Because of the considerable therapeutic histoiy and clinical efficacy of insulin and human growth
hormone available from conventional sources, Genentech anticipates expeditious completion of
clinical programs involving corresponding products produced by microorganisms, even though such
products are not identical in all respects to the materials previously in clinical use.
The FDA has ultimate responsibility for approval and permission to market products in the
United States. There can be no assurance as to the timing or ultimate approval of the Company s
products for marketing. (See "Government Regulation.")
Marketing
The largest portion of Genentech s current revenues is derived from customer contracts, each of
which relates to a particular product development program and provides Genentech with a short-
term source of revenues as well as the potential for long-term returns. The terms of each contract
are unique, and depend largely upon the skills and interests of each party involved and the com
mercial potential for a particular product under development. Generally, however, a typical con
tract will provide for cash payments to Genentech in accordance with the conduct of research
activities and/ or the achievement of certain "benchmarks" in the development process for a particular
product, and then additional payments upon eventual commercial application. Benchmark payments,
when received, are non-refundable and have been treated as deferred revenue and recognized as
20
124
revenue as work under the contract progresses. Representative contract "benchmarks" have included
microbial production of the desired product, demonstration of the product s therapeutic activity,
delivery of various quantities of product so produced and attainment of specified yield criteria. In its
performance to date, Genentech has successfully attained each scheduled benchmark of its several
contracts in a timely fashion. To date, all contract revenues received by the Company have arisen
from developmental activities rather than from royalties or product sales to end users.
Ordinarily, Genentech s contracts are cancellable by the customer on relatively short notice in
the early research stages, and at times prior to the completion of certain benchmarks. In the case
of the Lilly, Kabi and Roche agreements announced by Genentech, those benchmarks have been
completed, but there is no assurance that any such customer will pursue commercialization of the
resulting products to the point of entitling Genentech to royalty or other income upon market
introduction. The Company is presently receiving payments under five other agreements with cus
tomers for its technology. These agreements are variously cancellable on notice of 90 days or less. In
the event of any such cancellation, Genentech has no obligation to refund any payment previously
received, and generally all manufacturing, marketing and other rights with respect to the product
revert to Genentech.
Following the full term of their agreements with the Company, Roche, Kabi and Lilly will retain
the right to use certain microorganisms provided by Genentech free of any royalty obligation to the
Company. Genentech possesses and intends to retain stocks of the same microorganisms. Following
expiration of the exclusivity provisions of the agreements referred to, the Company will be free to
use these microorganisms for its own account in producing interferon, human growth hormone and
human insulin for sale wherever governmentally approved.
Genentech s development contracts with Lilly, Kabi and Roche accounted for approximately
24%, 21% and 18%, respectively, of Genentech s total revenues in 1979. For the first six months of
1980, Roche and Lilly accounted for approximately 27% and 16%, respectively, of Genentech s total
revenues, while Kabi accounted for less than 10%. The Company has received all research and
development payments due under its agreement with Kabi. One additional customer accounted for
approximately 11% of total revenues in 1979, while another accounted for approximately 17% of
total revenues in the first six months of 1980.
As of June 30, 1980, and based on the continuation of contracts currently in effect, Genentech
expects to recognize at least $7r<
>
million in contract revenues during the research and development
stage of its present contracts, compared to $1.8 million at June 30, 1979. The Company does not
believe that the loss of one or more of its unannounced contracts would have a material adverse
effect on its financial condition.
Over the longer term, Genentech expects to derive the major portion of its revenues from
product sales and royalties. Products may be marketed directly, under supply agreements with major
contract customers (for example, sales of human growth hormone to Kabi and human interferon to
Roche), by others who will share profit with Genentech, or under distribution agreements. In addition,
all of Genentech s contracts with customers provide for either royalties to Genentech on the sale of
licensed products manufactured by customers or for a sharing of the profits from such sales.
While Genentech has established a marketing group, it currently does not have its own sales force
or distribution system. Genentech s long-term strategy is to market its own products. Genentech
anticipates that its initial market area will be North America, and presently plans to sell certain of its
products directly in this market.
21
125
Proprietary Technology Patents and Trade Secrets
Genentech has a policy of seeking patents on inventions concerning novel techniques, processes,
products or microorganisms developed as part of its on-going research and development activities.
Worldwide, the Company has filed over 200 patent applications and, to date, several foreign patents
have been issued. The Company plans to seek a strong proprietary position in its technology through
the diligent pursuit of its patent claims and the protection of its knowhow. Genentech has supple
mented its customary reliance on outside counsel by hiring full-time in-house patent counsel.
To the extent certain of the Company s end products are similar to products that have previously
been isolated from other sources, patent protection on the end products may be unavailable. To
obtain patent protection in such cases, the Company would be obliged to seek patents on the processes,
plasmids, microorganisms and other means of end product manufacture, and to overcome obstacles
to the detection of infringement that are customary in the enforcement of process, intermediate product
and other such patents of secondary nature. The majority of the Company s patent applications now
on file relate to the means for manufacturing the Company s announced products.
Genentech participated in the recent U.S. Supreme Court case Diamond v. Chakrabarty as an
amicus curiae or "friend of the court." In the Chakrabarty case the Supreme Court decided diat a
genetically engineered microorganism was patentable subject matter under the law. The Commissioner
of Patents and Trademarks had asserted that the patent laws as presently enacted did not extend to
patents on microorganisms, and, pending the outcome of the case, the United States Patent and
Trademark Office had suspended examination of patent applications filed by Genentech and others in
its field. As a result of this favorable decision, Genentech believes that its patent applications on
genetically engineered microorganisms, as well as the plasmids, processes and other techniques used in
their manufacture, will now be reviewed. However, there can be no assurance that Genentech s patent
applications will be reviewed favorably by the Patent and Trademark Office or that patents will provide
the Company with sufficient protection if and when they are in fact issued. The patent laws of
various countries differ, and, while in certain foreign countries microorganism patents have been
recognized, there can be no assurance that patents on novel microorganisms and other products of
gene-splicing will be available in various countries to which the Company s business may extend.
Nevertheless, Genentech believes that patents will play an important role in the future development
of the industry, and plans to pursue a policy of enforcing such patents as it obtains.
The extent to which efforts by other researchers will result in patents or other proprietary rights
and the extent to which Genentech may need to obtain licenses from others are currently unknown.
Although the Company has applied for numerous patents, it does not intend to rely solely on patent
protection as the basis for protecting its proprietary technology. To the extent consistent with its policy
of permitting its scientists to publish meritorious achievements in scientific journals and seminars (
See
"Business Human Resources"), the Company likewise intends to rely upon trade secrets. It also
intends to rely on continuing technological innovation and manufacturing and marketing efforts to
develop and maintain its .commercial position.
Competition
Human insulin developed by Genentech was the first product of recombinant DNA technology
having major commercial potential. Based on information currently available, including past NIH
approvals for scaled-up manufacturing and the number of products the Company has devel
oped, Genentech believes it is the leader in developing products with commercial potential. How-
22
126
ever, competition can be expected to become more intense as technological advances are made
and additional competitors enter the field. Because the industry is still in the early stages of
development, competition is presently focused on research and development. The Company believes
competition in the industry will be based on scientific and technological superiority, the avail
ability of patent protection (see "Proprietary Technology Patents and Trade Secrets"), the ability
to commercialize technological developments and, in the case of pharmaceutical products, die ability
to obtain government approval for testing, manufacture and marketing. As of July 19SO, Genentech
or contract customers using its
technology had received NIH approval for scaled-tip manufacturing
in 9 of the 10 cases in which the NIH had granted such approval.
The Company believes significant long-term competition may come from large pharmaceutical
or chemical companies and others. These companies have extensive financial, marketing and human
resources, and the pharmaceutical companies have extensive experience in undertaking clinical tnals
and testing and in obtaining regulatory approval where necessary to market pharmaceutical products.
Hence, Genentech has developed a strategy of working with several of them on the development
and commercialization of products, as evidenced by its contracts with Lilly, Kabi and Roche. (See
"Products" and "Marketing.")
In addition to pharmaceutical and chemical manufacturers, other companies have announced
that they have entered the recombinant DNA field. Genentech is aware of the existence of several
such companies, and due to the high degree of interest in the field Genentech anticipates that addi
tional companies may enter the industry in die future.
Other groups active in the field of recombinant DNA include colleges, universities and public
and private research organizations, many of which are conducting research in recombinant DN"\
and which may seek patent protection of their inventions. These organizations exist primarily to
pursue scientific and educational objectives, however, and are not generally engaged in the direct
commercialization of dieir technical achievements. Several of these organizations compete \vtth
Genentech and its other competitors in recruiting personnel from a limited supply of scientists and
technicians.
Genentech believes that as this industry emerges from the current nascent stage of develop
ment, competition will focus more upon the ability of competitors to commercialize and market
their products, including their ability to fund the plant and equipment expenditures necessary for
manufacture.
Government Regulation
Genentech s present and proposed activities involve a field in which regulation by federal
governmental authorities is a significant factor. This regulation applies not only to Genentochs
research and development and manufacturing, but also to the marketing of present and proposed
products, particularly those involving pharmaceutical applications.
In general, Genentech s present research activities are not subject to government regulations
relating to recombinant DNA experimentation. However, Genentech and others in its field have
adopted a policy of voluntarily complying with guidelines promulgated by the National Institutes of
23
127
Health ("NIH"). One provision of the NIH guidelines imposes an initial limit of 10 liters on the size of
any population of genetically engineered microorganisms which may be grown. The NIH has estab
lished a procedure for exceeding the 10 liter limit upon recommendation by the Recombinanc DNA
Advisory Committee, and Genentech has applied for and received NIH approval to create populations
in excess of 10 liters of all of the genetically engineered microorganisms which it has announced.
(See "Products.")
In order to clinically test, manufacture and market pharmaceutical products, Genentech and/or
its contract customers must obtain the approval of the Food and Drug Administration ("FDA")
in the United States and comparable agencies in other countries. The FDA has established mandatory
procedures and safety standards which apply to the manufacture, clinical testing and marketing
of all pharmaceutical products. Obtaining FDA approval for the marketing of products and com
plying with FDA standards in manufacturing involve numerous procedures.
The procedure of seeking FDA approval of a new pharmaceutical product involves many steps,
beginning with the availability of the product in highly purified form. The product must first be
tested on animals to determine efficacy, safety and potential toxicity, and these animal test results
are then submitted to the FDA us part of an Investigational New Drug Application to begin clinical
trials on humans. After the completion of clinical trials a New Drug Application ("NDA")
must be
submitted to the FDA. When the FDA has reviewed the NDA and all additional information sub
mitted during the review process, it will decide whether or not, and under what labeling conditions,
it will permit the product to be sold. If the FDA approves the sale of a product, its regulations will
govern the manufacturing process and marketing activities. The FDA may also require that a post-
marketing testing and surveillance program be undertaken to monitor continuously a drug s effects.
The process of seeking and obtaining FDA approval of a new product traditionally can take a
number of years and may require substantial funding. No pharmaceuticals produced by means of
genetically engineered microorganisms have yet been submitted to the FDA for marketing approval,
although Genentech believes such approvals will eventually be obtained.
In addition to the foregoing, the Company s present and future business will be subject to
regulation under the Occupational Safety and Health Act, Environmental Protection Act, Resource
Conservation and Recovery Act, Toxic Substances Control Act and other present or possible future
legislation, as well as by governmental agencies with regulatory authority relating to Genentech s
business. From time to time, legislation has been introduced to regulate various aspects of die
technology, but Genentech is unaware of any proposed actions by federal, state or local authorities
which might materially impair Genentech s ability to conduct its business.
Human Resources
As of August 15. I960, Genentech employed 112 full-time employees and 14 consultants, of whom
40 hold PhD degrees and 17 hold other advanced degrees in scientific or technical fields. Of the t ull-
time employees, 54 were engaged in research, 30 in process development and manufacturing and 2S in
marketing, finance and administration. In each of the last two calendar years, Genentech has approxi
mately doubled the size of its full-time staff, and in 1980 Genentech expects the size of its staff to
more dian double.
24
-
MANUFACTURING PROCESS
Recombinant microorganisms are
grown through a process known
as fermentation, first on a small
scale (A) to determine optimal
growth conditions and then on
a larger scale for manufacturing
(B). Cellular extract from fermen
tation is then purified (C), to
make preparations (D) of the
Company s products.
Genentech, Inc.
129
The development process begins
by obtaining DNA either through ;.; "-,
: ;
organic synthesis (1) or derived from -
biological sources such as tissues (2) *_;;;. j
The DNA obtained from one or- ;
;;r-:^:
both sources is tailored to form the
basic "gene" (3) which contains
the genetic information to "code"
;;- :.
for a desired product, such as ,^
.
.;.;-
v .-,
human interferon or human f|risulih. p\
Control signals (4) , containing ;:^v\;
instructions are added to this gene (5);
Circular DNA molecules called plasmids
(6) are isolated from microorganisms
such as E. coll; cut open
1
;
(7) and :
;
-
spliced back. (8) together^with .^
genes and control signais^to form ::.--
"recombinant DNA" molecules. These :
molecules are then introduced into a
host cell (9). .;- ,
>&i -,. , ,.,.
Each plasmid is copjedIjmany:;?:^ ;
times in a cell (10), Each"cell
then translates the information #
contained in these plasmids Into
the desired product, a process ; ;
called "expression" (11). Cells
divide (12) and pass on to their
offspring the same genetic -information
contained in the parent cell.
Fermentation of large ,
populations . :
of genetically, engineered. micro- .
organisms is first done in shaker
flasks .
(13),Sair^.?Vien ;
|injlsrnaM.-;;i-
_..
--
fe rme nters (1 4 )
:
to ;
determ i n e :
:
growth , :
:
conditions, and eventually in larger ;
fermentation tanks (15)".
Cellular extract
obtained from the fermentation
process is then separated, ;purlfied {16),:
and packaged (17)
l
e!trier5fpr
Industrial
use (18) or health care applications.^ ;
!
Health care products ^a rejirst ;fc4& .;
tested in animal studies (19) to
demonstrate a product s pharma
cological activity and safety.. In
;^
the U.S., an InvestigatlonalyNew ,; ?-:;-:
Drug (INDJ^application (20) is sub
mitted to begin human clinical trials
to establish safety and efficacy.
Following clinical testing ,(21), a New
Drug Application (NDA) -:
(22) is \,
filed with the Food and Drug _. ;,,
Administration" (FDA) -In the U.S. ;
jiV/jJv
When the NDA has:
.
been -reviewed
and approved by the FDA the" product
may be marketed in the O.iS .
(23).:, :
.
-
"
:
4. Control
Signals
^ 5. Gene .
6. Plasmid ^SK7. Cutting
8. Recombinant DNA
13. Laboratory
;.;;. Scales..,-.-.
-
../!
Fermentation
11. Expression
12. Cell .;...
:
-. :
Division
nn
JCT DEVELOPMENT- PROCESS
18. Industrial
Applications
-
; 14. Process
Development
Scale-up
--
15. Large scale
Fermentation
21. Clinical
Testing
22. Submit
NDA
23. Health Care
Applications
o
131
RESEARCH AND DEVELOPMENT
Circular DNA molecules called
plasmids (above, inset) are genetically
engineered by "gene splicing"
techniques utilized at Genentech.
Once designed, the DNA is reintro-
duced into a microorganism cell
such as E. col! (above).
Shaker flasks (above
recombinant microorgnuSM>.
Organic chemistry laboratory
for gene synthesis (above).
Vessel (left) used in
"gene splicing"
132
Genentech provides its employees a professional working environment and opportunities for
internal and external interaction with scientific professionals. Genentech maintains an active seminar
and visitation program with the scientific community, and members of the organization publish in
key scientific journals and participate in professional seminars. Genentech offers an attractive com
pensation, incentive and fringe benefit program. In addition, many employees are presently share
holders, and Genentech recently established an Employee Stock Plan for all full-time employees.
(See "Management Employee Stock Plan.")
Genentech considers its employee relations to be
excellent.
Properties
In January 1978, Genentech entered into a lease on its current facilities at 460 Point San Bruno
Boulevard, South San Francisco, California, which now occupy approximately 24,000 square feet (all
of which is utilized) of office, laboratory and manufacturing space in a modern industrial park. The
Company has entered into several additional leases and now has leases or options extending through
December 31, 1983 on facilities covering a total of approximately 90,000 square feet. As of June 30,
1980, Genentech had invested approximately $2.2 million in leasehold improvements and equipment
in its present facilities. These improvements consist primarily of the cost necessary to convert an
industrial building to a laboratory and office configuration. Genentech commenced a capital expen
diture program in 1980 which will develop the remainder of the space under its current leases. The
cost of constructing and equipping facilities in this expansion will be approximately $10 million, con
sisting primarily of additional laboratory and office facilities, a manufacturing facility and an animal
facility for testing purposes. The aggregate rental for these total expanded facilities Ls approximately
$120,000 per year.
MANAGEMENT
The directors and executive officers of the Company are as follows:
Name Age Position
Robert A. Swanson 32 President, Chief Executive Officer and Director
Herbert W. Boyer 44 Vice President and Director
Thomas J. Perkins 48 Chairman of the Board of Directors
Fred A. Middleton 31 Vice President Finance & Administration, Chief
Financial Officer and Secretary
Robert F. Byrnes 35 Vice President Marketing
Thomas D. Kiley 37 Vice President and General Counsel
Donald L. Murfin 37 Director
All directors hold office until the next annual meeting of shareholders and until their successors
have been elected and qualified. Officers serve at the discretion of the Board of Directors.
Mr. Swanson, a founder of the Company, has served as President, Chief Executive Officer and
director of Genentech since April 1976. From January to April, 1976, he was a general partner of Boyer
& Swanson, a partnership formed to investigate the feasibility of commercializing recombinant DNA
technology. Prior to 1976, Mr. Swanson was a limited partner of, and a venture capitalist at, the venture
capital firm of Kleiner & Perkins. Mr. Swanson holds a bachelor s degree in chemistry and a master s
degree in management from the Massachusetts Institute of Technology.
25
133
Dr. Boyer, a founder of the Company, has been associated on a full-time basis with the
University of California at San Francisco since 1966 (as Professor of Biochemistry since 1976). From
January to April, 1976, he was a general partner of Boyer & Swanson, a partnership formed to investi
gate the feasibility of commercializing recombinant DNA technology. He has been Vice President_and
director of Genentech since April 1976, and serves as a consultant to the Company. Dr. Boyer holds a
PhD in microbiology from the University of Pittsburgh. Dr. Boyer is subject to the patent policy of
the University of California, \\ith whom the Company must reach agreement in order to gain rights
under any invention made by him in the course of his University employment.
Mr. Perkins, a director of the Company since April 1976, has been a general partner of the
venture capital firms of Kleiner & Perkins: Kleiner, Perkins, Caufield & Byers; and Kleiner, Perkins,
Caufield & Byers II since 1973, 1978 and 19SO, respectively. He is also a director of Spectra-Physics,
Inc. and Chairman of the Board of Directors of Tandem Computers Incorporated. Mr. Perkins holds
a bachelor s degree in electrical engineering from the Massachusetts Institute of Technology and
an MBA from Harvard University.
Mr. Middleton was Vice President Planning & Corporate Development for Chase Manhattan
Bank from 1977 to 1978 before joining Genentech in August 1978 as Vice President Finance &
Administration and Chief Financial Officer. In April 1980, Mr. Middleton was elected Secretary of
the Company. From 1975 to 1977, Mr. Middleton served as Assistant to the Chairman and Chief
Executive Officer of Studebaker Worthington, Inc., a diversified manufacturer of process and auto
motive equipment. Prior to 1975, he served as a consultant with the international management
consulting firm of McKinsey & Company. Mr. Midclleton holds a bachelor s degree in chemistry
from the Massachusetts Institute of Technology and an MBA in finance from Harvard University.
Mr. Byrnes was Vice President Marketing and Sales for the McGaw Division of American
Hospital Supply Corporation from 1976 to 1978 before joining Genentech in January 1979 as Vice
President Marketing. Prior to 1976, Mr. Byrnes was Vice- President Marketing for the Amar Stone
Division of American Hospital Supply Corporation, a manufacturer and marketer of hospital and
health care products. Previously, Mr. Byrnes held marketing positions with Eli Lilly and Company
and Abbott Laboratories. Mr. Byrnes holds a bachelor s degree in pharmacy from Ferris State College
and an MB5
A in marketing from Loyola University.
Mr. Kiley was associated with the law firm of Lyon & Lyon, specializing in patent, trade
mark and copyright law. from 1969 to 1980 (as a partner since 1975) before joining Genentech in
February 1980 as Vice President and General Counsel. Mr. Kiley holds a bachelor s degree in chemical
engineering from The Pennsylvania State University and a law degree from George Washington
University.
Mr. Murfin was elected a director of the Company in April 1980. Since October 1979, Mr. Murfin
has been President of Lubrizol Enterprises. Inc., a business development subsidiary of The Lubrizol
Corporation ("Lubrizol"), a manufacturer of chemical additives for lubricants and fuels and spe
cialty chemicals for industrial applications. In addition, since November 1978, Mr. Murfin has been
Assistant to the President of Lubrizol. Prior to November 1978, Mr. Murfin served with Lubrizol
in a number of capacities, including Assistant to the Chairman of the Board, Secretary, Assistant
Secretary and Assistant to the Vice President Administration and Secretary. Mr. Murfin has a bache
lor s degree in chemistry from the University of Iowa. See "Certain Transactions" for a description of an
arrangement between Genentech and Lubrizol regarding election of a representative of Lubrizol
to the Board of Directors.
26
134
Remuneration
The following table sets forth certain information as to each of the Company s executive officers
or directors whose aggregate direct remuneration exceeded $50,000, and as to all officers and directors
as a group, during the year ended December 31, 1979:
Cash and Cash
Equivalent Remuneration
Securities
Salaries, Fees and
Individual or Capacities in and Personal
Persons in Group Which Served Bonuses Benefits
Robert A. Swanson President $ 68,000
Robert F. Byrnes Vice President $ 67,000 $1,000(1)
Marketing
Fred A. Middleton Vice President Finance $ 53,000 $ 500(2)
& Administration
Officers and Directors as a
Group (6 persons) $256,000 $2,000(1) (2)
( 1 ) Includes $600 representing the difference between the fair market value, as determined by
the Board of Directors, and the purchase price of shares purchased under Genentech s Stock Purchase
Plan and $400 representing the difference between the interest rate ( 4% )
on Mr. Byrnes promissory
note to the Company and the approximate implicit interest rate (12%) on the Company s lease
line agreements during 1979.
(2) Represents the difference between the interest rate (4%) on Mr. Middleton s promissory note
to the Company and the approximate implicit interest rate (12%) on the Company s lease line
agreements during 1979.
Directors of Genentech receive no remuneration for their service as directors.
Employee Incentive Compensation Plan
The Board of Directors has adopted an Employee Incentive Compensation Plan (the "Incentive
Plan") which includes the award of bonuses to officers of Genentech. All employees of Genentech are
eligible to receive bonuses under the Incentive Plan upon the authorization of the Board of Direc
tors. Bonuses are based on the achievement of Genentech s goals and objectives as determined by
management and the Board of Directors.
Series B Restricted Stock Purchase Plan
The Board of Directors and shareholders have adopted a Series B Restricted Stock Purchase
Plan (the "Series B Plan") under which the Board of Directors may authorize the purchase by
employees of and consultants to the Company (including officers) of up to an aggregate of 400,000
shares of Genentech s Series B Restricted Stock for cash and/or promissory notes at a purchase
price of not less than 85% of fair market value. All authorizations to date under the Series B Plan
have been at purchase prices equal to the fair market value of the shares offered, as determined by
the Board of Directors.
Genentech s Series B Restricted Stock was created for use as an equity incentive for attracting
and rewarding employees and consultants. It has voting and liquidation rights junior to those of the
Common Stock, is not entitled to any dividends and is generally not transferable without the
27
135
Company s prior consent except to Genentech or by will or inheritance upon the death of the holder.
Due to these restrictions, the value of the Series B Restricted Stock has been determined to be less
than that of the Common Stock. The Series B Restricted Stock is automatically convertible into
Common Stock upon the occurrence of certain potential events. ( See "Description of Capital Stock
Series B Restricted Stock.")
As of September 30, 1980 the Board of Directors had authorized the purchase of a total of
201,750 shares of Series B Restricted Stock (all of which had been issued) under the Series B
Plan by one officer and 35 other employees and consultants at an average price of $1.27 per share.
See "Certain Transactions" for a description of the purchase of 60,000 shares of Series B Restricted
Stock under the Series B Plan by Thomas D. Kiley, an officer of the Company.
Employee Stock Plan
A total of 400,000 shares of Common Stock is presently reserved for issuance under Genentech s
Employee Stock Plan, which was adopted by the Board of Directors and approved by the share
holders in August 1980. The Employee Stock Plan, which is intended to qualify under Section 423
of the Internal Revenue Code of 1954, as amended, is administered by the Board of Directors.
Employees of Genentech (including officers) are eligible to participate if they are customarily
employed by Genentech 20 hours or more per week and more than five months per year. Under
the Plan, participating employees may receive rights to purchase Common Stock in such amounts and
for such prices (not less than 85% of the fair market value of the shares on the date of grant of the
right to purchase shares under the Plan or the date of purchase) as may be established by the
Board of Directors, and may pay for shares purchased under the Plan by means of regular payroll
deductions, lump sum cash payments or a combination of both as determined by the Board of
Directors. No single purchase right granted to an individual employee under the Employee Stock
Plan may cover more than 2.000 shares and no more than 30,000 shares may be purchased by all
participating employees under the Plan during any single calendar quarter. Employees may end
their participation in the Plan at any time and participation ends automatically on termination of
employment.
To date, no shares-.have been offered or sold under the Employee Stock Plan, but the Board of
Directors has authorized two types of grants. Initially, employees will be eligible to receive a right
to purchase 200 shares of Common Stock each at a price of 85% of the price of the shares offered
hereby. These rights will be exercisable by each participating employee on the date of the offering
covered hereby, with payment due on or before October 31, 1980. On an on-going basis, employees
will receive the grant of a right to purchase Common Stock with up to 10% of the participating
employee s basic compensation (up to Plan maximums) at a price of 85% of the lesser of (a) the
fair market value of the Common Stock on the date of grant and (b) the fair market value of the
Common Stock on the date of exercise. The rights will have a term of 27 months and will generally
be automatically exercisable on each January 1, April 1, July 1 and October 1 unless the participant
has terminated his employment or withdrawn from the Plan prior to such date. For new employees,
grants of rights under the Plan will be on the first grant date following employment by Genen
tech. Grant dates will occur on the date of the offering of the shares covered hereby and on the
first day of each ensuing January, April, July and October. Only newly eligible employees will
receive grants so long as participants hold a previously granted right, but a participant who has
voluntarily withdrawn from the Plan will be eligible to receive a new grant on the next grant date.
28
136
CERTAIN TRANSACTIONS
The founders of the Company are Robert A. Swanson and Herbert W. Boyer. In connection with
Genentech s formation, Messrs. Swanson and Boyer each received 25,000 shares of Genentech s
Common Stock ( subsequently reconstituted as 1,000,000 shares of Common Stock as a result of stock
splits and recapitalizations), in exchange for which each contributed $500 cash and his one-half
interest in a partnership which they had formed in January 1976 to investigate the feasibility of
commercializing recombinant DNA technology. The value of each partner s interest in the partnership
was determined by Messrs. Swanson and Boyer to be $12,000 on the basis of time (at regular consulting
rates ) and funds expended by the partners on behalf of the partnership in conducting its business. The
partnership had no tangible assets.
In May 1978, Wilmington Securities, Inc. purchased from Genentech 6,250 shares of Genentech s
Series A Preferred Stock (now reconstituted as 250,000 shares of Common Stock) for $500,000 cash
under a Preferred Stock Purchase Agreement dated April 28, 1978.
In September 1979, The Lubrizol Corporation ("Lubrizol"), parent of Lubrizol Enterprises, Inc.,
i business development subsidiary, purchased from Genentech 25,000 shares of Genentech s Series A
Preferred Stock (now reconstituted as 1,000,000 shares of Common Stock) for $10,000,000 cash under
i Preferred Stock Purchase Agreement dated August 28, 1979 (the "Lubrizol Agreement"). Lubrizol
transferred these shares and assigned its rights under the Lubrizol Agreement to Lubrizol Enterprises,
[nc. in December 1979. The Lubrizol Agreement provides, among other things, that so long as
Lubrizol holds at least 25,000 shares of Series A Preferred Stock or an equivalent amount of Common
Stock (1,000,000 shares), Genentech will use its best efforts to cause and maintain the election to the
Board of Directors of a mutually satisfactory representative of Lubrizol. At the April 1980 annual
meeting, the shareholders elected Donald L. Murfin, Assistant to the President of Lubrizol and Pres
ident of Lubrizol Enterprises, Inc., a director of the Company. Genentech and Lubrizol may in the
Future consider one or more cooperative projects, the commercial terms of which would be negotiated
3n an arm s length basis.
In November 1979, the Company received a $300,000 payment from Inco Limited, whose affiliate,
Inco Securities Corporation, was then a shareholder of the Company, in exchange for release of a
Dlaim by the Company to a small equity interest in, in exchange for information and assistance in
connection with the formation of, Biogen, S. A., a concern otherwise unaffiliated with the Company.
In March 1980, in connection with his becoming a full-time employee, Thomas D. Kiley, Vice
President and General Counsel of the Company, purchased 60,000 shares of Series B Common Stock
( now reconstituted as 60,000 shares of Series B Restricted Stock )
from Genentech at a price of 81.00
per share under Genentech s Series B Common Stock Purchase Plan. The purchase price was paid
with $6,000 cash plus a four-year 6% full recourse promissory note (renewable for an additional
four-year period) in the principal amount of 854,000 (all of which is presently outstanding), secured
by the shares purchased. Interest on the note has been paid monthly. In connection with Mr. Kiley s
relocation to join the Company, the Company guaranteed repayment of housing bridge loans in the
aggregate principal amount of approximately 3200,000, which loans have subsequently been repaid.
29
137
CERTAIN SHAREHOLDERS
The following table sets forth as of July 31, 1980 certain information regarding all shareholders
known by Genentech to be the beneficial owners of more than 5% of Genentech s outstanding Common
Stock and all directors and officers of Genentech as a group:
Number of Percent of
Name and Address Shares Class
Robert A. Swanson 925,000(1) 143%-
c/o Genentech, Inc.
460 Point San Bruno Blvd.
South San Francisco, CA 94080
Herbert W. Boyer 925,000 14.3%
c/o Genentech, Inc.
460 Point San Bruno Blvd.
South San Francisco, CA 94080
Lubrizol Enterprises, Inc.(2) 1,555,200 24.0%
29400 Lakeland Blvd.
Wickliffe, OH 44092
Kleiner & Perkins(3) 938,800(1) 14.5%
Two Embarcadero Center
San Francisco, CA 94111
Wilmington Securities, Inc 400,000(1), (4) 6.2%
One Customs House Square
Suite 550
One Customs Plaza
Wilmington, DL 19801
All directors and officers as a group (
7 persons ) 2,938,000(1), (5) 45.4%
(1) Kleiner & Perkins has informed the Company that it intends to distribute 844,920 of its
938, 800 shares of the Company s Common Stock to its partners shortly after completion of the offering.
As limited partners of Kleiner & Perkins (with interests of .12% and 40%, respectively), Robert A.
Swanson and Wilmington Securities, Inc. will receive 831 and 332,689 shares, respectively, and will
continue to have interests in the 93,880 shares retained by Kleiner & Perkins. Shareholdings shown for
Mr. Swanson and Wilmington Securities, Inc. do not include any shares held by Kleiner & Perkins.
Neither Mr. Swanson nor Wilmington Securities, Inc. has any voting or investment power over
any shares held by Kleiner & Perkins.
(2) Lubrizol Enterprises, Inc. is a wholly owned subsidiary of The Lubrizol Corporation, a
manufacturer of chemical additives for lubricants and fuels and specialty chemicals for industrial
applications. Donald L. Murfin, President of Lubrizol Enterprises, Inc., is a director of Genentech.
(3) Thomas J. Perkins, a director of the Company, is a general partner of Kleiner & Perkins, a
venture capital partnership.
(4) Includes 150,000 shares held by CRF Investments, Inc., a second-tier wholly owned subsidiary
of Wilmington Securities, Inc. Wilmington Securities, Inc. is a wholly owned subsidiary of The Hillman
Company, a company controlled by Henry L. Hillman and engaged in diversified operations and
investments.
(5) Includes 938,800 shares held by Kleiner & Perkins, a venture capital partnership of which
Thomas J. Perkins, a director of die Company, is a general partner. Excludes 1,555,200 shares held by
Lubrizol Enterprises, Inc., whose President, Donald L. Murfin, is a director of the Company. Mr.
Murfin disclaims beneficial ownership of such shares.
See "Certain Transactions" for a description of Series B Restricted Stock held by Thomas D. Kiley,
an officer of the Company.
30
138
Based on the shareholdings of the following persons and their respective positions with the
Company, Robert A. Swanson, Herbert W. Boyer, Kleiner & Perkins, The Lubrizol Corporation
(through Lubrizol Enterprises, Inc.) and Wilmington Securities, Inc. may each be deemed a "parent"
of Genentech within the meaning of the rules and regulations under the Securities Act of 1933, as
amended. Each of the aforementioned persons and companies disclaims any controlling interest in,
or that it is a "parent" of, the Company.
DESCRIPTION OF CAPITAL STOCK
Genentech s authorized capital consists of Preferred Stock, $.02 par value (2,000,000 shares
authorized), Common Stock, $.02 par value (18,000,000 shares authorized), and Series B Restricted
Stock, $.02 par value (2,000,000 shares authorized).
Preferred Stock
The Board of Directors is authorized to fix or alter the dividend rights, dividend rate, conversion
rights, voting rights, rights and terms of redemption (including sinking fund provisions), redemption
price or prices and liquidation preferences of any wholly unissued series of Preferred Stock, and die
number of shares constituting any such series and the designation thereof, and to increase or decrease
the number of shares of any series subsequent to issuance of shares of that series. No shares of Preferred
Stock are presently outstanding, and although such shares may be issued in the future, Genentech has
no present plans to issue any such shares.
Common Stock
Holders of shares of Common Stock are entitled to one vote per share on all matters to be voted
on by shareholders and are entitled to cumulate their votes in the election of directors. The holders of
Common Stock are entitled to receive such dividends, if any, as may be declared from time to time
by the Board of Directors, subject to any prior dividend rights of any outstanding Preferred Stock.
(See "Dividends and Dividend Restrictions" for a description of certain restrictions on Genentech s
ability to declare and pay dividends.) Upon liquidation or dissolution of Genentech, subject to any
prior liquidation rights of any outstanding Preferred Stock, the holders of Common Stock are entitled
to receive, prior and in preference to any distribution to the holders of Series B Restricted Stock by
reason of their ownership thereof, the greater of ( 1 ) $10.00 per share, or (
2 )
an amount per share
equal to 10 times die amount which, after such distribution, would remain available for distribution
to the holders of Series B Restricted Stock for each share of Series B Restricted Stock then held by
them. The foregoing liquidation preference is subject to appropriate adjustment in the event of any
stock split, stock dividend or other similar event affecting the Common Stock. The Common Stock has
no preemptive or other subscription rights, and there are no conversion rights or redemption or
sinking fund provisions with respect to such shares. All of the outstanding shares of Common Stock
are fully paid and nonassessable, as will be all shares in this offering.
Series B Restricted Stock
Series B Restricted Stock is sold to employees of and consultants to the Company pursuant to
the Series B Restricted Stock Plan. Holders of Series B Restricted Stock are entitled to one-tenth
vote per share on all matters to be voted on by shareholders and are entitled to cumulate their votes
in the election of directors. No dividends may be declared or paid with respect to any share of Series
B Restricted Stock. Upon liquidation or dissolution of Genentech, the holders of Series B Restricted
Stock are entided to receive pro rata their share of all assets remaining available for distribution to
shareholders after payment of (
1 ) liquidation preferences, if any, of holders of Preferred Stock
31
and (2) the liquidation preference of heUUrs of C&nmon Stock (see -Common Stock ). Generally,
no shares of Series B Restricted Stock may be assigned or transferred without the Company s prior
consent except (a) to the Company or (b) by will or inheritance upon the death of the holder. The
Series B Restricted Stock has no preemptive or other subscription rights, and there are no redempt.on
or sinking fund provisions
with respect to such shares. All of the outstanding shares of Senes B
Restricted Stock are fully paid and nonassessable.
Each share of Series B Restricted Stock (whether issued or unissued) shall automatically be
converted into one share of Common Stock upon: (i) the last day of any fiscal year m which the
Company realizes gross revenues of at least $16 million; or (ii) the last day of any fiscal yea, m
whTchTe Company realizes net earnings, after taxes and extraordinary items of at least $l.o million;
or (iii) the effectiveness of anv merger or consolidation of the Company w:th or into another cor
poration or any reorganization (as defined in Section 181 of the California Corporation, Code) m
fvhTcl^he Company Is the acquired company, or any sale of all or substantially all of the assets of
the Company.
The voting rights and conversion rate applicable to the Series B Restricted Stock are
subject
to
pro rata adjustment in the event of any stock split, stock dividend or other similar event affecting
the Common Stock.
Outstanding Registration Rights
The holders of an aggregate of approximately 3,500,000 shares of Common Stock issued
^upon
conversion of Series A Preferred Stock sold by Genentech pursuant to four Preferred Stock Pur-
hase Agreements are entitled under such Agreements to request that Genentech at it, expense
file a Registration Statement under the Securities Act of 1933, as amended (the Act ) covering
die sale of some or all of the shares owned by such holders. Upon such request by the holders
o not las te a specified number of shares purchased under such Agreements, Cenentech
oblSed to exert its best efforts to effect such registration, provided the number of shares pro
posed o be Registered is not less than certain minimum amounts set forth in such Agreement
and subject to certain other conditions. Cenentech is not required to effect more than a total
three such registrations.
In addition, under the aforementioned Preferred Stock Purchase Agreements and t ree subse
quent letter agreements, whenever Genentech proposes to register any of Us Commo .Stock under
the Act For sale to the public solelv for cash, Genentech is required to nohfy the holders c
reate^ approximately 3,700,000 shares of Common Stock, and to include m such regon
hOlflPfS SHUI UC UUl lie: uy anvii .! -.-_ --.- j; .
,-;,rl,*-o
Sd for the account of each. All holders of such registration rights have waived their right
with respect to this offering.
The holders of the registration rights described above include Kleiner & Perkins. Lubrizol
Enterprises, Inc.. Wilmington Securities, Inc. and CRF Investments, Inc.
Transfer Agent and Registrar .
The Ftat National Bank of Boston is the Transfer Agent and Registrar of Genentech s C
Stock.
140
Reports to Shareholders
Genentech intends to furnish its shareholders with annual reports containing audited financial
information and to distribute quarterly reports containing unaudited financial information for the
first three quarters of each year.
UNDERWRITING
The Underwriters named below have severally agreed, on the terms and conditions of the
Underwriting Agreement, to purchase from Genentech, and Genentech has agreed to sell to the
Underwriters, the respective number of shares of Common Stock set forth opposite their names below:
Name
Number of
Shares to Be
Purchased
Blyth Eastman Paine Webber Incorporated 162,000
Hambrecht & Quist 162,000
ABD Securities Corporation 10,000
Advest, Inc 5,000
Bache Halsey Stuart Shields Incorporated 18,000
Bacon, Whipple & Co 5,000
Robert W. Baird & Co. Incorporated 5,000
Basle Securities Corporation 10.0C
Bateman Eichler, Hill Richards Incorporated 5,000
George K. Baum & Company Incorporated 2,00
Bear, Stearns & Co . 18.0C
Sanford C. Bernstein & Co., Inc 5,000
Birr, Wilson & Co., Inc 2,000
William Blair & Company 5,000
Blunt Ellis & Loewi Incorporated 5.0C
Boettcher & Company 5,000
J. C. Bradford & Co., Incorporated 5,OC
Alex. Brown & Sons 10,000
Cazenove Inc 10.000
The Chicago Corporation 5,000
Cowen & Company 2,000
Craigie Incorporated 2,000
Crowell, Weedon & Co 5,000
Dain Bosworth Incorporated 5,00
Davenport & Co. of Virginia, Inc 2,00(1
Davis, Skagss & Co., Inc 2,000
R. G. Dickinson & Co. 2,000
Donaldson, Lufkin & Jenrette Securities Corporation 18,OC
F. Eberstadt & Co., Inc 10,00
A. G. Edwards & Sons, Inc 10,000
Eppler, Guerin & Turner, Inc 5,000
Europartners Securities Corporation 10,000
Fahnestock & Co 5,000
First Equity Corporation oF Florida 2,OC
Robert Fleming Incorporated ... 10.000
Foster & Marshall Inc 5.000
Goldman. Sachs & Co 1S.OOO
J. J. B. Billiard, W. L. Lyons. Inc. 5,000
E. F. Hutton & Company, Inc. .
.
.
18.000
Janney Montgomery Scott Inc 5,000
Johnson, Lane, Space, Smith & Co., Inc 5,000
Johnston, Lemon & Co. Incorporated 10,000
33
141
Number of
Shares to Be
Purchased
Kidder, Peabody & Co. Incorporated 18,000
Kleinwort, Benson Incorporated 10,000-
Ladenburg, Thalmann & Co., Inc 10,000
Lazard Freres & Co 18,000
Lehman Brothers Kuhn Loeb Incorporated 18,000
McDonald & Company 5,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated . . . .
18,000
Montgomery Securities 5,000
Morgan, Keegan & Company, Inc 2,000
Moseley, Hallgarten, Estabrook & Weeden Inc 10,000
Neuberger & Berman 5,000
New Court Securities Corporation 10,000
Nevvhard, Cook & Co. Incorporated 2,000
The Ohio Company 5,000
Pacific Securities Inc 2,000
Parker/Hunter Incorporated 2,000
Piper, Jaffray & Hopwood Incorporated 5,000
Prescott, Ball & Turben 5,000
Rauscher Pierce Refsnes, Inc 5,000
Robertson, Colman, Stephens & Woodman 10,000
The Robinson-Humphrey Company, Inc 5,000
Rodman & Renshaw, Inc 5,000
Rotan Mosle Inc 5,000
L. F. Rothschild, Unterberg, Towbin 18,000
Scherck, Stein & Franc, Inc 5,000
Schneider, Bernet & Hickman, Inc 5,000
Shearson Loeb Rhoades Inc 18,000
Smith Barney, Harris Upham & Co. Incorporated 18,000
Somers, Grove & Co., Inc 2,000
Stephens Inc 5,000
Sutro & Co. Incorporated 5,000
Thomson McKinnon Securities Inc 10,000
Tucker, Anthony & R. L. Day, Inc 10,000
Warburg Paribas Becker Incorporated X". .
18,000
Wertheim & Co., Inc 18,000
Wheat, First Securities, Inc 5,000
Dean Witter Reynolds Inc 18,000
Bank Julius Bar & Co. A.G 5,000
Banque Nationale de Paris 5,000
Banque de Paris et des Pays-Bas 5,000
Baring Brothers & Co. Limited 5,000
Compagnie de Banque et d Invesrissements 5,000
Credit Commercial de France 5,000
Grieveson, Grant & Co 5,000
Lazard Brothers & Co., Limited 5,000
Samuel Montague & Co. Limited 5,000
Pictet International Ltd 5,000
S. G. Warburg & Co. Ltd 5,000
Total 1,000,000
The Underwriters are committed to purchase all of the shares of Common Stock offered hereby
if any are purchased.
.34
142
Genentech has been advised by BIyth Eastman Paine Webber Incorporated and Hambrecht &
Quist, as Representatives, that the Underwriters propose to offer the shares of Common Stock to
the public at the initial offering price set forth on the cover page of this Prospectus, and to certain
securities dealers at such price less a concession not in excess of $1.25 per share, and that the
Underwriters and such dealers may reallow to certain dealers, including any Underwriters, a dis
count not in excess of $.25 per share. The public offering price and concessions and discounts to
dealers may be changed by the Representatives. At the request of the Company, the UnxJerwriters
have reserved up to 50,000 shares to be first offered for sale at the initial offering price to employees
and business associates of the Company. Any shares so purchased will not be available for sale to the
general public.
Genentech has agreed to indemnify the Underwriters against certain liabilities, including liabil
ities under the Securities Act of 1933, or to contribute to payments the Underwriters may be reqisired
to make in respect thereof.
