Looks Like $100 Million to Me!

 NIELS REIMERS AND BOB SWANSON

Venture capitalist Tom Perkins was trying to convince Genentech cofounders Bob Swanson and Herb Boyer to take the company public. Three-year-old Genentech had successfully used the recombinant DNA technique to synthesize human insulin and now supplied small batches of the hormone to large pharmaceutical companies such as Eli Lilly. These companies would manufacture the hormone in volume and sell it.

Genentech was profitable, though barely. It employed more than one hundred full-time employees (more than one-third of them with PhDs), who worked in a warehouse in South San Francisco. Rents were low and activists scarce in the self-proclaimed “Industrial City.” For a while, Genentech’s neighbor was a distributor of soft porn.

Perkins, Swanson, and Boyer agreed that Genentech needed cash to build manufacturing facilities. The company’s tepid efforts to raise money by selling itself to Lilly or Johnson & Johnson had failed. Perkins believed that a public offering would give Genentech the opportunity to set the template for this new industry, recently christened “biotech.”^XI A successful IPO would also provide a profitable exit for his venture capital firm.

The industry had not entirely shaken the mad-scientist reputation that had shadowed its earliest years, but overall, the public had become less fearful and more admiring of biotechnology. Genentech had hired Regis McKenna to help explain and promote the new technology, and whether due to his influence or simply the passage of time, the company had been the subject of glowing stories in publications that included Time, BusinessWeek, the Wall Street Journal, and the New York Times. Headlines proclaimed, “ ‘Astonishing’ Report on Gene Research,” “Gene-Splicing Field Is Swiftly Approaching the Commercial Stage,” and “The Bold Entrepreneurs of Gene Engineering.”¹ A few large companies that could imagine using genetic engineering in their products had even invested in several young biotech companies.^X

Perkins believed that Genentech had everything it needed to go public: profits, a product, big-name customers, and public approval. Moreover, he warned Swanson and Boyer, if another, less conservatively managed company went public first, it could dim Genentech’s prospects later. Genentech needed to move quickly to define for the public what it meant to be a biotech company.

Swanson disagreed. He thought that Genentech was not ready. Profits were tiny—only slightly more than $100,000 on roughly $3 million in revenues—and came not from selling products to patients or hospitals but from supplier agreements with the big pharmaceutical companies. Swanson did not believe that a barely profitable business without product revenue was a good candidate for a public offering. It did not help that the University of California was suing Genentech for alleged theft of genetic research materials.^2IX Moreover, the US Supreme Court had not yet determined if novel life-forms—the heart of Genentech’s intellectual property and products—could be protected with patents.^VIII There was too much uncertainty.

Swanson did not want to add to his list of concerns the attention and reporting requirements that would come with public ownership. He was already running Genentech in a near-constant state of anxiety, “worried most of the time,” as he put it. Often, he said, he felt as if the stress was “chewing on my heart.”³

Swanson said he wanted to wait a year. Perkins hurled his pencil onto the table. “That’s the most ridiculous thing I ever heard!” he yelled, “Why don’t I just sell all my stock and resign from the board?”⁴

Perkins asked Boyer to break the tie. The scientist demurred, saying only, “I always vote with my friends.”

Chairman and CEO battled on. Finally, Perkins, playing on Swanson’s competitiveness, asked him how he would feel if Cetus, the company that had declined to hire him to launch a recombinant DNA effort back in 1974, became the first biotech company to go public. That decided it.

The next step was to find investment banks to underwrite the offering. Eugene Kleiner asked Alfred “Bud” Coyle, a partner at New York’s Blyth Eastman Paine Webber, to come out of retirement for the Genentech offering. Here, as had been and would be the case so many other times in Silicon Valley, connections forged among an earlier generation of entrepreneurs supported the following generation’s success. Three decades earlier, Coyle, along with his then junior associate, Arthur Rock, had brokered the deal that had launched Fairchild Semiconductor, of which Kleiner was one of eight cofounders. The Fairchild deal—funding eight young unknown scientists and engineers who had decided to leave their Nobel Prize–winning boss and launch a competitor company—had been revolutionary. Kleiner knew that Coyle was a risk taker.

