Determining Valuation for Early and Latter Development-Stage Biotechnology Companies –
All biotech entrepreneurs at some point must address the question “how much is your company worth?” The answer determines the slice of equity for yourself, employees, and current and future shareholders. As a result, most BioEntrepreneurs tend to overvalue their company at the start-up and early development stages. However, overvaluing your company is counterproductive and detrimental to attracting institutional and venture capital during these critical stages. Although there are standard valuation methods for determining the value of growing companies with product revenue, how do start-up and preclinical stage biotechnology companies without product revenue value their organization?
For valuation purposes, biotechnology companies should be divided into two groups: Early Development and Latter Development Stage Companies. Early Development Stage companies are Seed, Start-up, and Preclinical Stage organizations. Latter Development Stage companies are those with an FDA approved IND (Investigational New Drug application) and companies with a product in human clinical trials. For diagnostic and medical device companies, Latter Development Stage refers to companies with products ready for human testing prior to a 510(k) or Pre Market Approval (PMA) application.
When assessing the valuation of Latter Development Stage Companies the following methods are best utilized. Each of these methods can provide differing valuations but the best valuation is an estimate determined by utilizing all three methods.
1. Valuation by Comparables: Identify similar organizations in similar sectors at similar development stages that have been recently valued by a financing round. Although this is generally not public information, there are available venture capital resources (for fees) you can utilize to obtain this information. Also, if you know or have worked with Venture or Institutional Capital, they can help you obtain this type of information.
2. Valuation by Public and Private Exit Valuations: Find the prices paid for mature organizations in your sector during an exit such as an acquisition or an Initial Public Offering (IPO). An appropriate adjustment to this price is then made based upon the return multiples required by a typical institutional investor. For instance, if an institutional investor today requires a potential 8-10x return on their investment in order to invest, then your organization could be valued at $25 to $31 million based upon an acquisition value of $250 million for a mature company in your sector.
3. Valuation by Risk-Adjusted Discounted Cash Flow (rDCF): This is determined by first estimating the company’s future revenues minus the costs associated with generating those revenues, then discounting these by an appropriate interest rate. This is called a Discounted Cash Flow (DCF) or Net Present Value (NPV) of those future earnings. Then, the value of those future earnings is discounted again by the risk of successfully completing Phase I, II, III and receiving FDA approval. The final value is called a Risk-Adjusted DCF. Although this method sounds complicated, there are good mathematical programs for calculating these figures. The uncertainty comes from the estimates made about the company’s future revenues and when determining the risk associated with clinical and regulatory success.
4. Adjustments to Valuation: There are several value-adding or value-detracting factors. Examples include the completeness and caliber of the management team, the acuteness of the medical need for their product (e.g.HIV, Alzheimer’s, Cystic Fibrosis), follow-on applications, and the strength of existing financial and development partners in supporting ongoing product development. The Current Financing Window and the Need to Raise Capital: There are other adjustments to valuation. When a biotech company urgently needs capital but doesn’t have readily available financing their valuation is somewhat reduced. Conversely, an organization that is adequately funded with adequate resources to reach their next value enhancing milestone is valued differently.
For Early Development Stage Companies, you can use all the same methods except the Risk-Adjusted Discounted Cash Flow Method (rDCF). Early Development Stage companies have many more financial and scientific uncertainties that weaken the ability to confidently utilize the rDCF method. These companies lack certainty of successfully reaching the next stage of development and uncertainty in securing adequate funding to continue progress toward the clinical testing and regulatory phases. Also, the cost, risk and time associated with the research and development phase of any one particular biotechnology product is uncertain. More importantly, Venture Capital does not use rDCF for valuation of Early Development Stage companies, and they are the most common investor at this stage of development. However, once a company receives FDA approval to begin human clinical testing (IND approval), there is a better understanding of the development path and the risks associated with these products reaching commercialization.
The Takeaway Tidbit
Accurately determining the valuation of a development-stage biotechnology company is important for attracting financing, issuing stock at “fair-market’ value and ensuring that future financing partners are not soured by an unrealistically valued company. Many valuation methods are available for companies with product revenue but all methods do not work equally well for early and development-stage biotechnology companies. The reason for this lies in that early-stage biotech investors are VCs who typically do not use rDCF when determining valuation of companies at these early stages. The key to arriving at a fair valuation is using the appropriate methods for your company’s stage of development. Having a realistic valuation for your company will increase the likelihood of financing your enterprise. In reality, after utilizing all these valuation methods, never forget, valuation is ultimately determined by the investor who writes the check.
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