Genentech has granted an option to the Underwriters, exercisable during the 30-day period
after the date of this Prospectus, to purchase up to a maximum of 100,000 additional shares of
Common Stock at the same price per share that Genentech will receive for the 1,000,000 shares
being purchased by the Underwriters as described above. The Underwriters may exercise such
option only to cover over-allotments. i
The Representatives of the Underwriters have informed Genentech that the Underwriters do
not expect sales to discretionary accounts to exceed 5% of the total number of shares of Common
Stock offered hereby and that the Representatives do not intend to confirm sales to any accounts
over which they exercise discretionary authority,
See "Certain Shareholders" for shares owned by Kleiner & Perkins (of which Thomas J. Perkins,
a director of the Company and a limited partner of Hambrecht & Quist, is a general partner) and
Lubrizol Enterprises, Inc. (a limited partner of H & Q Ventures). H & Q Ventures is an affiliate of
Hambrecht & Quist, a Representative of the Underwriters. Venture Associates, S.A., an aiBliate
of Hambrecht & Quist, holds 69,400 shares ot Common Stock.
Pricing of the Offering
Prior to this offering, there has been no public market for the Common Stock of the Company.
Consequently, the offering price has been determined by negotiation between Genentech and the
Representatives of the Underwriters. Among the factors considered in such negotiations were pre
vailing market conditions, the prices paid by previous investors in Genentech s stock, estimates of
the business potential of the Company and the present state of the Company s development. Based
on the initial public offering price of $35.00 per share, the market value of the shares to be out
standing after the offering (assuming no exercise cf the over-allctment option) would be approxi
mately S262 million. The offering price set forth on the cover page of this Prospectus should not,
however, be considered an indication of the actual value of the Common Stock of the Company.
LEGAL MATTERS
The legality of the shares of Common Stock offered hereby is being passed upon for the
Company by Cooley, Godward, Castro, Huddleson & Tatum, San Francisco, California. Pillsbury,
Madison & Sutro. San Francisco, California, are acting as counsel for the Underwriters in connection
with certain legal matters relating to the shares of Common Stock offered hereby.
35
143
EXPERTS
The financial statements at June 30, 1980 and for the six-month period then ended, for each
of the three years in the period ended December 31, 1979 and the period from April 7, 1976 (date
of incorporation) to December 31, 1976, included herein, and the related schedules included in the
Registration Statement have been examined by Arthur Young & Company, certified public accountants,
as set forth in their reports appearing elsewhere herein and in the Registration Statement, and have
been included herein in reliance upon such reports and upon the authority of such firm as experts.
The opinion of Lyon & Lyon, Los Angeles, California, concerning the alleged claim against Hoffmann-
La Roche Inc. set forth in "Business Products Leukocyte and Fibroblast Interferon" is included
herein on the authority of that firm as experts in patent and related matters.
ADDITIONAL INFORMATION
Genentech has filed with the Securities and Exchange Commission, Washington, D.C. 20549,
a Registration Statement under the Securities Act of 1933, as amended, with respect to the Common
Stock offered hereby. This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further information with respect
to Genentech and such Common Stock, reference is hereby made to such Registration Statement,
exhibits and schedules.
36
144
REPORT OF CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
GENENTECH, INC.
We have examined the accompanying balance sheet of GENENTECH, INC. at June 30, 1980
and the related statements of operations, shareholders equity and changes in financial position for
the six-month period then ended, each of the three years in the period ended December 31, 1979,
and the period from April 7, 1976 (date of incorporation) to December 31, 1976. Our examinations
were made in accordance with generally accepted auditing standards and, accordingly, included such
tests of the accounting records and such other auditing procedures as we considered necessary in the
circumstances.
In our opinion, the statements mentioned above present fairly the financial position of GENEN
TECH, INC. at June 30, 1980 and the results of operations and changes in financial position for the
six-month period then ended, each of the three years in the period ended December 31, 1979, and
the period from April 7, 1976 (date of incorporation) to December 31, 1976, in conformity with
generally accepted accounting principles applied on a consistent basis during the period.
ARTHUR YOUNG & COMPANY
San Francisco, California
August 14. 1980
37
145
GENENTECH, INC.
BALANCE SHEET
June 30, 1980
ASSETS
Current assets:
Cash $ 716,192
Certificates of deposit 8,510,000
Commercial paper, at cost 1,429,882
Accounts receivable 886,606
Interest receivable 537,538
Prepaid income taxes and other assets (Note 6) 300,527
Total current assets 12,380,745
Equipment and improvements, at cost:
Equipment 241,301
Leasehold improvements 1,824,133
Equipment under capital leases (Note 2) .
117,955
2,183,389
Less accumulated depreciation and amortization (491,480)
Net equipment and improvements 1,691,909
Patents pending and other assets (
Note 1 )
100.642
$14,173.296
See accompanying notes.
38
146
GENENTECH, INC.
BALANCE SHEET
June 30, 1980
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Accounts payable $ 176,938
Accrued liabilities 238,016
Taxes payable 256,800
Current obligations under capital leases (Note 2) 20,885
Deferred revenue (Note 4) 2.167,370
Total current liabilities 2,860,009
Long-term obligations under capital leases (Note 2) 56,212
Total liabilities 2,916,221
Commitments and contingencies (Note 3)
Shareholders equity (Note 5) :
Preferred Stock, $.02 par value;
2,000,000 shares authorized; none issued
Common Stock, $.02 par value;
18.000,000 shares authorized;
6,472.102 shares issued and outstanding 129,442
Series B Restricted Stock, $.02 par value;
2,000,000 shares authorized;
152,000 shares issued and outstanding 3,040
Capital in excess of par value 11,974,889
Deficit * (691,230)
. Notes receivable from sale of stock ( 159,066 )
Total shareholders equity 11,257,075
$14,173,296
See accompanying notes.
39
147
S-lJSj,
Ipl
J
3 S co
3 o-.
i o
1-1 in m co oo i
CM r-i CM in t- oo
TJ< O *~t *~1 ^ "^1
oo" o"
"* oo" CM" CD"
oo I I I oo I
C*- I l t-- i
of of
o>
o_
t-" o"
!c
in co
ft
in co in o
in oj w o
i t O ^ O
o" o"
-" o"
CO t- CM O O) CM
(CD O O CM O
V <
CM "
CO 00
S"
co" CD"
"
o"
< I H OO
CD
_. t-
CM -^
o in"
CO
"
O5
CM
00
E
p
o a
2-i 8" 3
in in co
oo f- in
r- co o
co_
t- CM
of oT co"
in T CM
C3 C3
O 00
? CD
t*. OS * OS I
O Q
O O
1C O 8?
I- CO
o
f. 3
111
en to S
S 5 S
^5
= 3
S o S
_
5 8 8
i ss
* i
Q o o
3 5
o S
= 1 i 1
eu O 5
* i i
.3 .3 2 .1,3.3 I
"ill
* S 1 I
S3 a S M
7 M n
M
C3
*
5 S* S o S^
sll
** r > S r i s,
^ (J e O .i
P CO M
a
E
B
Z jirlFliI
C 03
40
148
GENENTECH, INC.
STATEMENT OF CHANGES IN FINANCIAL POSITION
Period from
April 7, 1976
( date of incor
poration) to
December 31,
1976
Year Ended December 31,
Six Months Ended
June 30,
1977 1978 1979 1979
(Unaudited)
1980
Cash, certificates of deposit and
commercial paper, beginning
of period $ $ 85,192 $487,945 $ 953,059 $ 953,059 $10,621,855
! Sources:
Net income (loss) before extraor
dinary item (88,601) (426,481) (373,286) 81,536 6,069 51,802
Depreciation and amortization . 194 4,526 63,611 258,912 80,042 165,689
Total working capital from
(used in) operations be
fore extraordinary item (88,407) (421,955) (309,675)
Extraordinary item utilization
of loss carryforward
Increase (decrease) in accounts
payable and accrued liabilities 78,722 70,102
Increase (decrease) in note pay
able to preferred shareholder 50,000 (50,000)
Retirement of fixed assets .... 9,815
Issuance of stock for cash and
notes
Increase in deferred revenue . .
Increase in taxes payable
Decrease (increase) in patents
pending and other assets ....
Increase in receivables and pre-
paids
Equipment purchases
Leasehold improvement
purchases
Decrease (increase) in lease obli
gations
Repurchase of common stock
^ash, certificates of deposit and
commercial paper, end of period 3 85,192 S4S7.945 $953,059 310,621.855 Sl.113,396 $10.656.074
Working capital at the end of each period is as follows: December 31, 1976 $36,542; 1977 8406,289:
978 -$503,879; 197959,943,164; and June 30, 1979 $508,218; and 1980 $9,520,736.
See accompanying notes.
41
149
GENENTECH, INC.
NOTES TO FINANCIAL STATEMENTS
(Information for the six-month period ended June 30, 1979 is unaudited) -
1. Summary of Significant Accounting Policies
Equipment and leasehold improvements
Equipment and leasehold improvements are stated at cost. Depreciation of equipment and leased
equipment under capital leases is calculated using the straight-line basis over useful lives of eight
years and seven years, respectively. Leasehold improvements are amortized over the length of the
lease, including any option period. As a result of the Company entering into additional leases and
options, the estimated life of certain leasehold improvements was extended by 24 months in 1980,
which decreased depreciation expense. The effect was to increase income before extraordinary item
by $89,000 ($.01 per share) and net income by $118,000 ($.02 per share) for the six months ended
June 30, 1980.
Maintenance and repairs are charged to expense as incurred. The cost of betterments and
renewals is capitalized. At the time properties are retired or otherwise disposed of, the related costs
and accumulated depreciation are removed from the accounts and resultant gains and losses taken
into income.
Patents
It is the Company s practice to seek patent protection on processes and products in various
countries. Patent application costs of approximately $95,000 have been capitalized. The cost of patents
that are approved will be amortized over their useful lives, not exceeding 17 years, on a straight-
line basis.
In connection with the research and development contracts discussed in Note 4, certain customers
have agreed to incur the costs associated with seeking foreign patents. Through June 30, 1980, these
customers had incurred filing costs of approximately $246,000. Portions of these costs may be
recovered by these customers through reduced royalty payments to the Company.
Revenue Recognition
Payments for research and development are generally received in advance and are recognized as
revenue over the periods of time stated in the related agreements.
Investment tax credits
Investment tax credits, when utilized, will be recorded by the flow-through method.
150
NOTES TO FINANCIAL STATEMENTS (Continued)
2. Obligations Under Capital Leases
The following is a schedule, by years, of future minimum lease payments under capital lease
obligations together with the present value of the net minimum lease payments as of June 30, 1980:
19SO (six months to December 31) $14,868
1981 27,430
1982 19,828
1983 16,465
1984 16,465
1985 4,116
Total minimum lease payments 99,172
Less amount representing interest 22,075
Present value of net minimum lease payments .... 77,097
Less current portion 20,885
Long-term portion $56,212
The Company is responsible for taxes, insurance and maintenance under its equipment leases.
3. Commitments
The Company has entered into three equipment lease agreements aggregating $1.5 million, of
which approximately $1.1 million has been utilized and $350,000 committed under purchase orders
at June 30, 1980. The Company is required to maintain $250,000 in short-term investments as a security
deposit.
These agreements require, among other things, that the Company maintain 8750,000 of working
capital (as defined), place limits on certain types of debt and preclude the payment of dividends
without prior approval.
At June 30, 1980, the Company had $50,000 of standby letters of credit outstanding for lease
obligations which expire through December 31, 1983.
The following is a schedule, by years, of future minimum rental commitments under operating
IeaSCS:
Leased
Facility Equipment Total
1980 (six months to December 31) $60,460 S 101,632 S 162.092
1981 115,616 203,264 318.880
1982 120,396 203,264 323.660
1983 120.396 203,264 323,660
1984 203,264 203.264
1985 203,264 203.264
Thereafter 162.218 162.218
Total 8416,868 81,280.170 S 1.697.038
At August 1, 1980, the Company was contingently liable for approximately $40,000 as guarantor of
certain employees notes payable.
The Company is responsible for taxes, insurance and maintenance under its equipment leases.
43
151
NOTES TO FINANCIAL STATEMENTS (Continued)
4. Contract Revenue
The Company has entered into separate agreements with a number of customers--for-the purpose
of developing special microorganisms. The contracts generally provide for nonrefundable payments
which are recognized as revenue over the periods specified in the agreements. These contracts are
subject to review and renewal and are intended to fund research costs expected to be incurred by the
Company. In return for payments and royalties, contract clients will receive certain manufacturing
and marketing rights. Cash payments received by the Company which have not yet been recognized
as revenue are recorded as deferred revenue.
Several major customers (3 in 1978, 4 in 1979, and 4 and 5 in the six months ended June 30, 1979
and 1980, respectively) contributed substantially all of the Company s contract revenues in each
period. Contract revenues from customers in Western Europe were approximately $400,000 in 1978,
$1.1 million in 1979, and $600,000 and 8500,000 for die six months ended June 30, 1979 and 1980,
respectively.
5. Capital Stock
Pursuant to the Articles of Incorporation, each outstanding share of Series A Preferred Stock was
automatically converted into 10 shares of Common Stock as of December 31, 1979, such date being
the last day of the first fiscal year in which the Company had gross receipts of at least $2 million.
On December 19, 1979, the Board of Directors approved a recapitalization, which was approved
by the shareholders and became, effective on January 31, 1980. The recapitalization created two series
of Common Stock, Series A and Series B, with the Series A carrying superior voting, liquidation (
at
least $10 per share) and other rights over the Series B. Each outstanding share of Common Stock was
converted into four shares of Series A Common Stock. A new Preferred Stock was also created for
possible future issuance on terms to be fixed by the Board of Directors. In August 1980, the Series A
Common Stock was converted into Common Stock and the Series B Common Stock was converted
into Series B Restricted Stock.
As part of the recapitalization, a stock purchase plan was approved by the Board of Directors and
shareholders. Under this plan, as amended in August 1980, the Company may issue up to 400.000
shares of its Series B Restricted Stock at a price not less than 85% of fair market value. As of
June 30, 1980, 152,000 shares had been issued for cash and notes and 31,750 additional shares had
been authorized for issuance. The plan, which can be terminated at the Company s option, expires on
December 31, 1983.
No dividends may be declared or paid on the Series B Restricted Stock, each share has one-tenth
the voting and liquidation rights of a share of Common Stock and such shares are generally not
transferable. Each share of Series B Restricted Stock is to be automatically converted into one share of
Common Stock upon the realization in any fiscal year of gross revenues of $16 million or net income
of $1.5 million or the occurrence of a merger or acquisition of the Company.
The Company has issued Common Stock pursuant to a stock purchase plan which expired
December 31, 1979. Under the plan, 146,476 shares were sold for cash and notes. The plan allowed
the Company to sell Common Stock to officers, employees and consultants of the Company at prices not
less than 85% of fair market value.
44
152
26
NOTES TO FINANCIAL STATEMENTS (Continued)
A portion of the shares sold under the employee plans is held in escrow and, if termination of
employment
occurs prior to the completion of a specified period, the Company has the option to
repurchase,
at the price originally paid, those shares which have not accrued to the benefit of the
purchaser
as of the date of termination. The escrowed shares accrue to the benefit of the purchaser on
a straight-Hue basis over the term of the escrow agreement.
6. Income Taxes
The provision for income taxes is based upon the statutory Federal and state income tax rates
and consists of the following:
Year Ended Sir Months Ended
December 31, June 30,
The tax benefit of the utilization of accounting loss carryforwards has been reflected as an
extraordinary credit in the statement of operations for the year ended December 31, 1979 and the
six-month periods ended June 30, 1979 and 1980.
Deferred income taxes relate entirely to the reporting of taxable income (principally deferred
contract revenues) on a cash basis.
For financial reporting purposes, the Company has a loss carryforward of approximately $600,000
at June 30, 19SO.
7.
Supplementary Information Charged to Costs and Expenses
Other supplementary items have been omitted since they are less than 1% of total revenues.
2
21
2
45
20
21
153 APPENDIX F
GENENTECH, INC.
Purchase of Common Stock
By Corning Glass Works
And Formation of
Genencor, Inc.
1982
154
lentech, Inc.
,iiniS:in Bruno Bouievari!
(Ml I l *"
, -, . ,* I ,-. /-v
San Francisco. CA 94080
952-1000
: 9103717168
March 25, 1982
James L. Flynn
Vice President and Treasurer
Corning Glass Works
Houghton Park, NY 14831
Dear Jim:
I am writing to formalize what I believe to be our mutual*
understanding concerning Coming s proposed equity investment in
Genentech and to finalize several points which remained open after our
March 16 meeting.
Coordination with Formation of Genencor, Inc.
Both Corning and Genentech see Coming s proposed equity investment
in Genentech as an important element in an overall relationship between
us, which also includes our proposed joint venture in the field of
industrial enzymes. Therefore, it is. important to both parties that the
proposed investment and joint venture commence simultaneously. As a
result, we need to finalize the negotiations and complete the
documentation for both transactions quickly, particularly so that the
joint venture can commence. We understand that Corning may have some
interest in announcing the commencement of the Genencor, Inc. joint
venture and your equity interest in Genentech at your annual meeting on
April 13th. Our intent is to produce definitive documents jointly
working together prior to Coming s April 13th Board meeting, with
signing and closing occurring the week of April 12th at a mutually
convenient meeting place. With the large number of agreements and
documents involved, time is clearly of the essence!
L
155
Corning Letter
^rch 25, 1982
page Two
Initial $20 Million Investment
It was our understanding after the March 16 meeting that essentially
the only open issue on Coming s proposed initial $20 million investment
was price. We believe that we had both reached agreement on four
purchase dates in $5 million installments for the $20 million
investment, as follows:
Purchase Date Aggregate Purchase Price
April 15, 1982 $5,000,000
February 1, 1983 5,000,000
May 1, 1983 5,000,000
February 1, 1984 5,000,000
We understand that Coming s commitment on the $20 million
investment would be irrevocable, the only condition releasing Corning
from the obligation of investing in the latter three installments being
that Genentech is in bankruptcy proceedings or liquidation. As to
price, we understood your best offer to be a flat price of $35 per share
for all four installments, $35 being the approximate average market
price of Genentech s Common Stock over the four-month period ending with
mid-March 1982. We requested an increase in price for the last three
installments, to give recognition to the time cost of money and to give
Corning an incentive to invest early if its cash liquidity significantly
improved. After negotiating, you indicated that Corning does not wish
to consider any price increase over the $35 per share flat price.
i We have decided to accept your $35 offer, contingent upon Coming s
willingness to accelerate the installments if Corning sells its interest
in Owens-Corning Fiberglass Corporation in a manner which substantially
improves Coming s cash liquidity position prior to any installments
becoming due. We understand that, Corning s current cash liquidity
position does not allow you to invest $20 million immediately, but feel
that if this situation is materially improved, we request that you agree
to accelerate the investment.
Further Investments
In the course of the March 16 meeting, we asked for firm commitments
from Corning beyond the initial $20 million, but understood from you
that Corning is not in a position to give- such a commitment. Corning
and Genentech agree, however, that additional investments by Corning in
Genentech would be desirable for both parties.
156
prning Letter
arch 25, 1982
|pge
Three
We understand from you that Corning is interested in having the
.opportunity eventually to purchase more than 20% of Genentech s stock in
order that Corning may account for its investment in Genentech on the
equity method. Genentech is interested in planning any investments by
Corning far enough in advance so that Genentech will have ample time to
arrange for its financing needs if Corning does not desire to provide
for them.
Although you originally sought an "option"
from Genentech, Genentech
is not willing to formally commit to sell stock to Corning until Corning
is in a position to formally commit to buy the stock. An option, from
Genentech s point of view, might benefit Corning but we do not see it
benefitting Genentech. Genentech would have no assurance that its
capital needs would be met and the option would constitute an overhang
on Genentech s equity which could only have a depressing effect on the
market price of its stock. We do not feel that such a one-sided ;
arrangement is in the spirit of the mutually beneficial relationship on
which we are embarking.
As a result, we proposed a series of decision dates, by which
Jporning would decide whether it wanted to -invest in-Genentech during the
1
ensuing period. More specifically, the following dates and investment
periods, designed to meet Genentech s primary capital needs and
Coming s cash flow availability were proposed as follows:
Commitment Dates
March 31, 1983
March 31, 1984
March 31,1985
Investment Made in Equal
Installments in the
Following Periods*
Fourth Quarter 1983
First Quarter 1984
Second Quarter 1984
Third Quarter 1984
Fourth Quarter 1984
First Quarter 1985 .
Second Quarter 1985
Third Quarter 1985
Fourth Quarter 1985
First Quarter 1986
*Exact timing to be established on Commitment Dates.
Corning could, on any decision date or dates, commit to purchase a
cumulative amount of Genentech stock which, when added to the shares,
-
157
Corning Letter
;
March 25, 1982
Page Four
already purchased by Corning, would give Corning more than a 20%, equity
interest in Genentech. There would be no penalty for Corning foregoing
the opportunity to invest in one or both of the first two decision
dates. Corning could still commit to purchase the entire amount on the
last decision date.
If Corning obtained a 20% or greater equity interest in Genentech
through the aforementioned investments, Genentech would give Corning a
right to participate in Genentech s future equity financings on the same
terms as other investors so that Corning could retain a 20% interest in
Genentech if Corning desired to.
At the March 16 meeting, we had a very lengthy discussion of pricing
further investment by Corning. It was agreed that each investment
should in principle be reflected at the market price at the time of
investment, more specifically defined as the average of the bid and
asked (if OTC) or closing (if traded on an exchange) prices of
Genentech s Common Stock for the three-month period immediately
proceeding the actual purchase. For example, if on March 31, 1984,
Corning committed to invest $20 million during the ensuing period
installments "of" $5" mill ion each"commencing" on November 15, 1984) the
price of the third $5 million installment (due May 15, 1985) would be
the average market price of Genentech s Common Stock during February,
March and April 1985.
Both Genentech and Corning expressed concern about the risk of the
market price at the time of the investment being too low or high
compared to original expectations. As a result, we discussed use of
maximum and minimum prices (the "collar" concept). You seemed primarily
interested in setting such prices at the present time. Upon reflection
we do not think it is possible to reflect fair maximum and minimum
prices so far in advance (almost four years as to the last investment).
No one can predict market price performance that far in the future. As
a result, we propose that maximum and minimum prices if used be
negotiated at the time of the relevant commitment if the parties believe
it appropriate in the circumstances.
Other Corning Requests
You requested standard piggyback registration rights in connection
with Coming s investment and we agreed to give you substantially the
same piggyback rights as we gave Lubrizol. in their investment.
We also agreed to provide a formal provision for Board of Directors
representation when Corning has acquired from Genentech 10% or more of
Genentech s stock and for so long as Corning held at least a 10%
158
Corning Letter
March 25, 1982
Page Five
interest. Of course it is possible that Corning may be invited to
participate on Genentech s Board with less than a 10% interest.
Purchase Agreement
With Peter Booth s concurrence, we have asked Lee Benton to commence
preparation of a draft Stock Purchase Agreement and to work on the
Shareholder s Agreement for Genencor and other related documents. We
would hope to be able to forward it to you early next week if we can get
quick resolution of the final open points.
Needless to say, all of us here at Genentech are looking forward to
a successful conclusion to these negotiation and to commencing a long
standing relationship with Corning and I look forward to speaking with
you.
Sincerely,
... , Fred- A..Middleton ..
Vice President
Finance and Corporate Development
0884f
cc: Chesley P.W. Booth
Richard Dulude
,
Robert E. Leach
Joseph C. Littleton
William C. Ughetta
Thomas J. Perkins
Robert A. Swanson
Thomas D. Kiley
Gary T. Steele
John W. Schlicher
Lee F. Benton
Kenneth L Guernsey
L
160
u Inc.
o.Boulcv.utl
A 94080
Contact:
Nancy Suey
Corning Glass
Public Relations
(607) 974-8147
Vicki Grant
Genentech, Inc.
Public Relations
(415) 952-1000
CORNING GLASS, GENENTECH TO FORM INDUSTRIAL ENZYME COMPANY
-Corning to Become Equity Investor in Genentech-
CORNING, N.Y., April 13, 1982 Corning Glass Works
and Genentech, Inc. announced today that their Boards have
approved an agreement to form an industrial enzyme company.
Ifte new company, Genencor, Inc. (pronounced Ja-NEN-cor) ,
will combine genetic engineering and enzyme immobilization
.to-produce enzymes for food processing and chemical industries.
In a related announcement., Corning Board Chairman* Amory
i
Houghton, Jr. said today at the company s annual meeting that,
as part of the growing relationship between the two companies,
Corning plans to become an equity investor in Genentech.
Houghton said Corning will purchase $20 million of newly-issued
Genentech common stock during the next two years. The private
placement of 571,000 shares at $35.00 per share represents
6.5% of Genentech s outstanding common stock. Genentech said
proceeds will be used for general corporate purposes including
Genentech s contribution to the development of Genencor.
Houghton said, "the goal of the new company is to become
a world leader in the development and production of enzymes
for industrial applications using recombinant DNA technology".
The new company will sponsor significant new research
and development activities at the laboratories of the
-MORE-
-3- 161
cheese whey into food ingredients is not part of the new
company s charter. This particular process is in
commercialization with The Kroger Company of Cincinnati,
Ohio and the Milk Marketing Board of England and Wales.
Genentech, Inc. is a leader in the application of
recorabinant DNA technology (commonly referred to as
genetic engineering) for pharmaceutical and agricultural
industries. Last year, Genentech established a Biocatalysis
Department to develop industrial applications for the
technology. Industrial enzyme products developed by this
research group will be commercialized by Genencor.
i tt # # i
.r
Corningand (Genentech to FonrtCompany;
toss, and Genentech plan
j,tiy
owned company to
jjial tnzymeS, and eadi
Ibout $40 million Into the-
next flw years.
By ANN HUGHKT-
Staff Reporter of TOT WAU. Stanr JOUBHAL
CORNING, N.Y.-Coramf Glass Works
and Genentech Inc. said they agreed to form
a- jointly owned company to make industrial
Richard Dulude, Coming s senior vice
president, said hi an Interview that each
company will put about $40- million into the
new company over the next five years.
Corning, a maker of glass housewares
and other consumer, electronic and tadim"-
caT products, "alsd said it wuT buy 571,000
shares of newly issued Genentech stock, or
about a.5% of the. genetic engineering, com-.
pany^ shares outstanding, at $35 *! , for a
total of $20 million cash over the next two
years.* Corning also will have a representa
tive on- Genenteeh s board. Mr. Dulude said
the company may buy more Genentech
shares later. .
The new company, Genencor Inc., will be
based here. It will develop and make en
zymes protems that can be used at cata
lysts hi chemical .reactions for the food
processing and chemical industries.
Mr. Dulude estimated the total U.S. mar
ket for enzymes at about $150 million a year
and the world market at about double that
. The market Is growing about 15% a year; he
said. A small enzyme. business Corning ac
quired last year from Rohnr & Haas Co. will
become a part of the joint company.. .
The announcement was- made, at Cora-
Ing s annual meeting hen by Amory Hough-
fan Jr., Coming s chairman. He noted Com
ing already has an enzyme process for con
verting cheese whey (a waste product) into
food ingredients, that Is being commercial-
Ized in Coming s joint ventures with Kroger
Co. of Chmdnnati and the Milk Marketing
Board of England and Wales.
Mr. Dulude said Genencor products are
about three years away. Corning has a. his
tory of Involvement In Joint ventures. They
currently range from the whey conversion
operations to Dow Corning. Corp. in Midland,
Michigan, a joint venture with Dow Chemi
cal Co., which makes silicon products for
various industries.
Genencor is Genentecfa s first such jointly
owned company.
"I
think its a very positive move for
both companies," said Mark Hassenberg, an
analyst at Donaldson, Luflon It Jenrett Se
curities Corp. Mr. Hassenberg said* Genen
tech acquires from Corning, the- industrial
expertise and access to industrial markets
that it lacks. Corning, he said, gets to work
more closely with Genentech researchers
than It would if It only licensed Genentech
technology. Corning has worked with Genen
tech on a contract basis.
Stephen J. McGruder. an analyst at
Eberstadt Asset Management Inc., said the
Genencor project Is hard to evaluate Ini
tially. While Corning is "playing
with one of
the leaders in the field," Mr. McGruder said
he isn t sure what Corning gets with Its Ge
nentech stake, since Genentech doesn t
make very much money.
nentech s profit was $300,010. or four cents a
share, on sales of S2L3 million. Large hold
ers of its stock include Lubrizol Incx, found
ers Herbert Boyer and Robert Swanson, and
Wilmington Securities Inc. a company con
trolled by investor Henry, L, Hfflmaa.
At a presentation for securities; analysts
after the annual meeting, Eric Birch, /a-.
Corning vice president, said the"
company^
ha* developed a pan-glass, part-plastic lens
material called Corion that combines the
ightaess. of plastic with the durability and
scratch-resistance of glass. Corning- makes
eyeglass I*T *1 and Is entering the sun-
liases business this year. Corion lenses are
expected to become. available nationally by
November, Corning said, r
Corning reported a 47% drop in profit for
the 12- weeks ended March 28, to S1Z5 mil
lion, or 59 cents a share. Sales for the period
declined 8% to S394 million. . ,
Wednesday, April 14, 1982
Genentech, Corning
Form Joint Venture
By Harre
Genentech Inc., the South
San Francisco genetic engi
neering company, yesterday
announced it will form a
company with Corning Glass
Works to produce enzymes
for food processing and chem
ical production.
As part of the arrangement to
form Ganencor Incs, Corning will
buy $20 million of. newly issued
Genentech common stock over the
next two years. Corning has agreed
to pay $35 per share for 571,000
shares, giving it a 6.5 percent
interest in Genentech.
When the company went pub
lic in October 1980, the asking price
was $35 a share. Within two days
the price shot up briefly to $89 a
share. The stock, traded over the
counter, was bid yesterday at 31
with an asked price of 31 Vi.
Fluor Corp. in Orange County
bought 4 percent of Genentech in
1980. Last September, a Japanese"
consortium that included banks
and insurance companies bought
145.000 shares for about $31 a share.
One. of the company s original
backers, Lubrizbl Corp./ in Cleve
land, owns about 20 percent
.
According to Vicki Grant, Ge
nentech spokeswoman, Genentech
has -agreed to invest some of the
funds from the stock issue to
W. Demoro
develop the new company, Genen-
cor. which will be based initially in
Coming s headquarters city, Corn
ing, N.Y.
Grant said the companies were
not disclosing how much each will
own of Genencor when it is estab
lished, but that eventually each will
own half.
Both Corning and Genentech
have been producing enzymes,
which are proteins used to speed up .
or cause chemical reactions.
"If it wasn t for enzymes, you d
have real cloudy wine," Grant said.
Corning, which makes glass
and ceramic containers, bought its
enzyme unit from Rohm and Haas
Co. last year. It,will become part of
the new jointly owned company,
Grant said.
164
SHAREHOLDERS AGREEMENT
AGREEMENT made this 13th day of April, 1982, by and
Between GENENTECH, INC., a corporation organized and
ixisting under the laws of the State of California having
.ts principal place of business at 460 Point San Bruno
jQulevard, South San Francisco, California 94080
;.(:"Genentech") ; CORNING GLASS WORKS, a corporation organized
and existing under the laws of the State of New York having
principal office at Houghton Park, Corning, New York
14831 ("Corning"); and GENENCOR, INC., a corporation being
&!.
organized under the laws of the State of Delaware having its
;5;&- principal office at Houghton Park, Corning, New York 14831
y ("Genencor" or the "Company"). ,, ,
RECITALS
WHEREAS, Corning has conducted research and possesses
technical information relating to Enzymes (as such term is
defined in Article I) and to .the immobilization of Enzymes
on inert carriers;
WHEREAS, Genentech has conducted research and possesses
technical information relating to genetic engineering (in
cluding recombinant DNA) and to the production of proteins;
165
WHEREAS, Corning and Genentech believe that genetic
Igineering techniques will have important application to
jjifr- production of Enzymes and may result in efficiencies
^available by other means;
WHEREAS, Corning and Genentech believe that Enzymes
llerived from conventional techniques and from genetic
^engineering techniques will find increasing use in
It-
applications, and each wishes to participate in
he growth of the market for Enzymes and in opportunities
K&
if-"
:
j$ifor using Enzymes; and.
WHEREAS, Corning and Genentech believe that the develop-
of new Enzymes and new organisms for the production of
fc-Enzymes can best be fostered and accomplished by a single
^corporate entity dedicated to such purposes and to the
manufacture, use and sale of Enzymes (either separately or
in conjunction with carriers);
NOW, THEREFORE, in consideration of the mutual promises
and covenants hereinafter set forth, IT IS HEREBY AGREED AS
\
FOLLOWS :
;
ARTICLE I - DEFINITIONS
i
As used in this Agreement, the following terms shall
have the following meanings:
m
166
1.01. Enzyme. Any enzyme that is, during use in
enzymatic conversion, either separate from a cell or
ff^contained in a dead cell, provided, however, that lactases
shall not be considered Enzymes.
1.02. Field of Activity. The manufacture and sale of
Enzymes, Immobilized Enzyme Carriers and Immobilized Enzyme
.Composites for uses other than those involving veterinary,
diagnostic, research, medical or agricultural (including
.without limitation the production or growth of any plant or
animal) applications, as well as use of such Enzymes,
Carriers and Composites other than in such applications,
provided, however, that manufacture, use and sale of trypsin
inhibitor removal enzyme shall be within the Field of
Activity. r
Examples of activities within the Field of Activity.
use of Enzymes in the large-scale synthesis of
ammonia, whether or not used as a fertilizer.
manufacture and sale of Enzymes for use in food
\
processing.
Examples of activities outside the Field of Activity:
t
manufacture and sale of Enzymes for pharmaceutical
use, as well- as manufacture of Enzyme ,
intermediates susceptible of conversion to
pharmaceutically active forms.
3 .
167
use of Enzymes as herbicides, pesticides or as
catalysts in the production of antibiotics,
manufacture, use and sale of Enzymes for removal
of bioinactivating precursors from recombinant DNA
expression products comprising B-endorphin.
1.03. Immobilized Enzyme Carrier. Any inert material
designed to be used as a carrier for immobilizing Enzyme.
1.04. Immobilized Enzyme Composite. Any aggregate
.
comprising an Enzyme and an Immobilized Enzyme Carrier,
including any means binding such Enzyme to such Carrier.
1.05. Investor. Genentech or Corning, or, when used
in the plural, Genentech and Corning.
1.06. Party. Genentech, Corning or Genencor or, when
used in the plural, Genentech, Corning and Genencor".
1.07. Subsidiary. A corporate entity more than 50% of
the voting stock of which is owned or controlled, directly
or indirectly, by a Party.
i
ARTICLE II - FORMATION OF COMPANY
2.01. Formation. No later than one month after the
date of this Agreement, the Investors shall establish, or.
cause to be established, Genencor, which shall be organized
under the laws of the State of Delaware for the principal
4.
168
purpose of manufacturing, using and selling Enzymes,
Immobilized Enzyme Carriers and Immobilized Enzyme
^Composites within the Field of Activity. Immediately after
its formation, Genencor shall become party to this .Agreement,
2.02; Initial Capital. The initial capital of the
Company shall consist of a total of 50,000 shares of Common
Stock, each with a par value of U.S. $.01 and the right to
one vote ("Common Stock"); and 25,000 shares of 8% Non-
Cumulative Convertible Preferred Stock, each with a par
value of U.S. $1.00 and no voting rights ("Preferred
Stock"). The Preferred Stock shall be convertible/ at the
option of the holder, into Common Stock on a share-for- share
basis, subject to adjustment as provided therein, and shall
have such other rights, preferences and designations, and be
subject to such limitations and restrictions, as are set
forth in the Certificate of Incorporation of the Company..
2.03. Subscription. Corning hereby subscribes for
25,000 shares of Common Stock of the Company, and Genentech
\
hereby subscribes for 25,000 shares of Preferred Stock of
the Company. The subscription price for all shares, whether
of Common Stock or Preferred Stock, shall be U.S. $100 per
share. Each Party shall pay the full subscription price for
the shares subscribed by it in cash at such time or times as
call for payment is made by the Board of Directors of the
Company, provided that any such call shall be for an equal
5.
169
number of shares of Common and Preferred Stock and shall be
pro rata among stockholders.
2.04. Certificate of Incorporation. The Certificate
of Incorporation of the Company shall be substantially in
the form of Annex A hereto, with such changes therefrom as
the Investors may mutually agree.
2.05. By-Laws. The By-Laws of the Company shall be
substantially in the form of Annex B hereto, with such
changes therefrom as the Investors may mutually agree.
2.06. Name and Principal Office. The corporate desig
nation of the Company shall be "Genencor, Inc." or such
other name as may be selected by the Parties. The principal
office of the Company shall be provisionally located in
Corning, New York.
2.07. Additional Capital. No additional capital
shares may be issued by the Company except in accordance
with a written agreement between Corning and Generitech.
Corning and Genentech shall meet no less frequently than
\
annually during the five years following the formation of
the Company to determine the capital needs of the. Company in
the succeeding year and to discuss the advisability of issu
ing additional capital stock pro rata to their then current
holdings.
2.08. Employee Incentives . The parties shall meet
periodically following the formation of the Company to
170
determine the need of the Company to utilize equity and
other incentives for its officers, employees, directors and
consultants and to discuss the advisability of adopting
plans or programs under which such persons could purchase
the Company s stock or other securities.
ARTICLE III - MANAGEMENT
3.01. Board of Directors. The business of the Company
shall be managed by a Board of Directors consisting
initially of eight members. All actions by the Board of
Directors shall require the affirmative vote of a majority
| of the directors present at a meeting at which a quorum is
present, except for such action as to which a highest than
|; majority vote is required pursuant to the provisions of this
Agreement, the Certificate of Incorporation, the By-Laws or
I applicable law.
\
ARTICLE IV - OPERATIONAL PROVISION
i
i
4.01. Actions Recmiring Consent of Parties. None of
the actions set forth in this Section 4.01 shall be per
mitted by the Parties to be taken by the Company unless the
Company shall have obtained the consent of both of the Inves-
,tors:
7-
171
(a) The entry by the Company into any business
outside the Field of Activity;
(b) Any lending- or borrowing of money in excess
of U.S. $100,000 by the Company;
(c) The acquisition, mortgage, pledge, sale,
assignment, transfer or other disposition of
property having a fair market value in excess
of U.S. $100,000 or of any interest (regard
less of value) in the legal or beneficial
ownership of any other corporation or enter
prise;
(d) The adoption of annual capital, operating and
research plans and budgets (and material modi
fications thereof); and *
(e) Entry by the Company into any agreement with
an Investor or a Subsidiary of an Investor
other than with respect to a purchase or sale
of products in the ordinary course of the Com-
\
pany
1
s business.
4.02. Accounting and Controls. The Parties shall
cause the management of the Company to conduct the business
of the Company at all times in accordance with the highest
standards of business ethics and to maintain the Company s
accounts in accordance with generally accepted accounting
principles and, specifically, to:
.8.
172
(a) make and keep books, records and accounts
which, in reasonable detail, accurately and
fairly reflect the transactions and disposi
tions of the assets of the Company; and
(b) devise and maintain a system of internal
accounting controls sufficient to provide
reasonable assurances that (ji) transac
tions are executed in accordance with general
or specific authorizations, ( ii ) transac
tions are recorded as necessary to permit
preparation of financial statements in con
formity with generally accepted United States
accounting principles or any other criteria
applicable to such statements and to maintain
accountability for assets, ( iii ) access
to assets is permitted only in accordance
with general or specific authorizations, and
(iv) the recorded accountability for
\
assets is compared with existing assets at
reasonable intervals and appropriate action
is taken with respect to any differences.
Each Investor and its auditors shall have full access to all
such books, records and accounts of the Company.
4.03. Fiscal Year. The Company shall keep its books
and accounts on the basis of a fiscal year ending on the
173
| Sunday nearest the thirty-first day of December in each
year.
4.04. Auditors. The Company shall employ Price Water-
house & Co. as the independent auditors of the Company.
Such firm shall be retained in such capacity by the Company
until the Parties shall have agreed upon another firm as
independent auditors.
05 OS. Financial and Business Information. The Parties
shall cause the management of the Company to:
(a) Present annual capital, operating and
research plans and budgets (and material
modifications thereof) to the Board of
Directors and Investors for approval;
(b) Make available to all members of ther
Board of
Directors (and, where appropriate, the
Investors) on a regular basis all such infor
mation as may be required to permit
-
the Direc
tors and/or the Investors, as the case may
V
be, to make informed judgments with respect
to such plans and budgets and all other
matters of interest to them; and
(c) provide to the Investors regular periodic
financial statements showing profit and loss,
cash flow, assets and liabilities and
including appropriate comparisons to budgets,
analyses and forecasts.
10.
174
4.06. Independent Enterprise. The Company shall at
I all times be conducted as an independent enterprise for the
I
I. profit of all shareholders, and all commercial transactions
M
between the Company and an Investor or Subsidiary of an
Investor shall be conducted on an arm s- length basis with
neither granting to the other terms or conditions more favor
able than would be accorded non-related third-party cus
tomers or suppliers except as the Parties may otherwise -all
agree prior to such transaction. It is intended that all
major corporate functions, including, without limitation,
finance, accounting, purchasing, research, development,
| production and sales will ultimately be staffed by the
employees of the Company. In order to ensure that the Com
pany will receive adequate staff services at the Company s i
$/ request during the period of ten years beginning on the date
of this Agreement, Corning and the Company shall enter into
| a Services Agreement substantially in the form attached
hereto as Annex C immediately following the establishment of
I the Company.
ARTICLE V - LICENSE, CONTRACT RESEARCH
AND TECHNICAL ASSISTANCE
.5.01. Licenses. Immediately following the establish-
;inent of the Company, the Investors shall enter into License
11.
175
I Agreements with the Company substantially in the forms
| attached hereto as Annexes D and E.
5.02. Contract Research. Immediately following the
establishment of the Company, the Investors and the Company
I shall enter into a Research Agreement substantially in the
form attached hereto as Annex F.
ARTICLE VI- FINANCING
6.01. Borrowing by the Company . The Parties contem-
!.
plate that the Company will borrow money from financial
I institutions to finance major capital investments to the
I. extent that such borrowings are available. Where satisfac-
i I
I. tory borrowing terms .are contingent upon parent-company
i
1
I guarantees, each Investor will be expected to guarantee such
| borrowing proportionately to its equity interest in the
Company, assuming full conversion of Preferred Stock. If
I satisfactory terms from such lenders cannot be obtained
fj
v
| through parent-company guarantees proportionate to equity
interests, Corning shall, upon request from Genentech,
guarantee to such lenders the full payment of up to
I $40, 000, 000 in amounts borrowed by the Company for major
fi
:
I capital investments; and in such case Genentech shall
guarantee to Corning the payment by the Company of
iGenentech s share of such borrowings and shall pay to
jCorning a fee calculated at the annual rate of 1% on
12.
176
Genentech s share of the daily outstanding balance of such
f
borrowing.
ARTICLE VII - EXISTING ENZYME BUSINESS
7.01. Purchase of Business. Immediately following the
I establishment of the Company, Corning and the Company shall
enter into an agreement substantially in the form attached
hereto as Annex G pursuant to which the Company shall become
|: obligated to purchase the existing enzyme business of
| Corning.
ARTICLE VIII - SALE OR TRANSFER OF SHARES
i
8.01. No Sale o_r Transfer for Five Years. Neither
Investor shall sell, transfer, pledge or otherwise encumber
any shares of Common or Preferred Stock in the Company dur
ing the period of five years beginning on the date of this
Agreement .
8.02. Desire to Sell. If after five years from the
date hereof, either Investor shall desire to sell all or a
part of its shares of the Company, such Investor, shall first
provide the other Investor with written notice of its desire
o sell, including a description of the number of shares to
e
offered, their proposed price and the financial terms on
13.
177
which they" will be offered. The other Investor shall have
thirty days after receipt of such notice to exercise, by
mailing to such selling Investor a written notice thereof, a
right of first refusal or option to purchase such shares at
the price and upon financial terms offered by the selling
Investor. If the other Investor exercises such right of
first refusal or option to purchase, it shall have an addi
tional period of ninety days after such exercise within
which to make payment for, and take title to, such shares.
If the other Investor does not exercise such right of. first
refusal or option to purchase, the selling Investor shall
have a ninety day period in which to sell the shares at a
!r
price and upon financial terms no less favorable to the
selling Investor than those specified in the selling Inves-i
I tor s notice to the other Investor.
8.03. Permitted Transfers. The provisions of Section
8.01 and 8.02 notwithstanding, an Investor may transfer all
(but not part of) the shares held by it to any corporation
which succeeds to all or substantially all of such Inves
ts tor s business and properties, or which wholly owns or is
wholly-owned by, such Investor; provided, however, that the
transferee shall have agreed to be bound jointly with the
Investor by all of the terms and conditions of
14,
178 APPENDIX G
GENENTECH CLINICAL
PARTNERS, LTD.
A Limited Partnership
$55,600,000
Limited Partnership
Interests
Offered in Units
Of $50,000
1982
Volume 1
PETER O. A. SOLBEHT
WILLIAM D. TUCKER, JR.
PETER A. BATOR
JOHN p. CARROLL, JR.