The Genentech offering was similarly radical. “It was science, it was hardly profitable, and it had essentially no revenue,” says Brook Byers, Swanson’s former apartment mate who joined Kleiner & Perkins (now Kleiner Perkins Caufield & Byers) in 1972. Genentech, attempting to be the first new pharmaceutical business launched in many years, would compete against established giants. Without Coyle behind the offering, Byers muses, “no New York investment banker would have paid any attention to it.”⁵

Perkins suggested that the West Coast investment bank be Hambrecht & Quist, an operation he knew well and whose principals he considered “Boy Scouts” among the cynical moneymakers of investment banking.^VII6 Bill Hambrecht and George Quist had launched their partnership a dozen years earlier, in 1968. At the time, they believed that West Coast venture capitalists did not know how to take small high-technology companies public and East Coast bankers, who knew how, did not want to take the risk. Hambrecht and Quist embraced what was then an unusual business model: their business served as both a venture capital firm that made early investments in risky young companies and as an investment bank that made money by taking young companies public.

Long Island native Hambrecht, amazed by how easy it was to try something new at the western edge of the continent—the new firm raised $1 million from four prominent San Francisco families in a single afternoon—credited California’s “pioneer traditions.”⁷ “Nobody ever asked me, ‘Well, why do you think you could do it?’ We just said we could!” Hambrecht says. “We found out by doing some of these—yes, there was a market for it.”⁸

Bill Hambrecht may be alone among wildly successful financiers in having chosen his college (Princeton) because Norman Thomas, the six-time presidential candidate from the Socialist Party of America and a hero to Hambrecht’s grandfather, was an alum.⁹ Bill Hambrecht would gain fame in 2004 when he employed an “auction model” to make it easier for the general public to buy into the Google public offering. But he had been trying to increase public access to high-potential companies since early in his career. The year prior to launching his partnership with George Quist, he had visited an entrepreneur, Bill Farinon, who wanted Hambrecht (then with the investment firm F. I. du Pont & Co.) to take his electronics company public.^VI Hambrecht had explained that the business was too small. To go public, companies needed to hit certain targets: $1 million profits, $10 million in revenues, five years of profitability. Those were the same metrics that had made Swanson hesitant to take Genentech public.

Farinon demanded, “Who set up those rules?”

“I don’t know. They’re just the rules,” Hambrecht said,

Farinon was indignant. “Those goddamn rules. They were set up for you guys so you could make a lot of money! They have nothing to do with me.” He pressed Hambrecht. “Do you think I have a good company here? Would you put in some of your own money?”

Hambrecht admitted that he would love to buy stock in the company.

Farinon looked triumphant. “If you’re willing to buy stock for yourself, why aren’t you willing to sell it to the public?”¹⁰ That challenge became the credo of Hambrecht & Quist.

By the time Perkins called Hambrecht to see if he might be interested in taking Genentech public, Hambrecht & Quist, after struggling through several rough years, was a success. The bank had four senior managing partners and twelve general partners.¹¹ Hambrecht reviewed Genentech’s financials and agreed to join a tour of the company’s facility. He listened to the explanations of the cooling and warming rooms, visited the wet labs with scientists in white coats, and peered at the state-of-the-art fermenter with multiple dials and colored valves and pipes. After the tour, Perkins asked Hambrecht, a history major, what he thought of the operation. Hambrecht paused, looked around, and said, “Well, it looks like $100 million to me!”¹² He wanted his firm’s venture arm to invest in the next round of funding, and the banking side to bring Genentech public.

In September 1980, Swanson began a four-day, six-city European “road show” tour in preparation for the company’s initial public offering, slated for the next month. Accompanying him across the continent were cofounder Boyer and board chair Perkins, as well as Genentech’s CFO and three bankers. From Paris through Geneva and Zurich and on to Edinburgh, Glasgow, and London, the men moved as a pack. Black cars ferried them from airports, to breakfasts with pension fund managers, to one-on-one meetings with representatives from major trusts, to lunch presentations before rooms of insurance fund managers, to afternoon appointments and the occasional dinner—and back to the airport.

The presentations had been refined and repeated to the point that any member of the group could have given any part of them. But the men stuck with the script. CFO Fred Middleton ran through the financials, pointing out that Genentech had been the first to synthesize human insulin and was profitable. Boyer talked about the science behind recombinant DNA, using a string of brightly colored children’s plastic pop beads as props. He would connect the beads end to end to represent a plasmid and then pop the circle open to insert new beads that represented DNA from a different source. To demonstrate inserting the plasmid into E. coli bacteria, he placed the mixed ring of beads into a clear plastic box.¹³

“People just listened and gaped,” recalled Middleton of the road show presentations. “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. Everyone was just amazed.”¹⁴ Nearly anyone who heard about the science behind Genentech’s business walked away with the same thought: I’m not sure exactly what this is, but it feels huge. Already the company had found a way to synthesize life-sustaining human insulin in a test tube. What would come next?