WILLIAM A. KAYNOR
HENRY L. KINO
RICHARD B. SMITH
EDWIN DEANE LEONARD
BRUCE W. NICHOLS
SAMUEL F. PRYOH, III
ROBERT B. F1SKE, JR.
EDWARD 8. REID
PHILIP C. POTTER, JR.
JOHN I. BROKAW
JAMES F. DOLAN
RICHARD E. NOLAN
M.CARR FERGUSON, JR.
JOHN A. CORRY
RICHARD D.SPIZZIRR!
ALLAN A. A. FLYNN
CHARLES S. HOPPIN
JOEL J.COHEN
TROLAND S. LINK
HERBERT M.LOBL
JOHN J.MCATEE.JR.
JONATHAN M.CLARK
CHRISTOPHER CROWLEY
LYDIA E. KESS
JAMES W. B. BENKARD
COLIN E. HARLEY
DANIEL F. KOLB
DONALDSON C. PILLSBUHY
DAVID J. BTRUPP
OUY MILLER STRUVE
JOSEPH ALSOP CHUBB
JAMES WOODMAN LLOYD
BARTLETT H.MeOUIRC
STEPHEN H. CASE
FRANCIS J.MORISON
FRANK S. MOSELEY
JEFFREY SMALL
ALAN D. 3RANOUIST
JESSE ROBERT LOVEJOY
DAVID C. OXMAN
WILLIAM PARSONS, JR.
CHARLES S. WHITMAN, III
ARTHUR F. OOLDEN
STEVEN F. OOLDSTONE
DENNIS S. HERSCH
WINTHROP CONRAD, JR.
LOWELL OORDON HARRISS
Wg F. KROENER, Ml
RICHARD J. SANDLER
ROBERT F. WISE, JR.
JOHN P. COONEY, JR.
ROBERT LEE HECKART
WILLIAM S. KABLE
OODEN N. LEWIS
BRADLEY Y. SMITH
MARLENE ALVA
PETER R. DOUOLAS
JOHN FOUHEY
CHRISTOPHER MAYER
PIERRE BK SAINT PHALLE
ROBERT J.LEVINE
JOHN j. MCCARTHY, JR.
JEROME O. SNIDER
WILLIAM E. WURTZ
179
DAVIS POLK & WARDWELL
I CHASE MANHATTAN PLAZA
NEW YORK, N.Y. IOOO5
2I2-53O-4OOO
TELEX: ITT-<ZI34I RAPIFAX:2I2-4Z2-OZ38
TELECOPIER: 212-269-1976
WRITER S DIRECT NUMBER:
530-4489
COUNKL
LEWIS B. KADEN
MIKEL M. ROLLYSON
KN10R COUHBCL
D. NELSON ADAMS
S. HAZARD O1LLESPIE
ANDREW Y. ROGERS
TAOOART WHIPPLE
WALLACE S.JONES
499 PARK AVENUE, NEW YORK, N.Y. lOOfc
TELEPHONE! 212 - 5 3O --4OOO
1575 I STREET, N. W., WASHINGTON, O. C. ZOOOB
TELEPHONE: 2Oe-7B9-7IOO
A, PLACE DE LA CONCORDE, 7BOO6 PARIS
TELEPHONE: zes. M. 01
KCBIDCKT PAfTTNERB:
HERBERT M. LOBL
RICHARD J. SANDLER
II COPTHALL AVENUE, LONDON ECZR 7LU
TELEPHONE: 01 - ese -ene
MU1DENT PAWTNCn:
FRANCIS J.MORISON
April 1, 1983
Mr. Fred Middleton
Genentech, Inc.
460 Pt. San Bruno Boulevard
South San Francisco, CA 94080
Dear Mr. Middleton:
Enclosed please find the bound volume for
the offering of limited partnership interests by
Genentech Clinical Partners, Ltd., a Limited Partner
ship.
We enjoyed working with you on this offering
and are looking forward to future transactions.
Laura M. Rubenstein
Legal Assistant
Enclosure
180 Memorandum Number
Issued to
1 R78
-
Genentech, Inc.
OFFICE COPY
NOT FOR EXTERNAL DISTRIBUTION
GENENTECH CLINICAL PARTNERS, LTD.,
A Limited Partnership
Confidential Private
Placement Memorandum
BEPW DEVELOPMENT CORPORATION
a wholly owned subsidiary of
BLYTH EASTMAN PAINE WEBBER
HAMBRECHT & QUIST
INCORPORATED
181
THIS IS NOT AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE
INTERESTS DESCRIBED HEREIN IN ANY JURISDICTION TO ANY PERSON TO WHOM IT
IS UNLAWFUL TO MAKE SUCH AN OFFER OR SALE.
THIS OFFERING IS BEING MADE IN RELIANCE UPON AN EXEMPTION FROM REGIS-
TRATON UNDER THE SECURITIES ACT OF 1933 FOR AN OFFER AND SALE OF SECURI
TIES WHICH DO NOT INVOLVE A PUBLIC OFFERING. NO PUBLIC OR OTHER MARKET
WILL DEVELOP FOR THE INTERESTS. INTERESTS ARE NOT TRANSFERABLE WITHOUT
THE CONSENT OF THE GENERAL PARTNER AND SATISFACTION OF CERTAIN OTHER
CONDITIONS. SEE "RISK FACTORS" AND "TRANSFERABILITY OF INTERESTS". PRO
SPECTIVE INVESTORS SHOULD PROCEED ONLY ON THE ASSUMPTION THAT THEY
MAY HAVE TO BEAR THE ECONOMIC RISK OF AN INVESTMENT IN THE INTERESTS FOR
AN INDEFINITE PERIOD OF TIME.
PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS
MEMORANDUM AS INVESTMENT, TAX OR LEGAL ADVICE. THIS MEMORANDUM AND
THE EXHIBIT HERETO AND OTHER DOCUMENTS DELIVERED HEREWITH, AS WELL AS
THE NATURE OF THE INVESTMENT, SHOULD BE REVIEWED BY EACH PROSPECTIVE
INVESTOR, HIS INVESTMENT, TAX OR OTHER ADVISORS, OR HIS ACCOUNTANTS OR
LEGAL COUNSEL.
THE INTERESTS OFFERED HEREBY HAVE NOT BEEN REGISTERED WITH OR
APPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION OR
THE SECURITIES REGULATORY AUTHORITY OF CERTAIN STATES, NOR HAS SUCH
COMMISSION OR THE REGULATORY AUTHORITY OF ANY STATE PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS MEMORANDUM. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
NO GENERAL SOLICITATION WILL BE CONDUCTED AND NO OFFERING LITERA
TURE OR ADVERTISING IN WHATEVER FORM WILL OR MAY BE EMPLOYED IN THE
OFFERING OF THESE INTERESTS, EXCEPT FOR THIS MEMORANDUM (INCLUDING
AMENDMENTS AND SUPPLEMENTS TO THIS MEMORANDUM), THE EXHIBIT HERETO
AND DOCUMENTS SUMMARIZED HEREIN. NO PERSON IS AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS
MEMORANDUM OR IN THE EXHIBIT HERETO, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON.
THE INFORMATION CONTAINED IN THIS MEMORANDUM HAS BEEN SUPPLIED BY
THE GENERAL PARTNER, AND HAS BEEN INCLUDED HEREIN IN RELIANCE ON THE
GENERAL PARTNER. THIS MEMORANDUM CONTAINS SUMMARIES, BELIEVED BY THE
GENERAL PARTNER TO BE ACCURATE, OF CERTAIN DOCUMENTS, INCLUDING THE
DOCUMENTS DESCRIBED UNDER "SUMMARY OF MATERIAL CONTRACTS" AND "SUM
MARY OF THE LIMITED PARTNERSHIP AGREEMENT", SET FORTH IN THIS
MEMORANDUM, BUT REFERENCE IS HEREBY MADE TO THE LIMITED PARTNERSHIP
AGREEMENT, ATTACHED AS EXHIBIT A TO THIS MEMORANDUM, AND THE ACTUAL
CONTRACTS, COPIES OF WHICH ARE AVAILABLE AT THE OFFICES OF GENENTECH
DEVELOPMENT CORPORATION, 460 POINT SAN BRUNO BLVD., SOUTH SAN FRANCISCO,
CALIFORNIA 94080, ATTENTION: MS. ANNE D. GUNDERSON, BEPW DEVELOPMENT
CORPORATION, 1221 AVENUE OF THE AMERICAS, NEW YORK, NEW YORK 10020, ATTEN
TION: MR. STEPHEN EVANS-FREKE, OR HAMBRECHT & QUIST, 235 MONTGOMERY
STREET, SAN FRANCISCO, CALIFORNIA 94104, ATTENTION: MR. PETER W. WALLACE,
FOR COMPLETE INFORMATION CONCERNING THE RIGHTS AND OBLIGATIONS OF THE
PARTIES THERETO. ALL SUCH SUMMARIES ARE QUALIFIED IN THEIR ENTIRETY BY
THIS REFERENCE.
182
THIS OFFER CAN BE WITHDRAWN AT ANY TIME BEFORE CLOSING AND IS SPECIFI
CALLY MADE SUBJECT TO THE TERMS DESCRIBED IN THIS MEMORANDUM. THE
GENERAL PARTNER AND THE SALES AGENTS RESERVE THE RIGHT TO REJECT ANY
SUBSCRIPTION IN WHOLE OR IN PART OR TO ALLOT TO ANY PROSPECTIVE INVESTOR
LESS THAN THE NUMBER OF UNITS SUBSCRIBED FOR BY SUCH PROSPECTIVE INVES
TOR. PRIOR TO THE CONSUMMATION OF THE OFFERING, ALL SUBSCRIPTION FUNDS
AND INVESTOR NOTES WILL BE DEPOSITED WITH BANK OF AMERICA NATIONAL
TRUST AND SAVINGS ASSOCIATION, AS ESCROW AGENT, TO BE HELD FOR THE INVES
TORS. SEE "SUBSCRIPTION PROCEDURES".
THIS MEMORANDUM HAS BEEN PREPARED SOLELY FOR THE BENEFIT OF PRO
SPECTIVE INVESTORS INTERESTED IN THE PROPOSED PRIVATE PLACEMENT OF THE
INTERESTS AND CONSTITUTES AN OFFER ONLY IF THE NAME OF A PROSPECTIVE
INVESTOR APPEARS IN THE APPROPRIATE SPACE PROVIDED ABOVE. DISTRIBUTION
OF THIS MEMORANDUM TO ANY PERSON OTHER THAN SUCH PROSPECTIVE INVES
TOR AND THOSE PERSONS RETAINED TO ADVISE HIM WITH RESPECT THERETO IS
UNAUTHORIZED, AND ANY REPRODUCTION OF THIS MEMORANDUM, IN WHOLE OR
IN PART, OR THE DIVULGENCE OF ANY OF ITS CONTENTS, WITHOUT THE PRIOR WRIT
TEN CONSENT OF THE GENERAL PARTNER, IS PROHIBITED. EACH PROSPECTIVE
INVESTOR, BY ACCEPTING DELIVERY OF THIS MEMORANDUM, AGREES TO RETURN IT
AND ALL OTHER DOCUMENTS TO EITHER SALES AGENT AT THEIR RESPECTIVE
ADDRESSES SPECIFIED ABOVE, IF THE PROSPECTIVE INVESTOR DOES NOT INTEND TO
SUBSCRIBE FOR THE PURCHASE OF THE INTERESTS, THE PROSPECTIVE INVESTOR S
SUBSCRIPTION IS NOT ACCEPTED OR THE OFFERING IS TERMINATED.
WITH REGARD TO CALIFORNIA RESIDENTS, IT IS UNLAWFUL TO CONSUMMATE A
SALE OR TRANSFER OF THIS SECURITY, OR ANY INTEREST THEREIN, OR TO RECEIVE
ANY CONSIDERATION THEREFOR, WITHOUT THE PRIOR WRITTEN CONSENT OF THE
COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA, EXCEPT AS
PERMITTED IN THE COMMISSIONER S RULES.
WITH REGARD TO FLORIDA RESIDENTS, THE INTERESTS REFERRED TO IN THIS
MEMORANDUM WILL BE SOLD TO, AND ACQUIRED BY, THE HOLDER IN A TRANSAC
TION EXEMPT UNDER SECTION 517.061 OF THE FLORIDA SECURITIES ACT. THE INTER
ESTS HAVE NOT BEEN REGISTERED UNDER SAID ACT IN THE STATE OF FLORIDA. IN
ADDITION, ALL FLORIDA RESIDENTS SHALL HAVE THE PRIVILEGE OF VOIDING THE
PURCHASE WITHIN THREE (3) DAYS AFTER MAKING SUCH PURCHASE.
WITH REGARD TO PENNSYLVANIA RESIDENTS, SECTION 207(m) OF THE PENN
SYLVANIA SECURITIES ACT OF 1972 PROVIDES THAT ANY PURCHASER OF INTERESTS
IN PENNSYLVANIA HAS THE RIGHT TO RESCIND HIS AGREEMENT TO PURCHASE
UNITS OFFERED HEREBY WITHIN TWO BUSINESS DAYS AFTER THE LATER OF THE
EXECUTION OF HIS SUBSCRIPTION AGREEMENT AND DELIVERY OF HIS INVESTOR
NOTE AND PAYMENT OF HIS CASH CAPITAL CONTRIBUTION, AND, UPON SUCH
RESCISSION, TO RECEIVE A FULL REFUND OF HIS CAPITAL CONTRIBUTION.
183
$55,000,000
GENENTECH CLINICAL PARTNERS, LTD.,
A Limited Partnership
1,100 Units of Limited Partnership Interests
$50,000 Per Unit -Minimum Investment Two Units
(1) The minimum investment is two Units, except that the Sales Agents named below (the "Sales Agents"), or
their affiliates, may at their discretion, after consultation with Genentech Development Corporation, the
general partner (the "General Partner") of Genentech Clinical Partners, Ltd., a Limited Partnership (the
"Partnership"), and a wholly owned subsidiary of Genentech, Inc. ("Genentech"), make sales consisting of
.
::J. a single Unit, or a single Unit and a partial Unit. Sales of partial Units will be made on the same terms as
sales of single Units.
(2). The limited partnership interests offered hereby (the "Class A Limited Partnership Interests" or the
"Interests") will be offered and sold on a "best efforts" basis exclusively through the Sales Agents, or their
affiliates, and, at the discretion of the Sales Agents, or their affiliates, after consultation with the General
Partner, through one or more selected dealers ("Selected Dealers"). The Sales Agents, or their affiliates,
will receive from the Partnership selling commissions aggregating up to 7% and investment banking fees
aggregating 2% of the aggregate amount of the Units sold to investors ("Investors" or "Class A Limited
Partners"). The actual selling commissions payable to the Sales Agents, or their affiliates, may vary
according to the number of Units purchased by each Investor. Sales of Interests, aggregating not more
than $1,000,000, may be made to certain directors, officers or employees of Genentech, who are qualified
investors, without the payment by the Partnership of any selling commissions. Medical Investors Corpora
tion (the "Class B Limited Partner") holds a limited partnership interest in the Partnership (the "Class B
Interest"). The Class B Limited Partner is jointly owned by the Sales Agents, or their affiliates. For
information relating to amounts payable to the Class B Limited Partner, see "Summary of Material Con
tracts" and "Summary of The Limited Partnership Agreement".
(3) Before deducting expenses related to this offering, payable by the Partnership, estimated to be approxi
mately 1 - 1V4% of the aggregate purchase price of the Interests.
THE PURCHASE OF THESE INTERESTS WILL ENTAIL A HIGH DEGREE OF RISK. NO
PERSON SHOULD INVEST IN THESE INTERESTS WHO IS NOT IN A POSITION TO LOSE HIS
ENTIRE INVESTMENT. SEE "RISK FACTORS". INVESTORS WILL BE REQUIRED TO MAKE
REPRESENTATIONS WITH RESPECT TO THEIR NET WORTH AND INCOME AND TO
REPRESENT, AMONG OTHER THINGS, THAT THEY ARE FAMILIAR WITH AND UNDERSTAND
THE TERMS OF THIS OFFERING. SEE "SUITABILITY STANDARDS" AND "SUBSCRIPTION
PROCEDURES".
BEPW DEVELOPMENT CORPORATION
a wholly owned subsidiary of
BLYTH EASTMAN PAINE WEBBER
HAMBRECHT & QUIST
INCORPORATED
The date of this Memorandum is October 11, 1982.
184
GLOSSARY OF TECHNICAL TERMS
Adjunctive To be added to another.
Cachexia A life threatening condition in which the body rapidly consumes its !
protein due to a severe metabolic imbalance; also known as wast|
away syndrome.
Constitutionally Delayed Short
Stature or CDSS A medical condition in which a child has a lower than average gro|
rate for no currently identifiable cause.
Cytotoxic Lethal to all living cells.
DNA ,
The chemical carrying the hereditary material of most living organis|
Disease state A medical condition resulting in an unhealthy individual.
Efficacy Effective for intended use.
FDA i United States Food & Drug Administration.
hGH . Human growth hormone.
Hypopituitary Low output/performance of the pituitary gland.
Hypopituitary dwarfism Short stature resulting from a child s production of abnormally \\
amounts of hGH.
Immune system . The body s natural protective response system against infections.
Immuno-potentiation- An increase in the activity of the immune system.
In vitro Testing performed in laboratory conditions outside of living organisn
In vivo Testing performed in living organisms.
IND Investigational new drug application.
Indication . A set of symptoms characteristic of a particular disease state.
Linear growth Growth in height and bone length.
NDA New drug application.
Organic cause An identified cause of a medical condition.
Parenteral A route of administration into the body other than through the moult
e.g., intravenous.
Plasmid A circular strand of DNA.
Protocol A program of testing the effectiveness and safety of a pharmaceutic
product.
Recombinant The re-combination of elements in a new fashion.
Syndrome A particular series of symptoms without a clear clinical cause.
Topical Applied to the surface area of the skin.
2
tinj
ft
ism
lot
185
INDEX
SUMMARY OF THE OFFERING
SUITABILITY STANDARDS
THE BUSINESS OF THE PARTNERSHIP
THE PARTNERSHIP S DEVELOPMENT PROGRAM
THE PARTNERSHIP S PRODUCT OBJECTIVES
THE PARTNERSHIP S PATENT AND OTHER PROPRIETARY RIGHTS
MARKETING PLANS
DEVELOPMENT FINANCING
BUSINESS PLAN PRODUCT REVENUE ASSUMPTIONS
RISK FACTORS
FIDUCIARY RESPONSIBILITY OF THE GENERAL PARTNER
SUMMARY OF MATERIAL CONTRACTS
SUMMARY OF THE LIMITED PARTNERSHIP AGREEMENT
THE GENERAL PARTNER
DESCRIPTION OF GENENTECH, INC
SUMMARY OF INCOME TAX CONSEQUENCES
SUBSCRIPTION PROCEDURES
TRANSFERABILITY OF INTERESTS
CERTAIN LEGAL MATTERS
REPORTS
SALES AGENTS .
EXHIBIT A Limited Partnership Agreement
PACE
4
8
9
9
10
17
18
18
19
20
25
26
31
37
37
41
55
57
58
58
58
snis
uth,
ical
TABLES
PACE
Minimum Investment and Schedule of Payments 5
The Partnership s Development Budget 5
Potential Markets to be Addressed by the Partnership s Products 5
Business Plan Product Revenue Assumptions 5
Potential Financial Returns for $100,000 Investment . 6
Potential Markets to be Addressed by Human Growth Hormone 11
Potential Markets to be Addressed by Gamma Interferon 15
Cancer Patients in the U.S 15
Estimated Partnership Receipts and Disbursements 18
Development Budget 19
Human Growth Hormone and Gamma Interferon Revenue Projections . . , . . 19
Genentech, Inc., Statement of Operations 40
Genentech, Inc., Condensed Balance Sheet 40
186
SUMMARY OF THE OFFERING
The following is a summary of certain information relating to the offering that is containc
elsewhere in this Memorandum and does not purport to be complete. This summary is
qualified in
alj
respects by the remainder of this Memorandum, which should be read in its entirety.
The Business of the Partnership
The Partnership intends to undertake extensive human clinical testing programs necessary to
establish the efficacy and safety of human growth hormone ("hGH") and gamma interferon. These]
testing programs are required by the FDA before approval can be granted for marketing new human]
pharmaceutical products. The Partnership also plans to develop scaled-up manufacturing processes for|
these products and to develop alternative delivery systems.
The Partnership will hold a license for the manufacture and sale of hGH and gamma interferon as!
human pharmaceutical products in the United States, using recombinant DNA technology developed!
by Genentech. Naturally derived. hGH is known to be an effective treatment for hypopituitary dwarfn
ism, and, based on early published studies, may also have applications as treatment fpr other serious
growth disorders and cachexia (wasting-away syndrome). Based upon limited published studies
and|
pre-clinical work, gamma interferon may be effective as a treatment for cancers, for whidh there is
noj
effective drug therapy available at present. However, existing data is extremely limited and extensive!
human clinical testing will be required to determine whether gamma interferon will prove effective in !
practice. In vitro studies indicate that gamma interferon has an anti-viral effect similar to the anti
viral effect of all other types of interferon. The General Partner believes that the anti-viral activity of j
gamma interferon may enable the product to compete in various segments of the market for treatment.,
of serious and non-serious viruses.
Summary of Principal Risk Factors
<
No assurance of efficacy of hGH or gamma interferon
Possibility of adverse side effects
No assurance of FDA approvals, or timing thereof
No assurance of market acceptance for new products
Regulation by government agencies
Limited manufacturing and marketing experience of Genentech
Potential competition
No assurance of Joint Venture or purchase of Interests
Possible need for additional funds
Conflicts of interest between Partnership and Genentech
Tax risks, due in part to lack of legal precedents and IRS rulings
Very limited transferability of Interests and rights to receive payments in respect of sales of
Interests
Summary of Tax Aspects
The substantial part of Investors payments to the Partnership should be currently
deductible as research or experimental expenditures.
Partnership income during the Joint Venture stage will be taxable as ordinary income.
The substantial part of payments received under the Partnership Purchase Agreement
should be taxable as long-term capital gain and the remainder as ordinary income.
187
188
Potential Financial Returns to Investors
If the revenue projections for hGH and gamma interferon are achieved, the financial returns to
Investors could be substantial. Prospective investors should be aware, however, that the revenue
projections are only estimates and there can be no assurance that they will be attained. Based on the
revenue projections, potential financial returns for Investors with a maximum tax rate of 50% who
invest a total of $100,000 and elect the deferred payment option are shown in the following table. The
table should be read in light of the possible tax treatment of the payments to the Class A Limited
Partners for the purchase of their Interests. See "Summary of Income Tax Consequences".
Potential Financial Returns for 5100,000 Investment
Year
Payment
Date
1982 11/30/82
1983 3/15/83
1984 3/15/84
1985.... 3/15/85
1986 . ... 3/15/86
1987
1988
1989
1990
1991 1....
1992
1993
1994
1995
1996
1997
1998 (6 mo.)....
Payment
Amount
$18,182
22,727
22,727
18,182
18,182
Potential
Tax
Deductions
$12,289*
19,953
20,133
18,378
18,279
Potential
Cash
Distributions
$
1,267
8.237
40,533
54,344
63,645
57,833
26,098
36,171
36,804
37,229
37,229
37,680
37,680
37,680
18,840
Potential Tax
Savings (Taxes
Payable)
$ 6,145
9,976
9,433
5,071
(4,463)
(12,269)
(15,596)
(15,216)
(7,222)
(10,504)
(11,131)
(11,655)
(12,009)
(12,480)
(12,773)
(13,040)
(6,618)
Annual Net
Cash Flow
$(12,037)
(12,751)
(12,027)
(4,874)
17,888
42,075
48,049
42,617
18,876
25,667
25,673
25,574
25,220
25,200
24,907
24,640
12,222
Cumulative
Net Cash
Position
$(12,037)
(24,788)
(36,815)
(41,689)
(23,801)
18,274
66,323
108,940
127,816
153,483
179,156
204,730
229,950
255,150
280,057
304,697
316,919
*
This amount may be reduced by up to $47 1 ,
unless excess offering expenses are offset by
discounted commissions resulting from institutional sales.
Assumptions and Definitions Underlying Potential Investor Financial Returns
(
1. Investors capital contributions will be $55,000,000.
2. All Investors will adopt the deferred payment option and Investors cash payments to the Partner|
ship will occur as planned in 1982 through 1986.
3. Approximately 90% of the Investors capital contributions will be deductible for Federal income ta!J
purposes.
4. Each Investor will reflect in his quarterly estimated tax return the tax consequences relating to
hiij
investment in the Partnership for such quarter.
189
5. The Joint Venture will be formed as of January 1, 1984 and the Partnership will have, during the
duration of the Joint Venture, a 22% participation in the net income of the Joint Venture.
6. Genentech will exercise its option to purchase the Class A Limited Partnership Interests on July 1,
1986. Payments in respect of such purchase will be made on a quarterly basis, beginning with the third
calendar quarter of 1986, in accordance with the terms of the Partnership Purchase Agreement. Genentech
will also exercise its option to purchase the Class B Interest on October 1, 1986.
7. Distributions of income earned by the Joint Venture will be taxed as ordinary income. Payments
following the purchase of the Class A Limited Partnership Interests will be treated for Federal income tax
purposes
as capital gains, except for a portion of the payments (based on 9% annual simple interest) which
will be treated as interest income and taxed at ordinary income rates.
8. There will be no effect on Investors of the Federal alternative minimum tax. However, the impact of
this tax to each Investor, which will depend upon his particular tax situation, could lower the returns to him.
Each Investor should consult his own tax advisor to determine the applicability to him of this tax.
9. No effect has been given to state and local income taxes.
Joint Venture Agreement
Upon FDA approval for the first of the Partnership s products, Genentech may enter into a joint
venture (the "Joint Venture") with the Partnership, pursuant to a joint venture agreement (the "Joint
Venture Agreement"), to manufacture and market all of the Partnership s products, as they are approved by
the FDA. Genentech would be paid by the Joint Venture for manufacturing and marketing the products
and administering the Joint Venture. While the Joint Venture Agreement remains in forcev the Partnership
will receive 22% of the Joint Venture s profits and losses.
Partnership Purchase Agreement
Upon the earlier of (a) the Joint Venture having been in existence for at least four years and
(b) the Partnership having received an amount equal to 15% of the aggregate capital contributions made by
Class A Limited Partners ($8.25 million) in Joint Venture profits and the Joint Venture having been in
existence for at least two years, Genentech has the option to purchase the Interests. If this option is
exercised, (
the consideration will be as follows: (i) an advance payment of an amount equal to 10% of the
aggregate capital contributions made by the Class A Limited Partners ($5.5 million) (which is credited
against future payments); and (ii) quarterly payments representing the following percentages of all hGH
and gamma interferon sales: 7% (3 /i% in the first quarter) of revenues until total payments (including the
advance payment) of $55 million; and then 5% of revenues until total payments (including the advance
payment) of $1 10 million; and then 3% of revenues until June 30, 1998.
Furthermore, Genentech has agreed to make quarterly payments of at least $1 million for the first 12
quarters following the date on which the Interests are purchased, if there are any sales of hGH or gamma
interferon in such quarters. Payments to the Class A Limited Partners will be reduced by 5% each quarter,
which will be paid to the Class B Limited Partner if Genentech exercises its option to purchase the Class B
Interest, after the Class A Limited Partners receive 100% of their original investment.
Genentech will have the right at any time to make offers to buy out the remaining payment obligations
for stock, cash or other consideration. If at any time any offer shall have been accepted by 80% of Class A
Limited Partners, Genentech has the right to buy out the remaining Class A Limited Partners and the Class
B Limited Partner in accordance with a pre-determined formula. See "Summary of Material Con
tracts
Partnership Purchase Agreement".
190
SUITABILITY STANDARDS
The Interests will be offered and sold only to prospective investors who: (a) represent, among other
things, that they are acquiring Interests for their own-accounts, for investment only and not with a view
toward the resale or distribution thereof, and that they are aware that the Interests have not been registered
under the Securities Act of 1933 (the "Act") and that their transfer rights are restricted by the Ait,
applicable State securities laws, the. Limited Partnership Agreement dated as of October 1, 1982 (the
"Partnership Agreement") and the absence of a market for the Interests; and (b) are investors meeting the
suitability standards hereinafter set forth.
The Partnership will require as a general Investor suitability standard that each Investor represent in
writing that: (1) he,is a director or executive officer of the General Partner, or (2) he is purchasing at least I
$ 1 50,000 of the Interests, where his total purchase does not exceed 20 per cent of his net worth at the time of I
sale, or joint net worth with his spouse, or (3) he is a natural person who has a net worth or joint net worth
with his spouse exceeding $1,000,000 at the time of his purchase, or (4) he is a natural person who had an
individual income in excess of $200,000 in each of the two most recent years and who reasonably expects an
income in excess of $200,000 in the current year, or (5) it is either (a) a bank as defined in section 3(a)(2) of
the Act whether acting in its individual or fiduciary capacity, (b) an insurance company as defined in section
2(13) of the Act, (c) an investment company registered under the Investment Company Act of 1940 or I
business development company as defined in section 2(a)(48) of such Act, (d) a Small Business Investment
Company licensed by the U.S. Small Business Administration under section 301 (c) or (d) of the Smaij
Business Investment Act of 1958 or (e) an employee benefit plan within the meaning of Title I of the
Employee Retirement Income Security Act of 1974, if the investment decision is made by a plan fiduciary
as defined in section 3(21) of such Act, which plan fiduciary is either a bank, insurance company or
registered investment advisor or if the employee benefit plan has total assets in excess of $5,000,000, or (6) |
is a private business development company as defined in section 202(a)(22) of the Investment Advisers Apt
of 1 940, or (7) it is a corporation, partnership or trust, and each and every equity owner of such entitjjl;
certifies that he meets the qualifications set forth in either (3), (4), (5) or (6) above. As used in
thlj
Memorandum, the term "net worth" means the excess of total assets over total liabilities. In
determining
income, an Investor should add to his adjusted gross income any amounts attributable to tax exempt income-
received, losses claimed as a limited partner in any limited partnership, deductions claimed for depletionf;
contributions to an IRA or Keogh retirement plan, alimony payments, and any amount by which incornij
from long-term capital gains has been reduced in arriving at adjusted gross income.
The suitability standards referred to above represent minimum suitability requirements for prospective
investors and the satisfaction of such standards by a prospective investor does not necessarily mean that the
Interests are a suitable investment for such prospective investor. The General Partner or either Sales Agent;?
or its affiliate, may make or cause to be made such further inquiry and obtain such additional information as
it deems appropriate with regard to the suitability of prospective investors. The General Partner or either
1
Sales Agent, or its affiliate, may reject subscriptions, in whole or in part, in its absolute discretion. If this
offering is oversubscribed, the General Partner will determine which subscriptions shall be accepted.
THE SUITABILITY STANDARDS DISCUSSED ABOVE REPRESENT MINIMUM]
SUITABILITY STANDARDS FOR PROSPECTIVE INVESTORS. EACH PROSPECTIVE INVESTOR]
SHOULD DETERMINE WHETHER AN INVESTMENT BY SUCH INVESTOR IN THE INTERESTS!
IS APPROPRIATE.
191
JM
OR
;TS
THE BUSINESS OF THE PARTNERSHIP
e business of the Partnership will be to establish through clinical testing the safety and efficacy, as
pharmaceutical products, of hGH and gamma interferon, produced by means of Genentech s recom-
DNA technology, to continue the development of scaled-up manufacturing processes, to obtain
FDA approvals, and to earn income from the sale of these products in the United States. Naturally-
ffed hGH is effective in the treatment of hypopituitary dwarfism and, based on early published studies,
jnay be effective in the treatment of constitutionally delayed short stature (CDSS) and cachexia (wasting-
syndrome). Based on published studies and pre-clinical work, gamma interferon (also known as
interferon) shows promise as a treatment for cancer and various viral diseases (including, among
forms of herpes, hepatitis, and influenza), and is of particular interest because of its potential ability
the effectiveness of the body s natural immune system.
Both hGH and gamma interferon are natural substances that have important functions in the human
y, and each of these substances can be isolated by purification from human cells. Isolation of these
Substances through purification techniques, however, is very difficult and expensive, and until recently their
,.!jSttpply
nas been limited in quantity and quality. Genentech has been successful in genetically engineering
.-microorganisms capable of producing hGH and gamma interferon and has also developed processes to
,/f
produce these substances in small commercial quantities with a high degree of purity.
, .A..* Human growth hormone was first produced by Genentech, in the laboratory using recombinant DNA
technology, in 1979 and is currently undergoing clinical testing as a treatment for hypopituitary dwarfism.
,; Gamma interferon was first produced using this technology by Genentech in 1981 and human clinical testing
has: riot yet commenced. The Partnership s objectives will be (i) to complete the clinical testing program of
,ihGH as a treatment for hypopituitary dwarfism and to extend that testing to cover CDSS and cachexia, (ii)
to perform pre-clinical and clinical testing of gamma interferon with respect to a variety of cancers and viral
diseases, and (iii) to develop, where feasible, alternative delivery systems for these drugs, such as oral,
topical or implantable dosages, in addition to injectable forms of administration.
In addition, the Partnership will engage in applied research and development, including yield improve
ments, the development of alternative formulations and delivery systems, and the development of scaled-up
manufacturing processes. The Partnership does not expect at present to engage in basic research related to
genetic engineering.
THE PARTNERSHIP S DEVELOPMENT PROGRAM
The work that must be done by the Partnership in order to obtain FDA approval for hGH and gamma
interferon will be similar to the work involved in introducing any major new pharmaceutical product and is
expected to proceed as follows.
\
Pre-CIinical Studies and Submission of IND
Studies are conducted in the laboratory and in different species of animals to gain preliminary informa
tion on the product s efficacy and to identify major safety problems that might be expected to arise when the
drug is administered to humans. The results of these studies must be submitted to the FDA as part of a
Notice of Claimed Investigational Exemption for a New Drug ("IND") before approval can be obtained for
the commencement of testing in humans.
Research: Clinical Testing
The clinical testing program required for approval of a new drug involves a three-phase process. In
Phase 1, studies are conducted on human volunteers to determine the basic biological activity and side
effects of the substance in humans. In Phase 2, studies are conducted on groups of patients afflicted with a
specific disease in order to determine proper dosages and to gain preliminary evidence of efficacy and safety.
Phase 3 involves large-scale studies conducted on patients afflicted with the disease, in order to provide
enough data for the statistical proof of efficacy and safety required by the FDA.
192.
The data obtained from clinical testing, along with other information, are submitted to the FDJ
order to obtain marketing approval for the product. Even after initial FDA approval has been grant
further studies may be required to provide additional data on safety or to gain approval foi the use
of|
drug as a treatment for other indications.
Approximately 72% of the Development Budget is expected to be expended for the Partnersli
clinical testing program. See "Development Financing Development Budget".
Research: Applied
The Partnership will sponsor an ongoing program of applied research to increase the production yie|
of hGH and gamma interferon by development of improved microorganisms using recombinant D|
technology.
In order for medical substances to be administered to human beings, they must be formulated
other active and inert ingredients (such as solvents, buffers and stabilizers) to create a stable and effect^
pharmaceutical product. Genentech has developed an injectable formulation for hGH which is curren
being used in clinical testing, and the Partnership does not expect to devote significant resources to
refinement of that formulation. However, there is at present only an initial injectable formulation of gar
interferon, and the Partnership expects that several improvements in such formulation will be made durij
the course of clinical trials. i
Often the need for injections tends to discourage use of the product where the disease is not
serious|
treatment involves a prolonged course of therapy. Accordingly, in order to reach a broader patient popul
tion, the Partnership will seek to develop alternative means of drug delivery for hGH and gamma interfef|
(e.g., oral, topical or implantable dosages).
Approximately 7% of the Development Budget is expected to be expended on applied research.
"Development Financing Development Budget".
Development of Manufacturing Process
As a condition of receiving FDA approval to market a drug in the United States, the applicant mil
demonstrate to the satisfaction of the FDA that the process used to manufacture that drug is safe
controllable, and that it conforms with Good Manufacturing Practices established by the FDA. Appro*
mately 21% of the net proceeds of this offering will be expended to scale-up and refine the manufacture
processes of hGH and gamma interferon.
THE PARTNERSHIP S PRODUCT OBJECTIVES
Human Growth Hormone
The Substance
Human growth hormone is a naturally occurring human protein produced in the pituitary gland whic
regulates metabolism and stimulates growth. Human growth is a slow process which is completed whe
a child ends puberty. Human growth hormone is effective in stimulating linear growth before the end <
puberty, but will not stimulate growth after puberty.
Until the development of recombinant DNA technology, hGH could be obtained only through purifica-3
tion of an extract from pituitary glands collected at autopsies. As a result, supplies have been limite
and clinical use of hGH has been restricted to the treatment of hypopituitary dwarfism, a disorde
resulting from severely low levels of hGH. Genentech can produce supplies of hGH that will
sufficient to meet anticipated market demand and will be purer than that generally obtainable froni|
natural sources of supply. Clinical studies to date have shown safety and efficacy results similar to
those|
of hGH derived from pituitary glands.
10
193
:eron
Set
roxi-
iringl
History; Potential Uses
lowing its first successful clinical use in 1958, the small quantities of hGH available from natural
"
^resources have been used on a selective basis to treat children with demonstrable growth hormone
: !
V*^$eficiency,
and it is well-established that hGH is effective in the treatment of hypopituitary dwarfism.
trly
published studies suggest that hGH may be effective in the treatment of a larger population of
ildren, including some of those with CDSS. The General Partner believes that if clinical testing
.
? :*
_ji ows jjQpj to De effective and safe for treatment of CDSS, then a major market for hGH may develop.
,[,} te>v"
fi jr1
Another potential use of hGH is in the treatment of cachexia, a life-threatening condition occurring in
"jv,.,jnany Pat enls following major burns, severe trauma or major surgery. Cachexia is a condition in which
;.", j.-. .-.fhe body rapidly consumes its own protein, due to a severe metabolic imbalance. At present, treatment
5 ,:for cachexia requires an invasive form of parenteral nutrition, which is used only in extreme circum-
-;b; stances. Early published studies indicate that hGH may increase the efficacy of such nutritional
;>
supplements in treating cachexia, thereby improving therapy while permitting the administration of
smaller quantities of parenteral nutrition.
Market Analysis
;: The potential market for hGH for treatment of hypopituitary dwarfism is relatively well-defined, in
light of the existing use of pituitary-derived material for the same purpose. Estimating potential
.... demand attributable to CDSS and cachexia is more difficult because these indications are not adequate
ly treated with existing drugs. The market size discussed below, and the financial projections set forth
in the table under the caption "Potential Financial Returns to Investors", are based on the following
critical assumptions:
1. The clinical testing will prove the product to be safe and effective in treating hypopituitary
dwarfism.
2. The clinical testing will prove the product to be safe and effective in treating some cases i
of
CDSS. Patient acceptance and the availability of third-party reimbursement will be forthcoming.
3. The clinical testing will prove the product to be safe and effective, at least as adjunctive
therapy, in treating cachexia.
4. The planned process development, manufacturing scale-up work and clinical testing will be
completed without major delays, enabling Genentech to be the first company to market, in the United
States, hGH produced by recombinant DNA technology.
5. The product will be made available in delivery systems suitable for these three major uses,
including a non-injectable form for the CDSS market.
Potential Markets to be Addressed by Human Growth Hormone
Disease Indication
Hypopituitary dwarfism
Other growth disorders
Cachexia .
Hypopituitary Dwarfism. Independent estimates indicate that there are 10,000 to 15,000 treatable
patients in the United States with this condition. Due to limitations of supply, only approximately
2,500 to 3,000 of these children are currently receiving treatment. The General Partner believes that
approval of the sale of hGH by the Partnership as a treatment for hypopituitary dwarfism may be
achieved by the beginning of 1984, although there can be no certainty in this expectation. The General
Partner further believes that within three years after such approval, it might reasonably expect to
supply hGH for up to 50% of the treatable patients.
11
194
CDSS. The population of treatable CDSS patients cannot be estimated with statistical accuracy, sirJ
only limited clinical studies have been completed to date. The General Partner has made estimatf
which it believes to be reasonable, but these estimates should be considered much more uncertain th
those related to hypopituitary dwarfism or cachexia.
The shortest 3% of the children in the United States between the ages of 5 and 15
constitute]
population of approximately 1,000,000. The short stature of these children may be the result of sever!
.causes, including genetic, organic or other unidentified causes. On the basis of early published studie
the General Partner believes that approximately 1 50,000 to 200,000 of these children may benefit
fro|
treatment with hGH. Such benefits may include restoring children to a more normal growth pattern I
their age group. For purposes of calculating potential returns to the Investors, the General Partner 1
assumed that an FDA approval relating to CDSS will be granted in 1986 and that within three yea
thereafter 20% of the treatable patients will be treated with the Partnership s product. Under tlj
forecast, by. 1 989 the substantial portion of revenues realized by the Partnership from the sale of hGJj
will result from sales for treatment of CDSS.
Since the biological causes of CDSS are presently not well understood, FDA approval for treatment!
CDSS may be delayed. In order to expedite FDA approval, a portion of the Partnership s program
include the development of statistical information, diagnostic tests and assay procedures that
facilitate understanding of the causes of CDSS. In particular, the availability of third-party reimbur
ment for treatment of CDSS may be dependent on the further definition and diagnosis of CDSS
disease state.
Cachexia. Based on published sources, the General Partner estimates that approximately 100,0
patients per year are treated for cachexia. The General Partner further believes that up to 75,000]
those patients may benefit from treatment with hGH as well as nutritional supplements. Since cache
is a life-threatening condition, it is anticipated that hGH may be rapidly accepted as a treatment f|
this condition if clinical trials show it to be effective. For purposes of calculating potential returns to I
Investors, the General Partner has assumed that an FDA approval relating to cachexia will be granti
in 1986 and that within three years thereafter approximately 50% of cachexia patients will be treati
with the Partnership s product. The market for cachexia treatment could increase further if hC
proves to be sufficiently effective to allow the administration of more moderate quantities of nutritio
thereby permitting therapy in less extreme cases.
Clinical Testing and Product Development
Genentech has already completed preclinical testing and Phase 1 of the clinical testing program of hG|
produced by means of recombinant DNA technology. It is presently approaching the end of the
year of Phase 2 clinical testing in hypopituitary dwarfs. Because of the current scarcity of the natuiS
hormone, the FDA Bureau of Drugs has designated hGH to receive expedited review. The Genei]
Partner anticipates completion of Phase 2 and Phase 3 testing and the receipt of product approval
I
the FDA for treatment of hypopituitary dwarfism by the end of 1983.
The General Partner expects to begin Phase 2 clinical testing on CDSS and cachexia patients in
The complete clinical program is expected to require testing of several hundred patients. Each alterii
tive delivery system developed will require additional rounds of Phase 1, 2 and 3 clinical testin
although they may be shorter in duration.
Competition
There may be several sources of supply of hGH in the United States other than the Partnership,
first is the National Pituitary Agency ("NPA"), a government-sponsored entity, which presently
tributes pituitary-derived hGH without charge to approximately 2,000 children in the United States I
research and treatment of hypopituitary conditions. The second source of competition is commerc
pituitary-derived hGH supplied by companies other than Genentech. The General Partner estimatj
that fewer than 1,000 children in the United States presently receive hGH from commercial sourc
12
195
A potential third, and most important source of competition, may come from recombinant hGH
produced by other companies. Genentech has filed patent applications covering several aspects of its
hGH production. The General Partner believes that its patent position may make it more difficult for
competitors to manufacture and market hGH in the United States. However, Genentech is unable to
predict
which patents will issue and the extent of protection, if any, they will provide the Partnership.
See "The Partnershio s Patent and Other Proprietary Rights".
Potential competitors may have significantly greater financial, manufacturing and marketing resources
than either the Partnership or Genentech. The Partnership s product strategy is to be the first to
market hGH produced with recombinant DNA technology in the United States, in order to establish a
strong market position before the development of generic competition. The General Partner is not
aware of any company that has commenced clinical trials in the United States of hGH produced by
means of recombinant DNA technology. However, should any other company enter upon clinical trials,
there can be no assurance that the Partnership will receive FDA approval with a significant lead time.
Other synthetic or recombinant products with growth-promoting or metabolism-regulating effects may
be developed by Genentech or by others. Commencing ten years from the first commercial sale or use
of hGH by Genentech or any affiliate or licensee, KabiGen AB, a Swedish corporation, will have the
non-exclusive, non-transferable right under a license agreement with Genentech to manufacture and
sell products containing Genentech-developed hGH in the United States. For information concerning
the circumstances under which the Partnership or the Investors would receive payments based on the
sale by Genentech of such other products, see "Summary of Contractual Arrangements". Genentech
has entered into licensing arrangements providing for the sale by others outside the United States of
products containing hGH manufactured by Genentech.
Gamma Interferon
Interferons are proteins which are part of the body s natural immune system and are, believed to help
fight viral infections and cancer. Research efforts regarding interferons began with the discovery of alpha
and beta interferons (Type I interferons) in 1957 and led to the premise that these natural proteins trigger
anti-tumor and anti-viral mechanisms by interfering with the replication of cancer and virus cells. Gamma
interferon (Type II interferon) was first discovered in 1965 and its structure was identified in 1981 when
Genentech first produced the substance in the laboratory using recombinant DNA technology.
Published studies have shown that interferons exhibit anti-viral and anti-tumor activity. The extent of
this activity in humans is currently under investigation. Gamma interferon has not been tested to the same
extent as alpha and beta interferons, and the degree of its efficacy will not be known until extensive clinical
testing has been completed. However, the General Partner believes that gamma interferon may have greater
anti-tumor efficacy than either of the other interferons and that it appears to have the result of increasing the
effectiveness of the body s natural immune system ("immuno-potentiating effect").
Interferons are extremely difficult and expensive to produce by extraction from human cells. Until the
development of recombinant DNA technology, available supplies permitted only limited research. In addi
tion, interferon extracted from natural sources was relatively impure. Using recombinant DNA technology,
Genentech has developed a manufacturing process to produce highly pure gamma interferon in commercial
quantities. Laboratory tests performed by Genentech indicate that gamma interferon, produced by means of
recombinant DNA technology, exhibits generally the same properties as the protein derived from natural
sources.
Using recombinant DNA technology, Genentech has successfully produced alpha and beta interferons
as well as gamma interferon. Genentech has licensed its technology relating to alpha and beta interferons to
Hoffman-La Roche, Inc., a major pharmaceutical company, which has received world-wide manufacturing
and
marketing rights for these products. Genentech will supply Hoffman-La Roche, Inc. with a portion of
its
marketing requirements and will receive a royalty on product sales, but will not market alpha or beta
interferon itself. The Partnership will not derive any revenue from sales of alpha or beta interferon.
13
196
Potential Clinical Uses
Anti-Cancer Applications. Based on early published studies and its own pre-clinical work, the Gene?
Partner believes that gamma interferon may prove effective in a broad range of anti-cancer therapi|
However, existing data is extremely limited and extensive human clinical testing will be required
determine whether gamma interferon will prove effective in practice.
The potential value of gamma interferon as a cancer therapy is best understood when the substance!
compared with currently available cytotoxic drugs. These drugs, which are the active agent in curre
chemotherapy treatment, are toxic to all cells in the human body but are most lethal to the f
growing cells, including rapidly-growing cancer cells. Treatment with current cytotoxic drugs does
discriminate between malignant and rapidly-growing normal cells, and therefore has serious adver
1
side effects, including nausea, vomiting, diarrhea, immunosuppression and, in extreme cases, congest!?
heart failure. These side effects of chemotherapy limit its usefulness, in part because usage of su!
drugs is restricted by the patient s tolerance to their toxicity. In addition, the method by whi|
cytotoxic drugs act results in -the drugs being ineffective against slow-growing tumors (such as car
nomas of the colon or lung).
In contrast, gamma interferon is a substance occurring naturally in the human body. It exhibits tv
types of anti-tumor activity, both of which relate to the body s own defense mechanism to comE
cancer. First, gamma interferon appears to have the indirect effect of stimulating the body s natd
immune system. In in vitro studies conducted by Genentech, gamma interferon has increased t
effectiveness of white blood cells in controlling tumor cell growth. Increasing the anti-tumor action }
white blood; cells is important because the body s natural immune system provides a defense (thoud
frequently unsuccessful) against a broad range of cancers, independent of their type or location withf
the body. Second, published reports of in vitro studies, and Genentech s own in vitro work, indicate th
in addition to its indirect effect, gamma interferon works directly to inhibit the growth of tumor celjj
The Partnership also intends to explore preliminary indications that gamma interferon, when used
conjunction with other types of interferon, may provide greater anti-tumor effect than either form
interferon individually.
The anti-viral activity of gamma interferon also has important implications for its role as a cane
therapy, since patients undergoing treatment for cancer often have low resistance to viral infections,
form of cancer treatment that also counteracts viruses would be of considerable benefit to canc^
patients.
For the foregoing reasons, the General Partner believes that gamma interferon, besides having tli
potential to be effective against certain forms of cancer cells directly, could also prove to be a widelj
accepted means of adjunctive therapy for use in combination with other forms of anti-cancer therapji
For example, surgery and radiation treatment can be highly effective in the elimination of specif
tumor cells, and gamma interferon would not be expected to substitute directly for either of those for
of treatment to a significant extent. However, gamma interferon may prove highly effective as adjunc
live therapy for a patient who is also undergoing surgery or radiation therapy, in order to attack
remaining cancer cells or to bolster the body s natural immune system and provide anti-viral activity]
Anti-Viral Applications. In vitro studies indicate that gamma interferon has an anti-viral effect simila
to the anti-viral effect of all other types of interferon. The General Partner believes that the anti-vira
activity of gamma interferon may enable the product to compete in various segments of the market foi
treatment of serious and non-serious viruses. Serious viruses that may be susceptible to gamma
interferon activity include herpes, hepatitis and viral encephalitis. Non-serious viruses that may bej
treatable with gamma interferon include upper respiratory infections such as influenza and the common
cold, although the Partnership s business plan does not depend on penetration of the common cold|
market. Additional pre-clinical testing, as well as clinical testing, will be necessary to identify indica
tions for which gamma interferon will be effective and safe, together with treatment schedules and the|
different effects of alpha, beta and gamma interferons.
14
197
TheiGeneral Partner believes that the anti-cancer and anti-viral markets may present major opportuni
ties 1
although their size is extremely difficult to assess because no broadly effective therapy is now
;;?$?,
available for many of the major diseases for which gamma interferon may be used. Estimates of total
market size are constructed from estimates of the number of patients in the United States currently
diagnosed as having various cancers or viral diseases. The Partnership s business plan is based on the
"**
rfjiowing
critical assumptions:
*
*\C*;
4. The product will be safe and effective in some anti-cancer and anti-viral therapies, and will
cause only moderately adverse side effects.
T.I r*-
1
2. The product will be effective in the treatment of at least lung and breast cancer as well as
j;,
.certain major forms of leukemia and lymphoma.
,
!. ---rf.>:-i>;
3 ; FDA approval for the marketing of gamma interferon will be granted in 1985 with respect to
;
the first anti-viral indication and in 1986 with respect to the first anti-cancer indication.
4. The planned process development, manufacturing scale-up work and clinical trials will be
completed without major delays, enabling the Partnership to be the first to market, in the United States,
;
gamma interferon produced by recombinant DNA technology, in order to establish a strong market
position prior to the entry of any significant competition.
5. Alternative delivery systems will be. developed enabling gamma interferon to penetrate the
market for non-serious viral indications.
;
:-
".:
Potential Markets to be Addressed by Gamma Interferon
Estimated
, .- . .. Patients Receiving
Estimated Treatable Treatment
Patient Three Years After
Disease Indication Population /Introduction ,
Cancer 1,200,000 360,000
Viral diseases 20,000,000 1,000,000
Anti-Cancer Indications. At present there is no available anti-cancer drug therapy that is effective for a
broad range of applications. Accordingly, the General Partner has estimated the market for gamma
interferon by considering its possible role within the overall market for anti-cancer treatment, including
surgery, radiation and chemotherapy.
The following table presents the General Partner s estimate of the number of treatable cancer patients
in the United States in 1982, based upon sources believed authoritative and accurate by the General
Partner:
Cancer Patients in the U.S.
Type 1982
Lung. 194,000
Breast 169,000
Colon-Rectal 185,000
Prostate 1 10,000
Cervical 92,000
All Other 450,000
Total 1,200.000
The American Cancer Society has estimated that approximately 835,000 persons will be newly diagnosed in
1982 as having cancer, and authoritative sources estimate that at least 1,200,000 persons will receive some
form of treatment for cancer during this year. Independent estimates indicate that the direct cancer costs in
the United States in 1980 were approximately $15 billion, inclusive of hospital and outpatient expenses,
15
198
physicians fees, nursing services, home care and drugs. The indirect costs of cancer to society are estimatq
to be much larger.
Today only a very small portion of total direct cancer expenditures are spent on drug therapy. However, t|
General Partner believes that the market for anti-cancer drug therapy would expand very rapidly if
apparently effective and safe drug were available.
The General Partner estimates that by 1989, within three years of the first FDA approval of gamr
interferon as a cancer therapy, the drug will be administered to 30% of the total cancer patient populationJ
the United States. Cancer treatment would then account for a substantial percentage of the sales of gamr"
interferon.
Anti-Viral Indications. The anti-viral market is more difficult to assess than the anti-cancer market, since tti
available information is less precise and the market encompasses a greater range of serious and non-serioij
viral diseases. Authoritative sources indicate that approximately 20,000,000 persons per year in the Unite!
States are diagnosed as suffering from viral diseases, most of which are of a less serious nature. The Gener$
Partner believes that the total potential market for anti-viral medications exceeds $1 billion per year. Base
upon the assumptions set forth above, the General Partner estimates that gamma interferon will achieve
]
market share for anti-viral indications of 10% of the total potential market within three years of the fir|
FDA approval for anti-viral treatment, which is assumed to occur in 1985.
Clinical Testing and Product Development
Genentech has performed a number of pre-clinical studies with gamma interferon produced by mear
of recombinant DNA technology and has developed an injectable formulation of the drug. Genentecl
is currently in~the process of identifying patient populations and clinical investigators and
developin]
clinical protocols for the clinical testing, which is anticipated to commence in early 1983.
The clinical program for gamma interferon will be very extensive, both for the anti-cancer and the
antlj
viral markets. Total numbers of patients included in the clinical programs may exceed 1,000.
Th|
initial clinical trials scheduled for 1983 will focus primarily on the anti-cancer indications and af|
expected to continue for a period of two to four years.
Clinical studies of the anti-viral effects of gamma interferon will begin in 1983 for the most serious anc
life-threatening diseases, which will probably include cytomegalovirus and various types of
hepatitis]
Clinical studies on less serious indications are expected to begin after safety and efficacy have bee
demonstrated with respect to the more serious diseases.
Competition
The anti-cancer market is presently addressed by several types of therapy, including surgery, radiatioi
and chemotherapy. While gamma interferon may be competitive with these forms of therapy, thi
General Partner believes that its broad-spectrum and immuno-potentiating effect suggest that it is
more]
likely to be used as an adjunct to these therapies than as a replacement for such forms of treatment.
Future competition in the anti-cancer market may result from significant improvements in existini
therapies or the development of new therapies. The development of improved anti-cancer agents is thi
subject of intense scientific and commercial efforts, which may produce significant improvements in<
future years. Competition may result from alpha and beta interferons, which are currently in clinical,
testing for cancer indications. For a discussion of Genentech s licensing arrangements with Hoffman-
La Roche, Inc. relating to alpha and beta interferons, see "Gamma Interferon The Substance".
Today there are very few effective anti-viral agents on the market. Future competition may result from,
alpha and beta interferons, which are currently in clinical testing for viral indications. In addition, a
substantial number of other anti-viral chemical compounds are presently under development and in
clinical trials. The extent to which any of these compounds will prove to be safe and effective, and
competitive with gamma interferon, is not known.
16
199
"Potential competitors of the Partnership may include companies with financial, manufacturing and
Marketing resources that are significantly greater than those of the Partnership or Genentech. Addi-
Smilfy, Genentech itself may develop anti-cancer or anti-viral agents that treat the same indications as
jja mma interferon. See "Risk Factors Conflicts of Interest". For information concerning the circum
stances under which the Partnership or the Investors would receive payments based on the sale of other
?! inducts by Genentech, see "Summary of Material Contracts". Genentech has entered, and may enter,
licensing and supply agreements providing for the sale outside the United States of products
ri^i containing gamma interferon manufactured by Genentech.
% ^Finally, companies other than Genentech are known to be developing gamma interferon, and there
7
l*;
tcannot be any assurance that competitors will not introduce their own version of gamma interferon into
the market. Genentech has filed patent applications covering gamma interferon and its production
?
**."
process. The General Partner believes that its patent position may make it more difficult for competitors
to manufacture and market gamma interferon in the United States. However, Genentech is unable to
predict which patents will issue and the extent of protection, if any, that they will provide to the
Partnership. See "The Partnership s Patent and Other Proprietary Rights".
:-"* Tiiy
.
y ; : .
THE PARTNERSHIP S PATENT AND OTHER PROPRIETARY RIGHTS
Under the Cross License Agreement, Genentech has granted to the Partnership an exclusive license
within the United States of all Genentech patents and know-how useful in the manufacture, use and sale of
hGH and gamma interferon in the United States for human pharmaceutical use. See "Summary of Mate
rial Contracts Cross License Agreement". The Partnership is advised that Genentech has pursued a policy
of seeking patents on inventions concerning novel techniques, processes, products and microorganisms and
other biological systems developed as part of its research and development activities relating to hGH and
gamma interferon, as with its other products. Also, Genentech has sought diligently to protect its know-
how.
With respect to hGH, Genentech has filed patent applications in the United States covering plasmids
containing genes which encode hGH and methods for their construction, producing organisms and the
method of production. With respect to gamma interferon, Genentech has filed -a patent application in the
United States covering gamma interferon, plasmids containing the genes which encode gamma interferon,
producing organisms and the method of production. With respect to both hGH and gamma interferon, the
General Partner expects some protection will be likely from earlier patent applications by Genentech con
cerning basic recombinant DNA procedures and products. Counterparts of these applications have been or
are being filed extensively outside the United States.
The General Partner cannot predict what patents may ultimately be granted to the Partnership,
Genentech or others, but believes that the Partnership will have sufficient patents, or be successful in
obtaining sufficient licenses on reasonable terms, to permit the Partnership to develop and maintain a strong
commercial position. The extent to which efforts by other researchers will result in patents or other proprie
tary rights and the extent to which the Partnership may need to obtain licenses from others are currently
unknown.
To the extent it is advantageous to do so, the Partnership intends to protect its know-how (other than
patentable inventions) as trade secrets. Such know-how will include the knowledge about hGH and gamma
interferon acquired during clinical testing. Under present procedures, the results of such clinical testing
submitted to the FDA will be kept confidential. Under the Cross License Agreement, the Partnership has
agreed that Genentech may make such test results available to other licensees of Genentech who are
authorized to sell hGH and gamma interferon outside the United States, and Genentech has agreed to make
available to the Partnership the test results of such other licensees to the extent that Genentech is contractu
ally permitted to do so. See "Summary of Material Contracts Cross License Agreement".
17
200
MARKETING PLANS
If Genentech exercises its options to enter into the Joint Venture and to purchase the Class A Liij
Partnership Interests, Genentech will market the Partnership s products. See "Summary of
Mal|
Contracts".
In view of the indications for which hGH and gamma interferon are expected to be effective, the ij
sales effort for each product will be directed at a relatively small group of prescribing physicians
clinicians, generally based in major hospitals. To address these markets, Genentech intends to establi
relatively small sales force of specialists who will be primarily responsible for major medical centers!
particular region. Genentech would expand this sales force .according to market requirements. Distribi|
of the products would be done either directly by Genentech or through established drug wholesalers.
Approval of gamma interferon for use in non-serious viral indications would require Genentecl
expand its marketing program to contact a much larger number of physicians. Such an expanded marker
effort, which would include significant increases in promotional expenditures and sales force size, is
expected to be required prior to 1988.
Since Genentech does not presently have pharmaceutical products available for sale, it does noli
have a sales force. Genentech does not anticipate significant problems in the development of such a s|
force or the marketing of hGH or gamma interferon.
DEVELOPMENT FINANCING
To carry out the"
development effort, the Partnership will contract with Genentech to perform clinj
testing and other research and product development. Assuming that all of the Interests are sold, payrn?
to Genentech will aggregate approximately $49.0 million during the years 1982-1986. One million dollar;
budgeted to be contributed by the Partnership in 1984 to the working capital of the Joint Venture.
mated receipts and disbursements during the development phase are as shown in the following table:
.
Estimated Partnership Receipts and Disbursements
(In Millions)
1982 1983 1984 1985 1*86
Receipts:
Capital Contributions
Limited Partners $10.0 $12.5 $12.5 $10.0 $10.0
General Partner . 0.1 0.1 0.1 0.1 0.1
TOTAL $10.1 $12.6 $12.6 $10.1 $10.1
Disbursements:
Selling and Organization Expenses $ 3.3
Development Agreement Payments 6.8
Joint Venture Capital
TOTAL $10.1
$55
$ 1.7 $ 0.5 $ $ $
10.9 11.1 10.1 10.1
49J
1.0 - _Jj
$12.6 $12.6 $10.1 $10.1 $55J
* This amount may be reduced by up to
approximately $250,000, unless excess offering expenses ar|
offset by discounted commissions resulting from institutional sales.
18
201
Development Budget
(In Millions)
-
The General Partner has estimated the development budget over the period from October 1982 through
June 1 986 to include the categories of expenses shown in the following table:
"
1982 1983 1984 1985 1986 Total
.
.
ReseapH:"
^ Clinical ..... .................................... 2.4
TOTAL $4.6
i
BUSINESS PLAN PRODUCT REVENUE ASSUMPTIONS
The General Partner has developed a set of financial projections, which it believes have a reasonable
basis, fjased on information currently available, as a basis for its long-term business plan for the products
under development by the Partnership. These projections relate to the sale in the United States of hGH and
gamma interferon produced using recombinant DNA technology. With respect to every indication except
hypopituitary dwarfism, these sales projections relate to diseases and disorders for which no widely effective
therapy is now available and for which projections are very difficult to develop. There can be no assurance
that these projections will in fact be attained.
The revenue projections in the business plan are based upon certain marketing assumptions. For a
description of such marketing assumptions, see "The Partnership s Product Objectives: Human Growth
Hormone Market Analysis; Gamma Interferon Market Analysis". In addition to these assumptions, all
projected revenues are expressed in constant 1982 dollars, and patient populations are assumed to remain
constant based on estimated 1982 populations. The latter assumptions are made because the General
Partner cannot predict the effect of various factors, including price levels, demographic changes and compe
tition. Variances from the foregoing assumptions will affect the projections presented in the following table
and in the table above entitled "Potential Financial Returns for $100,000 Investment".
Total
$ 8
52
241
427
650
670
682
698
710
718
727
727
727
727
364
19
202
RISK FACTORS
Business Risks
No Assurance of Product Efficacy
The success of the Partnership will require, among other factors, demonstration through clinical
te|
that hGH and gamma interferon are safe and efficacious for the treatment of a variety of indical
Genentech has undertaken significant testing of the effects of hGH as a treatment for
hypopituf
dwarfism, though such testing is incomplete. There has been only limited testing of hGH as a treat
ij
for cachexia and CDSS. To date there has been no significant testing of the effects of gamma interf
when administered to humans, and the results of the in vitro laboratory tests of gamma interferonl
have been performed are not necessarily indicative of results that will be obtained from human cli
||
testing.
Possible Side Effects
In some cases, molecules produced from genetically-engineered microorganisms, while virtually idej
cal to the natural substances produced by the human body, may contain differences in
compositioi]
well as small amounts of impurities resulting from the manufacturing process, and could result in-i
effects when used in human treatment. Even if the marketing of hGH and gamma interferoi
approved by the FDA, either or both of the products may demonstrate adverse side effects that
prev|
their widespread use or limit their use to only life-threatening situations.
FDA Approval; Possible Delays
The success of the Partnership will also require approval by the FDA for the marketing of hGH |
gamma interferon. Genetic engineering is a new production technology and the Partnership s
produj
will be among the first pharmaceuticals produced by means of genetically-engineered microorgani^
to be considered by the FDA for marketing approval. There can be no assurance that the FDA
approve the marketing of either hGH or gamma interferon. Since the establishment of an early marjj
position may be important to the Partnership s competitive position, any delay in obtaining
approvals could have a material adverse effect on the commercial success of the Partnership.
No Assurance of Commercial Success
The Partnership will achieve its business objectives only if hGH and gamma interferon are prescril
by physicians and accepted by patients. Patients may depend on third-party financing to reimburse I
considerable expense of purchasing the drugs, which financing may not be available with respect to i
indications for which hGH and gamma interferon may be prescribed. In particular, the availability]
third-party financing for the treatment of CDSS may be dependent on the further definition aifj
diagnosis of CDSS as a disease state.
Competition
Companies, other than the Partnership, presently produce and market pituitary-derived hGH in
United States, and other companies are known to be attempting to develop hGH and gamma interf<
products using recombinant DNA technology. Other interferons are believed to have anti-tumor a
anti-viral properties. Such other interferons are already in clinical testing and there can
assurance that gamma interferon will receive FDA approval prior to another interferon product
successful marketing of such products in the United States by competitors may adversely affect sal
volume and prices realized by the Partnership s products. Although the Partnership holds varioi
patent rights under license from Genentech, there can be no assurance that such patent rights (or othe|
proprietary information of Genentech or the Partnership) will be effective in inhibiting competition wit|
respect to the manufacture and sale of hGH or gamma interferon. See "The Partnership s Produ<"
Objectives".
20
203
possible Need for Additional Funds
Si ^Although the Partnership believes that the proceeds from this offering will be sufficient to cover the
clinical and other research and development of hGH and gamma interferon for a variety of indications,
there can be no assurance that additional funds will not be required. In the event that Genentech does
not exercise both the Joint Venture Option and the Partnership Purchase Option, the Partnership may
require additional funds to manufacture and market its products. In any event, the Partnership may
require additional funds and there can be no assurance that such additional funds will be available or
3&, that raising additional funds will not result in substantial reduction in the value of an Interest.
,**
:
.1
r "
No Assurance of Joint Venture or Purchase of Interests
Genentech is not obligated to enter into the Joint Venture or, if it does enter into the Joint Venture, to
l9
^. exercise the Partnership Purchase Option. If it does enter into the Joint Venture and exercises its
A- , option to purchase the Interests, it is obligated to use diligence to manufacture and market hGH and
l& gamma interferon, or, if it determines that it cannot use such diligence, to license a third party to do so.
There can be no assurance, however, that Genentech will be able, despite its efforts, to manufacture or
sell hGH or gamma interferon, or to license a third party to do so, thereby generating economic benefits
for the Investors. If Genentech does not exercise its option to enter into the Joint Venture or to
purchase the Interests, the Partnership will need to seek other ways to exploit its rights in hGH and
.
gamma interferon. If Genentech exercises the Partnership Puchase Option and does not manufacture
and market hGH and gamma interferon, there will be no amounts payable to the Investors (other than
the 10% of aggregate capital contributions payable upon exercise of the Partnership Purchase Option),
even though Genentech has acquired all of the Partnership s right, title and interest with respect to
hGH and gamma interferon.
If Genentech does not exercise the Joint Venture Option or the Partnership Purchase Option, there may
; be no amounts payable to the Partnership unless the Partnership licenses or sells its rights with respect
to hGH and gamma interferon to another entity and the resulting products are marketed successfully.
There can be no assurance that another entity will acquire the Partnership s rights with respect to hGH
or gamma interferon if Genentech does not exercise the Joint Venture Option or the Partnership
Purchase Option, or that the terms of any sale or license to another entity would be as favorable as the
terms set forth in the Joint Venture Agreement or the Partnership Purchase Agreement. In any event,
the Partnership would not be able to market its rights to entities other than Genentech prior to expira
tion of the foregoing options.
Regulation by Government Agencies
The products of the Partnership are subject to approval, prior to marketing, by the FDA and certain
other government agencies. There can be no assurance that such approvals will be granted to the
Partnership or its licensees. If the FDA approves the sale of a product, its regulations will govern the
manufacturing process and marketing activities. In addition to regulation by the FDA, the Partnership
and Genentech will be subject to various environmental, safety and health regulations. The extent of
adverse government regulation which might arise from future legislative or administrative action cannot
be predicted.
Limited Operating History of Genentech
Genentech, which will conduct the research and development for the Partnership under the Develop
ment Agreement, has only limited experience in the development, manufacturing or marketing of
pharmaceutical products and the conduct of clinical testing programs required to obtain FDA approval.
While Genentech has had considerable technical success in its research activity and believes it is
capable of developing into an integrated pharmaceutical company, there is no operating history upon
which Investors may base an evaluation of the likely commercial performance of Genentech.
21
204
Conflicts Of Interest
The Partnership may be subject to various conflicts of interest arising from its
relationship with ()|
General Partner and its affiliates. The risk exists that such conflicts will not be resolved in the best interest*
of the Investors. These conflicts include:
Negotiation of Agreements $!
The terms of all of the agreements and arrangements between the Partnership and the General Partnl
or any of its affiliates were determined by negotiation between Genentech and the Sales Agents, whif
negotiations might not be considered to be arm s length.
|
Work Performed Under Development Agreement
Genentech will receive compensation from the Partnership for the research and development carried out
under the Development Agreement, and the interests of the General Partner and those of the Partner
ship may conflict with respect to various issues concerning the testing and development of hGH ai
gamma interferon, including the potential conflict of interest should the research and developmei
carried out under the Development Agreement prove to be more valuable for uses outside the Unit
States than for uses within the United States.
Joint Venture and Partnership Purchase Option Agreement t
Genentech is not obligated to exercise the Joint Venture Option or the Partnership Purchase Option ant
will exercise these options only if it views such exercise as being in its best interests, without regard
-
the best interests of the Partnership or the Limited Partners. ^
j
Operation of Joint Venture
Under the terms of the Joint Venture Agreement, Genentech will have exclusive managerial respo
sibility for operation of the Joint Venture and will manufacture and sell hGH and gamma interferon^
the United States for the Joint Venture. Genentech may also be manufacturing hGH and gamri
interfcron for sale outside of the United States for its own account or for foreign licensees.
Genentech is unable to produce an adequate amount of hGH and gamma interferon to supply all
these demands, this may have an adverse effect on the Partnership. In addition, Genentech will 1
responsible for marketing the products of the Joint Venture, and it is anticipated that such products wi
be marketed by the same sales force that sells Genentech s products generally. An incentive could ex
for Genentech, or for its sales personnel, to devote greater effort to the general sale of Genentech
products than would be devoted to the sale of the Joint Venture s products.
Development and Marketing of Other Products by Genentech
Genentech is engaged in ongoing research designed to produce new products, including huma
pharmaceutical products, using recombinant DNA techniques. New products that may be develop
by Genentech in the future may compete directly or indirectly with hGH or gamma interferon. Unde
the Development Agreement and Partnership Purchase Agreement, the sale by Genentech of competj
tive products introduced to the market within a four-year period after the introduction of hGH
gamma interferon will, under certain circumstances, result in payments by Genentech to the Limits
Partners. There can be no assurance that such payments, if any, would compensate the Investo
adequately for the effect of such competitive sales.
Competition by the Partnership for Management Services
The Partnership will not have independent management, and it will rely on the General Partner for
thjj
operation of the Partnership. The General Partner and its personnel may have conflicts of interest i|
allocating management time, services and functions between the Partnership, their current activitie
and any future activities or business ventures in which they may become involved. The General Partne
believes that it will be fully capable of discharging its responsibilities to all such competing interest
22
205
The General Partner and its affiliates may engage for their own account, or for the account of others, in
other business ventures, and, except as specifically provided in the Development Agreement and
.;.<;\)iJP<l>
Partnership Purchase Agreement with respect to competitive products, neither the Partnership nor any
Limited Partner is entitled to any interest therein. Each Sales Agent, or its affiliate, will have the right
to designate one director to the board of directors of the General Partner. Such directors will partici
pate generally in the management of the General Partner s business and will not be representing the
"
"
"
r "
interests of the Limited Partners.
Accounting for Transactions
.
Throughout the course of the relationship between Genentech and the Partnership, Genentech will be
responsible for accounting for transactions that affect both it and the Partnership. For example, certain
payments may accrue to the Limited Partners as a result of the sale of "combination products" which
will be composed of both the Partnership s products and Genentech s products. In such cases, a
subjective allocation will be made between the value contributed by each of the products.
Lack of Separate Representation
Counsel for the Partnership in connection with this offering (other than Special Tax Counsel) is also
counsel to Genentech and the General Partner. The attorneys and other professionals who perform
services for the Partnership may be expected to perform services for the Sales Agents, the General
Partner and its affiliates, including Genentech. If a conflict arises and cannot be resolved, or the consent
of the respective parties cannot be obtained to the continuance of such dual representation after full
disclosure of such conflict, such professionals will withdraw from the representation of one or both of
the conflicting interests with respect to the specific matter involved.
Other Risks
Restrictions on Transferability of Interests; No Market for Interests
The sale of the Interests has not been registered under the Securities Act of 1933 and the Interests may
not be resold unless such sale is subsequently registered thereunder or an exemption from registration is
available. The Investors have no right to require, and the Partnership has no intention to effect, such
registration. Moreover, there is no existing public market or other market for the Interests and it is not
anticipated that any such market will develop. The Interests will be transferable only subject to certain
restrictions in the Partnership Agreement (including the consent of the General Partner, which may be
withheld in its absolute discretion) and may be affected by restrictions on resales imposed by the laws of
some states. See "Transferability of Interests". Consequently, Investors may not be able to liquidate
theii; Interests in the event of emergency or for any other reason. Such factors might also limit the price
which an Investor would be able to obtain for his Interest.
Restrictions on Transferability of Payment Rights; No Market for Payment Rights
If Genentech exercises the Partnership Purchase Option, the Class A Limited Partners will sell to
Genenteoh all their right, title and interests in the Partnership in exchange for the right to receive
payments
based on Genentech s sales of hGH and gamma interferon ("Payment Rights") as described
in "Summary of Contractual Arrangements Partnership Purchase Agreement". Transfer of the Pay- .
ment Rights requires the consent of Genentech, which may be withheld in its absolute discretion and it
is not anticipated that any market will develop for their resale.
Possible Obligation To Return Distributions
The Partnership has been organized as a limited partnership and, as a general rule, no Limited Partner
will be personally liable for the debts of the Partnership. However, in the event the Partnership is
unable otherwise to meet its obligations, then, under California law, Limited Partners could be obli
gated to return cash distributions previously received by them from the Partnership, together with
23
206
interest, to the extent such distributions are deemed to constitute a return of their capital contribii
or are deemed to have been paid to them wrongfully. .,
Summary Of Principal Federal Income Tax Risks
The Federal income tax consequences of investment in the Partnership will have a material effect i
economic consequences of the investment, and the Internal Revenue Service ("IRS") or the courts
disagree with positions taken by the Partnership as to such tax consequences. The income tax
consequj
of an investment in the Partnership are complex and will not be the same for all investors. Prosp
investors are strongly urged to consult their own tax advisors prior to investment in the Partnership,
more detailed discussion of the Federal income tax aspects, see "Summary of Income Tax Consequen
Among the more significant Federal income tax risks associated with investment in the
Partnership!
No IRS Rulings
The Partnership will not seek IRS rulings as to any of the Federal income tax consequences of ir
ment in the Partnership. Thus, positions taken by the Partnership as to tax consequences could i
from positions ultimately taken by the IRS in auditing tax returns, in issuing rulings or other
While the Partnership will obtain an opinion of Davis Polk & Wardwell, Special Tax Counsel to
Partnership ("Special Tax Counsel"), as to the principal Federal income tax consequences of an inv
ment in the Partnership, opinions of tax counsel are not binding on the IRS or the courts and therej
be no assurance that the intended tax consequences of an investment in the Partnership will be realj;
Overall Recharacterization of Transactions
It is essential" to the Federal income tax conclusions reached in the opinion of Special Tax Coun
referred to above that the overall form of the Partnership s and the Limited Partners transactions]
respected. The IRS could contend that Genentech (rather than the Partnership) is the true owner jj
developer of the Technology for tax purposes, and that the Partnership is merely providing financin
Genentech in the form of a non-recourse loan with contingent interest payments, a purchase
Genentech of a profits interest in Genentech s technology or an equity investment in Genentech.
IRS were to succeed with such a contention, the Limited Partners would be denied the benefit
deductions under Section 174 of the Internal Revenue Code of 1954 as amended (the "Code")
probably would be denied the benefits of long-term capital gain treatment, thus significantly reduc
their return. Although the Partnership would have substantial arguments in response to these possi|
contentions by the IRS, there can be no assurance that the IRS position would not prevail.
Deductibility of Research and Experimental Expenses
The substantial portion of the contributions of the Limited Partners to the Partnership is expected i
used for the types of research or experimental expenditures which the General Partner and Special
:
Counsel believe will qualify as deductible expenditures under Section 174 of the Code. Howe
prospective investors should be aware that there is only a small body of case law and rulings deal!
with the question of what specific types of expenses qualify as research or experimental expendituc
within the meaning of Section 174, and most of the expenditures of the types the Partnership will inc.
have not been the subject of any prior cases or rulings. In addition, it is possible that the IRS
challenge the timing of anticipated research and experimental deductions because of modest dispariti
between the time of payments from the Partnership to Genentech and the time of correspondii
expenditures by Genentech. Thus, there can be no assurance that all of the expenditures of
Partnership for development of the Technology will be currently deductible for Federal income
purposes.
Treatment of Gain on Sale of Partnership Interests
If the Interests should be purchased by Genentech pursuant to its rights under the Partnership PurchaJ
Option, the opinion of Special Tax Counsel, based on law on the date of that opinion, would support tlf
24
207
Limited Partners filing of their Federal income tax returns on the basis that gain on that sale is
long-
term capital gain, subject to the specific exceptions set forth in that opinion (including the exception for
stated or imputed interest, which will be ordinary income and which will increase in amount the later
each payment is received), and further assuming that the Limited Partner in question has held (or is
deemed to have held) his Interest more than one year. See "Summary of Income Tax Consequences".
The treatment of such gain as long-term capital gain is subject to substantial uncertainty, however,
because the IRS might argue that: (1) the sale of the Interests by the Limited Partners should be
recharacterized for tax purposes as a sale of the Technology by the Partnership, in which case ordinary
income could result if the Technology were found not to constitute capital assets or other assets poten
tially eligible for capital gain treatment; (2) even if the sale of the Interests by the Limited Partners is
respected as such and is not so recharacterized, the "collapsible partnership" rules of Section 751 of the
Code should require taxing substantially all of the gain as ordinary income, on the theory that the
Technology constitutes "unrealized receivables" or "substantially appreciated inventory items" within
the meaning of Section 751, because (among other possible theories) the Technology was developed
solely or primarily for ultimate sale and is therefore properly held "primarily for sale to customers in
the ordinary course of [the Partnership s] trade or business" or constitutes an asset the disposition of
which occurs as part of the everyday operation of the Partnership s trade or business. Although the
Partnership would have substantial arguments in response to each of these possible contentions by the
IRS, there can be no assurance that the IRS position would not prevail. Apart from these possible
contentions, the gain could be taxable in the hands of any particular Limited Partner as ordinary gain
depending, for example, on the Limited Partner s activities involving property of the type constituting
the Technology or the amount of that Limited Partner s gains and losses with respect to Section
1231(b) Property.
Changes in Law
The opinion of Special Tax Counsel referred to above is based upon law in effect on the date hereof,
including the Tax Equity and Fiscal Responsibility Act of 1982. There are frequent and sometimes
retroactive changes in tax law, however. Regulations, rulings and interpretations of Existing statutes by
court decision may also change the law with retroactive effect. Therefore, there can be no assurance
that there will not be adverse changes in the Code or its interpretation during the life of the investment
in the Partnership which would materially and adversely affect the economic consequences of the
investment.
Audit of the Partnership s Tax Returns
There is a significant possibility that the tax returns of the Partnership will be examined by the IRS.
Such an examination could result in adjustments to the tax consequences initially reported by the
Partnership. Although the Tax Equity and Fiscal Responsibility Act of 1982 provides generally for the
determination of partnership tax issues at the partnership level, an examination by the IRS of the
Partnership s tax returns could also result in audits of the Limited Partners personal income tax
returns. Any such audits could involve items not related to investment in the Partnership as well as
Partnership items.
FIDUCIARY RESPONSIBILITY OF THE GENERAL PARTNER
The General Partner is under a fiduciary duty to conduct the affairs of the Partnership in the best
interests of the Partnership and consequently must exercise the utmost good faith and integrity in handling
Partnership affairs. Prospective investors who have questions concerning the duties of the General Partner
should consult with their respective counsel.
The Partnership Agreement provides that neither the General Partner nor any of its officers, directors,
or agents shall be liable to the Partnership or the Limited Partners for any act or omission based upon errors
of judgment or other fault in connection with the business or affairs of the Partnership so long as the person
against whom liability is asserted acted in good faith on behalf of the Partnership and in a manner reason
ably believed by such person to be within the scope of its authority under the Partnership Agreement and in
25
208
the best interests of the Partnership, but only if such action or failure to act does not constitute negligent!
willful misconduct. The General Partner and its officers, directors and agents will be indemnified
Partnership to the fullest extent permitted by law for any (a) fees, costs and expenses incurred in
conne,,
with or resulting from any claim, action or demand against the General Partner, the Partnership or
anf
their officers, directors or agents that arise out of or in any way relate to the Partnership, its
properji
business or affairs and (b) such claims, actions and demands and any losses or damages resulting from sii
claims, actions and demands, including amounts paid in settlement or compromise (if recommende
attorneys for the Partnership) of any such claim, action or demand; provided that this indemnification s|S
apply only so long as the person against whom a claim, action or demand is asserted has acted in good fa
on behalf of the Partnership and in a manner reasonably believed by such person to be within the scope ol
authority under the Partnership Agreement and in the best interests of the Partnership, but only if
action or failure to act does not constitute gross neglience or willful misconduct. See "Summary of
Limited Partnership Agreement Limitation on Liability of General Partner" and "Summary of The LJ|
ited Partnership Agreement Indemnification of General Partner". Thus, the Limited Partners may havq
more limited right of action than would otherwise be the case absent such provisions.
SUMMARY OF MATERIAL CONTRACTS
Cross License Agreement
The Partnership will enter into the Cross License Agreement with Genentech (the "Cross Licenl
Agreement") pursuant to which Genentech will grant to the Partnership an exclusive royalty-free Heel)
(with the right to grant sublicenses) to use all patent rights, know-how and biological materials now own!
by Genentech or acquired by Genentech during the term of the Development Agreement to the extent the
are necessary and useful in the use, including any use in connection with research and experimentatiM
manufacture, sale or other disposition of hGH and gamma interferon ("GI")
in the United States for humfj
pharmaceutical use in the United States (collectively, the "Technology"). Genentech will also agree;
grant the Partnership the right to use all biological materials now owned by Genentech or acquired
Genentech during the term of the Development Agreement to the extent they are necessary and useful to tB
Partnership* for the use, including any use in connection with research and experimentation, manufactur
sale or other disposition of hGH and GI in the United States for human pharmaceutical use in the Unit^
States. The Partnership will grant to Genentech an exclusive royalty-free license (with the right to gra"
sublicenses) to all patents and know-how produced under the Development Agreement for all purposes othjj
than the use, including any use in connection with research and experimentation, manufacture, sale or
othjj
disposition of hGH, GI or any Formulation in the United States. The Partnership will also grant
Genentech an exclusive royalty-free license to manufacture hGH and GI in the United States for sa
outside of the United States.
The Partnership will agree to use the same degree of care that it would use to protect its own confide
tial information of like character to keep confidential, and not disclose to third parties, all know-how an
biological materials received under the Cross License Agreement from Genentech, subject to certain
excepj
tions specified in the Cross License Agreement.
Genentech will, at the expense of the Partnership, file patent applications that are useful to protect thj
Technology and will use reasonable diligence to prosecute and maintain in force resultant patent|
Genentech will have the right to bring patent infringement actions against third parties that infringe any i"
the Partnership s rights under patents licensed to the Partnership. The expenses of maintaining such action
will be shared equally by the Partnership and Genentech, and the proceeds of any judgment or settlement dfl
any such actions (after payment of such expenses) will be paid to the Partnership. In addition, the
Partne^
ship will have the right, at its own expense, to maintain such patent infringement actions, should Genente
fail to do so. Genentech will defend any action brought against it or the Partnership alleging infringement ol|
a United States patent of a third party by reason of the use of any of the Technology. Genentech and the
Partnership will share equally the expenses of defending, and any amounts awarded or paid in respect of any
judgments or settlements of, such actions.
26
209
er Cross License Agreement will only terminate upon dissolution of the Partnership, unless prior to
dissolution the Partnership has sublicensed any of its rights under the Cross License Agreement, in
tne Cross License Agreement will continue.
ent Agreement
it if -
y^Tpfie Partnership will enter into the Development Agreement with Genentech (the "Development Agree-
)> pursuant to which Genentech will agree to use its best efforts to perform research and experimenta-
ifrcluding research and experimentation necessary to receive FDA approval for the sale or other disposi-
of hGH and GI in the United States for pharmaceutical use in the United States, for which the
Partnership will pay Genentech, unless the Partnership and Genentech agree otherwise, an amount equal to
ii& expenditures on this research and development plus a retainer fee of $3,600,000, subject to a maximum
cxpefid ture of the capital contributions of the General Partner and the Limited Partners (reduced to reflect
any aVhounts not paid by Limited Partners defaulting in respect of their Investor Notes, if such amounts are
hot recovered through collection efforts or investments by new Limited Partners) less (a) $1,000,000 to be
contributed to the Joint Venture referred to below, unless the Joint Venture Option, referred to below,
expires unexercised, (b) selling commissions, investment banking fees and offering and organizational costs
and (c) reasonable expenses (other than amounts paid under the Development Agreement) of operating the
Partnership. The first payment by the Partnership will be made within ten days of the Closing Date and will
be for an amount equal to the retainer fee plus Genentech s estimate of its expenditures from December 1,
1982 through March 31, 1983. Subsequent payments will be due on March 31 of each year thereafter and
will be for an amount equal to Genentech s estimate of its expenditure for the 12 months following such
March 31, adjusted to reflect (i) differences between actual expenditures in prior years and estimates for
such years and (ii) amounts currently in default in respect of Investor Notes.
Genentech will agree to use the same degree of care it would use to protect its own confidential
information of like character in order to keep confidential, and not disclose to third parties, the Technology,
subject to certain exceptions specified in the Development Agreement.
Genentech will maintain, at its own expense, liability insurance, on behalf of itself and the Partnership
and will pay (to the extent not covered by insurance) all damages and costs (including costs of settlement)
finally awarded or paid (except amounts up to any deductible limits on such insurance, which will be shared
equally by Genentech and the Partnership) because of any product liability claim arising from the research
conducted under the Development Agreement (the "Research Program"). Genentech and the Partnership
shall each, pay one-half of the expenses of defending against any such product liability claim.
Genentech will agree to make to the Partnership payments of a certain percentage of the revenues
recognized by Genentech from the sale or other disposition, within the United States, of certain of its
products that are competitive with GI or hGH and that receive FDA approval for sale within the United
States for the same indication as a formulation of hGH or GI within the four-year periods commencing on
the date that any formulation of hGH or GI receives its first FDA approval for sale within the United States.
Such payments will be made in any year during such four-year periods if, in the previous year, unit sales of
hGH or GI in the United States by Genentech, its affiliates, the Joint Venture, the Partnership or any
affiliate of the Partnership, as the case may be, shall have declined.
The Development Agreement, other than the provisions relating to confidentiality, insurance and pay
ments in respect of competitive product revenues, will terminate upon (a) expenditure of all funds made
available to Genentech under the Research Program, (b) bankruptcy of either Genentech or the Partnership
(c) notice by one party after a breach of the Development Agreement by the other party. The Partnership
will agree to use its best efforts to resell the Interests of any Defaulting Limited Partner and to collect any
amounts in default.
27
210
Joint Venture and Partnership Purchase Option Agreement ;
The Partnership will enter into the Joint Venture and Partnership Purchase Option Agreement with
Genentech, the Class B Limited Partner and each of the Class A Limited Partners (the "Option Agree
ment") pursuant to which the Partnership will grant to. Genentech an option (the "Joint Venture
Option"),
exercisable for a period of 90 days after the date upon which Genentech receives notice that the FDA has
approved at least one formulation for sale in the United States for human pharmaceutical use, to enter into a
joint venture agreement (the "Joint Venture Agreement") with the Partnership pursuant to which the
Partnership and Genentech will enter into a joint venture to manufacture and market within the United
States hGH and GI (the "Joint Venture"). If Genentech agrees to form the Joint Venture, it will have an
additional option (the "Partnership Purchase Option") to purchase the Class A Partnership Interests,
exercisable for a period of 1 20 days after the earlier of (a) the date, after the Joint Venture shall have been
in existence for not less than twenty-four (24) months, on which the Partnership shall have been distributed
profits pursuant to the Joint Venture Agreement equal to 1 5% of the capital contributions of the Class A
Limited Partners; and (b) the last day of the forty-eighth (48th) month in which the Joint Venture shall
have been in existence (the "Exercise Date"); provided that if the Exercise Date occurs prior to the date on
which all amounts payable to Genentech pursuant to the Development Agreement shall have been paid to
Genentech, then such option will not be exercisable until such date.