Swanson spoke of the company’s origins and promise. He was a natural, poised and enthusiastic, the model of a successful executive at only thirty-two. Over the past three years, he had raised more than $1 million in three rounds of private financing. Within the company, he knew how to wheedle, badger and cajole the scientific staff, armed with “just enough [science] to be annoying,” as one Genentech researcher put it. Genentech’s scientists hardly lacked motivation, however. Dave Goeddel, who headed the successful push to be the first to make human insulin, liked to say, “You either came in first or you might as well be last.” He designed a T-shirt adorned with the Harley-Davidson logo, a DNA double-helix, and the phrase “Clone or Die.”

The road show blur left Swanson “wrung out like a wet dishrag,” in his own description. At day’s end, some of the others repaired to the hotel bar or lobby to sink into the plush seats and enjoy a cigar. But not Swanson. For him, the trip was about much more than bankers and investors and balance sheets. There was someone else along on the road show, someone who did not even work for Genentech. And Swanson felt that he owed her an apology. He had never meant for it to happen , but the trip was doubling as his honeymoon.^V

He had married less than a week before the road show had begun. He and his new wife, Judy, had enjoyed a single weekend together before the six other executives joined them for a honeymoon that Swanson characterized as “Snow White and the Seven Dwarves.” Judy Swanson tried to squeeze quick tourist look-sees into the two-hour blocks while her new husband pitched to potential investors. When the group spent several days in London, she rented a car and drove to the Lake District. “What’s a nice American girl like you doing alone?” she was asked.

“I’m on my honeymoon,” she replied.¹⁵

On October 14, 1980, Genentech began trading on the NASDAQ exchange under the symbol GENE. In the first twenty minutes, the opening price of $35 per share zoomed to $89—the fastest first-day gain in Wall Street history. (“George Quist is the one who really made that happen,” theorizes venture capitalist Brook Byers. “I think he just picked up the phone and called all of the people he knew in New York and said, ‘You ought to buy this.’ ”)¹⁶ When the closing bell rang, the price had settled a bit, and Genentech was valued at $532 million ($1.6 billion in 2015 dollars). Swanson and Boyer’s original $500 investments were each worth about $65 million ($199 million in 2015 dollars), as was the stake that Kleiner & Perkins bought for $100,000 in the first round and an additional $100,000 later.^IV

At least one scientist, seeing Boyer as a turncoat, not a pioneer, remarked that the windfall might not be good for Boyer’s scientific career, since business still retained an unsavory reputation in scientific circles.¹⁷ But many more disagreed. A dozen biotech companies, all of them with scientists in key roles, went public in the two years after Genentech’s IPO.¹⁸ Recombinant DNA, one chronicler has theorized, “pushed genetics from the realm of science into the realm of technology.”¹⁹ Venture capitalists knew how to build companies around technology.

The morning of Genentech’s IPO, Perkins phoned Bob Swanson back in California and roused him from a sound sleep. “Bob,” he said to the drowsy young entrepreneur he had once fired, “You’re the richest man I know.”²⁰

On the same day Genentech went public, Paul Berg, the Stanford biochemist who had organized the Asilomar conference on the safety of recombinant DNA and who had criticized the Cohen-Boyer patent for “claiming everything,” was awarded the Nobel Prize in Chemistry. The Nobel Committee cited him for his “fundamental studies of the biochemistry of nucleic acids, with particular regard to recombinant-DNA.” Berg shared the prize with Frederick Sanger of the MRC Laboratory of Molecular Biology in England and Walter Gilbert, the Harvard researcher whose team had worked in a British biological warfare facility during Cambridge’s 1976 moratorium.

At no point in the Nobel proceedings was Stan Cohen or Herb Boyer’s fundamental work mentioned.²¹ Some observers claim that Cohen and Boyer had merely “reduced to practice” the breakthrough work by the prizewinners and others, such as Janet Mertz and Peter Lobban. It is also possible that Cohen and Boyer’s acquiescing to Reimers’s suggestion to patent the recombinant DNA process cost Cohen and Boyer the prize.²² If successful, the patent application would mean that Cohen and Boyer would receive credit as “inventors,” as well as substantial financial remuneration, for research that built on other scientists’ work (as all science, including that of all the Nobel laureates, does).