Genentech will also have the option to purchase the Class B Interest, exercisable for,a period of 90 days
commencing 90 days after the date upon which Genentech exercises its option to purchase the Class A
Limited Partnership Interests. If Genentech does not exercise its option to purchase the Class A Limited
Partnership Interests, Genentech and the Partnership will be obligated to continue the Joint Venture until
the earlier of 12 months from the expiration of Genentech s option to purchase the Class A Partnership
Interests and the dissolution of the Joint Venture pursuant to the Joint Venture Agreement. :.,.
The Partnership shall not have the right to license or sell the Technology to third parties unless and
until Genentech fails to exercise either the Joint Venture Option or the Partnership Purchase Option.
The Partnership will agree under the Option Agreement to undertake development of the Technology
and to use its best efforts to conclude the Research Program. Subject to Genentech s rights under the Cross
License Agreement and Development Agreement, Genentech will have access to the Technology only for the
purpose of determining whether to exercise the options granted to it under the Option Agreement,
Genentech and the Partnership will agree to consult with each other to evaluate the current state of the
Technology and proposed or pending patent applications, and each will notify the other of improvements in
or developments to the Technology. ^
The Option Agreement will terminate upon the earliest of (i) the termination unexercised of the option
to form the Joint Venture, (ii) the termination unexercised of the option to purchase the Class A Limited
Partnership Interests, (iii) the termination unexercised of the option to purchase the Class B Interest anii
(iv) the date on which Genentech purchases the Class B Interest. j|
Joint Venture Agreement
If Genentech exercises the Joint Venture Option, the Partnership will enter into the Joint Venture
Agreement with Genentech, which will provide for the formation and conduct of the Joint Venture betwee|
Genentech and the Partnership for the purpose of manufacturing and marketing hGH and GI for sale in thf
United States for human pharmaceutical use in the United States. The Joint Venture will be a general
partnership created under the laws of the State of California and will be located at 460 Point San Bru
Boulevard, South San Francisco, California 94080.
The Partnership will contribute to the Joint Venture: the sum of $1,000,000, the right to use th
Technology on a royalty-free basis for the term of the Joint Venture Agreement, and its agreement t|
provide the Joint Venture with the use of any improvements or developments to the Technology. Genentec|
will contribute to the Joint Venture: its agreement to make loans (which will be noninterest bearing)
"
additional capital contributions or to borrow, on behalf of the Joint Venture (with all interest and othej
amounts, except amounts in respect of principal, payable by Genentech), if and to the extent thi
J
28
211
><ijererttech,
as tne mana8 n8 venturer (the "Managing Venturer"), determines that such capital contribu
tions or loans are required by the Joint Venture to meet its working capital requirements; and its agreement
to manufacture at cost and to market hGH and GI during the term of the Joint Venture Agreement,
including its agreement to make available its facilities and personnel for these purposes. In return for the
foUgoingv Genentech will receive reimbursement of its costs of manufacturing hGH and GI, an annual
marketing fee equal to 40% of the net sales of the Joint Venture and an annual fee of 10% of such net sales
as reimbursement for its costs incurred in connection with its management and administration of the Joint
Venture.
^
^ Under the Joint Venture Agreement, the Partnership shall be entitled to receive 22% of the profits and
losses of the Joint Venture and Genentech shall be entitled to receive 78% of such profits and losses (the
"Percentages").
The management and control of the Joint Venture shall be vested solely in Genentech.
>
<Jenentech will maintain, at its own expense, liability insurance in the name of the Joint Venture, and
will pay (to the extent not covered by insurance) all damages and costs (including costs of settlement) finally
awarded or paid (except amounts up to any deductible limits on such insurance, which will be shared by
Genentech and the Partnership in the Percentages) because of any product liability claim arising in connec
tion with the sale or other distribution of hGH or GI. Genentech and the Partnership shall share in the
Percentages the expenses of defending against any such product liability claim.
Distributable cash (cash revenues less cash expenditures not including expenditures to repay capital
contributions and loans) for each quarter will be distributed to Genentech and the Partnership in the
Percentages within sixty days after the end of such quarter. The Managing Venturer will agree, during the
period when its option to purchase the Class A Partnership Interests is in effect, to cause the inventory of the
joint Venture to be as low as is commercially practicable.
The Joint Venture will maintain books of account that will sufficiently explain the transactions and
financial position of the Joint Venture and will cause its books and other records to be kept in a manner
permitting them to be properly audited. The Joint Venture s books will be kept on an accrual basis and ,the
Joint Venture s fiscal year will be the calendar year. The Managing Venturer will send to each venturer
annual reports and quarterly reports, containing financial statements (audited in the case of annual financial
statements) and other information relating to the Joint Venture. The Managing Venturer will also send to
each venturer tax information sufficient to enable it to prepare its Federal income tax returns. The Manag
ing Venturer will agree to make a proper election under Section 174 of the Internal Revenue Code to treat
research and experimentation expenditures as expenses which are not chargeable to capital accounts, and to
deduct such expenditures as paid, on the first Federal income tax information return filed on behalf of the
Joint Venture.
Subject to Genentech s rights under the Development Agreement and the Cross License Agreement, (a)
Genentech shall have access to the Technology, under the Joint Venture, solely for the purposes of manufac
turing and marketing hGH and GI in the United States, and for continuing, on behalf of the Joint Venture,
research and development of improvements to the Technology and (b) upon termination of the Joint Ven
ture, Genentech shall return the Technology to the Partnership.
The Joint Venture shall be dissolved (a) upon the sale to Genentech of the Class B Interest, (b) if
Genentech does not exercise its option to purchase the Class A Partnership Interests during the exercise
period (i) upon the sale or license of the Technology by the Partnership after 90 days notice to Genentech or
(ii) upon 90 days notice by either venturer at any time, after the expiration of a one-year period which
commences after Genentech s option to purchase the Class A Limited Partnership Interests expires, (c) by
operation of law, (d) upon bankruptcy of Genentech or (e) upon unanimous consent of Genentech and the
Partnership.
Upon liquidation, the assets of the Joint Venture, after payment of its liabilities, shall be distributed to
the venturers pursuant to applicable law. If the assets of the Joint Venture are insufficient to cover the Joint
Venture s liabilities, the venturers respective capital accounts will be charged with such amounts. If, upon
29
212
dissolution of the Joint Venture, any venturer has a negative capital account, it will be required to resto|
the Joint Venture the amount of such negative balance.
Partnership Purchase Agreement
If Genentech exercises its option to purchase the Class A Limited Partnership Interests (which
arises if Genentech has exercised the Joint Venture Option), each Class A Limited Partner, the Clasf
Limited Partner and the General Partner will enter into the Partnership Purchase Agreement
Genentech (the "Partnership Purchase Agreement"), which will set forth the terms by which GenentJ
may purchase the Class A Limited Partnership Interests and the Class B Interest. The option to
purchfj
the Class A Limited Partnership Interests is exercisable for a period of 120 days commencing on
Exercise Date; provided that if the Exercise Date occurs prior to the date all amounts payable to Genentl
under the Development Agreement shall have been paid to Genentech, then such option will notl
exercisable until such date. The option to purchase the Class B Interest is exercisable for 90 days commel
ing 90 days after the date upon which Genentech exercises its option to purchase the Class A Limif
Partnership Interests.
If Genentech exercises the Partnership Purchase Option, it will make payments ("Payments") to i
Class A Limited Partner (the "Payment Recipient") for each Payment Recipient s pro rata share of (1
following amounts: (a) an initial payment of 10% of the aggregate of the capital contributions to
tf
Partnership of all Class A Limited Partners (the "Advance Payment") and (b) for each quarter, commeS
ing with the quarter in which the date (the "Purchase Date") on which the purchase of the,Class A Limftf
Partnership Interests falls, payments of (i) 7% (less any amounts payable to the Class B Limited Partn
referred tq below) of Genentech s revenues from the sale, lease, license or other disposition of any prodij
forming part of, or derived from, the Technology, including hGH or GI (a "Product") in the United Sta|
for human pharmaceutical use in the United States (the "Revenues") (which shall include revenues fro
Combined Products and revenues from competitive products, referred to below), for such quarter (exc
that the Payment at the end of the first such quarter, will be one-half of such amount) until each Class j
Limited Partner shall have received distributions aggregating 100% of such Class A Limited Partne
capital contribution to the Partnership and thereafter (ii) 5% (less any amounts payable to the ClassS
Limited Partner, referred to below) of the Revenues for such quarter until each Class A Limited Paring
shall have received distributions aggregating 200% of such Class A Limited Partner s capital contribution J
the Partnership (the "200% Date") and thereafter (iii) 3% (less any amounts payable to the Class B Limitiji
Partner, referred to below) of the Revenues for such quarter. Such Payments shall continue until the twelf
anniversary of the Purchase Date, unless, as of such date, the 200% Date shall not have occurred, in whic
case such Payments shall continue until the 200% Date or the fourth quarter of the year 2000, whichevij
occurs first.
For revenues from the disposition by Genentech of any product (a "Combined Product") that is com
prised in part of hGH or GI and in part of another pharmaceutical product, Genentech will allocate t|
Revenues, which form the base for calculating the above quarterly Payments, the portion of revenui
recognized on the sale or other disposition of the Combined Product which is attributable to hGH or GI.
addition, such Revenues shall also include 50% of any revenues recognized by Genentech from the sale
pj
other disposition within the United States of certain of its products that are competitive with hGH or GI aiii
that receive FDA approval for sale within the United States for the same indication as a formulation of hG"
or GI with the four-year periods commencing on the date that any formulation of hGH or GI received ii
first FDA approval for sale within the United States, except that revenues recognized by Genentech for
thijj
purpose will not include revenues from Hoffman-LaRoche, Inc., in connection with sales of alpha or beti
interferon or revenues from the Lederle Laboratories Division of American Cyanamid Co., in connection!
with sales of Herpes vaccine or Hepatitis vaccine. Payments based on competitive product revenues will b(
payable in any year, if, in the previous year, unit sales of hGH or GI in the United States by Genentech or iti
affiliates, as the case may be, shall have declined.
Notwithstanding the foregoing, Genentech is required to make a payment of $1 million in each quarter]
for the first three years, so long as there are any Revenues of hGH or GI in such quarter. Genentech shall]
30
213
have the right to credit such payments dollar for dollar against amounts payable in any subsequent quarters
in excess of $1 million, except that such credits shall not reduce below $1 million payments in any quarter
during the first three years. Genentech will have the right to credit the Advance Payment against amounts
payable in any quarter commencing 3 /6 years after the Purchase Date. Such credit will be dollar for dollar
against Payments attributable to Revenues in such quarter which are in excess of the average Revenues for
the two quarters prior to the Purchase Date.
If Genentech exercises its option to purchase the Class B Interest, it will pay to the Class B Limited
Partner for each quarter after the date on which the Class B Interest was purchased (the "Class B Purchase
Date") by Genentech, commencing with the calendar quarter in which Revenues recognized after the Class
B Purchase Date shall have aggregated at least $674,269,000, 5% of the amount obtained by multiplying the
above percentages, applicable in a given quarter, times the Revenues for such quarter.
The Partnership Purchase Agreement will permit Genentech to make an offer or offers to the Payment
Recipients or the Class B Limited Partner to prepay Genentech s obligations to make payments to the
Payment Recipients or the Class B Limited Partner. If at any time at least 80% in value of the Payment
Recipients shall have accepted the terms of any such offer or offers (the "Acceptance Date"), Genentech
shall have the right for a period of 30 days after the first anniversary of the Acceptance Date to prepay its
obligations to make (i) payments to the Payment Recipients who have not accepted any such offer, by
payment of an amount equal to three times the payment due to such Payment Recipients during the year
after the Acceptance Date and (ii) payments to the Class B Limited Partner, if it shall not have accepted the
terms of any offer to it, by payment of an amount equal to three times the Payments due to it during the year
after the Acceptance Date.
Genentech will covenant, in the Partnership Purchase Agreement to (a) prevent dissolution of the
Partnership for at least three months after the Purchase Date and (b) use diligence to manufacture and sell
hGH, GI and Formulations in the United States, or if Genentech determines that it cannot reasonably use
such diligence, to use its best efforts to license the Technology to a third party. The Payment Recipients and
the Class B Limited Partner will not be permitted to sell or assign their rights to receive Payments without
the prior written consent of Genentech, which it may withhold in its absolute discretion.
SUMMARY OF THE LIMITED PARTNERSHIP AGREEMENT
The following is a summary of certain provisions of the Partnership Agreement. The summary con
tained hereunder is qualified in its entirety by reference to the full text of the Partnership Agreement (which
is attached to this Memorandum as Exhibit A) and to the balance of this Memorandum. The Partnership
Agreement should be read in its entirety.
Partnership Capital
General. No Partner shall be entitled to interest on any capital contribution to the Partnership or on
such Partner s capital account. Except as otherwise provided in the Partnership Agreement, no Partner has
the right to withdraw, or to receive any return of, his capital contribution. Neither the Class B Limited
Partner nor any Class A Limited Partner (collectively, the "Limited Partners") has the right to receive
property other than cash in return for his capital contribution.
No Requirement For Additional Capital Contributions. The General Partner is authorized to admit
Class A Limited Partners to the Partnership in the manner and subject to the conditions set forth in the
Partnership Agreement. No Limited Partner shall be required or authorized to make any additional capital
contributions to the Partnership. Under the Partnership Agreement, the General Partner is obligated to
make capital contributions to the Partnership equal in the aggregate to at least one percent of the aggregate
capital contributions of all Partners.
31
214
Allocation of Profits and Losses
Until Payout, Profits or Losses of the Partnership shall be allocated 99% to the Limited Partnj
proportion to their respective capital contributions and 1% to the General Partner in proportion to its i
contribution ("capital
contributions" is defined to include cash and notes given to the Partnership).
P.ayout, Profits of the Partnership shall be allocated 1 % to the General Partner, 5% to the Class B
Partner, and the balance to the Class A Limited Partners, in proportion to their capital contribufjj
Losses shall be allocated 1% to the General Partner and 99% to the Limited Partners in proportion to tj
capital contributions. During each fiscal year, Losses that would otherwise be allocated to Limited Par
whose capital accounts would thereupon become negative shall be reallocated to the other Limited Partlrf
(except the Class B Limited Partner).
The Profits or Losses of the Partnership, for any fiscal year, attributable to an interest in the Partjjj
ship that was assigned during that period shall be allocated between the assignor and the assignee
upon the length of time during such period that the interest was owned by each of them. "Profits !
"Losses" means the profits or losses of the Partnership for Federal income tax purposes, including, wit
limitation, each item of Partnership income, gain, loss, deduction or credit. "Payout"
occurs at the timji
which the aggregate of all cash distributions from the Partnership to the Limited Partners (including tB
assignees and substituted Limited Partners but not including any Limited Partner who defaults on a
ment due under his Investor Note ("a Defaulting Limited Partner")) is sufficient in amount to equal
cash delivered to the Partnership by such Limited Partners (including cash paid to the Partnership un|
any promissory notes of such Limited Partners).
The losses of the Partnership for any fiscal year attributable to the interest of a Defaulting LimjS
Partner shall be allocated among the Class A Limited Partners as if such Defaulting Limited Partner hajf
zero balance in his capital account. If a qualified purchaser purchases the Interest of the Defaulting Limit!
Partner, Profits and Losses of the Partnership attributable to such Interest, for the fiscal year in which sue
purchase occurs (a "Reallocation Year"), shall be allocated between the Defaulting Limited Partner
anj
such purchaser based upon the length of time the Interest was owned by each of them. During the fiscal yef
following such a Realtocation Year, Losses shall be allocated to such purchaser until his capital accoun
becomes equal in amount to the capital account the Defaulting Limited Partner would have possessed an
beginning of such fiscal year had he not defaulted.
Cash Distributions
The General Partner is required to distribute to the Partners all of the Partnership s Distributable Casl
as soon as practicable after the end of any fiscal quarter, in proportion to the Partners respective capi
accounts as of the end of such fiscal quarter. Distributable Cash is defined as all cash revenues of
Partnership (other than funds received as capital contributions, loans, interest or other income earned on an]
temporary investment of Partnership funds, and proceeds from the sale of assets in partial or complii
liquidation) in such period, less all amounts expended by the Partnership pursuant to the Partnershr
Agreement (not including payments made under the Development Agreement, sales commissions, invest
ment banking fees and formation and organizational expenses of the Partnership) and less such workini
capital or reserves or other amounts as the General Partner reasonably determines to be necessary for th
proper operation of the Partnership s business and its winding up and liquidation. The General Partner in i
sole discretion may declare other funds of the Partnership to be Distributable Cash. It is anticipated
thai
Distributable Cash will be generated principally by the sale of hGH or GI in the United States, eithd
through the Joint Venture or otherwise.
Enforcement of Investor Notes
The Partnership Agreement gives the General Partner full power to enforce the Investor Notes held
by|
the Partnership. If any Limited Partner fails to pay an installment under his Investor Note when due, thats
Limited Partner will not be entitled to any cash distributions from the Partnership during such period of;
default, and will be subject to the allocations of Profits and Losses set forth above. The General Partner
have the option of selling the Defaulting Limited Partner s Interest to any qualified purchaser at a sharply.
32
215
price, with the Defaulting Partner receiving not more than ten percent of the cash he had
invested prior to his default and being relieved of his obligation under his Investor Note, and each Limited
Partnet irrevocably appoints the General Partner such Limited Partner s attorney-in-fact, with full power, in
su^fi kiniited Partner s name, place and stead, to carry out such sale. The General Partner may also cause
suit to be brought against the Defaulting Limited Partner to collect the amount due, together with interest
fiierjfpri
".and any costs of collection.
*
of the General Partner
General Partner shall have exclusive management and control of the business of the Partnership,
have the authority, on behalf of the Partnership, to do all things which, in its sole judgment, are
necessary, proper, or desirable to carry out their duties, except as the Partnership Agreement may expressly
limit such powers.
Contracts with General Partner or Affililates
The General Partner may, on behalf of the Partnership, enter into contracts with itself or its affiliates.
The validity of any agreement, transaction or payment involving the Partnership and the General Partner or
any of its affiliates (including those listed in Schedule C to the Partnership Agreement) shall not be affected
by reason of (1) the relationship between the Partnership and the General Partner or its affiliate, or between
such affiliate and the General Partner or (2) the approval of said agreement, transaction or payment by
officers or directors of the General Partner.
Rights of Limited Partners to Vote and Call Meetings
The Limited Partners have no right to participate in the management or supervision of the business of
the Partnership. However, the Partnership Agreement does give the Limited Partners certain voting rights,
including the following:
. 1. The right to amend the Partnership Agreement by the affirmative vote of a majority in interest
. of the Limited Partners, without the consent of the General Partner, provided that such amendment
does not (a) without the consent of each Partner to be adversely affected by the amendment, convert a
Limited Partner into a General Partner, modify the limited liability of a Limited Partner, alter the
Federal income tax status of the Partnership, or alter the interest of any Partner in the Profits or Losses
or in the cash distributions of the Partnership, it being understood that this limitation is not intended to
affect the right to vote to amend the Partnership Agreement as is necessary or appropriate to permit the
issuance of additional Interests; or (b) amend any provision of the Partnership Agreement which
requires the action, approval or consent of a specified percentage in interest of the Limited Partners,
unless such specified percentage in interest of the Limited Partners consents to such amendment; or (c)
alter any provision requiring the consent of a majority in interest of the Limited Partners to permit
approval by any lesser percentage of interest of the Limited Partners.
2. The right to terminate the Partnership by the affirmative vote of a majority in interest of the
Limited Partners, provided that such right shall exist only after all capital contributions to the Partner
ship agreed to be made by the Limited Partners (including all interest or other income earned thereon)
have been expended, and provided further that no such vote shall be effective unless, prior to or
concurrently with such vote, there shall have been established procedures for the assumption of the
Partnership s obligations under the agreements listed on Schedule C to the Partnership Agreement and
all related agreements, and there shall have been appointed an agent who shall hold such powers as are
necessary for all other parties to such agreements to deal with such agent as if the agent were the sole
owner of the Partnership s interest, and such procedures and agency relationship have been agreed to in
writing by each of the other parties to such agreements.
3. The right to remove the General Partner upon the written consent or vote of a majority in
interest of the Limited Partners. The removal of the General Partner shall not affect the validity or
enforceability of the agreements listed on Schedule C to the Partnership Agreement.
33
216
4. The General Partner may not resign or withdraw from the Partnership without, amongj
things, obtaining the consent of a majority in interest of the Limited Partners.
5. The sale of all or substantially all of the assets of the Partnership must be approved
.
affirmative vote of a majority in interest of the Limited Partners.
6. Upon the removal of the General Partner, or within 90 days after the resignation or withd^j
of the General Partner in violation of the Agreement or the dissolution or bankruptcy of the Ge
Partner, a majority in interest of the Limited Partners may, if and to the extent permitted by law,.i
to carry on the business of the Partnership with one or more substituted General Partners.
Upon receipt of a written request from at least 10% in interest of the Limited Partners, the GeH
Partner shall call a meeting of the Limited Partners. The General Partner may also call a meeting 6
Limited Partners on its own initiative, or submit proposed amendments to the Limited Partners for actiofl
their written consent.
Limitation on Liability of General Partner
Neither the General Partner nor any of its officers, directors, employees or agents shall be liable to.
Partnership or the Limited Partners for any act or omission based upon errors of judgment or other faul
connection with the business or affairs of the Partnership, provided the person against whom liabiljt
asserted acted in good faith on behalf of the Partnership and in a manner reasonably believed by such pe
to be within the scope of his authority under the Partnership Agreement and in the best interests of
Partnership, and provided that such action or failure to act does not constitute negligence or wil
misconduct.
Indemnification of General Partner
The General Partner, its officers, directors, employees and agents shall be indemnified by the Partn
ship in respect of all (a) fees, costs and expenses incurred in connection with or resulting from any clai
action or Demand against the General Partner, the Partnership or any of their officers, directors, employi
or agents that arise out of or in any way relate to the Partnership, its properties, business or affairs and
such claim, action and demand and any losses or damages resulting from such claim, action and demami
including amounts paid in settlement or compromise (if recommended by attorneys for the Partnership) p ;
any such claim, action or demand; provided, however, that this indemnification shall apply only in the even \
the person against whom a claim, action or demand is asserted" has acted in good faith on behalf of
tfii[
Partnership and in a manner reasonably believed by such person to be within the scope of his authority und|
the Partnership Agreement and in the best interests of the Partnership, and only if such action or failure
*
act does not constitute gross negligence or willful misconduct.
Liability of Partners to Third Parties
The General Partner will be liable for all general obligations of the Partnership to the extent not paid by
the Partnership. The Partnership Agreement provides that no Limited Partner shall be personally liable for
the debts of the Partnership beyond the amount of his capital contribution and share of the undistributed
profits of the Partnership. In the event the Partnership is unable otherwise to meet its obligations, the-
Limited Partners might, under applicable law, be obligated under certain circumstances to return, with
interest, cash distributions previously received by them to the extent such distributions are deemed to
constitute a return of their capital contributions or are deemed to have been wrongfully paid to them.
Partners Independent Activities
The Partnership Agreement provides that the General Partner (as well as any Limited Partner) and any
shareholder, director, employee or affiliate thereof may engage in or possess an interest in other business-
ventures of any nature and description, whether or not such ventures are competitive with the Partnership.
>
f
34
217
Limitations
on Transferability of Interests
The Interests are subject to strict limitations upon transfer. A Limited Partner may assign his Interest
to qualified
investors only if certain conditions are satisfied. The assignee must meet all suitability standards
and other requirements applicable to the original Investors and must consent in writing, in form satisfactory
to the General Partner, to be bound by all the terms of the Partnership Agreement. Immediately after the
assignment, neither the assignee nor the assignor, if the assignor retained any part of his Interest, may hold
less than $100,000 of Interest and neither may hold Interests that are not an even multiple of $50,000. The
assignor must have paid in full, in cash, his capital contribution. Counsel for the assignee must have
delivered an opinion (which counsel and opinion are satisfactory to counsel for the General Partner) that
such Interest may be legally sold or distributed in compliance with then-applicable state and Federal stat
utes. The General Partner must have consented in writing to the assignment, which consent may be
withheld in its absolute discretion. In any event, no assignment may be made which, in the opinion of
counsel to the Partnership, would cause a termination of the Partnership for the purposes of the Internal
Revenue Code or would jeopardize the status of the Partnership as a partnership, for Federal income tax
purposes
or would violate any applicable governmental rule or regulation including, without limitation, any
applicable
Federal or state securities law. Upon request of the General Partner, the assignor will pay all
reasonable expenses, including attorney s fees, incurred by the Partnership in connection with the assign
ment of the Interest. Any purported assignment which is not in compliance with the Partnership Agreement
is null and void arid of no force and effect whatsoever. No assignment to a minor (except in trust or pursuant
to the Uniform Gifts to Minors Act) or to an incompetent shall be effective.
Any sale or transfer of an Interest, or any interest therein, in California or involving a California
resident requires the prior written consent of the Commissioner of Corporations of the State of California,
except as provided in the Commissioner s Rules.
The assignee of an Interest does not become a Limited Partner by virtue of such assignment, and
obtains no rights other than the right to receive, after the effective date of the assignment, distributions from
the Partnership and to receive allocations of the Profits or Losses of the Partnership. An assignee o[
an
Interest may become a substituted Limited Partner only upon the written consent of the General Partner,
which may be withheld in its absolute discretion. In any event, such consent shall be given only if the
assignee executes and acknowledges such instruments as the General Partner deems necessary or desirable
to give effect to such substitution. The substituted Limited Partner shall pay all reasonable expenses,
including attorney s fees, incurred by the Partnership in connection with such\substitution of the Limited
Partner.
/
Term and Termination
The Partnership shall continue until December 31, 2012 unless sooner terminated upon the occurrence
of any one or more of the following events: (a) the passage of 90 days after dissolution or bankruptcy of the
General Partner unless the Limited Partners elect to carry on the business of the Partnership; (b) the sale of
all or substantially all of the assets of the Partnership, as permitted by the Partnership Agreement; (c) the
affirmative vote of a majority in interest of the Limited Partners, subject to the conditions discussed above in
the section on "Rights of Limited Partners to Vote and Call Meetings"; (d) termination as required by
operation of law; or (e) the transfer of all of the Partnership Interests to Genentech pursuant to its exercise
of the Partnership Purchase Option and its option to purchase the Class B Limited Partner Interest set forth
in the Joint Venture and Partnership Purchase Option Agreement or pursuant to a vote by a majority in
interest of the Limited Partners to accept a Genentech purchase offer.
Upon termination of the Partnership, the affairs of the Partnership will be wound up and all of its debts
and liabilities discharged in the order of priority provided by law. The remaining assets of the Partnership
will be distributed to the General Partner and the Limited Partners in proportion to their capital accounts at
the time of termination. Each Partner shall receive his share of the assets in cash or in kind, and the
proportion of such share that is received in cash may vary from Partner to Partner, all as the General
Partner in its sole discretion may decide.
35
218
Appointment of General Partner as Attorney-in-Fact
Each Limited Partner irrevocably constitutes and appoints the General Partner such Limited Partner
1
!
true and lawful attorriey-in-fact, with full power and authority in such Partner s name, place and stead to
make, execute, acknowledge and file all certificates and other instruments deemed advisable by the General
Partner to permit the Partnership to become or continue as a limited partnership, all instruments that effect
a change or modification of the Partnership in accordance with the Partnership Agreement, all
conveyances
and other instruments deemed advisable by the General Partner to effect the dissolution and termination of
the Partnership, and all other instruments that may be required or permitted by law to be filed on behalf of
the Partnership. Each Limited Partner also irrevocably constitutes and appoints the General Partner such
Limited Partner s true and lawful attorney-in-fact, with full power and authority in such Partner s
namej
place and stead to make and execute the Joint Venture and Partnership Purchase Option Agreement and the
Partnership Purchase Agreement and to amend such agreements.
Applicable Law
The Partnership Agreement will be construed and enforced in accordance with the laws of the State of
California.
Records and Reports
The Partnership Agreement provides that proper, complete records and books of accoun^of the business
of the Partnership shall be maintained, on the tax basis of accounting, and that each Limited Partner (or his
duly authorized representative) shall have access to them, upon reasonable notice and for a proper purpose
during reasonable business hours. Each Limited Partner will receive the following reports:
(1) within 120 days of the end of each fiscal year, an annual report containing financial statements
of the Partnership accompanied by a report from a firm of independent certified public accountants, a
general description of the Partnership s business during such fiscal year, and a summary of any material
transactions between the Partnership and the General Partner or its affiliates; :t
(2) within 60 days of the end of the fiscal quarter, an unaudited financial report; and
i*T
(3) within 75 days of the end of each fiscal quarter, a statement containing all information con:
cerning the Partnership necessary for the preparation of each Limited Partner s Federal income tai
return.
Section 174 Tax Election
The General Partner will, on the first tax return filed on behalf of the Partnership, make a proper,
election under Section 174 of the Internal Revenue Code of 1954, as amended, for purposes of completing
and filing the Partnership s Federal income tax returns, to treat research and experimentation expenditures
as expenses which are not chargeable to capital accounts and to deduct such expenditures as paid, which
election shall not thereafter be changed.
Partnership Purchase Option
If Genentech chooses to exercise the Partnership Purchase Option, see "Summary of Material Con-
tracts Joint Venture and Partnership Purchase Option Agreement", Genentech will notify the Class A5
Limited Partners of the exercise and the General Partner will transfer their Interests to Genentech in;
exchange for the consideration set forth in the Partnership Purchase Agreement (see "Summary of Material
Contracts Partnership Purchase Agreement"). Each Limited Partner irrevocably constitutes and appoints
the General Partner, with full power of substitution, such Limited Partner s true and lawful attorney-in-fact,
with full power and authority in such partner s name, place and stead to carry out the above transfer.
Genentech Offer in Lieu of Partnership Purchase Option
If Genentech chooses to offer to purchase the Interests of the Limited Partners on terms other than.r
those set forth in the Partnership Purchase Agreement, the General Partner will provide each Limited|
Partner with written notice of the terms of the offer and an accurate description of all material
conse-,|
quences, including tax consequences, to the Limited Partners of such sale, and shall give the Limited -|
36
219
Partners an opportunity to vote for or against accepting such offer. If a majority in interest of the Limited
i Partners
votes to accept such offer, the General Partner will transfer all of the Interests of the Limited
/Partners to Genentech in exchange for the consideration specified in the offer. Each Limited Partner
!
^rcyocably constitutes and appoints the General Partner, with full power of substitution, such partner s true
"
: >
i
afld lawful attorney-in-fact, with full power and authority in such partner s name, place and stead to carry
out the above transfer.
. THE GENERAL PARTNER
i
-
The General Partner is Genentech Development Corporation, a California corporation wholly-owned by
Gtnentech. Under the Development Agreement, the General Partner will be able to draw upon the full
resources of Genentech to carry out the research and development program of the Partnership.
The Board of Directors of the General Partner is composed of the following five persons:
Fred A. Middleton, age 32, is Vice President Finance and Corporate Development of Genentech. Mr.
iljddleton
has been employed by Genentech since 1978.
.{." James M. Gower, age 34, is Vice President Pharmaceutical Marketing of Genentech. Mr. Gower has
been employed by Genentech since 1981.
Brian C. Cunningham, age 39, is General Counsel of Genentech. Mr. Cunningham has been employed
by Genentech since 1982.
Stephen Evahs-Freke, age 31, is Vice President of Blyth Eastman Paine Webber Incorporated and
Executive Vice President of BEPW Development Corporation, one of the Sales Agents.
Peter W. Wallace, age 49, is a Partner of Hambrecht & Quist, one of the Sales Agents.
DESCRIPTION OF GENENTECH, INC.
The Company
Genentech was organized in 1976 upon the premise that advances in recombinant DNA, gene synthesis
and molecular biology made possible the development of a new technology which could produce a wide
variety of valuable substances with human and animal health care, industrial, agricultural and other com
mercial applications. Since its formation, Genentech s main activity has been research and product develop
ment, with an emphasis on those products which capitalize on the advantages of gene splicing technology
over current methods of production. Genentech s executive offices are located at 460 Point San Bruno
Boulevard, South San Francisco, California 94080 (telephone (415) 952-1000).
Summaries of Genentech s Statements of Operations since 1977 and of its condensed Balance Sheet as
of June 30, 1982 are presented below. These summary statements should be read in conjunction with the
financial statements included in Genentech s Annual Report to Shareholders for the year ended December
31, 1981 and its Quarterly Report to Shareholders for the quarter ended June 30, 1982, copies of which are
included with this Memorandum.
Recombinant DNA Technology
Recombinant DNA technology is being used by the genetic engineering industry to transform bacteria,
yeast or other microbes into tiny factories that turn out abundant quantities of beneficial biological products.
This sophisticated technology is revolutionary because it permits the large-scale manufacture of large,
complex proteins. Conventional purification or chemical synthesis methods cannot practicably or economi
cally accomplish the production of complex proteins, and so the full economic potential of the majority of
proteins has never before been realized.
Proteins are all-important in life processes. Two important classes of cell regulators hormones and
enzymesare proteins. Proteins give shape to cells, facilitate cell metabolism, and serve other vital func
tions in living organisms. Such essential and rare proteins are the principal products of the genetic engineer
ing industry.
Cells carry the instructions for constructing proteins in their genetic material or genes. The genes of
most living organisms are made up of a chemical called deoxyribonucleic acid, or DNA. DNA has four
37
220
different kinds of building blocks. Genes are composed of linear sequences of these building blocks. In tui
a string of genes makes up a chromosome.
For a protein to be made, the linear DNA instructions of a gene are first copied into an intermediajj
instruction composed of RNA or ribonucleic acid, a chemical similar to DNA. The RNA instruction t hi
directs the proper assembling of the building blocks of proteins amino acids.
The overwhelming majority of all living organisms, from bacteria to man, make proteins in this methbil
DNA to RNA to protein. Recombinant DNA technology makes use of this fact. In this technology, DNi
from one organism is programmed into (recombined with) the DNA of another organism. Because for ai
practical purposes every living thing uses the universal genetic language of DNA, a bacteria can
successfully}
decipher the genetic instructions of a man or a mouse.
This has tremendous advantages because microorganisms can be readily manipulated and are much
simpler than animals, plants or humans. Over the last 30 years, and particularly the last ten years, scientists
have learned how to identify and isolate gene coding for beneficial proteins. Over the past ten years they
have been perfecting methods to take these genes from humans and a variety of other animals and plants and
program them into microorganisms, such as bacteria or baker s yeast, or even into animal cells growing ft
laboratory culture. A landmark achievement came in 1973, when Herbert Boyer, professor of the University
of California, San Francisco (a co-founder of Genentech and a member of its Board of Directors) and
Stanley Cohen of Stanford University devised an ingenious and relatively simple method to transfer genes
from one organism to another. %
When scientists program a gene coding for a beneficial protein into the genetic material of micr
organisms, they also attach instructions that direct the microorganisms to make great quantities of the
protein, much more than is normally made in the natural state. Therefore, the microorganisms essentially
become specialized factories producing a particular kind of protein. Rare proteins, such as hGH and gamma
interferon, which are found only in vanishingly small amounts in humans, become available in ample"
amounts for the first time.
In sum, genetic engineering simply selects and amplifies the production of proteins by artful manipula-:
;
tion of nature s own methods. It transforms microorganisms into mini-factories single-mindedly producing
beneficial protein products by capitalizing on the fact that DNA is the universal genetic language.
Genentech s Technology
At Genentech, general procedures used in developing its products are as follows. First, DNA with a
coding sequence directing the manufacture of the desired substance is isolated and synthesized, and then it is
specially tailored and assembled with other key pieces of DNA in a precise alignment which is inserted into
microorganisms. These microorganisms then assimilate the newly encoded genetic information into their
cellular makeup. Using their normal protein making machinery, the cells translate the information con^
tained in the newly inserted DNA into the desired substance.
Once a single microorganism containing the correct "genetic code" has been engineered and identified,
it will divide and pass on to its offspring the same information contained in the parent cell. Then, using
"fermentation" techniques similar to those used in the production of antibiotics, large populations of geneti
cally engineered microorganisms can be grown to produce the desired product. These "microbial factories"
are capable of producing new products using their "spliced"
DNA as a source of genetic instructions.
Genentech operates its own fermentation facilities for the scaled-up growth of recombinant microorganisms :
and maintains a staff of fermentation specialists who operate these facilities.
Once production has taken place, Genentech "harvests" the genetically engineered microorganisms and
isolates the desired product through a series of separation and purification techniques. Genentech operates
facilities for undertaking the preparation of purified product obtained by these methods and employs protein j
chemists and development scientists to manage that preparation.
Other Product Developments
Genentech has engineered microorganisms to produce a number of medically and agriculturally
important products, including, in addition to hGH (in 1979) and gamma interferon (in 1981), somatostatin |
38
221
;
"-
>jjjj-
1977), human insulin (in 1978), thymosin alpha-one (in 1979), human proinsulin (in 1980), several sub
types
of human alpha interferon (in 1980), several hybrid alpha imerferons (in 1980), human beta interferon
(in 1980), bovine growth hormone (in 1980), porcine growth hormone (in 1981), vaccine for foot-and-mouth
disease (in 1981), human calcitonin (in 1981), human albumin (in 1981), bovine interferon (in 1982) and
;
&ue plasminogen activator (in 1982).
:
;
J$v.At present, hGH is one of four products made by microbes developed at Genentech that are in the
clinical testing stage. The other three products include human insulin and two types of human alpha
.interferon.
-5: In 1978, Genentech entered into a long-term agreement with Eli Lilly and Company ("Lilly") under
which Lilly will manufacture and market human insulin developed by Genentech. In mid- 1980, Lilly began
construction of two manufacturing facilities to produce human insulin using recombinant DNA technology.
Insulin produced in these facilities has been approved for sale in the United Kingdom and West Germany,
and in the United States Lilly has completed clinical trials and submitted an NDA to the FDA. When
marketed, this product will be the world s first human pharmaceutical product from recombinant DNA
technology.
In 1980, Genentech entered into a joint development contract with Hoffman-La Roche, Inc. ("Roche")
to produce alpha and beta interferons for the therapeutic market. Under this agreement, in return for
payment of royalties on product sales, Roche received worldwide (including the United States) exclusive
marketing rights. Genentech has the right to supply Roche with a substantial percentage of Roche s
marketing requirements. Human clinical trials of two sub-types of alpha interferon produced under the
Genentech-Roche contract began in the United States in January 1981 under Roche sponsorship.
Genentech has supplied a portion of Roche s needs for these trials.
In addition to the foregoing, other products developed by Genentech that are currently undergoing
trials include bovine growth hormone and porcine growth hormone (developed under an agreement with
Monsanto Company) and vaccine for foot-and-mouth disease (developed in cooperation with the United
States Department of Agriculture). < ,
Genentech s development program also includes applications in industrial markets. In April 1982,
Genentech and Corning Glass Works announced the formation of a jointly-owned company, Genencor, Inc.
Genencor will produce industrial enzymes primarily for the food processing and chemical industries. It will
take advantage of Coming s enzyme immobilization techniques as well as Genentech s recombinant DNA
technology.
Manufacturing
Genentech operates its own manufacturing facilities to scale-up the production of its products and to
manufacture commercial quantities. In 1981, Genentech leased a site and began construction of a 72,000
square foot development and manufacturing facility that is currently being completed. Genentech believes
the productive capacity of its present manufacturing facilities, including the new facility, is adequate for its
manufacturing requirements for the next several years.
Research and Development
Substantially all of Genentech s operating expenses to date have been related to the development of
products either on its own behalf or under contracts with customers. The extent of Genentech s research and
development activity is expected to increase in future years.
As of June 30, 1982, Genentech employed 385 full-time employees and 38 consultants, of whom 75 hold
Ph.D. degrees and 69 hold other advanced degrees in scientific or technical fields. Of the full-time
employees, 162 were engaged in research, 26 in quality control and clinical research, 97 in manufacturing
and 100 in marketing, finance and administration.
Additional Information Regarding Genentech
For additional information regarding Genentech s business, see Genentech s Annual Report to
shareholders for the year ended December 31, 1981 and Genentech s Quarterly Report to Shareholders for
the quarter ended June 30, 1982, copies of which are included with this Memorandum.
39
222
GENENTECH, INC.
Statement of Operations
(In Thousands)
40
223
SUMMARY OF INCOME TAX CONSEQUENCES
V1
frimary outlines the more significant Federal income tax principles applicable to the Partnership,
HIand the Joint Venture. The statements, conclusions and opinions contained herein are based on
Wls contained in the Code, Treasury Regulations, administrative rulings and court decisions as of
is Memorandum. No assurance can be given that future legislative, administrative or court
.... not modify the legal bases for the statements, conclusions or opinions expressed. Any such
Pent may be applied retroactively to transactions completed prior to the date thereof.
jjiternal
Revenue Service ("IRS") has indicated that it intends to increase the number of its audits
urns filed by "tax shelter" partnerships and to examine 25% of the partnership returns reporting
$25,000. The IRS may examine the Partnership s returns and may disagree with the tax
;aken by the Partnership. If challenged by the IRS, the Partnership s tax position may not be
y.the courts. If the IRS makes an adverse determination upon an audit of a Partnership return, it
separate audits of the Investors tax returns, which could result in adjustments to tax liabilities
; to non-Partnership as well as Partnership items. Each prospective investor is strongly urged to
fills tax advisers regarding the possible tax consequences of an investment in the Partnership.
~
i [
Counsel
s. Davis Polk & Wardwell, Special Tax Counsel to the Partnership, will issue an opinion to the
Partnership in substantially the form set forth below, assuming that there is no substantial change in the
JSelljibases for such opinion between the date of this Memorandum and the Closing Date. This opinion will
Tepfesentthe best judgment of Special Tax Counsel under existing statutes, judicial decisions and adminis-
rtrative-iregulations and interpretations. However, opinions of tax counsel have no binding effect on the IRS
tiile:.courts.
- ~ .
"You have requested our opinion as to (1) the classification for federal income tax purposes of
t: r/Genentech Clinical Partners, Ltd., a Limited Partnership, a California limited partnership (the
;:.. ^Partnership"), (2) the deductibility for federal income tax purposes of payments made by the Partner-
,:-ship to Genentech, Inc. ("Genentech") for research or experimentation and (3) (
the character, for
federal income tax purposes of payments, if any, received by the Class A Limited Partners in the
,, .Partnership (the "Investors") from Genentech if Genentech pursuant to the Partnership Purchase
~
.
Agreement referred to below should purchase from the Investors their interests in the Partnership (the
"Interests").
"In
rendering this opinion, we have reviewed the Limited Partnership Agreement dated as of
October 1, 1982 among Genentech Development Corporation (the "General Partner"), the Investors
and Medical Investors Corporation (the "Class B Limited Partner"); the Confidential Private Place
ment Memorandum of the Partnership dated October 11, 1982; the Development Agreement between
Genentech and the Partnership; the Joint Venture and Partnership Purchase Option Agreement among
Genentech, the Partnership, the Class B Limited Partner and the Investors, to which are attached as
exhibits, the Joint Venture Agreement between Genentech and the Partnership and the Partnership
Purchase Agreement among Genentech, the General Partner, the Investors and the Class B Limited
Partner; the Cross License Agreement between Genentech and the Partnership; arid the balance sheets
of the General Partner dated as of December 31, 1981 and June 30, 1982 (all of the foregoing
agreements being referred to herein as the "Agreements"). In addition, in rendering this opinion we
have relied upon factual representations from Genentech and the General Partner, which facts are set
forth in a letter to us dated the date hereof, and this opinion is expressly based upon the accuracy of
those facts. Furthermore, this opinion is based upon law in effect on the date hereof.
"Based
upon the foregoing:
"(I) We believe that the Partnership constitutes a partnership and not an association for federal
income tax purposes, and accordingly that each Investor will take into account in determining his own
Federal income tax liability his distributive share of the Partnership s income, gain, loss, deduction
and credit.
41
224
"(2) Although the matter is not free from doubt, primarily by reason of the uncertain scope of f
Supreme Court s decision in Snow v. Commissioner, 350 U.S. 831 (1974), and the limited body!
authority determining what constitutes a research or experimental expenditure within the
meaning!
Section 174 of the Internal Revenue Code of 1954, as amended (the "Code"),
we believe that substa
tially all of the Partnership s payments to Genentech pursuant to the Development Agreement shoii
be deductible under Section 174 of the Code when paid by the Partnership, and that if the IRS were!
challenge such deductibility in court, the Investors should ultimately prevail.
"(3) Although the proper characterization of any gain recognized by the Investors on the transjfi
of the Partnership Interests pursuant to the Partnership Purchase Agreement is not free from doui)
primarily because of the paucity of direct legal authorities, and subject to the exceptions set forth 1
subparagraphs (a) through (c) below, we believe that the arguments in favor of the position that su|
gain is capital gain outweigh the arguments to the contrary, and therefore that a court should hold th
such gain is capital gain. Such capital gain would be long-term capital gain if the particular Investq
has held (or is deemed to have held) his Interest for more than one year on the date of the
transfej
This characterization involves various facts which will be determined and events which will occur in US
future, however, both of which will be subject to interpretation by a court, and accordingly there can I
no assurance as to the outcome. The exceptions referred to in the first sentence of this paragraph
the following:
"(a)
A portion of the payments will be ordinary income to the extent of ,any, stated inter
pursuant to the Partnership Purchase Agreement and to the extent of any interest imputed on sue
payments under Section 483 of the Code; the portion of each payment which constitutes intere
will increase the longer the period of time between the sale of the Interests and receipt of th|
payment.
"(b)
To the extent that payments are attributable to any inventory of pharmaceutic
products that the Joint Venture holds on the date of purchase of the Interests, long-term capital]
gain treatment is unlikely to be available. Genentech has represented, however, that it expects an|
such inventory to be minimal in amount.
"(c)
To the extent that a particular Investor is, because of his activities apart from thi
Partnership, a dealer in property such as the Technology, capital gain treatment will be unavail|
able to that Investor.
The General Partner has attempted to structure the Partnership s activities so that an investment in th
Partnership will offer the Investors both (a) the possibility of a pre-tax profit if the Partnership s busin
activities should be successful, and (b) the possibility of Federal income tax benefits in the form of
deductions under 1 74 amounting to a substantial portion of the Investors capital contributions to thi
Partnership and (ii) long-term capital gain treatment in respect of a portion of payments (if any) received!
from Genentech if Genentech should elect to exercise its Partnership Purchase Option. There is i
assurance that any of these goals will be met. (See "Risk Factors".) As to the Federal income tax benefi
described above, Special Tax Counsel has advised the General Partner that, although the matter is not fi
from doubt (for the reasons set forth in greater detail below), Special Tax Counsel believes that the federa
income tax benefits described in this paragraph are, in the aggregate, more likely than not to be realized b;
the Investors.
Tax Treatment of Partnership Transactions
In order for the structure of the transactions to afford the opportunity for the tax benefits potentially!
available as a result of the Partnership s ownership of the Technology, it is a prerequisite that the form of the]
various transactions and agreements be recognized. The IRS might contend that the form of the
Partner-|
ship s transactions should be disregarded on the basis that the Partnership is only providing financing orl
services, or both, to Genentech or the General Partner, that the Partnership is only purchasing froml
Genentech a profits interest in hGH and gamma interferon, or that the activities of the Partnership should!
be attributed to Genentech or the General Partner. A recent case illustrating this type of argument was]
42
225
Estate of Helliwell v. Commissioner, 77 T.C. 964 (1981), in which a limited partnership which purported to
incur expenses in the production of a film was held merely to have purchased a profits interest in the film
from the corporation which the court held to be the true payor of those expenses. Thus, the partnership s
payments
were treated as non-deductible costs of purchasing an asset (i.e., the profits interest) rather than
deductible expenses of producing a film. Helliwell can be distinguished from the Partnership s situation,
because (1) in Helliwell the partnership had a binding legal obligation to deliver the film to another party
upon completion, whereas the Partnership may continue to own the Technology indefinitely; (2) in Helliwell
the partnership provided less than one-half of the total funds needed to produce the film, whereas the
Partnership s expenditures of approximately $50 million on the Project will represent the substantial
percentage of the overall funds expected to be necessary to create hGH and gamma intereron and to obtain
FDA certification for those drugs in the United States market; and (3) the economic structure of the
transaction in Helliwell was found to more closely resemble a loan by the Partnership for a limited profits
participation
than a genuine entry by the Partnership into a business, whereas the Partnership should be
found to own, and to exploit, the Technology for its own account. (Genentech has spent approximately $8.1
million already on development of hGH and gamma intereron). Nonetheless, the IRS could argue that the
Partnership Purchase Option is essentially equivalent to an option to purchase the Technology, and further
that that option is the equivalent of a firm purchase contract on the theory that Genentech is almost certain
to exercise it. The General Partner believes that it is uncertain whether the Partnership Purchase Option
will be exercised, and Special Tax Counsel has therefore advised the Partnership that, although the matter is
not free from doubt, an IRS argument analagous to the holding in Helliwell should ultimately not succeed.
If, however, a court were to agree with such an argument by the IRS, Genentech or the General Partner,
rather than the Partnership, would be deemed to have incurred the research or experimental expenditures
and would be deemed to be the tax owner of the Technology. Disallowance of deductions by the Partnership
for research or experimental expenditures would result, and the Investors might also be denied the benefits of
the capital gain provisions and of Section 1231 (discussed below).
The IRS might also assert that the Partnership s activities, coupled with activities of Genentech or the
General Partner (or both), should be recharacterized as an informal partnership with Genentech or ,the
General Partner (or both), in which case the Partnership might be disallowed deductions for a portion of its
expenditures for research and experimentation and might not be treated as the tax owner of the Technology.
Special Tax Counsel believes, on balance, that such an assertion by the IRS should not prevail in court.
Partnership Expenditures
(a) Research and Experimental Expenditures
The partnership will elect under Section 1 74 of the Code to deduct its research and experimental
expenditures and thus will report its payments to Genentech pursuant to the Development Agreement as
deductions in the year paid. No ruling has been or will be sought from the IRS as to whether such payments
will be research or experimental expenditures that are currently deductible. It is the opinion of Special Tax
Counsel that, although the matter is not free from doubt, the Partnership should be entitled to deduct
substantially all of the research or experimental expenditures anticipated to be incurred and referred to in
the opinion of Special Tax Counsel. A substantial reduction in tax benefits from an investment in the
Partnership would result if, notwithstanding such opinion of counsel, it were ultimately determined that the
Partnership s payments for research and experimentation were not deductible.
Treas. Reg. 1.174-(a)(2) provides that a taxpayer may deduct as "research or experimental expendi
tures"
payments made to a third party to perform research on behalf of the taxpayer if certain requirements
are
satisfied, including the requirement that the third person s expenditures qualify as "research or experi
mental expenditures" within the meaning of Section 1 74 and the requirement in certain circumstances that
the expenditures be made at the taxpayer s risk. The General Partner believes, based upon the advice of
special Tax Counsel, that the expenditures made under the Development Agreement will be on behalf of the
Partnership and at the Partnership s risk.
43
226
Treas. Reg. 1.174-2(a)(l) defines "research or experimental expenditures" as those expendit?
incurred in connection with the taxpayer s trade or business that represent research and development co^i
ihe "experimental or laboratory sense," including generally all costs incident to the development ojjj
experimental or pilot model, a plant process, a product, a formula, an invention, or similar properly, andj
improvement of already existing property of the type mentioned. The Technology is expected to
co|
largely of rights to patents or patent applications previously developed by Genentech, the value of t
rights having been augmented primarily by the clinical testing for FDA approvals (if any) funded by
Partnership. The Treasury Regulations referred to above do not specifically indicate whether the te
"research or experimental expenditures" includes expenditures solely for clinical testing and regulate
approvals of a pharmaceutical compound (such as hGH or gamma interferon) which has already
developed. It is conceivable, therefore, that the IRS could challenge the Partnership s deductions ui
Section 174 for, its clinical testing expenditures (which constitute the majority of the Partnership s
ant]
paied expenditures) on the theory that Section 174 does not apply to expenditures for testing and regulai
approvals after a product already exists. Such a position would be contrary, however, to the IRS concliis]
in a National Office Technical Advice Memorandum, Doc. No. 8211004 (November 27, 198;
Furthermore, such a position may be inconsistent with Treas. Reg. 1.174-2(a)(l), which excludes fromj
definition of "research or experimental expenditures" any expenses for "ordinary testing or inspection.
materials or products for quality control," thus suggesting that expenses for clinical testing required in 01
10 market a pharmaceutical product would qualify. Special Tax Counsel has advised that, on balance,
does not believe the IRS should be successful if it attempted to exclude the Partnership s tlinical tesfi:
expenses from the scope of Section 174.
The Partnership Agreement requires the General Partner to use its best efforts to ensure that substai
tially all of the Partnership s expenditures will constitute research or experimental expenditures deductibl
under Section 174. Subject to uncertainty arising from the paucity of authority on the issue, and subject
the Partnership s commitment to expend substantial sums for clinical testing of the type described in tl
immediately preceding paragraph, the General Partner (based upon the advice of Special Tax Counsel!
anticipates that substantially all of the payments made to Genentech by the Partnership under the Develop
mem Agreement will constitute such expenditures.
Regulations under Section 174 provide that the costs of acquiring from another person a "patenj
model, production or process" are not "research or experimental expenditures" and therefore are not
rcntly deductible. Under the Development Agreement, the Partnership s first payment to Genentech wi
include a retainer fee in the amount of approximately $3,600,000. Under the Cross License Agreement, ll
Partnership will obtain certain rights as to patents previously developed by Genentech, in exchange for ri]
to use the Technology for applications other than sales of hGH and gamma interefon products in the Unit!
States. Apart from the rights conveyed under the Cross License Agreement, Genentech has already comi
menced some of the preliminary work of clinical tests necessary to the development of hGH. It is possibli
that the IRS may attempt to allocate a part of the retainer fee or of the other payments under the Develo]
ment Agreement to the Partnership s acquisition of rights under the Cross License Agreement or to
"patent, model, production or process"
which may have been created prior to the Closing Date. Genentecl
has represented that (i) the exchange of rights pursuant to the Cross License Agreement is a commercial);
reasonable exchange standing on its own, such as might be entered by two parties dealing at arm s length,
and (ii) on the Closing Date such preliminary work of clinical testing will not have progressed to the point.of;
creating any "patent, model, production or process"
or any other distinct "property" independent of the
underlying patents and patent applications, the value of which represents more than an insubstantial portion
of the retainer fee. Accordingly, Special Tax Counsel has advised the General Partner that, although the
matter is not free from doubt for the reasons discussed in this paragraph, substantially all of the Partner
ship s payments to Genentech will constitute "research or experimental expenditures" under Section 174.
Only research or experimental expenditures paid or incurred "in connection with a trade or business" of
the taxpayer are currently deductible under Section 174 of the Code. The Supreme Court in Snow v.
Commissioner, 416 U.S. 500 (1974), held that the taxpayer, a limited partner in a limited partnership that
had incurred research or experimental expenditures, could deduct his distributive share of such expenditures
44
227
even though the partnership had not yet sold or offered its technology or any products utilizing such
technology for sale, and therefore was not "engaged in a trade or business" within the meaning of Section
^j2, pf the Code. The partnership in Snow subsequently incorporated, and the successor corporation
irianufactured
and sold products utilizing technology developed by the partnership s research and experi-
iJ
mentai expenditures. Similarly, the Partnership will pay its research or experimental expenditures with a
view toward conducting a trade or business as a co-venturer with Genentech to manufacture and market
hGH and gamma interferon products. The conclusion that the Partnership will be in a trade or business at
that time is dependent upon the Joint Venture s constituting a partnership for Federal income tax purposes.
Special
Tax Counsel believes that the Joint Venture will constitute a partnership under current law because
(1) it will not possess more than two corporate characteristics within the meaning of the Treasury Regula
tions definition of "partnership," (2) Genentech and the Partnership will share net income and net losses,
and (3) the Partnership and Genentech will have exposure to real economic loss by reason of their capital
-
contributions to the Joint Venture, their ownership of other assets exposed to Joint Venture losses and the
requirement
in the Joint Venture Agreement that Genentech and the Partnership on the liquidation of the
Joint Venture contribute to it the amount of any negative balance in their capital accounts. It should be
noted, however, that the Partnership has no assurance that Genentech will exercise its option to enter into
the Joint Venture or that, if Genentech does not exercise that option, the Partnership will otherwise be in a
position
to manufacture or market hGH and gamma interferon products or any other product.
(.b) Alternative Minimum Tax
The Tax Equity and Fiscal Responsibility Act of 1982 (the "1982 Act") substantially revises the
alternative minimum tax for taxable .years beginning after December 31, 1982. One of the new items of tax
preference enumerated in Section 57 of the Code as amended by the 1982 Act is the excess of research and
experimental expenditures deductible under Section 174 of the Code over the amount which would be
deductible if an election were made to amortize those expenditures on a straight-line basis over a ten-year
period pursuant to new Section 58(i) of the Code. (In the case of expenditures incurred by a partnership, a
Section 58(i) election is made separately by each partner.) Assuming that no such election is made, a
substantial portion of the Section 174 deductions which a Limited Partner hopes to realize could be subject
to the alternative minimum tax. In addition to the research and development costs described above, the
preference items under the 1982 Act include (1) certain preferences which were subject to the add-on
minimum tax prior to the 1982 Act, (2) the deduction for long-term capital gains, (3) interest and dividend
income excluded under the $100 dividend exclusion, the All -Savers exclusion, and the 15-percent net
interest exclusion (which takes effect after 1984), (4) the excess of expensing over 120-month amortization
for mining exploration and development costs and magazine circulation expenditures and (5) the excess of
the fair market value of stock received upon the exercise of an incentive stock option over the exercise price.
Under the 1982 Act the alternative minimum tax for individuals will be the excess (if any) of (i) 20% times
any excess of "alternative minimum taxable income" over the exemption amount ($40,000 in the case of a
joint return, $30,000 in the case of unmarried individuals), over (ii) the "regular tax" for the taxable year.
(The 1982 Act eliminates the add-on minimum tax for individuals.) Since the amount of an Investor s
"alternative minimum taxable income" is dependent not only upon an investment in the Partnership but also
upon numerous other individual circumstances affecting that Investor, each potential investor is urged to
consult his own tax advisor and to weigh his own circumstances carefully with regard to the impact upon him
of the many potentially significant changes of the alternative minimum tax under the. 1982 Act.
(c) Timing of Deductions
As indicated above, the Partnership will elect under Section 1 74 of the Code to deduct its research or
experimental expenditures in the year paid. Since each payment by the Partnership to Genentech under the
Development Agreement, including the original retainer, will be based upon a reasonable estimate at that
time as to the current (in the case of the original retainer) or next fiscal period s required expenditures,
Special Tax Counsel believes that deduction of research or experimental expenditures by the Partnership
when paid will clearly reflect the income of the Partnership for Federal income tax purposes. However,
although Special Tax Counsel believes that such a result would be inconsistent with the policy of Section
45
228
174, the IRS might take the position that current deductions for payments by the Partnership to Geneh|
for research or experimentation do not clearly reflect income and therefore require deferral of
deduction^
such expenditures until the year in which the proceeds of those payments are spent by Genentech or
untilf
income associated with such expenditures is received. Moreover, even if income is
clearly reflected ai
Partnership level, it is possible that the IRS or a court would conclude that deductions at the partner li
materially distort income and require a deferral of such deductions. In either case, such a deferral c<3
result in a substantial reduction in the value of anticipated tax benefits to the Investors.
(d) Profit Objective and Section 183 of the Code
Section 183 of the Code provides generally for the disallowance of deductions resulting from activtf
of individuals, partnerships and Subchapter S corporations not engaged in for profit. The General Parw
believes that a profit-making motive is clearly present in the instant case, although there is no assurance tlj
the Partnership will earn a profit.
(e) Capital Expenses
Certain expenses paid or incurred by the Partnership will be capitalized and will not be
deductible^
the year paid or incurred. These expenses include organizational expenses related to the formation of 1
Partnership, which may be amortized over a period of not less than 60 months, beginning with the month t|
Partnership commences business, if a proper election is made under the Code. Any expenses incurred by i
Partnership with respect to the offering and sale of Partnership Interests are not deductible. Any otlj
expenses incurred by the Partnership prior to the time the Partnership is engaged in a trade or busine
within the meaning of Section 162 of the Code (by, for example, manufacturing and marketing hGH a
gamma interferon products), other than expenditures for research or experimentation, interest payments^
other expenditures the deduction of which is expressly allowed by the Code, will not be currently deductib|
but may be amortizable over a period of not less than 60 months beginning with the month the Partners!)
begins business if a proper election is made under the Code.
Research and Experimentation Tax Credit
The Economic Recovery Tax Act of 1981 (the "1981 Act") established a new tax credit in Section 4<
of the Code for incremental qualifying research and experimentation expenditures above the average of su<
expenditures during a base period. (This credit is independent of and in addition to the tax benefits
current deductibility under Section 174 of the Code.) Since the term "qualified research" for purposes"
? \
the credit is defined by reference to Section 174 of the Code, the payments from the Partnership fi <
Genentech which are deductible under Section 174 (as discussed above) will generally fall within the
sco|
of the credit. Unlike Section 1 74, however, which is available for expenditures incurred "in connection witji,
a trade or business, Section 44F makes eligible for the new credit only expenditures incurred "in
carryii
on" a trade or business. The legislative history of the 1981 Act indicates that Congress specifically intend*
to require the close connection between qualifying expenditures and a trade or business which is necessal
1
!
under Section 162, in contrast to the more liberal standard of Section 174. Therefore, despite the fact tha
there are significant uncertainties in the application of Section 44F to the Partnership, it is unlikely that t
new credit will be available to entities such as the Partnership which undertake research prior to the time
exploiting the resulting technology by engaging in marketing and sales. Furthermore, the credit is allowabl
only against the portion of a partner s tax attributable to the partnership s trade or business. According!}!
the written opinion of Special Tax Counsel (described above) will not cover the new credit, and potential
investors are advised not to rely upon any benefit from the new credit in determining the suitability of
a|
investment in the Partnership. It is possible, however, that the credit may be available in future years if t
Partnership is continuing its research and experimentation on some aspects of the Technology while t
Joint Venture is actively marketing and selling one or more products.
Income Realized from the Joint Venture
If Genentech exercises its option to enter into the Joint Venture with the Partnership, the Partnerships
taxable income or loss from the Joint Venture should be computed by including its distributive share of the
46
229
int Venture s items of income, gain, loss, deduction and credit. The income or loss realized by the Joint
>iii"ure
from the sale of hGH and gamma interferon products will constitute ordinary income or loss.
pf""
1
.
Income Realized from the Sale of the Interests
i. Wf^a)
Section 741 Capital Asset Treatment
t-
"
If Genentech purchases the Interests pursuant to the Partnership Purchase Agreement, the gain
Mirjognized by each Investor may qualify as long-term capital gain (except as discussed below) pursuant to
Section-
741 f tne Code. Although the proper characterization of any gain recognized by the Investors on
sueh a transfer of the Interests is not free from doubt, primarily because of the paucity of direct legal
authorities, it is the opinion of Special Tax Counsel that under existing law a court should hold that gain
(other
than that treated as interest income as described below or subject to the other specific exceptions
discussed below) recognized by the Investors on the transfer of their Interests pursuant to the Partnership
Purchase Agreement is gain from the sale of capital assets, but that the issue involves various questions
which are subject to interpretation by a court and there can be no assurance as to the outcome. The
exceptions referred to above are the following:
;,. ->
(1 ) A portion of the payments will be ordinary income to the extent of any stated interest pursuant
:,.
i to the Partnership Purchase Agreement and to the extent of any interest imputed on such payments
,
, i under Section 483 of the Code; the portion of each payment which constitutes interest will increase the
U longer the period of time between the sale of the Interests and receipt of the payment.
(2) To the extent that payments are attributable to any inventory of pharmaceutical products that
the Joint Venture holds on the date of purchase of the Interests, long-term capital gain treatment is
unlikely to be available. Genentech has represented, however, that it expects any such inventory to be
minimal in amount.
(3) To the extent that a particular Investor is, because of his activities apart from the Partnership,
a "dealer" in property such as the Technology, long-term capital gain treatment will be unavailable to
that Investor. * <
In order for an Investor s sale of his Interest to qualify for long-term capital gain treatment, the
following requirements must be met:
(i) The Interest must constitute a "capital
asset" in the hands of the Investor;
(ii) The Investor must have held the Interest for more than one year on the Purchase Date;
(iii) The disposition of the Interest must qualify as a "sale";
(iv) The gain must not be recharacterized as ordinary income pursuant to Section 751 of the Code
(dealing with substantially appreciated inventory items and unrealized receivables); and
(v) The sale by the Investors of their Interests must not be recharacterized as a sale of the
Technology by the Partnership (unless such a sale were determined independently to qualify for long-
term capital gain treatment).
Section 741 of the Code provides that gain or loss recognized by a partner upon sale or exchange of his
interest in a partnership will be considered gain or loss from the sale or exchange of a capital asset, thus
satisfying requirement (i) above. Since the Interests are not freely transferable, it is assumed for purposes of
this discussion that each Investor would have held his Interest more than one year on the Purchase Date,
thus
satisfying requirement (ii). Finally, since each Investor would be disposing of his entire Interest in
exchange for Genentech s obligation to make cash payments, the General Partner (based upon advice of
Special Tax Counsel) believe that a "sale" would have occurred, thus satisfying requirement (iii). There
fore, long-term capital gain treatment could only be precluded by Section 751 of the Code or by a
recharacterization of the transaction as a sale of the Technology by the Partnership. Even in the event of
such a recharacterization, long-term capital gain treatment would only be precluded if, and to the extent, it
were concluded that the sale of Technology did not constitute a transaction qualifying for long-term capital
gain treatment.
47
i
230
(b) Characterization under Section 751
Section 751 provides in effect that capital gain treatment is not available to the extent that a
transfef
partner receives money (or property) in exchange for a partnership interest which is attributable to "uni-et
ized receivables" as defined .therein, or "inventory items . . . which have appreciated substantially in valdl
as defined therein (referred to in this discussion as "Unrealized Receivables" and "Appreciated Inventory
respectively). Specifically, a partner will recognize ordinary gain or loss equal to the difference between
the amount realized that is attributable to his share of the partnership s Unrealized Receivables.^
Appreciated Inventory and (b) the basis that the partner s share of such property would have had in
hands if distributed in a current distribution immediately before the sale or exchange of his partnershl
interest. The difference between the balance of the partner s amount realized and the balance of his basis ifj
his partnership interest will be capital gain or loss. Thus, part or all of an Investor s gain on sale of Jj
Interest to Genentech would constitute ordinary income if the Partnership held (or was deemed to hold) ||
Unrealized Receivables or Appreciated Inventory on the Purchase Date.
The Joint Venture could conceivably hold some Unrealized Receivables on the Purchase Date in ti
form of receivables from outside purchasers of hGH and gamma interferon products which have bee!
delivered. It is likely that the Partnership s share of those Unrealized Receivables would be treated-^
Unrealized Receivables in its hands and thus would require characterization of Investors gain to that exteM
as ordinary income. Because the Joint Venture will employ an accrual method of accounting for taW
purposes, however, the Joint Venture is unlikely to possess any substantial rights to receive amounts if
payment for hGH and gamma interferon products delivered or to be delivered prior to recognition of thosf
amounts for tax purposes. Accordingly, the General Partner believes (based upon advice of Special Ta^
Counsel) that it is unlikely that the Partnership will be treated as holding, on the Purchase Date, more thalf
a minimal amount of Unrealized Receivables. .
4,
Appreciated Inventory is defined in Section 751(d) of the Code to include (if "substantiaM
appreciated") the following types of property which, in the hands of the partnership or the partner iff
question, would produce ordinary income if sold:
(A) "stock in trade" or "inventory" of the partnership, or property held by the partnership:
"primarily for sale to customers in the ordinary course of [the partnership s] trade or business;" .y
(B) any other property which, if sold by the partnership, would not qualify as a capital asset as;
defined in Section 1221 of the Code (a "Capital Asset") or as a depreciable asset used in the partner?
ship s trade or business as defined in Section 1231 of the Code (a "Section 1231 Asset"); ,|
r
(C) certain stock in foreign investment companies; or
(D) any property of the partnership which would fall into categories (A), (B) or (C) in the hands
of the transferor partner.
A
The Partnership s principal asset at the time of the Purchase Date would be its rights in the Technology.
Since the Technology is not stock in a foreign investment company, and since each Investor s particular
circumstances will impact whether the Technology might constitute Ordinary Income Property, as defined
below, in such Investor s hands, whether an Investor would recognize ordinary income under Section 751;
upon a sale of his Interest pursuant to the Partnership Purchase Agreement depends for purposes of this
discussion primarily upon whether the Technology in the hands of the Partnership would be property
described in categories (A) or (B) above (referred to herein as "Ordinary Income Property"). ii
The Technology would not constitute "inventory" or "stock in trade" of the Partnership within the
meaning of Section 751. The Technology will nonetheless be Ordinary Income Property in the hands of the
Partnership if (1) it is property held by the Partnership primarily for sale to customers in the ordinary course
of the Partnership s trade or business, or (2) property such as that involved in Corn Products Refining
Company v. Commissioner. 350 U.S. 52 (1955), that is, property not held as an investment in order to profit
from its appreciation in value but instead held and sold as part of the everyday operation of a business. The
Supreme Court in Malat \. Riddell, 383 U.S. 596 (1966), indicated that property held for the dual purposes
48
231
or development may constitute a Capital Asset, depending on the facts, and stated that the purpose of
st$i
!
<stat<utory provision is to differentiate between the "profits and losses arising from the everyday operation
j Bf-the business" and the "realization of appreciation in value accrued over a substantial period of time."
:
3%6 courts in some cases have found that property was Ordinary Income Property even when the taxpayer
tfgtiuired and disposed of only a single property, as, for example, in a situation in which there was a
committed buyer for such property prior to its acquisition by the taxpayer. The IRS could conceivably
assert on either of the foregoing grounds that the Technology is Ordinary Income Property by arguing that
the primary purpose of the Partnership was to sell the Technology, and that the sale occurred in the ordinary
cburse of the Partnership s trade or business. It is possible that a court would hold in favor of the IRS. Such
an argument would have to ignore the facts that the form of the contemplated transactions contemplates
that the Partnership will dispose of the Technology by contribution to the Joint Venture, that the Joint
Venture will not hold the Technology for sale, and that only upon the uncertain decision of Genentech may
the Interests (as distinguished from the Technology) be acquired by Genentech. Furthermore, the Tax
Court in Carmelo Ofria, 77 T.C. No. 38 (August 31, 1981), recently held that certain trade secrets and
know-how, although created exclusively for sale to a particular purchaser, were nonetheless Capital Asset.\
and that the proceeds of that sale constituted long-term capital gain. This case strengthens the Partne^bijVs
position
that the Technology would constitute property of a type qualifying for long-term capital gain
treatment. The IRS might also argue that since the Partnership will cease to exist for tax purposes upon
Genentech s purchase of all the Interests, that transaction is the equivalent of a sale by the Partnership of
the Technology. In that case, the Partnership might be said to have held the Technology "primarily for sale
to customers in the ordinary course of [its] trade or business," since the exercise of the Partnership Purchase
Option was at least a possibility from the inception of the Partnership, and the Partnership is a party to the
Joint Venture and Partnership Purchase Option Agreement (pursuant to which the Partnership Purchase
Option arises). On balance, however, Special Tax Counsel does not believe that the IRS should succeed in
such assertion, principally because the Partnership would not in fact hold the Technology for sale despite the
fact that Genentech s purchase of the Interests pursuant to the Partnership Purchase Agreement may1
be
characterized for certain tax purposes as a direct purchase of the Technology.
In addition, copyrights created by the personal efforts of the taxpayer and letters, memoranda and
similar property (including research papers and drawings), whether prepared by the taxpayer s personal
efforts or prepared or produced for the taxpayer, constitute Ordinary Income Property. Although the
question is not free from doubt, the General Partner believes that items of the Technology constituting
copyrights, letters, memoranda, and similar property will not constitute Ordinary Income Property, because
they will not be created by the "personal efforts" of the Partnership or any Investor and are not the type of
memoranda, research papers and drawings to which Sections 1231(b)(l)(C) and 1221(3) apply.
If the Technology is not Ordinary Income Property, Special Tax Counsel believes that substantially all
of the items which constitute part of the Technology that are not Ordinary Income Property should consti
tute depreciable property used in the Partnership s trade or business, that is, Section 1231 Assets. Such
property should be used in a trade or business of the Partnership if Genentech exercises its option to enter
into the Joint Venture with the Partnership or if the Partnership otherwise uses the Technology to manufac
ture hGH or gamma interferon products. Patents are property of a character which is subject to the
allowance for depreciation, and other intangible property is of that character if it has a limited useful life the
length of which can be estimated with reasonable accuracy. Subject to the rules discussed below, gain
recognized on a hypothetical sale or exchange of Section 1231 Assets would be eligible for treatment by the
Investors as long-term capital gain.
Items constituting part of the Technology that are not Ordinary Income Property and that are not of a
character which is subject to the allowance for depreciation should constitute Capital Assets. Gain
recognized on a hypothetical sale or exchange of such items would be taxable to the Investors as long-term
capital gain if such items have been held by the Partnership for more than one year at the time of the sale or
exchange.
49
232
The IRS could conceivably argue that Appreciated Inventory includes not only the categories of as|
specifically set forth in Section 751 of the Code (described in (A), (B), (C) and (D) above) but also-i
other asset of the Partnership which would result in ordinary income to the Partnership upon its disposit;
Special Tax Counsel has advised the General Partner that, although the matter is not free from doubt,.
IRS should not succeed with such a theory. If, however, the IRS were to raise such an argument, there,
several theories pursuant to which a hypothetical sale by the Partnership of the Technology would result
ordinary income (apart from treatment of the Technology as Ordinary Income Property). Specifically, siii
a sale would result in ordinary income if and to the extent that any of the following conditions exist:
(i) The Technology does not constitute "property"
for Federal income tax purposes;
(ii) The Partnership has held the Technology for one year or less at the time of sale; or
(iii) The tax benefit rule applies to recharacterize capital gain as ordinary income.
The following paragraphs discuss the implications of each of these requirements for characterizing gi
on the sale of the Technology as long-term capital gain.
"Property".
To avoid ordinary income treatment upon a hypothetical sale, the Technology would
to constitute "property"
for Federal income tax purposes. The Technology is anticipated to consist of rig;
in certain trade secrets, proprietary information, know-how and possibly also copyrights, and exclusive ri;
in certain patents (or patent applications), with each such right being limited to that right necessary
engage in certain fields of use and geographical areas (and, in the case of rights necessary for the u
manufacture or sale of hGH, each such right being subject to the nonexclusive right of a third person ins
trade secrets, proprietary information, know-how, copyrights and patents (or patent applications) to
manufacture and sell hGH, which right begins ten years after the first commercial sale of hGH
Genentech or any affiliate or licensee of Genentech). For a trade secret to constitute "property"
for Federl
income tax purposes, it must be secret and may also have to be in the nature of a patentable invention,
afforded substantial legal protection against unauthorized disclosure and use, and may have to confi
competitive advantage. The standards for determining whether know-how and other proprietary inform]
tion constitute "property"
for Federal income tax purposes are not well developed or clearly defined. Suf
information may have to meet standards comparable to those for a trade secret, although in several cases tl
courts have concluded that certain types of such information are property where they facilitate the use of,i
are ancillary and subsidiary to, for example, trade secrets or patents. Patents (or patent applications) ar
copyrights constitute "property"
for Federal income tax purposes. Although there is little or no relevaj
authority, exclusive rights to patents or patent applications within certain geographical areas and fields I
use may also constitute "property," although there is no assurance that the IRS would not take a contraf
position on this point. Although the question is not free from doubt, the General Partner believes, on
advic|
from Special Tax Counsel, that substantially all of the Technology (with the possible exception of
certaij
unpatented information disclosed on patent applications) will qualify as "property" for Federal income u|
purposes and will take all necessary and appropriate actions to protect the secrecy of and proprietary righ|
to all of the Technology with a view toward ensuring that it continues to constitute "property."
$&
Holding Period. As indicated above, in order for gain on a hypothetical sale of the TechnologyJ
qualify as long-term capital gain, the Technology must have been held by the Partnership for more than o||
year at the time of the sale. Court decisions indicate that a taxpayer s holding period for an inventioii
developed by the taxpayer begins when the invention is "reduced to practice." Genentech s option to
ent|
into the Joint Venture does not arise until at least one of the hGH or gamma interferon products is ready fit
commercial production and sale, indicating that the Technology for that product must have been "reduc^l
to practice."
Since Genentech s option to purchase the Interests becomes exercisable no earlier than t|
years after it enters into the Joint Venture, and, unless four years shall have passed, only after net profitsjf
an amount equal to not less than 15% of the capital contributions of the Investors shall have been distribute?
to the Partnership, the one-year holding period requirement should be satisfied as to the Technology for tMJ
product. However, the IRS could possibly assert that the Technology was "reduced to practice"
at a dif
later than the date determined under the Partnership Purchase Agreement. Furthermore, although tw
Partnership intends to develop the Technology for all products as promptly as possible, there can bef|
50
233
l ranee that the Technology as to other products will have been "reduced to practice" more than one year
f f
*S
or to the date of the Partnership Purchase Agreement. Accordingly, it is possible that a substantial part
Tthe Technology would not qualify for long-term capital gain treatment upon a hypothetical sale. The IRS
could conceivably argue on the theory described above, therefore, that a substantial part of the Technology
C
hould be treated as Appreciated Inventory, thus causing a corresponding portion of the Investors gain on
S
le of their Interests to be characterized as ordinary income. Special Tax Counsel has advised the Partner-
:
j y however, that it believes the IRS is unlikely to succeed with such an argument, since under Section 741
and 751 a partner s holding period for his partnership interest should determine whether any gain or loss is
long-term or short-term, regardless of the partnership s holding period for its assets.
Tax Benefit Rule. In Rev. Rul. 72-528, 1972-2 C.B. 481, the IRS ruled that an insurance recovery
with respect to a pilot model whose costs were deducted under Section 174 was taxable under the tax benefit
rule as ordinary income. The tax benefit rule characterizes as ordinary income the recovery of an amount
deducted in a prior taxable year to the extent it decreased the taxpayer s taxable income. Special Tax
Counsel believes that this revenue ruling is distinguishable from a hypothetical sale or exchange of the
Technology by the Partnership because there would not be a recovery of the identical items that were
deducted as research or experimental expenditures, and that the tax benefit rule should not apply to
recharacterize as ordinary income gain otherwise taxable as capital gain on a sale of the Technology.
Nevertheless, this ruling indicates that the IRS may assert that the tax benefit rule should apply to
recharacterize the Partnership s gain from a hypothetical sale or exchange of the Technology as ordinary
income to the extent of the Partnership s previous deductions for research or experimental expenditures.
(c) Interest on Deferred Payments
Apart from characterization of gain under Section 751 as ordinary income, a portion of the deferred
payments received by the Investors on a sale of Interests to Genentech pursuant to the Partnership Purchase
Agreement will be characterized as interest income and taxable as ordinary income. Under Section 483 of
the Code and Regulations thereunder, if some or all of the payments due under certain contracts of sale are
due more than one year after the date of sale, and if the contract does not state interest at a rate of at least
9% per annum simple interest on payments deferred more than six months from the date of sale, that portion
of such payments which, when added to stated interest, is equal to interest at a rate of 10% per annum
compounded semi-annually on the remaining portion of the payments, will be treated as interest. When the
due date or the amount of a deferred payment cannot be determined at the time of a sale or exchange, the
computation of imputed interest is determined separately for each payment, and the amount is calculated
from the date of sale to the date payment is made.
The Partnership Purchase Agreement provides that Genentech and the Partnership will determine a
rate of interest to be used in computing the amount of the portion of each payment to be treated as interest.
It is
anticipated that this rate of interest will correspond to the 9% simple interest rate that the Regulations
currently provide must be stated to avoid imputed interest at the 10% rate compounded semiannually under
those Regulations. If the IRS were to contend successfully that taxpayers may not "state" an interest rate in
this manner for payments whose amounts and whose due dates are contingent, interest would be imputed
under Section 483 at the then applicable higher imputed rate on payments received by the Investors more
than six months after the Partnership Purchase Date.
If the Partnership were to sell the Technology to a third person, the foregoing discussion will apply if
and to the extent the sale agreement provides for at least one deferred payment more than one year after the
date of sale and provides for the requisite stated interest under the applicable Regulations for payments
made more than six months after the date of sale. If the sale agreement does not provide for the minimum
stated interest, Section 483 will treat as interest a portion of each payment made more than six months after
the date of sale under the imputed interest rate applicable at the time of sale.
Prospective investors should note that both the Partnership Purchase Agreement and Section 483
(where the sale contract provides for no stated interest or insufficient stated interest) treat as interest a
greater portion of a deferred payment whose due date or amount cannot be determined at the time of sale
51
234 I
the longer the period of time the payment is made after the date of sale. Thus, a substantial portion of
payments the Investors receive from. a sale of the Interests to Genentech pursuant to the
Partnership
Purchase Agreement may constitute interest taxable as ordinary income at rates as high as
Classification as a "Partnership"
Treatment of the Partnership as a "partnership"
for Federal income tax purposes is essential to the
Investors ability to deduct their distributive shares of any Partnership tax deductions or losses and to
include in their income their distributive shares of any income or gains of the Partnership. Treasury
Regulations provide that an organization such as the Partnership will be treated as a partnership for Federal
income tax purposes (rather than an association taxable as a corporation) unless the organization has more
than two of the following corporate characteristics: (1) limited liability, (2) free transferability of interests,
(3) continuity of life and (4) centralization of management. Based upon the General Partner s satisfying the
minimum net worth requirements of Rev. Proc. 72-13, 1972-1 C.B. 735, the Partnership should not be
deemed to possess limited liability. Because transfer of an Investor s Interest requires the consent of the
General Partner (in its sole discretion) under Section 8.3.1 of the Partnership Agreement, the Partnership
lacks free transferability of Interests. Accordingly, it is the opinion of Special Tax Counsel that the
Partnership will constitute a partnership and not an association for Federal income tax purposes.
If, notwithstanding the opinion of Special Tax Counsel, the Partnership were treated as an association
taxable as a corporation instead of as a partnership, no part of the income and deductions of the Partnership
would flow through to the Investors, and the Partnership would pay Federal income tax at corporate tax
rates on its taxable income. Tax payable by the Partnership would reduce the amount available to be
distributed to the Investors. Amounts distributed to the Investors would be treated as ordinary dividend
income to the extent of the Partnership s current and accumulated earnings and profits and would not be
deductible by the Partnership in computing its tax liability.
Federal Income Taxation of Partnerships and Partners Generally
Partners, not Partnership. Subject to Tax. If treated as a partnership for Federal income tax purposes;
the Partnership as an entity will not pay Federal income tax. and each partner will be required to report oif
his Federal income tax return his distributive share of the income, gains, losses, deductions and credits of the:
Partnership for the taxable year of the Partnership ending within or with the taxable year of the partner. A
partner is taxable on partnership income or gain whether or not any distribution of money or property is
made to the partner during his taxable year, and therefore a partner s income or tax liability related to
transactions by the Partnership could exceed any amounts distributed to him by the Partnership in a
particular year. ;
"i"
Allocation of Partnership Profits and Losses for Tax Purposes. The Partnership Agreement allocates.:
the income, gains, losses, deductions and credits of the Partnership, 1% to the General Partner and 99% to
the Limited Partners, until an aggregate of 100% of the Limited Partners original investment has been.
allocated and distributed to the Limited Partners, after which 1 % of the Parnership s income, gains, losses,
deductions and credits will be allocated to the General Partner, 5% of the Partnership s net gains will be
allocated to the Class B Limited Partner, and the remainder of the Partnership s income, gains, losses,
deductions and credits will be allocated to the Limited Partners. Within each of these groups each item is
:
allocated among the partners based on the amounts in their capital accounts and on the portion of the
:
Partnership s taxable year that each partner is a member of the Partnership. See "Summary of the Limited-
Partnership Agreement." A partner s distributive share of a partnership s income, gain, deduction, loss
credit for Federal income tax purposes is generally determined in accordance with the provisions of
partnership agreement, and Special Tax Counsel believes that the partners distributive shares of
Partnership s items of income, gain, deduction, loss or credit for Federal tax purposes will be determined in
g
accordance with the allocations described above.
a
Limitations on Deductions of Partnership Losses; Basis in Partnership Interests. A partner is
entitlefTjj
to deduct on his Federal income tax return his distributive share of a partnership loss, but not in excess of his
adjusted, basis in his partnership interest at the end of the taxable year of the partnership in which such losi|
52
235
occurs. If a partner s distributive share of a partnership loss for any partnership taxable year exceeds the
Dartner s a(jj
usted basis in his partnership interest at the end of that taxable year, such excess may not be
deducted at that time but may be carried over and deducted in any later year if and to the extent the
partner s adjusted basis in his partnership interest at the end of the later taxable year otherwise exceeds zero.
Generally, a partner s adjusted basis in his partnership interest is equal to the amount of cash (or the
amount of the adjusted basis in any property) he contributed to the partnership, plus his share of the
partnership s liabilities, decreased (but not below zero) by distributions to the partner from the partnership
(including
constructive cash distributions resulting from a decrease in partnership liabilities) and by the
partner s distributive share for the taxable year and prior taxable years of losses of the partnership, and
increased by his distributive share for the taxable year and prior taxable years of partnership taxable
income. Thus, an Investor s adjusted basis for his Interest will be reduced in the amount of that portion of
the Investor s contributions to the Partnership which are deductible under Section 174. Accordingly, it can
be anticipated that, after the development period, each Investor s adjusted basis for his Interest will be very
low.
Distributions from Partnership. Cash distributions from a partnership to a partner are generally not
equivalent to partnership income as determined for Federal income tax purposes or as determined under
generally accepted accounting principles. If the amount of a distribution to a partner by the partnership
(which constructively includes, as indicated above, any decrease in the partner s share of liabilities of the
partnership) does not exceed the partner s adjusted basis in his partnership interest immediately before the
distribution, the distribution does not constitute income to the partner for Federal income tax purposes but
reduces the partner s adjusted basis in his partnership interest. However, if the amount of a distribution to a
partner in any taxable year of the partnership exceeds the partner s adjusted basis in his partnership interest
immediately before the distribution, the excess is taxable to the partner as though it were gain recognized on
the sale or exchange of the partner s interest.
Transfer of Partnership Interest. The sale or exchange of a partnership interest tan result in the
recognition of both ordinary gain or loss and capital gain or loss, as discussed in greater detail above. An
appropriate amount determined pursuant to Section 751 of the Code (based upon the partnership s Unreal
ized Receivables and Appreciated Inventory, if any) will be characterized as ordinary income, and the
balance of gain recognized by the partner will be characterized as capital gain. .
Such gain will be long-term
capital gain if the partner has held his partnership interest for more than one year at the time of the sale or
exchange. As indicated above, no assurance can be given that the IRS will not assert that the Partnership
holds Appreciated Inventory or Unrealized Receivables. If the IRS successfully maintained such an argu
ment, a significant portion or all of the gain recognized by an Investor on a sale or exchange of his Interest
would constitute ordinary income rather than capital gain.
Election to Adjust Basis of Partnership Assets. Pursuant to Section 754 of the Code, a partnership
may make an election to adjust the basis of the partnership s assets in the event of a distribution of
partnership property to a partner, a sale by a partner of his interest in the partnership or the death of a
partner. Depending upon particular facts at the time of any such event, such an election could increase or
decrease the value of a partnership interest to the transferee, because the election would increase or decrease
the basis of the partnership s assets for the purpose of computing the transferee s distributive share of
partnership income, gains, deductions and losses. The Partnership Agreement authorizes the General
Partner to make such an election. However, because the election, once made, cannot be revoked without
obtaining the consent of the Commissioner of Internal Revenue and because of the accounting complexities
that can result from having such an election in effect, there can be no assurance that the General Partner
will make this election.
New Rules for IRS and Court Determination of Partnership Tax Items. The Tax Treatment of
Partnership Items Act of 1982 (the "1982 Partnership Act") establishes significant changes in the treatment
of
partnership tax items in the event of administrative proceedings before the IRS and litigation in court,
which changes will be applicable to the Partnership. Whereas under prior law the IRS audit procedure and
court litigation of partnership items occurred exclusively at the partner level (thus permitting inconsistent
53
236
treatment of partnership items by two different partners in the same partnership), the 1982 Partnership \~
provides generally that the tax treatment of partnership items will be determined at the
partnership levei
Investors will generally be required to file their tax returns in a manner consistent with the
information
returns filed by the Partnership, unless the Investor in question files a statement with his tax return describ-
ing any inconsistency. The General Partner will be the Partnership s "tax matters partner" and as such wj||
have certain responsibilities with respect to any IRS audit and any court litigation relating to the Partner
ship, including in some circumstances the right to reach settlement agreements which will be binding on all
partners. In general, the 1982 Partnership Act will reduce somewhat the individual control which an
Investor will have over IRS audit and court litigation of Partnership issues as compared with the degree of
individual control which partners have had in the past. Each potential investor should consult his own tax
advisor as to the likely impact of these new procedural rules upon him.