“The Nobel Prize issue bothered me for a long while, to be honest about it,” Cohen admits, “but it’s something I’ve gotten over.”²³ (Boyer, who says that he is happy and “never would have expected to do what I have done,” has also said that he was disappointed by the Nobel announcement.)²⁴ Asked if it had been difficult to learn, on the same day that the prize was announced, that the cofounders of the company he had declined to cofound were each now worth tens of millions of dollars, Cohen says, “It was a delightful surprise that the business world had recognized that the valuation of a company devoting itself to this area could be so great.”²⁵ Cohen, who began accepting his inventor’s share of royalties on recombinant DNA in 1986 and donated them to charity, never measured success in terms of prizes or dollars.²⁶ “My turn-on comes from research,” he explains. “Evolution has given us TB and malaria and cancer. All of medical science is altering what evolution has given us.” He also adds, “I tried to do what was right.”²⁷

Two months after the Nobel Prize announcement, on December 2, 1980, attorney Bert Rowland called Niels Reimers at Stanford’s Office of Technology Licensing to say that after six years, the recombinant DNA patent was going to be issued. “Method patent allowed!” Reimers wrote in a triumphant memo to the file that by this time filled several drawers. He printed the new patent number at the bottom of the memo: 4,237,224.²⁸ That patent and related ones would be the source of nearly $255 million in income to Stanford and the University of California in the coming years.

Reimers had been expecting the patent to be issued for months, but there’s nothing like official paperwork to kick off a celebration in a licensing office.^III The Henrys celebration that Friday was jubilant.

A proud Stanford vice president told the San Jose Mercury, “This is the first time in my memory that a whole field of science has broken open to commercial application in ways that are both obvious and obviously profitable.”²⁹

At about the same time, Congress passed the Bayh-Dole Act. The act essentially codified in law the objective Reimers had pursued for five years: the right of universities to claim ownership to an invention that had been funded by Federal research grants. Reimers had pushed hard for the bill, meeting with senators and members of the California House delegation. Passage of Bayh-Dole was a high priority for him. He wanted all universities automatically to have the same rights Stanford had won piecemeal.

The patent in place, Reimers turned to refining the terms of the recombinant DNA license. The beauty of the Cohen-Boyer process—its simplicity—also meant that as the patent application sat in limbo for six years, scientists around the world had begun using the process. At the time the patent issued, the National Institutes of Health was spending $91.5 million to back 717 recombinant DNA projects; the National Science Foundation was spending $15 million on 184 grants; and the Department of Agriculture was supporting $5 million in research.³⁰ Academic and pure research institutions could continue their work without buying a license, but now that the patent had been issued, any company employing the technique needed to buy a license from the Office of Technology Licensing. That included Genentech, which used the process in developing its hormones.

Reimers had to design a license that would accomplish two hard-to-reconcile ends: bring in money to Stanford and the University of California and, at the same time, be priced fairly enough that companies would be willing to buy a license, rather than challenge the validity of the broad patent in court.³¹

For years, he had played with different models for terms. In the end, he adopted a shrewd approach that played on corporations’ instinctive dislike of uncertainty. Licenses that offered cheap terms would be available only to those who signed up within four months. After that . . . Reimers got creative. He decided not to offer any information about the terms that would be available after the four-month window closed.³² (“I don’t know where that idea came from; I guess in here,” he says, tapping his head.) In essence, he was telling companies that they could take a deal now or take their chances later.³³

Reimers sent drafts of the licensing terms to roughly a half-dozen companies, including Genentech.³⁴ This gave important companies a first look, and their feedback gave Reimers a better understanding of what mattered to potential licensees.^II Soon after receiving the draft terms, Genentech’s Bob Swanson, who had been in touch with Reimers since the month the company had launched, began petitioning for a custom license. Reimers refused. There would be only one deal. It could not be customized. To make the point, he had the final licensing paperwork bound into little pamphlets that looked more like finished books than legal documents that could be changed by scratching out and initialing corrections.³⁵

As much for publicity as for sales, Reimers placed advertisements in Science, Nature, and the Wall Street Journal during the first week of August 1981. The notice, which read almost like a birth announcement—“Stanford University, in cooperation with the University of California, announces that patent licenses are now available”—thanked the sponsoring organizations; laid out the terms of the license; warned obliquely that after December 15, terms “will be less favorable to the licensee”; and ended with the promise that the universities would use the royalty revenue for “educational and research purposes which, in turn, may result in yet other scientific advances for public use and benefit.”³⁶

Back on the Stanford campus, Sally Hines, Reimers’s longtime assistant, taped a large piece of paper to the front of her desk. She announced that she would keep a running tally of companies that signed up for a license. Reimers sent Andy Barnes, a business school student hired on a one-year contract, around the United States and to Europe and Japan to encourage companies to buy licenses.^I In Japan, where the government had named development of recombinant DNA processes a national goal and Silicon Valley was widely admired, Barnes says that he was treated “like a rock star” with media events and even a small group of paparazzi trailing him.³⁷ But in New York and Chicago, company representatives told Barnes that the patent was too broad to be enforceable.³⁸ In Europe, companies expressed concern about locking themselves into a royalty rate that might later prove too high.³⁹

Barnes recalls, “The plan was a little audacious. Everywhere the response was the same: ‘This should be in the public domain. How can Stanford be doing this?’ ”⁴⁰

Reimers hoped that Genentech would be the first company to sign a licensing agreement. “Their company had the name. They were not an old-line firm like SmithKline or Bristol Myers. They were clearly making a splash in the field,” he recalls.⁴¹ Soon, however, he learned that he could not be choosy. A Japanese company was the first to sign an agreement—Sally Hines proudly noted it with a large “1” on her butcher-paper tally—but that was it for more than a month. By mid-September, with only three months until the window closed, only one other company had signed up.⁴²

Stanford president Donald Kennedy began getting antsy. “I’m concerned about the last stages of licensing on Cohen-Boyer,” he wrote to a senior administrator in an early use of the campuswide email system. “Neils [sic] does not seem to have thought thru a firm strategy for how we approach the preannounced deadline, or what we do about rates afterward.”⁴³ Kennedy was also concerned that Reimers, without consulting a superior, had set aside $200,000—more than half the total income brought in by the Office of Technology Licensing in the previous year—to contest potential challenges to the patent.⁴⁴ Reimers wanted this amount set aside not only to defend the patent but also to “be sure we get the money from Cal.”⁴⁵

Privately telling himself that he would be happy if thirty companies bought licenses, Reimers prepared his office for an onslaught, even arranging to have a database program set up on Hines’s new computer to keep track.⁴⁶ Seven years earlier, the patent application had been typed on a typewriter. Now a computer would calculate its value.

License contracts trickled in. The tally on Hines’s desk moved into double digits. Then, on the morning of December 15—the day the licensing window closed—Hines noticed something unusual. Delivery trucks, one after the other, were pulling into the circular drive in front of Encina Hall, the drivers hopping out to bring envelopes into the Office of Technology Licensing. “We were just like kids with our big eyes,” Hines recalled. “So many trucks were there, and they were all for us.”⁴⁷

As the day neared its close, the paper on Hines’s desk was a mess of numbers and cross-outs. Seventy-two companies had signed up for a license.

Reimers, at his desk, reviewed the names of the new licensees, comparing them to his list of targets. Every one he wanted was there—except Genentech.⁴⁸ Then, at the last possible moment, Genentech’s contract arrived. Seventy-three contracts, representing $730,000 in immediate income and unknown amounts in the future, had come in.

Reimers, his satisfaction evident, reported the success to Stanford president Don Kennedy.⁴⁹

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I. Although Stanford did not hold an international patent, many foreign companies paid for licenses.

II. Draft licensing agreements went to Eli Lilly and Company, Genentech, Hoffmann-La Roche, Schering-Plough, SmithKline & French, and Upjohn. Cetus and Monsanto may also have seen a draft.

III. In March, Rowland had called it “95% definite patent will issue by end of year,” and in June, Reimers was feeling confident enough to drop a line to Bob Beyers, who had pointed him to the original Times article about the DNA breakthrough, thanking him for giving Stanford “the chance at obtaining what could be the most significant patent property Stanford (and UC—sigh) will ever have.”

IV. Kleiner & Perkins owned roughly 15 percent of Genentech at the IPO, about the same as Swanson and Boyer.

V. The SEC, worried about a possible violation of the “quiet period” before the offering, had forced Genentech to delay its IPO, which pushed it into the weeks after Swanson’s wedding.

VI. Farinon’s company, coincidentally, was the first one to use ASK’s MANMAN software.

VII. It was Hambrecht & Quist that turned down a first-round investment opportunity in Apple because they thought the personal computer was another CB radio-like fad.

VIII. In the landmark Diamond v. Chakrabarty decision that came down shortly before Genentech’s IPO, the US Supreme Court decided that such life-forms were patentable.

IX. Shortly before the IPO filing, Genentech made a $350,000 payment to the University of California.

X. In the fall of 1979, the chemical company Lubrizol paid $10 million for 15 percent of Genentech. In 1977, Standard Oil of Indiana paid $10 million for 23 percent of Cetus; Standard Oil of California bought another 26 percent for $13 million the following year.

XI. Fred Middleton says that the word “biotech” was coined by E. F. Hutton analyst Nelson Schneider for a conference in October 1979. Earlier, people had spoken of “genetic engineering” or “gene splicing.”