Other Federal Income Tax Provisions Relevant to an
Investment in the Partnership
Capital Gains and Losses. Under current law, a noncorporate partner may deduct from gross income
60% of any net capital gain for the taxable year (the excess of his net long-term capital gain for the taxable
year over his net short-term capital loss for such year). The non-deducted 40% of net capital gain is
subject
to taxation at the noncorporate partner s otherwise applicable rates. Since the 1981 .Act reduced the
maximum marginal tax rate for noncorporate taxpayers beginning in 1982 from 70% to 50%, the resulting
maximum rate of taxation on the net capital gain of a noncorporate partner will be 20%. In the case of a
noncorporate partner, the deductible portion of net capital gain for a taxable year may be subject to the
alternative minimum tax imposed by Section 55 of the Code at rates of 10-20% in 1982, and at the rate of
20% subsequently. A-corporate taxpayer is subject to tax on net capital gain at the lesser of 28% and the
applicable tax rate under Section 1 1 of the Code. In the case of a corporate partner, a portion of net capital
gain for a taxable year is an item of tax preference that may also be subject to the minimum tax imposed by
Section 56 of the Code.
Limitation on Interest Deductions. Limitations exist on the deducibility of interest on funds borrowed
to acquire or carry investment assets ("Investment Interest"). Interest on a loan incurred by an Investor to
purchase or carry an Interest will constitute Investment Interest and may be subject to these limitations. In
general, Investment Interest is deductible by an individual taxpayer only to the extent that it does not exceed
the sum of (i) $10,000 for a single individual or married persons filing a joint return ($5,000 for a married
person filing a separate return), plus (ii) "net investment income," that is, the excess of (a) the gross income
from interest, dividends, rents, royalties, net short-term capital gain attributable to the disposition of
property held for investment, and recapture of depreciation and intangible drilling costs over (b) expenses,
excluding the interest expense, incurred in earning such income. The applicability of the investment interest
limitation to an Investor will depend upon his overall investment situation. The investment interest limita
tion is not applicable to corporations, other than "subchapter S"
corporations.
Foreign Taxpayers. Investors who are foreign taxpayers as to the United States, such as nonresident
aliens, foreign corporations, and foreign trusts and estates ("Foreign Taxpayers"), will be considered as
being engaged in a trade or business in the United States after the Partnership s trade or business com
mences. If Genentech exercises its option to enter into the Joint Venture, or if the Partnership otherwise
uses the Technology in a trade or business, the distributive share of a Foreign Taxpayer in income received
by the Partnership from such use of the Technology may be effectively connected with the conduct of that
;:|
trade or business and taxable as ordinary income to the Foreign Taxpayer at rates as high as 50%. If th f
Partnership licenses the Technology of sells the Technology to a third party pursuant to a contract having -I
purchase price more than half of which in the taxable year is contingent on the productivity, use or disposal
tion of the Technology, the distributive share of a Foreign Taxpayer in such income may be subject to||
United States withholding tax at a rate of 30% of the gross amount of such income (subject to reduction 1
an income tax convention between the United States and another country which applies to the ForeigQj
Taxpayer) or may be income effectively connected with the trade or business of the Partnership, and thus (
the Foreign Taxpayer, and taxable at rates depending on whether it is capital gain or ordinary income.
54
237
lExpayer should sell his Interest to Genentech pursuant to the Partnership Purchase Agree-
fffqrijthat
sale would be taxable to the Foreign Taxpayer in the same manner as other Investors
IpTaxpayer is engaged in a trade or business in the United States for its taxable year in which
Igj/ecejved ancj jf those payments are "effectively connected with" that trade or business. If
ffxinases its rights under the Partnership Purchase Option, the first payment received by any
&stor
?
will be treated as effectively connected with a U.S. trade or business. Payments received in
years of that Foreign Investor, however, may avoid such treatment if the Foreign Inves-
in a trade or business in the United States. In that case, those payments to the
to the sale of his Interest may be subject to U.S. withholding tax or conceivably
Federal income tax entirely.
Returns and Schedules. The Partnership will file an information return on IRS Form
iirprovide information on Schedule K-l to each partner following the close of the Partnership s
;vestor
All of the tax discussion herein and the opinion of Special Tax Counsel as to Federal
[ "matters discussed above are based upon the law as of the date hereof. There can be no assurance
^"changes
in the Code, Regulations, IRS rulings or judicial decisions will not have the effect of
;
ly reducing the tax benefits associated with investments in the Partnership.
State and Local Taxes
ir&tftdition to the Federal income tax consequences described above, prospective Investors should
consitfel^he potential state and local tax consequences of an investment in the Partnership.
depefiding on the location of the Partnership s business and the applicable state and local tax laws,
sofrie*Hedubtions and credits that are available to Investors for Federal income tax purposes may not be
available for state or local tax purposes. Each prospective investor is advised to consult his own tax advisor
to determine if and to what extent his distributive share of the income, gains, losses, deductions and credits
of the Partnership would have tax consequences in the state and locality in which he is a resident.
the Partnership will be formed under the laws of, and will carry on most of its business in, California,
where it will file appropriate tax returns. Although not presently contemplated, the Partnership may operate
in dthef states or jurisdictions which impose taxes with respect to the activities or income of the Partnership.
To the extent that the Partnership operates in such other jurisdictions, it may itself be subject to tax liability.
In addition, Investors may be subject to tax return filing obligations and income, franchise, estate, inher
itance or other taxes in jurisdictions in which the Partnership does business, as well as in their own states or
localities of residence or domicile.
Importance of Obtaining Professional Advice
The foregoing analysis is not intended as a substitute for careful tax planning, particularly since the
income tax consequences of an investment in the Partnership are complex and certain of these consequences
could vary significantly with the particular situation of each prospective investor. Accordingly, prospective
investors are strongly urged to consult their tax advisors with specific reference to their own situations
regarding the possible tax consequences of investment in the Partnership.
SUBSCRIPTION PROCEDURES
In order to subscribe for Units, each prospective investor will be required to complete, execute and
deliver the following to a Sales Agent as indicated in the subscription materials:
1. Two copies of the Subscription Agreement, which makes certain representations concerning
such investor s
subscription;
2. A certified or official bank check payable to Genentech Clinical Partners, Ltd., a Limited
Partnership Escrow Account, in the amount of $50,000 for each Unit subscribed for, or alternatively,
if the investor has selected the deferred payment option, a certified or official bank check in the amount
of $9,091 and an investor note (the "Investor Note") in the amount of $40,909 for each Unit subscribed
55
238
for, with, in the case of subscriptions of partial Units, a proportionate reduction of the
foregoj
amounts;
ling
3. The appropriate Prospective Purchaser Questionnaire and related subscription materials; and
4. Two counterpart signature pages to the Limited Partnership Agreement.
The cash payment of each prospective investor accompanying the Subscription Agreement will be
deposited in a segregated, interest-bearing escrow account (the "Escrow Account") with Bank of America
National Trust and Savings Association, as Escrow Agent (the "Escrow Agent").
Such cash, together with
any Investor Note of such investor, will be held by such Escrow Agent pursuant to the terms of the Escrow
Agreement dated as of October 1, 1982, among the Partnership, the Sales Agents and the Escrow Agent
(the "Escrow Agreement"). If investors have not been admitted to the Partnership by November 30, 1982
the date this offering will terminate (which date may be advanced for a period of time not exceeding fifteen
days or extended by the Sales Agents, after consultation with the General Partner, for a period of time noi
exceeding thirty-one days), the Escrow Agent will return to the investors the full cash amount, with accrued
interest thereon, together with any Investor Notes. Upon the admission of the investors to the
Partnership,
such investors. shall become Class A Limited Partners. Subscription amounts (and any interest accrued
thereon) of subscribers who become Class A Limited Partners will be transferred to the Partnership upon
consummation of this offering.
The Escrow Agent will have the authority to invest the funds in the Escrow Account and to disburse
funds received in the account and earnings thereon. However, the Escrow Agent will have no responsibilities
in respect of the acceptance or rejection of subscriptions or the adequacy of any documents.
The Subscription Agreement executed by each Investor grants the Partnership a security interest in the
Investor s Interest to secure his obligations to the Partnership under his Investor Note.
Two-Day Rescission Right for Pennsylvania Residents. The Partnership has filed, and will amend as
necessary, a notice of exemption as required by Section 203(d) of the Pennsylvania Securities Act of 1972
(the "Pennsylvania Act"). Section 207(m) of the Pennsylvania Act provides that any purchaser of securities
in Pennsylvania, if such securities are exempted from registration pursuant to Section 203(d) of the Penn
sylvania Act, may withdraw his purchase agreement and receive a full refund of all moneys paid, within two
business days after he enters into a binding contract of purchase, or makes any payment for the securities
being offered or the exemption becomes effective, whichever is later. Therefore, any Pennsylvania resident
who has executed a Subscription Agreement, paid the purchase price for the Interests or paid the first
installment and delivered his Investor Note, and received notification that a notice of exemption has been
filed, is entitled to exercise the statutory rescission right within two business days after the later of (i)
delivery of his cash payment or Investor -Note and (ii) the execution of his Subscription Agreement. Such
investor may exercise such right by telephone, telegram or letter notice to Cooley, Godward, Castro, Hud-
dleson & Tatum, counsel for the Partnership, Five Palo Alto Square, Suite 400, Palo Alto, California 943W
(telephone (415) 494-7622), attention: Lee F. Benton, Esq. Any telegram or letter should be sent of
postmarked prior to the end of such second business day. Any letter should be mailed by certified mail
return receipt requested, to ensure its receipt and to evidence the time of mailing. Any oral requests should
be confirmed in writing.
A condition of compliance with the Pennsylvania Act in connection with this offering is that each
purchaser in Pennsylvania must agree not to sell his Interest within 12 months after the date of purchast
The Subscription Agreement contains such a provision. In addition to the one-year restriction, the Subscrip
tion Agreement contains a representation by all Investors that they are not purchasing with a view to
distribution.
Three-Day Rescission Right for Florida Residents. Section 517.061(1 l)(e) of the Florida Securiii*
Act (the "Florida Act") provides that any purchaser of securities in Florida, if such securities are exempt"
from registration under Section 517.061 of the Florida Act, may withdraw his subscription agreement
aid
receive a full refund of all moneys paid, within three business days after he purchases such securiti
Therefore, any Florida resident who purchases an Interest is entitled to exercise the foregoing statutory
rescission right prior to three business days after purchasing such Interest by telephone, telegram or
56
239-
tice to Cooley, Godward, Castro, Huddleson & Tatum, counsel to the Partnership, Five Palo Alto Square.
Suite 400, Palo Alto, California 94304 (telephone (415) 494-7622), attention: Lee F. Benton, Esq. Any
leeram or letter should be sent or postmarked prior to the end of such third business day. Any letter
should be mailed by certified mail, return receipt requested, to ensure its receipt and to evidence the time of
mailing. Any oral requests should be confirmed in writing.
TRANSFERABILITY OF INTERESTS
The Interests are subject to strict limitations upon transferability pursuant to the terms of the Partner
ship Agreement. An Investor may assign his Interest to qualified investors only if certain conditions are
satisfied. The assignee must, at the time of the assignment, meet all suitability standards as set forth above
under the caption "Suitability Standards", and other requirements applicable to the original Investors and
must consent in writing, in form satisfactory to the General Partner, to be bound by all the terms of the
Partnership Agreement. Immediately after the assignment, neither the assignee nor the assignor, if the
assignor retained any part of his Interest, may hold less than $100,000 in Interest. The assignor must have
paid in full, in cash, his capital contribution. Counsel for the assignee must have delivered an opinion (which
counsel and opinion are satisfactory to counsel for the General Partner) that such Interest may be legally
sold or distributed in compliance with then-applicable State and Federal statutes. The General Partner
must have consented in writing to the assignment, which consent may be withheld in its absolute discretion.
In any event, no assignment may be made which, in the opinion of counsel to the Partnership, would cause a
termination of the Partnership for the purposes of the Internal Revenue Code or would violate any appli
cable governmental rule or regulation, including, without limitation, any applicable Federal or State securi
ties law. Upon request of the General Partner, the assignor will pay all reasonable expenses, including
attorneys fees, incurred by the Partnership in connection with the assignment of the Interest. Any
purported assignment which is not in compliance with the Partnership Agreement is null and void and of no
force or effect whatsoever. No assignment to a minor (except in trust or pursuant to the Uniform Gifts to
Minors Act) or to an incompetent shall be effective.
Any sale or transfer of an Interest, or any interest therein, in California or involving a California
resident requires the prior written consent of the Commissioner of Corporations of the State of California,
except as provided in the Commissioner s Rules. Additionally, the Subscription Agreement will bear the
following legend:
"IT IS UNLAWFUL TO CONSUMMATE A SALE OR TRANSFER OF THIS SECURITY.
OR ANY INTEREST THEREIN, OR TO RECEIVE ANY CONSIDERATION THEREFOR.
WITHOUT THE PRIOR WRITTEN CONSENT OF THE COMMISSIONER 6F CORPORA
TIONS OF THE STATE OF CALIFORNIA, EXCEPT AS PERMITTED IN THE COMMIS
SIONER S RULES."
The assignee of an Interest does not become a Limited Partner by virtue of such assignment, and
obtains no rights other than the right to receive, after the effective date of the assignment, distributions from
the Partnership and to receive allocations of the profits or losses of the Partnership. A" assignee of an
Interest may become a substituted Limited Partner only upon the written consent of the General Partner.
which may be withheld in its absolute discretion. In any event, such consent shall be given only if the
assignee executes and acknowledges such instruments as the General Partner deems necessary or desirable
to give effect to such substitution. The substituted Limited Partner shall pay all reasonable expenses,
including attorney s fees, incurred by the Partnership in connection with such substitution of the Limited
Partner.
In addition to the restrictions on the transferability of the Interests set forth in the Partnership Agree
ment as described above, the alienability of the Interests is further restricted by the Securities Act of 1933.
A registration statement has not been filed with the Securities and Exchange Commission ("SEC")
in
connection with this offering. The Interests are being privately offered pursuant to an exemption from the
registration requirements. The Interests must be purchased for investment only and not with a view towards
istnbution. An Investor s right to dispose of or transfer his Interest is limited by the requirements of the
57
240 .-..
Act and the Rules and Regulations of the SEC thereunder and Interests cannot be offered or resold vv
either registration under the Act or an exemption therefrom.
CERTAIN LEGAL MATTERS
Davis Polk & Wardwell, New York, New York, has acted as special counsel to the
Partnership for the
purpose of rendering an opinion with respect to certain Federal income tax matters. Davis Polk & Wardwell
has also acted as counsel for Medical Investors Corporation and the Sales Agents in connection with the
offering of the Interests. Cooley, Godward, Castro, Huddleson & Tatum, San Francisco, California, has
acted as special counsel for the Partnership and counsel for the General Partner. Neither counsel has been
engaged to protect the interests of Investors.
V&
REPORTS j
r
Financial information contained in all reports to the Investors will be prepared on a tax basis of
accounting. Tax information will be provided to the Investors within 75 days following the close of each
fiscal year. Within 120 days after the end of each fiscal year, the Investors will be furnished an annual
report containing financial statements of the Partnership certified by independent public accountants. Such
annual report will also include a general description of the activities of the Partnership during the period
covered by the report and a description of any material transactions between the Partnership and the
General Partner or any of its affiliates. Within 60 days after the end of each fiscal quarter, the Investors will
be furnished a quarterly report containing an unaudited balance sheet as at the end of such quarter, a
statement of income for the period covered by the report and a description of material events in the
Partnership s operations.
SALES AGENTS
The Sales Agents have provided in the past and may continue to provide investment banking services for
Genentech. Thomas J. Perkins, a limited partner of Hambrecht & Quist, one of the Sales Agents, is
Chairman of the Board of Directors of Genentech.
58
APPENDIX H
241
GENENTECH CLINICAL
PARTNERS II
$33,850,000
Limited Partnership
Interests
Offered in Units
Of $50,000
1983
242
$32,250,000
GENENTECH CLINICAL PARTNERS II
645 Units of Limited Partnership Interests
$50,000 Per Unit - Minimum Investment One Unit
(1) The minimum investment is one Unit, except that Genentech Clinical Partners II (the "Partnership")
may make sales consisting of a partial Unit to not more than 35 employees, directors or consultants
of Genentech, Inc. ("Genentech ), the parent of Genentech Development Corporation, the general
partner (the "General Partner") of the Partnership. Employees, directors and consultants (who have
written consulting agreements with Genentech) of Genentech ("Genentech Investors") and investors
,
.
("Investors"
or "Limited Partners") who purchase ten or more Units will be entitled to purchase the
limited partnership interests offered hereby ("Interests"),
at a reduction in the offering price per Unit
equal to the reduction in fees payable to the sales agent named below (the "Sales
Agent"), or its
affiliates, in respect of the sales of such Units. Except as set forth below, selling commissions of 7%
and investment banking fees of 2% apply to sales of Units to Investors. The selling commissions
payable in respect of sales to Investors who purchase at least ten and fewer than 20 Units will be
reduced to 4% and the selling commissions payable in respect of sales to Investors who purchase
20 or more Units will be reduced to 3%. No selling commissions or investment banking fees will be
payable in respect of sales of up to $2,000,000 of Interests to Genentech Investors. See "Plan of
Distribution".
(2) The Interests will be offered and sold on a "best efforts" basis exclusively through the Sales Agent, or
its affiliates, and, at the discretion of the Sales Agent, or its affiliates, after consultation with the Gen
eral Partner, through one or more selected dealers.
(3) Before deducting expenses related to this offering, payable bv the Partnership, estimated to be approx
imately 2% of the aggregate purchase price of the Interests. Cash paid by subscribers will be deposited
in a segregated, interest bearing escrow account with The First National Bank of Boston (the "Escrow
Agent") pursuant to an escrow agreement dated as of May 9, 1983 between the Sales Agent and the
Escrow Agent.
(4) Does not include any of 32 additional Units ($1,600,000) which may be sold as an overallotment
by mutual agreement of the Sales Agent and the General Partner. See "Plan of Distribution".
NO PERSON SHALL BE ACCEPTED AS A LIMITED PARTNER PRIOR TO THE CLOSING
OF THE SALE OF INTERESTS. THE GENERAL PARTNER OR THE SALES AGENT, OR ITS
AFFILIATES, IN THEIR ABSOLUTE DISCRETION, MAY REJECT THE SUBSCRIPTION REQUEST
OF ANY PERSON AT ANY TIME PRIOR TO SUCH CLOSING. ANY REPRESENTATION TO THE
CONTRARY IS UNAUTHORIZED AND MUST NOT BE RELIED UPON.
THE PURCHASE OF THESE INTERESTS WILL ENTAIL A HIGH DEGREE OF RISK. NO
PERSON SHOULD INVEST IN THESE INTERESTS WHO IS NOT IN A POSITION TO LOSE HIS
ENTIRE INVESTMENT. SEE "
RISK FACTORS". INVESTORS WILL BE REQUIRED TO MAKE
REPRESENTATIONS WITH RESPECT TO THEIR NET WORTH AND INCOME AND TO REP
RESENT, AMONG OTHER THINGS, THAT THEY ARE FAMILIAR WITH AND UNDERSTAND
THE TERMS OF THIS OFFERING. SEE "SUITABILITY STANDARDS" AND "SUBSCRIPTION
PROCEDURES".
BEPW DEVELOPMENT CORPORATION
a wholly owned subsidiary of
BLYTH EASTMAN PAINE WEBBER
INCORPORATED
The date of this Memorandum is May 9, 1983
243
501
THIS IS NOT AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE
INTERESTS DESCRIBED HEREIN IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SALE.
THIS OFFERING IS BETNG MADE IN RELIANCE UPON AN EXEMPTION FROM REGIS-
TRATION UNDER THE SECURITIES ACT OF 1933 FOR AN OFFER AND SALE OF INTERESTS
WHICH DOES NOT INVOLVE A PUBLIC OFFERING. NO PUBLIC OR OTHER MARKET WILL
DEVELOP FOR THE INTERESTS. INTERESTS ARE NOT TRANSFERABLE WITHOUT THE CON
SENT OF THE GENERAL PARTNER AND SATISFACTION OF CERTAIN OTHER CONDITIONS.
SEE "RISK FACTORS" AND "TRANSFERABHJTY OF INTERESTS". PROSPECTIVE INVESTORS
SHOULD PROCEED ONLY ON THE ASSUMPTION THAT THEY MAY HAVE TO BEAR THE
ECONOMIC RISK OF AN INVESTMENT IN THE INTERESTS FOR AN INDEFINITE PERIOD OF
TIME.
PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS MEMO
RANDUM AS INVESTMENT, TAX OR LEGAL ADVICE. THIS MEMORANDUM AND THE EXHIB
ITS HERETO AND OTHER DOCUMENTS DELIVERED HEREWITH, AS WELL AS THE NATURE
OF AN INVESTMENT IN THE INTERESTS, SHOULD BE REVIEWED BY EACH PROSPECTIVE
INVESTOR, HIS INVESTMENT, TAX OR OTHER ADVISORS, OR HIS ACCOUNTANTS OR LEGAL
COUNSEL.
THE INTERESTS OFFERED HEREBY HAVE NOT BEEN REGISTERED WITH OR APPROVED
BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES
REGULATORY AUTHORITY OF CERTAIN STATES, NOR HAS SUCH COMMISSION OR THE REG
ULATORY AUTHORITY OF ANY STATE PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS MEMORANDUM. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
NO GENERAL SOLICITATION WILL BE CONDUCTED AND NO OFFERING LITERATURE
OR ADVERTISING IN WHATEVER FORM WILL OR MAY BE EMPLOYED IN THE OFFERING
OF THESE INTERESTS, EXCEPT FOR THIS MEMORANDUM (INCLUDING AMENDMENTS AND
SUPPLEMENTS TO THIS MEMORANDUM), THE EXHIBITS HERETO AND DOCUMENTS SUM
MARIZED HEREIN OR ENCLOSED HEREWITH. NO PERSON IS AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS MEMO
RANDUM OR IN THE EXHIBITS HERETO, AND, IF GIVEN OR MADE, SUCH OTHER INFOR
MATION OR REPRESENTATION MUST NOT BE RELIED UPON.
THE INFORMATION CONTAINED IN THIS MEMORANDUM HAS BEEN SUPPLIED BY THE
GENERAL PARTNER, AND HAS BEEN INCLUDED HEREIN IN RELIANCE ON THE GENERAL
PARTNER. THIS MEMORANDUM CONTAINS SUMMARIES, BELIEVED BY THE GENERAL
PARTNER TO BE ACCURATE, OF CERTAIN DOCUMENTS, INCLUDING THE DOCUMENTS
DESCRIBED UNDER "SUMMARY OF MATERIAL CONTRACTS" AND "SUMMARY OF THE LIM
ITED PARTNERSHIP AGREEMENT", SET FORTH IN THIS MEMORANDUM, BUT REFERENCE
IS HEREBY MADE TO THE LIMITED PARTNERSHIP AGREEMENT, ATTACHED AS EXHIBIT A
TO THIS MEMORANDUM, AND THE ACTUAL CONTRACTS, COPIES OF WHICH ARE AVAIL
ABLE AT THE OFFICES OF GENENTECH DEVELOPMENT CORPORATION, 460 POINT SAN
BRUNO BLVD., SOUTH SAN FRANCISCO, CALIFORNIA 94080, ATTENTION: MS. ANNE D. GUN-
DERSON, OR BEPW DEVELOPMENT CORPORATION, 1221 AVENUE OF THE AMERICAS, NEW
YORK, NEW YORK 10020, ATTENTION: MR. STEPHEN EVANS-FREKE, FOR COMPLETE INFOR-
MATION CONCERNING THE RIGHTS AND OBLIGATIONS OF THE PARTIES THERETO. ALL
SUCH SUMMARIES ARE QUALIFIED IN THEIR ENTIRETY BY THIS REFERENCE.
ANY INVESTOR MAY ASK QUESTIONS AND RECEIVE ANSWERS CONCERNING THE TERMS
AND CONDITIONS OF THIS OFFERING OR REQUEST ADDITIONAL INFORMATION TO VERIFY
THE INFORMATION CONTAINED HEREIN BY CALLING DURING NORMAL BUSINESS HOURS
OR WRITING GENENTECH DEVELOPMENT CORPORATION AT THE ADDRESS SET FORTH
ABOVE.
THIS OFFER CAN BE WITHDRAWN AT ANY TIME BEFORE CLOSING AND IS SPECIFI
CALLY MADE SUBJECT TO THE TERMS DESCRIBED IN THIS MEMORANDUM. THE GENERAL
PARTNER AND THE SALES AGENT EACH RESERVE THE RIGHT TO REJECT ANY SUBSCRIP
TION EM WHOLE OR IN PART OR TO ALLOT TO ANY PROSPECTIVE INVESTOR LESS THAN
THE NUMBER OF UNITS SUBSCRIBED FOR BY SUCH PROSPECTIVE INVESTOR. PRIOR TO
244
CONSUMMATION OF THE OFFERING, ALL SUBSCRIPTION FUNDS AND INVESTOR
NOTES WILL BE DEPOSITED WITH THE FIRST NATIONAL BANK OF BOSTON, AS ESCROW
AGENT, TO BE HELD FOR THE INVESTORS. SEE "SUBSCRIPTION PROCEDURES".
THIS MEMORANDUM HAS BEEN PREPARED SOLELY FOR THE BENEFIT OF PROSPEC
TIVE INVESTORS INTERESTED IN THE PROPOSED PRIVATE PLACEMENT OF THE INTER
ESTS AND CONSTITUTES AN OFFER ONLY IF THE NAME OF THE PROSPECTIVE INVESTOR
APPEARS IN THE APPROPRIATE SPACE PROVIDED ABOVE. DISTRIBUTION OF THIS MEMO
RANDUM TO ANY PERSON OTHER THAN SUCH PROSPECTIVE INVESTOR AND THOSE PER
SONS RETAINED TO ADVISE HTM WITH RESPECT THERETO IS UNAUTHORIZED, AND ANY
REPRODUCTION OF THIS MEMORANDUM, IN WHOLE OR IN PART, OR THE DIVULGENCE
OF ANY OF ITS CONTENTS, WITHOUT THE PRIOR WRITTEN CONSENT OF THE GENERAL
PARTNER, IS PROHIBITED. EACH PROSPECTIVE INVESTOR, BY ACCEPTING DELIVERY OF
THIS MEMORANDUM, AGREES TO RETURN IT AND ALL OTHER DOCUMENTS TO THE
SALES AGENT AT ITS ADDRESS SPECIFIED ABOVE IF THE PROSPECTIVE INVESTOR DOES
NOT SUBSCRIBE FOR THE PURCHASE OF THE INTERESTS, THE PROSPECTIVE INVESTOR S
SUBSCRIPTION IS NOT ACCEPTED OR THE OFFERING IS TERMINATED.
WITH REGARD TO CALIFORNIA RESIDENTS, IT IS UNLAWFUL TO CONSUMMATE A
SALE OR TRANSFER OF ANY OF THE SECURITIES OFFERED HEREBY, OR ANY INTEREST
THEREIN, OR TO RECEIVE ANY CONSIDERATION THEREFOR, WITHOUT THE PRIOR
WRITTEN CONSENT OF THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALI
FORNIA, EXCEPT AS PERMITTED IN THE COMMISSIONER S RULES.
WITH REGARD TO FLORIDA RESIDENTS, THE INTERESTS OFFERED HEREBY WILL BE
SOLD TO, AND ACQUIRED BY, THE HOLDER IN A TRANSACTION EXEMPT UNDER SECTION
517.061 OF THE FLORIDA SECURITIES ACT. THE INTERESTS HAVE NOT BEEN REGISTERED
UNDER SAID ACT IN THE STATE OF FLORIDA. IN ADDITION, ALL FLORIDA RESIDENTS
SHALL HAVE THE PRIVILEGE OF VOIDING THE PURCHASE WITHIN THREE (3) DAYS AFTER
MAKING SUCH PURCHASE.
WITH REGARD TO PENNSYLVANIA RESIDENTS, SECTION 207 (m) OF THE PENNSYL
VANIA SECURITIES ACT OF 1972 PROVIDES THAT ANY PURCHASER OF INTERESTS IN PENN
SYLVANIA HAS THE RIGHT TO RESCIND HIS AGREEMENT TO PURCHASE INTERESTS
OFFERED HEREBY WITHIN TWO (2) BUSINESS DAYS AFTER THE LATER OF (i) THE
EXECUTION OF HIS SUBSCRIPTION AGREEMENT AND (ii) DELIVERY OF HIS INVESTOR
NOTE AND PAYMENT OF HIS CASH CAPITAL CONTRIBUTION, AND, UPON SUCH RESCIS
SION, TO RECEIVE A FULL REFUND OF HIS CAPITAL CONTRIBUTION.
THE STATE CORPORATION COMMISSION OF VIRGINIA HAS NOT PASSED UPON THE
ADEQUACY OR ACCURACY OF THE DISCLOSURE CONTAINED IN THIS MEMORANDUM NOR
HAS IT PASSED UPON THE MERITS OF THE OFFERING. THE COMMISSION EXPRESSES NO
OPINION AS TO THE QUALITY OF THE SECURITIES OFFERED HEREBY.
THE SECURITIES OFFERED HEREBY HAVE BEEN REGISTERED WITH THE CORPO
RATION COMMISSIONER OF THE STATE OF OREGON UNDER PROVISIONS OF OAR 815
DIVISION 36. POTENTIAL INVESTORS ARE ADVISED THAT THE COMMISSIONER HAS MADE
ONLY A CURSORY REVIEW OF THIS MEMORANDUM AND HAS NOT REVIEWED THIS DOCU
MENT SINCE IT IS NOT REQUIRED TO BE FILED WITH THE COMMISSIONER. THE INVESTOR
MUST RELY ON THE INVESTOR S OWN EXAMINATION OF THE ISSUER OF THE SECURI
TIES OFFERED HEREBY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS
AND RISKS INVOLVED IN MAKING AN INVESTMENT DECISION ON THESE SECURITIES.
THESE SECURITIES ARE OFFERED PURSUANT TO A CLAIM OF EXEMPTION UNDER THE
ALABAMA SECURITIES ACT. A REGISTRATION STATEMENT RELATING TO THE SECURITIES
OFFERED HEREBY HAS NOT BEEN FILED WITH THE ALABAMA SECURITIES COMMISSION.
THE COMMISSION DOES NOT RECOMMEND OR ENDORSE THE PURCHASE OF ANY OF
THESE SECURITIES, NOR DOES IT PASS UPON THE ACCURACY OR COMPLETENESS OF
THIS PRIVATE PLACEMENT MEMORANDUM. ANY REPRESENTATION TO THE CONTRARY
*S A CRIMINAL OFFENSE.
3
245
GLOSSARY OF TECHNICAL TERMS
The following terms are used throughout this Memorandum:
Deep vein thrombosis An obstruction of the deep veins caused by a blood clot.
DNA Deoxyribonucleic acid, the chemical carrying the hereditary ma
terial of most living organisms.
Embolism A blockage of a vein or artery caused by a blood clot that origi
nated elsewhere in the circulatory system.
Efficacy Effectiveness for intended use.
Fibrin A fibrous protein that binds together a blood clot.
FDA United States Food and Drug Administration.
Formulation A combination of t-PA with other material to create a human
pharmaceutical product.
i
In vivo experiments Experimental testing performed in living organisms.
IND Notice of claimed investigational exemption for a new drug sub
mitted to the FDA.
Indication A set of symptoms characteristic of a particular disease state.
Myocardial infarction An obstruction of the arteries of the heart, often the cause of
heart attack.
Natural sources ,
Sources other than recombinant DNA or chemical synthesis.
NDA New drug application submitted to the FDA containing data
demonstrating that a drug is safe, effective and produced in
accordance with good manufacturing practice.
Peripheral arterial occlusion An obstruction of the peripheral arteries.
Plnsmid A circular strand of DNA.
Plasmin A protein that dissolves fibrin.
Plasminogen An inactive protein in the blood that converts to plasmin.
Protocol A program of testing the effectiveness and safety of a pharma
ceutical product.
Pulmonary embolism An obstruction of the blood vessels of the lungs caused by a
blood clot.
Recombinant Pertaining to the recombination of elements in a new fashion.
Systemic Occurring throughout the circulatory system.
Thrombolytic Having the ability to dissolve clots.
T-PA Tissue-type plasminogen activator.
246
INDEX
Summary of the Offering 6
Investor Suitability 10
The Business of the Partnership 11
Development Program 11
Product Objectives 12
Patent Rights and Other Proprietary Rights 16
Marketing Plans 17
Use of Proceeds 18
Business Plan Product Revenue Assumptions 18
Risk Factors 19
Fiduciary Responsibility of the General Partner 26
Summary of Material Contracts 26
Summary of the Limited Partnership Agreement 33
The Partnership and the General Partner 39
Description of Genentech, Inc 41
Summary of Income Tax Consequences 45
Plan of Distribution 62
Subscription Procedures 63
Employee Subscriptions 63
Transferability of Interests 64
Certain Legal Matters r . 65
Reports 66
Sales Agent 66
Exhibit A Limited Partnership Agreement
Exhibit B Financial Statements of the General Partner
TABLES
Page
Minimum Investment and Schedule of Payments 7
Use of Proceeds 7
Potential Markets to be Addressed by the Partnership s Products 7
Product Revenue Assumptions 7
Potential Financial Returns Summary 9
Potential Financial Returns Cash 9
Estimated Partnership Receipts and Disbursements 18
Development Budget 18
Estimated t-PA Sales . 19
Genentech, Inc., Statement of Operations 44
Genentech, Inc., Condensed Balance Sheet 44
247
SUMMARY OF THE OFFERING
This summary is qualified in all respects by the remainder of this Memorandum, which includes
Genentech financial information, and which should be read in its entirety.
The annual financial statements of Genentech have been audited by Arthur Young ir Company.
The projections contained herein, including potential financial returns to investors, have not been audited
or reviewed by Arthur Young 6- Company.
The Business of the Partnership
The principal business objective of the Partnership is to derive income from the manufacture and
sale of tissue-type plasminogen activator (t-PA) for human pharmaceutical use in the United States.
The Partnership will hold a license for the manufacture and sale of t-PA human pharmaceutical
products in the United States, using recombinant DNA technology developed by Genentech. Based upon
early published studies and pre-clinical work by Genentech and its collaborators, t-PA shows promise as
a treatment for dissolving blood clots that are a major cause of many cardiovascular diseases. However,
existing data is limited and extensive human clinical testing will be required prior to market approval.
-
During the development period, the principal activities of the Partnership will be to:
Conduct the extensive human clinical trials necessary to establish the safety and efficacy of t-PA;
Seek necessary FDA approvals to manufacture and market t-PA in the United States; and
Continue development programs to improve yields and scale up processes to manufacture t-PA.
The Partnership intends to obtain FDA approval for the following major indications:
Heart attack or myocardial infarction ( obstruction of the arteries of the heart ) ;
Pulmonary embolism (obstruction of the blood vessels of the lungs);
Deep vein thrombosis (
obstruction of the deep veins ) ;
and
Peripheral arterial occlusion ( obstruction of the peripheral arteries )
.
Summary of Principal Risk Factors
No assurance of efficacy of t-PA
Possibility of adverse side effects
No assurance of FDA approvals or timing
thereof
No assurance of market acceptance
No assurance of commercial scale
production
Potential competition
No assurance of Joint Venture or
Partnership Purchase
Regulation by government agencies
Limited manufacturing and marketing
experience
Possible need for additional funds
Potential product liability
Conflicts of interest
Tax risks
Very limited liquidity
Summary of Tax Aspects
A substantial part of Investors payments to the Partnership should be currently deductible as
research or experimental expenditures.
Partnership income during the Joint Venture stage will be taxable as ordinary income.
Substantially all of the value of Genentech common stock and a substantial part of the payment
stream received, as applicable, under the Partnership Purchase Agreement should be taxable as
long-term capital gain and the remainder will be taxable as ordinary income.
An opinion in the form set forth under the caption "Summary of Income Tax Consequences" will be
obtained from Davis Polk & Wardwell, Special Tax Counsel to the Partnership, as to the principal Federal
income tax consequences of an investment in the Partnership.
248
Minimum Investment and Schedule of Payments
The minimum investment will be one Unit of $50,000. Investors will pay the purchase price for each
Unit in four installments, as follows:
Date
Amount
Per Unit
At Subscription $15,000
July 1, 1984 12,500
July 1, 1985 12,500
July 1, 1986 10,000
$50,000
Expected
Peductibility
71%
92
94
101
88%
The General Partner has committed to review the status of the development program prior to the date
of each installment.
Use of Proceeds
1983
Development Budget
Research
Applied $1.2
Clinical 2.1
Development 3.7
Selling and Organizational Expenses 2.8
Joint Venture Contribution
Total .
$9^8
1984
$ 1.8
4.4
3.8
0.7
$107
1985
(In Millions)
$1.6
4.3
3.8
0.5
10.2
1986
$0.1
1.3
0.5
$1.9
Includes General Partner s contribution.
Potential Markets to be Addressed by the Partnership s Products
(See "The Business of the Partnership Product Objectives")
Disease Indication
Estimated Eligible
Patient Population*
Total
$ 4.7
12.1
11.8
3.5
0.5
$32.6
Myocardial Infarction 750,000
Pulmonary Embolism 200,000
Deep Vein Thrombosis 175,000
Peripheral Arterial Occlusion 55,000
Annual estimates, based on various authoritative sources including the American Heart- Association and the National
Center for Health Statistics and on surveys conducted on behalf of Genentech and others.
Product Revenue Assumptions
( See "Business Plan Product Revenue Assumptions" )
19S5 1986 1987 1988 1989
Estimated t-PA Sales $ 33 86
1987 1988
(In Millions)
$172 $243 $268
1990
$275
1991-98
( average
annual )
$297
249
The Joint Venture
Upon FDA approval for the commercial sale of t-PA, Genentech has the option to enter into a Joint
Venture with the Partnership to manufacture and market all of the Partnership s products, as they are
approved by the FDA. During the Joint Venture period the Partnership will receive 22% of the Joint
Venture s profits and losses. See "Summary of Material Contracts Joint Venture Agreement".
Purchase of Limited Partnership Interests
Upon (a) the Limited Partners having received distributions from the Joint Venture equal to 15% of
their capital contributions and the Joint Venture having been in existence for at least two years, or (b) the
Joint Venture having been in existence for at least four years, whichever shall occur earlier, Genentech
may exercise the Partnership Purchase Option.
If Genentech exercises the Partnership Purchase Option, each Limited Partner will have the oppor
tunity to select one of two alternative forms of payment per Unit.
Genentech Stock Alternative
1,000 shares of Genentech common stock (ad
justed for stock splits, stock dividends and
similar events).
The two alternatives are:
Payment Stream Alternative
Down payment of $7,500 (credited against
later payments )
Quarterly payments to be based upon a per
centage of revenue to Genentech from sales of
t-PA in the United States, as follows:
7% until the receipt of $50,000,
5% until the receipt of an additional
1
$50,000,
3% through the end of the twelfth year
of the payment stream.
In any event, the payment stream will termi
nate by the end of the year 2000.
If foreign sales of t-PA commence prior to FDA approval for a major indication of t-PA, the Limited
Partners will receive payments of 3%% of Genentech s revenue from such sales until such approval is granted.
Genentech may at any time make an offer to buy out Investors, including while they are receiving
the Payment Stream Alternative. If at any time Investors receiving payments under the Payment Stream
Alternative represent fewer than 20% of all Units, Genentech may purchase for cash those payment rights
at a predetermined formula price. See "Summary of Material Contracts Joint Venture and Partnership
Purchase Option Agreement" and
"
Partnership Purchase Agreement".
Potential Financial Returns to Investors
If the revenue assumptions for t-PA are realized, the financial returns to Investors will be substantial.
If Genentech exercises the Partnership Purchase Option, then each Investor will select either the Payment
Stream Alternative (cash payments based on future sales of t-PA) or the Genentech Stock Alternative
( 1,000 shares of Genentech common stock for each Unit )
.
Prospective Investors should be aware, however,
that the revenue assumptions are only estimates and there can be no assurance that they will be attained
or that Genentech will exercise the Joint Venture Option or the Partnership Purchase Option.
Each Investor should consider the possible tax consequences of the purchase of his Interest. See
"Summary of Income Tax Consequences".
250
at 1/1/87
Payment Stream Alternative N.A.
Genentech Stock Alternative $ 35.00
$ 50.00
$100.00
Potential Financial Returns Summary
Assumed
Market Price
Per Share
Pre-tax
Cash on
Cash
After-tax
Cash on
Cash
4.4x
l.Ox
1.3x
2.3x
5.5x
1.3x
1.8x
3.2x
Internal
Rate of
Return"
36%
14%
28%
60%
Estimated
Investment
Period
15.5 yrs.
3.5 yrs.
3.5 yrs.
3.5 yrs.
Annual effective rate which equates the present value of future returns to the present value of the investment outlay,
after adjustment for all tax effects.
The following table shows potential financial returns for Investors who purchase one $50,000 Unit
and select the Payment Stream Alternative at the time that Genentech exercises the Partnership Purchase
Option. Investors who select the Genentech Stock Alternative would receive (i) the same distributions up
to the Partnership purchase date as Investors selecting the Payment Stream Alternative, and (ii) 1,000
shares of Genentech common stock at that date, and no further distributions.
Potential Financial Returns Cash Per One Unit ($50,000) Investment"
Year
1983
1984
1985*
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Payment
Amount
$15,000
12,500
12,500
10,000
Potential
Tax
Deductions
$10,700
11,500
11,800
10,100
Potential
Cash
Distributions
4,500
11,600
26,200
25,700
20,800
13,800
18,400
13,200
13,400
13,700
13,900
14,100
14,400
14,600
Cumulative
Potential
Cash Dis
tributions
4,500
16,100
42,300
68,000
88,800
102,600
121,000
134,200
147,600
161,300
175,200
189,300
203,700
218,300
Potential
Tax Savings
(Taxes
Payable)
$5,400
5,800
3.600
(800)
(5,500
6,000)
(5,200
3,700
(5,200
3,900
4,100
4,300
4,500
4,700
4,900
5,100
Annual Net
Cash Flow
Cumulative
Net Cash
Position
9,600)
6,700)
4,400)
800
20,700
19,700
15,600
10,100
13,200
9,300
9,300
9,400
9,400
9,400
9,500
9,500
$ (9,600
( 16,300
(20,700
( 19,900
800
20,500
36,100
46,200
59,400
68,700
78,000
87,400
96,800
106,200
115,700
125,200
"All amounts have been rounded to the nearest hundred.
"Joint Venture assumed to be in operation 1985-86.
""Partnership Interests assumed to be purchased on 1/1/87.
Assumptions Underlying Potential Financial Returns
The above tables are based upon the assumptions set forth in "The Business of the Partnership Product Objectives"
and "Business Plan Product Revenue Assumptions" and the following additional critical assumptions. There is no assurance
that any of these assumptions will be realized.
1. Investors capital contributions will be $32,250,000, paid as scheduled.
2. Approximately 88% of the Investors capital contributions will be deductible for Federal income tax purposes.
3. Each Investor will reflect in his quarterly estimated tax return the tax consequences relating to his investment in
the Partnership for such quarter.
4. The Joint Venture Option will be exercised by Genentech, the Joint Venture will be formed during the first
quarter of 1985 and the Partnership will receive distributions quarterly during the duration of the Joint Venture.
5. Genentech will exercise the Partnership Purchase Option to purchase the Limited Partnership Interests on
January 1, 1987, at which time each Investor will receive his choice of the Payment Stream Alternative, payable quarterly,
or the Genentech Stock Alternative.
6. Investors are assumed to be in the 50% tax bracket.
7. Joint Venture distributions will be taxed as ordinary income. Consideration received under the Payment Stream
Alternative or Genentech Stock Alternative will be taxed as long-term capital gains, except for a portion of the payment
stream (based on 9% annual simple interest) which will be treated as interest income and taxed at ordinary income rates.
Investors who choose the Genentech Stock Alternative will pay capital gains tax in the quarter in which they receive
such stock.
8. There will be no effect on Investors of the Federal alternative minimum tax. However, the impact of this tax to
each Investor, which will depend upon his particular tax situation, could lower the returns to him.
9. No effect has been given to state and local income taxes.
251
INVESTOR SUITABILITY
The Interests will be offered and sold only to prospective Investors who: (a) represent, among other
things, that they are acquiring Interests for their own accounts, for investment only and not with a view
toward the resale or distribution thereof, that they are aware that the Interests have not been registered
under the Securities Act of 1933 (the "Act")
and that their transfer rights are restricted by the Act,
applicable state securities laws, the Limited Partnership Agreement dated as of May 9, 1983 (the "Partner
ship Agreement") and the absence of a market for the Interests; and (b) are investors meeting the suitability
standards hereinafter set forth.
The Partnership will require as a general investor suitability standard that each Investor represent
in writing that: (1) he is a natural person who has a net worth or joint net worth with his spouse exceed
ing $1,000,000 at the time of his purchase, or (2) he is a natural person who had an individual income
in excess of $200,000 in each of the two most recent years and who reasonably expects an income in excess of
$200,000 in the current year, or (
3 ) he or it is purchasing at least $150,000 of the Interests, where his total
purchase does not exceed 20% of his net worth, or joint net worth with his spouse, at the time of sale,
or (4) he is a director or executive officer of the General Partner, or (5) it is either (a) a bank as
defined in section 3(a)(2) of the Act whether acting in its individual or fiduciary capacity, (b) an insur
ance company as defined in section 2(13) of the Act, (c) an investment company registered under the
Investment Company Act of 1940 or a business development company as defined in section 2(a) (48) of such
Act, (
d ) a Small Business Investment Company licensed by the United States Small Business Administration
under section 301 (c) or (d) of the Small Business Investment Act of 1958 or (e) an employee benefit
plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974, if the invest
ment decision is made by a plan fiduciary, as defined in section 3(21) of such Act, which plan fiduciary
is either a bank, insurance company or registered investment advisor or if the employee benefit plan has
total assets in excess of $5,000,000, or (6) it is a private business development company as defined in
section 202(a)(22) of the Investment Advisers Act of 1940, or (7) it is an organization described in
section 501 (c) (3) of the Internal Revenue Code with total assets in excess of $5,000,000, or (8) it is a cor
poration or partnership, and each and every equity owner of such entity certifies that he meets the quali
fications set forth in either (1), (2), (4), (5), (6) or (7) above, or (9) he is an Investor who meets
the suitability standards set forth under the caption "Employee Subscriptions." As used in this Memorandum,
the term "net worth" means the excess of total assets over total liabilities. In determining income, an Investor
should add to his adjusted gross income any amounts attributable to tax exempt income received, losses
claimed as a limited partner in any limited partnership, deductions claimed for depletion, contributions to
an IRA or Keogh retirement plan, alimony payments, and any amount by which income from long-term
capital gains has been reduced in arriving at adjusted gross income.
The suitability standards referred to above represent minimum suitability requirements for prospective
Investors and the satisfaction of such standards by a prospective Investor does not necessarily mean that
the Interests are a suitable investment for such prospective Investor. The General Partner or the Sales
Agent, or its affiliates, may make or cause to be made such further inquiry and obtain such additional
information as it deems appropriate with regard to the suitability of prospective Investors. The General
Partner or the Sales Agent, or its affiliates, in their absolute discretion, may reject subscriptions, in whole
or in part, in their absolute discretion.
THE SUITABILITY STANDARDS DISCUSSED ABOVE REPRESENT MINIMUM SUITABILITY
STANDARDS FOR PROSPECTIVE INVESTORS. EACH PROSPECTIVE INVESTOR SHOULD
DETERMINE WHETHER THIS INVESTMENT IS APPROPRIATE FOR SUCH INVESTOR.
sale
NO PERSON SHALL BE ACCEPTED AS A LIMITED PARTNER PRIOR TO THE CLOSING OF
THE SALE OF INTERESTS. THE GENERAL PARTNER OR THE SALES AGENT, OR ITS
AFFILIATES, IN THEIR ABSOLUTE DISCRETION, MAY REJECT THE SUBSCRIPTION REQUEST
OF ANY PERSON AT ANY TIME PRIOR TO SUCH CLOSING. ANY REPRESENTATION TO THE
CONTRARY IS UNAUTHORIZED AND MUST NOT BE RELIED UPON.
Re
In
act
pa
ev
co:
on
efl
10
252
THE BUSINESS OF THE PARTNERSHIP
tf^.The principal business objective of the Partnership is to derive income from the manufacture and
sSle of t-PA for human pharmaceutical use in the United States.
-
The Partnership will hold a license for the manufacture and sale of t-PA human pharmaceutical
products in the United States, using recombinant DNA technology developed by Genentech. Based upon
e"arly published studies and pre-clinical work by Genentech and its collaborators, t-PA shows promise as
^treatment for dissolving blood clots that are a major cause of many cardiovascular diseases. However,
existing data is limited and extensive human clinical testing will be required prior to market approval.
"During the development period, the principal activities of the Partnership will be to (1) conduct the
extensive human clinical trials necessary to establish the safety and efficacy of t-PA, (2) seek FDA approvals
to/1
manufacture and market t-PA in the United States, and (3) continue development programs to
improve yields and scale up processes to manufacture t-PA. The Partnership intends to concentrate its
efforts in establishing t-PA as an indicated treatment for four disease states in which blood clots can
precipitate life-threatening conditions: (1) heart attack or myocardial infarction (obstruction of arteries
of the heart), (2) pulmonary embolism (obstruction of the blood vessels of the lungs), (3) deep vein
thrombosis (obstruction of the deep veins), and (4) peripheral arterial occlusion (obstruction of the
beripheral arteries).
F
,
:, T-PA is a naturally occurring substance that plays an essential role in dissolving blood clots in the
body. Although it is possible through means other than recombinant DNA technology to isolate minute
quantities of t-PA from human cells, the process is very difficult and expensive. These natural sources
do not presently offer any practical possibility of producing sufficient quantity or quality of t-PA for
widespread medical use. Genentech has been successful in using recombinant DNA technology to pro
duce t-PA in relatively larger quantities with a high degree of purity.
/v
In 1982 Genentech first produced t-PA in the laboratory using recombinant DNA tedinology. Hum/an
clinical testing for the first major indication is expected to commence in 1983. The Partnership s business
plan assumes FDA marketing approval of t-PA for the first major indication in early 1985.
;.
Development Program
The work that must be done by the Partnership in order to obtain FDA approval for t-PA will be
similar to the work involved in introducing to market any major new pharmaceutical product and is
expected to proceed as described below.
Pre-Clinical Studies and Submission of IND
Studies are conducted in the laboratory and in certain species of animals to gain preliminary infor
mation on the product s efficacy and to identify major safety problems that might bfe expected to arise
when the drug is administered to humans. The results of these studies must be submitted to the FDA
as part of an IND before approval can be obtained for the commencement of testing in humans.
Research Clinical Testing
The clinical testing program required for approval of a new drug involves a three-phase process.
In Phase 1, studies are conducted (typically on human volunteers) to determine the basic biological
activity and side effects of the substance in humans. In Phase 2, studies are conducted on groups of
patients afflicted with a specific disease in order to determine proper dosages and to gain preliminary
evidence of efficacy and safety. The Partnership s present plan calls for Phase 1 and Phase 2 to be pursued
concurrently on patients afflicted with particular diseases. Phase 3 involves large-scale studies conducted
on patients afflicted with the disease in order to provide enough data for the statistical proof of safety and
efficacy required by the FDA.
11
253
The data obtained from clinical testing, along with other information, are submitted to the FDA in
order to obtain marketing approval for the product. Even after initial FDA approval has been granted,
the General Partner may conduct further studies to provide additional data on safety or efficacy or to
gain approval for the use of the drug as a treatment for other indications.
Approximately 42% of the development budget is expected to be expended for the Partnership s
pre-clinical and clinical testing program. See "Use of Proceeds Development Budget".
Research Applied
The Partnership will sponsor an ongoing program of applied research to increase the production yields
of t-PA by developing improved technology with respect to the production of t-PA.
In order for medical substances to be administered to human beings, they must be formulated
with other materials (such as solvents, buffers and stabilizers) to create a stable and effective pharma
ceutical product. The Partnership expects to develop an injectable formulation for t-PA which will be
used in clinical testing. Because the Partnership will seek approval of t-PA for treatment of acute conditions
in .which injection into the blood stream (directly or through a catheter) is an appropriate means of
delivery to patients, the Partnership does not anticipate developing alternative means of delivery of t-PA.
Approximately 17% of the development budget is expected to be expended on applied research.
See "Use of Proceeds Development Budget".
The Partnership does not expect to engage in basic research related to recombinant DNA technology.
Development of Manufacturing Process
As a condition of receiving FDA approval to market a drug in the United States, the applicant must
demonstrate to the satisfaction of the FDA that the process used to manufacture that drug is safe and
controllable, and that it conforms with Good Manufacturing Practices established by the FDA. The
Partnership will also continue to develop manufacturing processes to enable the Partnership to meet the
anticipated demand for t-PA following FDA approval. This component of the Partnership s development
program will include efforts directed toward creating new fermentation and product recovery processes for
the efficient and economic production of t-PA.
Approximately 41% of the development budget is expected to be expended to develop the manu
facturing processes for t-PA. See "Use of Proceeds Development Budget".
The Substance
Product Objectives
T-PA is a naturally occurring human protein produced by a number of different body tissues and
by cells lining the blood vessels.
T-PA is part of a complex system in the body that creates and dissolves blood clots. When a blood
vessel is injured, this system serves to stop the flow of blood from the injured blood vessel by the creation
of a blood clot. This process is called coagulation. All blood clots contain a fiber-like protein called fibrin,
which serves as the cohesive factor for the blood clots. When the wound is healed, an opposite process
dissolves the clot. T-PA initiates this clot-dissolving process by converting plasminogen, an inactive protein
normally present in circulating blood, into plasmin, which dissolves the fibrin that holds the clot together.
Early published studies indicate that t-PA operates to convert plasminogen to plasmin only when the
t-PA is bound to fibrin. This means that t-PA appears to act selectively at the site of blood clots
and not throughout the entire blood system. Such selective operation minimizes the risk of hemorrhaging
and other adverse side effects when compared to the operation of other currently marketed anti-clotting
or clot dissolving drugs, which do not operate specifically at the site of clots, but rather operate indis-
12
254
crirninately throughout the system. Based on animal studies, t-PA appears to have a short half-life in
that it is cleared from the circulatory system in a relatively short period after administration, thereby
further reducing the risk of adverse side effects. See "Risk Factors Possible Side Effects".
Until the development of recombinant DNA technology, extraction from human cells was the only
means of obtaining t-PA. T-PA is extremely difficult and expensive to produce by extraction from human
cells, however, and t-PA from these natural sources has been relatively impure. Although t-PA was first
discovered in 1947, medical researchers have been hampered until recently in discovering t-PA s
properties
and clinical uses because of the small and impure quantities available. In 1979 a group headed by
Dr. Desire
1
Collen at the Center for Thrombosis and Vascular Research at the University of Leuven in
Belgium was able to isolate and purify enough t-PA from natural sources to conduct pilot studies in
dogs and rabbits and limited clinical tests in humans.
Genentech, working with materials provided by Dr. Collen, was able in 1982 to identify the structure
of t-PA and first produce small quantities of highly pure t-PA in the laboratory using recombinant
DNA technology.
In 1982 Dr. Collen s team, operating under an exclusive scientific collaboration agreement with
Genentech, demonstrated in in vivo experiments with rabbits the effectiveness of Genentech s t-PA. In
such experiments, Genentech s t-PA proved as .effective in dissolving clots as naturally derived t-PA.
Laboratory tests performed to date by Genentech suggest that t-PA produced by means of recombinant
DNA technology exhibits the same properties as the protein derived from natural sources.
Potential Clinical Uses
Blood clots are a major cause of many cardiovascular diseases, which are the leading cause of death
in the United States. By obstructing a blood vessel or lodging at an inappropriate place, such clots can
precipitate heart attacks or grave injury to the lungs. These clots are also prone to fonfri in the legs ior
other extremities, where they can obstruct veins or arteries and permanently hamper circulation or break
away to lodge in the lung.
Based on early published studies and pre-clinical work by Genentech and its collaborators, the General
Partner believes that t-PA may prove more effective in dissolving injurious blood clots than currently
available thrombolytic (clot-dissolving) drugs. If effective, t-PA might be administered, for example,
during the early stages of a heart attack to unblock the clogged coronary artery and might thereby save a
substantial part of the heart muscle that would otherwise die from lack of oxygen. Based on such studies
and pre-clinical work, the General Partner believes t-PA might be used similarly to treat pulmonary
embolism, deep vein thrombosis and peripheral arterial occlusion by dissolving clots in the lungs or
extremities. However, existing data is limited and extensive human clinical testing will be required
to determine whether t-PA will prove effective on humans in practice.
The potential of t-PA as a therapy for heart attack, pulmonary embolism, deep vein thrombosis and
peripheral arterial occlusion is due in significant part to the fact that, as indicated in early published
studies and pre-clinical work, t-PA acts specifically at the site of clots, where fibrin is present, and does
not disturb the delicate balance of blood factors that control clotting throughout the circulatory system.
Any therapy that upsets this delicate balance, such as by converting plasminogen to plasmin throughout
the
circulatory system or by destroying other blood factors important for clotting, can create a serious
risk of hemorrhage. Based upon the work to date, the General Partner believes that treatment with
t-PA will minimize the risk of hemorrhage when compared with other therapies. In addition, the Gen
eral Partner believes this site specific action of t-PA should permit the effective administration of t-PA
by its
injection intravenously and in quantities substantially smaller than would be required if it acted
generally throughout the circulatory system.
By contrast, the other currently used clot-dissolving drugs, streptokinase and urokinase, act on plas-
minogen throughout the circulatory system. The systemic action of these drugs also results in the
13
255
destruction of other blood factors that balance the coagulation system. These effects make hemorrhage
a significant risk of therapy with these drugs. Also, larger doses of streptokinase and urokinase are
required to dissolve a clot than would be required if such drugs operated on a site specific basis. See
"Competition" below.
The Partnership intends to seek FDA approval for administration of t-PA by intravenous injection for
myocardial infarction, pulmonary embolism and deep vein thrombosis. For peripheral arterial occlusion,
the Partnership intends to seek FDA approval for administration of t-PA by catheterization, since medical
procedures for peripheral arterial occlusion generally include catheterization in any case. Although the
Partnership may later seek FDA approval for intravenous administration of t-PA for peripheral arterial
occlusion, such approval is not presently included in the Partnership s business plan.
Market Analysis
The General Partner believes that the potential markets for t-PA present a major opportunity.
Achievement of the Partnership s business plan is based on each of the following critical assumptions.
The Partnership believes that these assumptions are reasonable based on information currently available.
There can be no assurance, however, that these assumptions will be realized.
1. T-PA will be safe and effective in treatment of myocardial infarction, pulmonary embolism and
deep vein thrombosis when administered by intravenous injection, and in treatment of peripheral arterial
occlusion when administered by catheterization, and side effects will be at an acceptable level.
2. T-PA will .prove significantly more site specific in its activity than other currently available clot-
dissolving agents.
3. FDA approval for the marketing of t-PA will be granted in early 1985 with respect to myocardial
infarction, and during 1986 for pulmonary embolism, deep vein thrombosis and peripheral arterial occlusion.
4. The planned process development, manufacturing scale-up work and clinical trials will be com
pleted without m^jor delays, thereby enabling the Partnership to establish a strong market position for
t-PA in the United States prior to the entry of any significant competition.
5. The Partnership will have an adequate patent position with respect to t-PA produced by recom-
binant DNA technology.
6.
Following FDA approval for particular indications, t-PA will receive general market acceptance
in the medical community as a treatment for such indications.
Myocardial Infarction
The American Heart Association ("AHA")
has estimated that as many as 1,500,000 Americans may
have a heart attack this year. Based on information from the AHA and other authoritative sources and
surveys conducted on behalf of Genentech, the General Partner estimates an eligible patient population
of 750,000 in 1983.
Based upon the assumptions set forth above, the General Partner believes that t-PA will ultimately
achieve a market share of approximately 50% of the eligible patient population suffering heart attacks
in the United States. Such treatment would then account for a substantial percentage of the sales of t-PA.
Pulmonary Embolism
Authoritative sources indicate that as many as 500,000 persons per year in the United States may
suffer from pulmonary embolism. Studies conducted on behalf of Genentech indicate that approxi
mately 200,000 cases per year in the United States are diagnosed. On this basis, the General Partner
estimates an eligible patient population of 200,000 in 1983. Based upon the assumptions set forth above,
the General Partner believes that t-PA will ultimately achieve a market share of approximately 30%
of the eligible patient population.
14
256
Deep Vein Thrombosis
The deep vein thrombosis market is more difficult to assess than the myocardial infarction and pul
monary embolism markets, since deep vein thrombosis is less likely to be detected and diagnosed than
the other two diseases. Studies conducted on behalf of Genentech indicate that approximately 175,000
persons .per year in the United States are diagnosed as suffering from deep vein thrombosis. This excludes
those patients who also are diagnosed as having pulmonary embolism with associated deep vein throm
bosis. On this basis the General Partner estimates an eligible patient population of 175,000 in 1983. Based
upon the assumptions set forth above, the General Partner believes that t-PA will ultimately achieve a
market share of approximately 30% of the eligible patient population.
Peripheral Arterial Occlusion
Authoritative sources indicate that in 1981 there were approximately 110,000 new patient visits to
physicians for peripheral arterial occlusion and about half of those patients received anticoagulant or
thrombolytic therapy. The General Partner estimates an eligible patient population of 55,000 in 1983.
Based upon the assumptions set forth above, the General Partner believes that t-PA will ultimately achieve
a market share of approximately 30% of the eligible patient population.
Other Indications
T-PA may also eventually prove effective for other indications caused by obstruction of blood vessels
by clots, such as central retinal vein occlusion (which is a significant cause of blindness in one eye),
Clotting of arterial venous shunts in hemodialysis patients and the majority of strokes. The Partnership s
development budget does not presently include clinical testing for any of these indications. The Partner
ship s product revenue assumptions do not include revenues derived from the marketing of t-PA for any
of these indications. Existing data is very limited and extensive human testing would be required to
determine whether t-PA would prove effective in any of these indications.
i
Clinical Testing and Product Development
Genentech and its collaborators have performed pre-clinical studies with t-PA produced by means of
recombinant DNA technology and the Partnership expects to develop a formulation of the drug capable
of being delivered by intravenous injection or catheterization. Genentech is. currently in the process of
identifying patient populations and clinical investigators and is developing protocols for the clinical
testing, which is anticipated to commence in late 1983. See "Potential Clinical Uses" above.
The clinical program for t-PA will be very extensive for each of the intended markets. As many as
1,000 patients are expected to be included in the clinical programs. The initial clinical trials will focus
primarily on the myocardial infarction indications, with first FDA approval expected in early 1985. Con
currently with the clinical tests for myocardial infarction, the Partnership plans to conduct clinical tests
.on. the use of t-PA for treatment of peripheral arterial occlusion. Commencement of clinical testing of
l-PA for use in treatment of pulmonary embolism and deep vein thrombosis is presently scheduled for 1984.
Competition
jvi
?; The currently available clot-dissolving drugs are streptokinase and urokinase. Both drugs have the
..(disadvantages discussed above of activating plasminogen at places other than the clot site, causing the
...destruction of various coagulation factors and creating a significant risk of hemorrhage. See "Potential
ifCJlinical Uses" above.
Streptokinase, the more widely used drug, has troublesome side effects. In addition to its systemic
ation of the anti-clotting system in the body, streptokinase stimulates the body to produce antibodies
;ainst it because it is a foreign bacterial protein. This may cause allergic reactions. Streptokinase has
approved by the FDA for use as therapy in heart attacks, acute pulmonary embolism and deep
thrombosis and certain other ancillary indications. Approval of the use of streptokinase for dissolving
nary blood clots during a heart attack has been limited to administration by catheterization directly
the affected coronary artery in the heart, a relatively difficult process involving significant risks and
15
257
time delay. The General Partner believes that because t-PA could be administered by intravenous injection
and therefore would not require catheterization, more rapid and safer delivery would be significantly
facilitated.
Although treatment with urokinase avoids the allergic reactions associated with streptokinase, it
is substantially more expensive than streptokinase. It is presently approved by the FDA only as a treatment
for pulmonary embolism.
Anti-coagulant therapies, such as the widely-used drugs heparin and coumadin, only prevent or
slow down blood clot formation and do not eliminate injurious blood clots that have already formed.
Potential competitors of the Partnership may include companies with financial, manufacturing and
marketing resources that are significantly greater than those of the Partnership or Genentech. Addi
tionally, Genentech itself may develop other products that treat the same indications as t-PA. A foreign
licensee of Genentech is currently undertaking a project to develop urokinase that was originally expressed
by Genentech. Genentech has entered, and may enter, into licensing and supply agreements providing
for the sale outside the United States of products containing t-PA manufactured by Genentech. Under
certain limited circumstances the Partnership would receive payments based on marketing of products
outside the United States or on the sale by Genentech of products competitive with t-PA. See "Summary
of Material Contracts" and "Risk Factors Conflicts of Interest".
Finally, companies other than Genentech are attempting to develop t-PA and, notwithstanding the
Partnership patent position, there cannot be any assurance that competitors will not introduce their own
version of t-PA into the market.
Patent Rights and Other Proprietary Rights
Genentech has filed patent applications covering t-PA and its production process. The law firm of
Lyon & Lyon has reviewed the Genentech patent application relating to t-PA and has provided the
Partnership with an opinion in substantially the form set forth below. This opinion represents the best
judgment of Lyofi & Lyon under existing statutes, judicial decisions and administrative regulations and
interpretations. However, opinions of patent counsel have no binding effect on the United States Patent
Office or the courts.
"You have asked us to review the Genentech t-PA patent application and advise you regarding
validity.
"We have reviewed the validity search results which you recently provided us. Those results
are based on a search made by Genentech and by the British firm of Mewburn, Ellis, & Co. The areas of
technology indicated to have been searched, in our opinion, should have produced the most pertinent
prior art relating to t-PA and its production. There is nothing in the search results which describes
the method of producing t-PA as set forth in the Genentech patent application or the resulting
t-PA produced by that method. Thus, we are of the opinion that, based upon the search results we
have, the Genentech t-PA application is directed toward novel subject matter.
"Patentability requires non-obviousness as well as novelty, however. Based upon discussions with
Genentech personnel, we have determined that the process of producing t-PA, as set forth in the
Genentech patent application, involved non-obvious techniques. Thus, we are of the opinion that the
patent application is directed to non-obvious subject matter.
"We further understand that Genentech has demonstrated biological activity, hence utility for
the t-PA compound produced via the recombinant technology disclosed in the Genentech patent
application. Thus, we are of the opinion that the Genentech patent application is directed to patentable
subject matter.
"We cannot at this time know the form of claims which might issue. However, it is our opinion,
based upon the facts referred to above, that Genentech will obtain significant patent protection covering
t-PA and its method of production.
16
258
"Further, we have reviewed the U.S. patents obtained in the prior art search results discussed
above which relate to t-PA and its production. In our opinion, none of those patents would be infringed
by the manufacture, use or sale of t-PA made according to the Genentech application."
Under the Cross License Agreement, Genentech has granted to the Partnership an exclusive license
within the United States to use all Genentech patents and know-how useful in the manufacture, use
and sale of t-PA in the United States for human pharmaceutical use. See "Summary of Material Con
tacts Cross License Agreement". The Partnership has been advised that Genentech has pursued a
policy of seeking patents on inventions concerning novel techniques, processes, products and micro
organisms
and other biological systems developed as part of its research and development activities
relating to t-PA, as with its other products. Also, the Partnership has been advised that Genentech has
sought diligently to protect its know-how.
Genentech has filed patent applications in the United States covering t-PA, plasmids containing
the genes which encode t-PA-producing organisms and its method of production. With respect to
t-PA, the General Partner expects some protection will be likely from earlier patent applications by
Genentech concerning basic recombinant DNA procedures and products. Counterparts of these appli
cations are being filed extensively outside the United States.
Although the General Partner believes that the Partnership s patent position may make it more
difficult for competitors to manufacture t-PA in the United States, Genentech is unable to predict which
patents will issue and the extent of protection, if any, that they will provide to the Partnership. The extent
to which efforts by other researchers will result in patents or other proprietary rights and the extent
to which the Partnership may need to obtain licenses from others are currently unknown.
To the extent it is advantageous to do so, the Partnership intends to protect its know-how (other
than patentable inventions) as trade secrets. Such know-how will include the knowledge about t-PA
acquired during clinical testing. Under present procedures, the results of such clinical testing submitted
to the FDA will be kept confidential. Under the Cross License Agreement, the Partnership has agreed
that Genentech may make such test results available to other licensees of Genentech who are authorized
to sell t-PA outside the United States, and Genentech has agreed to make available to the Partnership
the test results of such other licensees to the extent that Genentech is contractually permitted to do so.
See "Summary of Material Contracts Cross License Agreement".
Marketing Plans
If Genentech exercises its option to enter into the Joint Venture, Genentech will be obligated to
market the Partnership s products. If Genentech purchases the Partnership Interests, Genentech will be
responsible for marketing t-PA. See "Summary of Material Contracts Joint Venture Agreement" and
"
Partnership Purchase Agreement".
In view of the indications for which t-PA is expected to be effective, the initial sales effort will
be directed at a relatively small group of prescribing physicians and clinicians in the United States,
generally based in major hospitals. To address these markets, Genentech intends to deploy a relatively
small sales force of specialists who will be primarily responsible for major medical centers in a par
ticular
region. Genentech expects to expand this sales force according to marketing requirements. Distribu
tion of the product will be accomplished either directly by Genentech or through established drug
wholesalers to hospital pharmacies and retail pharmacies.
Since Genentech does not presently have pharmaceutical products available for sale, it does not yet
nave a sales force. Genentech intends to use the same sales force for the marketing of t-PA as it intends
o establish for the marketing of its other human pharmaceutical products. Genentech does not antici
pate <
significant problems in the development of such a sales force. It is anticipated that t-PA will be
second human pharmaceutical product to be marketed by Genentech.
17
259
Use of Proceeds
To carry out the development program, the Partnership will contract with Genentech to perfo
clinical testing and other research and product development. Assuming that 645 Units are sold, ]
ments to Genentech will aggregate approximately $28.6 million during the years 1983 through 1986.
Partnership is
budgeting $500,000 for the working capital of the Joint Venture to be contributed by
Partnership in 1985 if the Joint Venture Option is exercised during that year. Estimated receipts
disbursements during the development phase are as shown in the following table:
Estimated Partnership Receipts and Disbursements
1983
Receipts
Capital Contributions
Limited Partners $9,675
General Partner 98
Total $9,773
Disbursements
Selling and Organizational Expenses $2,798
Development Agreement Payments 6,975
Joint Venture Capital
Total . . .
$9,773
1984 1985
(In Thousands)
$8,062
81
1986
$8,063
82
$8145 $8,143 $6,515
$6,450
65
$ 645 $ $
7,500 7,643 6,515
500
$8,145 $8.143 $6.515
Total
$32,250
3261
$32,578]
$ 3,443 i
28,633 j
500]
$32,576 j
Development Budget
The General Partner has estimated the development budget over the period from April 1983 throug
June 1986 to include the categories of expenses shown in the following table:
1983 1984
Research
Applied $1.2 $ 1.8
Clinical 2.1 4.4
Development 3.7 3.8
Total .
$7.0 $10.0
1985
(In Millions)
$1.6
4.3
3.8
$9.7
1986
$0.1
1.3
0.5
$1.9
Total .
I
-j
$ 4.7 ,
12.1
11.8
$28.6
In the event that more than 645 Units are sold through exercise of the overallotment referred to und^j
the caption "Plan of Distribution", the additional proceeds to the Partnership will be applied to increa
research and development expenditures, as determined by the General Partner.
Business Plan Product Revenue Assumptions
The General Partner has developed a set of financial assumptions, which it believes are reason
able based on information currently available, as a basis for its long-term business plan for the sal
in the United States of t-PA produced using recombinant DNA technology. The assumptions relate
diseases and disorders for which limited therapy is now available and for which market size is diffic
to define. There can be no assurance that these assumptions will be realized.
In addition to these assumptions and the assumptions described in "Business of the Partnership
Product Objectives", all revenue assumptions are expressed in constant 1983 dollars, and patient popu-j
lations are assumed to increase at the rate of 2.5% per year from 1983 through 1990 and 1.7% per yea
thereafter.
18
)
perform
;old, pay-
1986. The
;d by the
:eipts and
Total
$32,250
326
$32,576
$ 3,443
28,633
500
$32,576
33 through
i Total
$ 4.7
,
12.1
11.8
I
$28.6
1 to under
,o increase
re reason-
|-
the sale
relate to
.s difficult
inership
;nt popu-
per year I
260
.riance from the foregoing assumptions will affect the amounts presented in the following table and
tables above entitled "Potential Financial Returns Cash" and "Potential Financial Returns
;ary".
assumptions represent estimated sales of t-PA by the Joint Venture in 1985 and 1986 and esti-
sales of t-PA by Genentech in 1987 through 1998. The return to the Partnership and the Investors
estimated sales will be calculated as described in "Summary of Material Contracts Joint
Agreement"
and
"
Partnership Purchase Agreement".
1985
$33
1986
$86
Estimated t-PA Sales
(In Millions)
1987 1988 1989
$172 $243 $268
1992
$281
1993
$289
1994
$294
1995
$299
1996
$304
1990 1991
$275 $280
1997 1998
$309 $315
.("f.:Y,-
RISK FACTORS
Business Risks
No Assurance of Product Efficacy
The success of the Partnership will require, among other factors, demonstration through clinical
testing that t-PA is safe and efficacious for the treatment of one or more indications. To date there
has been no significant testing of the effects of t-PA when administered to humans, and the results
.
of the pre-clinical laboratory tests of t-PA that have been performed are not necessarily indicative
of results that will be obtained from human clinical testing.
Possible Side Effects
In some cases, molecules produced from recombinant DNA technology, while virtually identical
to the natural substances produced by the human body, may contairr differences in composition
as well as small amounts of impurities resulting from the manufacturing process, and could result
in side effects when used in human treatment. Even if the marketing of t-PA is approved by the
FDA, the product may demonstrate adverse side effects that prevent its widespread use or limit
its use to only life-threatening situations. A known side effect of t-PA is that t-PA does not dis
tinguish between beneficial clots and injurious clots in the body, thereby creating a risk to patients
who have had major bleeding episodes in the recent period prior to administration of t-PA. Other
side effects may be discovered in the course of clinical trials or the use of t-PA.
Scale Up of Manufacturing Processes
To date Genentech has not manufactured t-PA in quantities sufficient for commercial marketing.
There is no assurance that the Partnership will be successful in scaling up manufacturing processes
for the production of t-PA in such quantities.
FDA Approval; Possible Delays
The success of the Partnership will also require approval by the FDA for the marketing of t-PA.
There can be no assurance that the FDA will approve the marketing of t-PA. Any delay in obtaining
FDA approvals would have a material adverse effect on the commercial success of the Partnership.
Genetic engineering is a new production technology and the Partnership s products will be among
the first pharmaceuticals produced by means of recombinant DNA technology to be considered by the
FDA for marketing approval.
19
261
No Assurance of Commercial Success
Even if t-PA is approved for marketing by the FDA, there is no assurance that t-PA will be
scribed by physicians or accepted by patients.
Competition
Other companies are attempting to develop t-PA products using recombinant DNA technology,
successful marketing of such products in the United States by competitors may adversely affect
volume and prices realized by the Partnership s products. Although the Partnership holds variot!
patent rights under license from Genentech, there can be no assurance that such patent rights
other proprietary information of Genentech or the Partnership) will be effective in inhibiting COE
petition with respect to the manufacture and sale of t-PA.
Possible Need for Additional Funds
Although the Partnership believes that the proceeds from this offering (including any proceeds fro
sales of additional Units in connection with the overallotment referred to under the caption "Plq
of Distribution") will be sufficient to cover the clinical testing and other research and developmeij
of t-PA for a variety of indications, there can be no assurance that additional funds will not
required. In the event that Genentech does not exercise both the Joint Venture Option and
Partnership Purchase Option, the Partnership may require additional funds to manufacture
market its products. In any event, the Partnership may require additional funds and there
be no assurance that such additional funds will be available or that raising additional funds will no]
result in substantial reduction in the return to Investors from the Partnership.
No Assurance of Exercise by Genentech of Joint Venture Option or Partnership Purchase Option
Genentech is not obligated to exercise its option to enter into the Joint Venture or, if it does ent<|
into the Joint Venture, to exercise its option to purchase the Partnership Interests. If Genentech do
exercise these options, there can be no assurance that Genentech will be able, despite its efforts,
manufacture or sell t-PA, or to license a third party to do so, thereby generating economic benefi^
for the Investors. If Genentech exercises the Partnership Purchase Option and does not manufac
and market t-PA, there may be no amounts payable to the Investors who choose the Payment Stre
Alternative (other than the distributions equal to 15% of the Units of Limited Partnership Intere
payable upon exercise of the Partnership Purchase Option), even though Genentech will have acquir
all of the Partnership s right, title and interest with respect to t-PA.
If Genentech does not exercise the Joint Venture Option or the Partnership Purchase Option, the
may be no amounts payable to the Partnership unless the Partnership licenses or sells its rights wit;
respect to t-PA to another entity and the resulting products are marketed successfully. There can
no assurance that another entity will acquire the Partnership s rights with respect to t-PA if Genentec
does not exercise the Joint Venture Option or the Partnership Purchase Option, or that the terms
any sale or license to another entity would be as favorable as the terms set forth in the Joint Vent
Agreement or the Partnership Purchase Agreement. In any event, the Partnership would not be ;
to market its rights to entities other than Genentech prior to expiration of the foregoing options.
Regulation by Government Agencies
In addition to regulation by the FDA, the Partnership and Genentech will be subject to variot
environmental, safety and health regulations. The extent of adverse government regulation whic
might arise from future legislative or administrative action cannot be predicted.
Product Liability
The testing and marketing of pharmaceutical products entails an inherent risk of possible productl
liability. The General Partner intends to seek insurance against such risks on behalf of the Partner-j
20
262
ship, and Genentech has agreed to indemnify the Partnership against certain liabilities. There is no
assurance, however, that a product liability claim would not adversely affect the business of the
Partnership or the return to Investors from the Partnership.
Limited Operating History of Genentech
Genentech will conduct the research and development for the Partnership under the Development
Agreement and, if Genentech exercises its option to enter into the Joint Venture, will manufacture
and market for the Joint Venture. Genentech has only limited experience in the development,
manufacturing and marketing of pharmaceutical products and the conduct of clinical testing programs
required to obtain FDA approval. Thus, there is no operating history upon which Investors may base
an evaluation of the likely commercial performance of Genentech.
Conflicts of Interest
The Partnership may be subject to various conflicts of interest arising from its relationship with
the General Partner and its affiliates. The risk exists that such conflicts will not be resolved in
the best interests of the Investors. These conflicts include:
Negotiation of Agreements
The terms of all of the agreements and arrangements between the Partnership and the General
Partner or any of its affiliates were determined by negotiations between Genentech and the Sales
Agent, which negotiations might not be considered to be arm s length.
Work Performed Under Development Agreement
Genentech will receive compensation from the Partnership for the research and development carried
out under the Development Agreement. The interests of the General Partner and those of the
Partnership may conflict with respect to various issues concerning the testing and development of
t-PA, including the potential conflict of interest should the research and development carried out
under the Development Agreement prove to be more valuable for uses outside the United States
than for uses within the United States.
Joint Venture and Partnership Purchase Option Agreement
Genentech is not obligated to exercise the Joint Venture Option or the Partnership Purchase Option
and will exercise these options only if it views such exercise as being in its best interests, without
regard to the best interests of the Partnership or the Limited Partners.
Operation of Joint Venture
Under the terms of the Joint Venture Agreement, Genentech will have exclusive managerial respon
sibility for operation of the Joint Venture and will manufacture and sell t-PA in the United States
for the Joint Venture. Genentech may also be manufacturing t-PA for sale outside of the United
States for its own account or for foreign licensees. If Genentech is unable to produce an adequate
amount of t-PA to supply all of these demands, this may have an adverse effect on the Partnership.
In addition, Genentech will be responsible for marketing the products of the Joint Venture, and it is
anticipated that such products will be marketed by the same sales force that sells Genentech s prod
ucts and the products of other partnerships or joint ventures, generally. An incentive could exist for
Genentech, or for its sales personnel* to devote greater effort to the sale of such other products than
would be devoted to the sale of the Joint Venture s products.
21
263
Bob Swanson and Fred Middleton in July 1999 celebrating Fred s 50th birthday in Hillsborough, California, a few
months before Bob s death later that year.
264
INDEX--Fred A. Middleton
Abbott Laboratories, 50, 55
Adams, Daniel, 13
Agilent, 53
Amdahl Computer, 46
Amdahl, Gene, 40, 46
Amgen, 19, 22, 46, 47
Apple Computer, 28
Applied Biosystems, 53, 54
Arscott, Dave, 5
Bank of America Leasing, 16
Baxter Travenol Genentech Diagnostics,
21,54-56,58
Benton.Lee, 31, 58,62
Biogen, 19, 25, 27, 30, 35-36, 47, 48
biotechnology analysts, 35-36
biotechnology companies/industry
clinical trials, 47
FIPCO strategy, 47
first conference, 26
instrumentation for, 53-54, 58
R&D partnerships, 47
U.S. corporate interest in, 58. See
also specific corporations
Blyth Eastman Paine Webber, 18, 28, 30,
32,40
Boehringer Ingelheim, 1 9
Bowman, Elaine, 7
Boyer, Herbert W., 8, 12, 28, 29, 31, 33, 37
Byers, Brook, 1 1
Byrnes, Bob, 21,25
Caltech, 9
Campbell-White, Annette, 36-37
Celera Genomics, 53
Centocor, 46
Cetus, 19, 25, 27, 30, 35-36, 47, 48, 53-54
Chase Manhattan Bank, Middleton
employment at, 9, 1 1
Chiron, 47, 54
Ciba-Geigy, 52
City of Hope Medical Center, 9
Clayton, Shirley, 20
clinical research organizations, 38
Cohen, Stanley N., 8
Cooley Godward, 62
Coming Glass Works, 21, 24, 34, 48-52,
55,58. See also Genencor
Coyle, Bud, 28, 30, 46
Coyne, Chuck, 67
Cultor, 50
Cunningham, Brian, 58
Daiichi Seiyaku, 34
Dakin, John, 32
Davis Polk & Wardell, 46
diagnostic products, 55-56
Diamond v. Chakrabarty, 37
drug companies, 29, 38, 39
Eastman Kodak, 50
E.F. Hutton, 26-27
Eli Lilly, 12, 29, 33
Elanco division, 52
insulin contract, 16-17, 26, 29, 64
growth hormone competition, 23
Epogen, erythropoietin, 25, 36
Emst & Young, 60
Evans-Freke, Stephen, 46
Fairchild Semiconductor, 28
Financial Accounting Standards Board, 61
FEPCO, Genentech as, 22-24
Fluor Corp., 2 1,32, 33
genetic engineering. See recombinant
DNA/generic technology.
Genenchem, 53, 54, 56
Genencor, 21, 34, 48-50, 56
Genentech, business aspects/facilities
acquisition by Roche, 39
agricultural program, 51-52
benchmarks, 63-67
biosafety facility, 14, 37
board of directors, 21, 52, 57, 61
business/financial strategy, 17-20,
24,36
clinical partnerships. See R&D
partnerships
clinical trials, 39, 44-45
contract research programs, 56
facilities, 14-15, 19,28,33
265
Genentech, business aspects/facilities
(continued)
and FDA, 38
fermenter, 28
financing/budgeting, 26, 27, 29,
34-35, 39, 44, 68. See also specific
instruments
FIPCO, 22-24, 44, 46
foundation, 8-9
industrial products group, 5 1
intellectual property, 16, 18, 37,45
.
joint ventures, 48-49, 51-58
junior common stock, 59-63
IPO, 17-18,26-32,35,37
joint ventures, 20, 51-58, 67
limited R&D partnerships, 18-19, 35,
39-48, 68
management team, 10-12, 20
outlicensing, 24, 45-46
pharmaceutical focus, 48, 51
premium market capitalization,
34-35
private placements, 34, 39, 57
product development teams, 67-68
product evaluation teams, 67-68
research foci, 24-25
stock, royalties, warrants, 16, 31-32,
41,42,46,59-66
Genentech Development Corporation, 44
Genentech R&D limited partnerships, 18-19, 35,
39-47
Genentech projects/products
CD4, 42, 44
growth hormone, 23, 26, 29,
33,38,39,41,42,45,46,51,64
industrial chemicals, 57
industrial enzymes. See Genencor.
insulin, 8, 10, 12, 16-17,25
interferons, 19, 24, 25, 26, 29, 33,
39,41,51-52
somatostatin, 12
synthetic DNA and, 37
tPA, 19, 24-26, 33, 36, 38, 39, 40, 41,
42, 45, 46-47
tumor necrosis factor, 42, 44
vitamin C, 57
Genetic Systems, 43
Genex, 27, 30
Gilbert, Walter, 36
Gist Brocades, 49
GLC Associates, 57
Goeddel, Dave, 25
Gomez, Reinaldo, H., 51, 58
government regulation of rDNA research,
37-38
granulocyte colony-stimulating factor, 19
Guernsey, Ken, 17
Hall, Ted, 7
Hambrecht, Bill, 27, 28, 32
Hambrecht & Quist, 18, 27, 28, 30, 40
Harvard Business School, Middleton s
education at, 4-5
Hewlett-Packard [HP] Genenchem, 53, 54,
56,58
Heyneker, Herb, 49
Hillman family venture capital, 14
Hoechst, 12, 16-17
Hoffmann LaRoche, 25, 26, 34, 54, 57
acquisition of Genentech, 39
Houghton, Amory, 21
EDEC Pharmaceuticals, 43
Inco Venture Capital Management, 1, 26
industrial enzymes, 52. See also Genencor
Intel, 28
interleukins as commercial products, 47
InterMune Pharmaceuticals, 1 9
IRS, 39, 61
Johnson & Johnson, 12, 29
Kabi, 26
Kaiser, Dave, 2
Katzenbach, John, 7
Kennedy, Edward, 37
Kiley, Thomas D., 16, 21, 58
Kleiner, Eugene, 8, 13, 27, 28
Kleiner & Perkins, 1 1, 16, 27, 31, 33
Swanson s employment with, 8, 13
Larson, Don, 7
Leach, Robert E., 21,49
Levin, Mark, 67
Levinson, Art, 22
Lindgren, Bob, 3
266
Loucks, Vemon R., 54, 55
Loustaunou, Jack, 8, 27
Lubrizol, 14, 21, 26, 33, 56, 57, 58
Lyon & Lyon, 1 6
MacCallum, David, 36
Mann, Bruce, 3 1
Marsh, Reid, 2
Massachusetts Institute of Technology
biochemistry course, 3-4
Middleton s education at, 2-4
Sigma Chi fraternity, 2-3
Sloan School of Management, 4
Mayfield Fund, 13,26
McGrath, Patricia, 20
McKinsey & Co., Middleton s employment
at, 5-7
MedVenture Associates, 36
Merrill Lynch, 40, 46
Mitsubishi, 34
Molecular Devices, 54
Monsanto, 51
Morgan Stanley Research Venture Partners,
and Middleton, 21,43
Murfm, Don, 21,32, 57
NTH recombinant DNA advisory committee,
37
NovoNordisk, 12, 16-17,49
Ostrach, Michael S., 35
Packard, Dave, 21
Paine Webber Development Corporation,
41,46
Perkins, Tom, 8, 13, 27, 29, 30, 32, 35, 40,
46
Peters, Tom, 7
Pettinga, Cornelius, 16, 17, 29
Pfaff, Dave, 20
polymerase chain reaction, 54
Procter & Gamble, 49-50
PruTech, 56-57
Quist, George, 27
Rastetter, William H., 58
Rathmann, George, 1 9, 25
recombinant DNA controversy, 37
recombinant DNA technology/genetic
technology, 14, 26-27, 28, 30, 31, 48
and diagnostics, 55-56
and industrial chemicals, 57, 58
and industrial enzymes, 49-50, 58
and monoclonal antibodies, 55
and pharmaceutical products. See
also specific Genentech projects
Swanson s early interest in, 8, 12, 46
Robertson, Sanford R., 54
Robertson, Colman, Siebel & Weisel, 27
Roche. See Hoffmann-La Roche
Rock, Arthur, 28
Rohm & Haas, 50
Ross, Michael J., 58
Ruffm, Fred, 20
San Francisco Examiner article & Middleton,
30
Securities & Exchange Commission [SEC],
30-31,60-61,62
Sheehan, Brian, 10, 12, 25
Silicon Graphics, 43
Steele, Gary, 5 1
stem cell controversy, 37
Step, Gene, 29
Studebaker-Worthington, Middleton s
employment at, 6
Swanson, Judy, 3 1
Swanson, Robert A., 17, 33, 37
and FDA, 38
Genentech organization &
management, 10, 15, 16, 20, 21,
31,32,33, 46,50,52,55,56,68
pre-Genentech, 2-7, 11-12, 13, 14, 27
and IPO, 28-30
Tandem Computers, 8, 27
Tappan, Dave, 21
Tax Reform Act, 43
Treybig, Jimmy, 8, 27
Trilogy, 46
Unterberg, Towbin, 27-28, 35
267
venture capital/venture capital industry, 5-6,
8, 10, 14, 43. See also specific companies
Vincent, James L., 23
Waterman, Bob, 7
Wilmington Securities, 26
Wood, Dick, 29
Young, Bill, 33
Young, Dendy, 3
Glenn E. Bugos
Since 1994 has served as principal historian with The Prologue Group, a
corporate history consulting firm. He received his Ph.D. in 1988 from the
University of Pennsylvania, through the Department of the History and
Sociology of Science, Technology, and Medicine. He has published on the
history of biotechnology, aerospace, and other topics in the recent history of
business and technology.