BIOTECHNOLOGY VALUATION

– SELLING DREAMS, BUT WHAT ARE THEY WORTH?

 

Having an idea about what your technology is worth can provide you with bargaining power and is of course essential for raising money, in/out-licensing etc. However, putting a price on early-stage opportunities is covered with significant estimates – estimations of development risks, estimations of potential sales, estimations of suitable discount rates etc.

Here we will only provide a short introduction into the financials of biotech valuation with referral to current industry standards and recommended external resources (websites, papers and book resources for discussion and introduction into the financial models):

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By comparables – if it is possible to get valuation data from somewhat similar fundraising deals (VC investments into technologies at similar development stage for instance), such data can provide you with very valuable benchmarking tools. These data can naturally be highly complicated to get access to.

By direct financial forecasting – discounted cash flow models or option pricing models can be utilized to estimate project value more directly (see industry standards). To take advantage of these models, you need to perform actual financial forecasting. Such forecasting are inherently difficult with any early-stage technology with unsure potential/risks – the better the input data, the better the output. For actual financial forecasting models, in short, the major inputs you need to include in your modelling are:

  • Future cash flow forecasts: outflow & inflow. This for the R&D development phase and with a forecast of future cash flow from product launch untill the end of the product life together with the cost of capital utilized.
  • The time horizon of the R&D and commercialization stages.
  • Risks associated with your product R&D discovery and development phases
  • A discount rate – the opportunity cost of capital (the rate of return that could be earned on an investment in the financial markets with similar risk).

In general, it might be valuable to start your analysis with estimates of the future possible cash flows generated during the commercialization stage. This requires a financial forecast of future free cash flows generated from the product with estimates of expected revenue and the costs of generating these sales. Estimates of market size and market penetration are needed for this (see also the section cash, time and risks – therapeutics). Secondary are costs associated with the R&D phases until market launch (costs of all preclinical R&D +clinical trials+registration for instance for drug discovery projects) estimated. Estimations of the risks associated with both the R&D phases (product failure/stop of program) and the commercialization stage is applied for risk-adjusted models. Different scenarios (for instance operating with different Target Product Profiles for pharmaceuticals) can be useful at the early stages where you do not have the final molecules yet.

Discount rates – The resulting cash flows have to be discounted (together with discounted with respect to risks) at the opportunity cost of capital. The used discount rate can have very significant effects on the value estimation – some VC´s use 30-40% to compensate them for the typical high risk they are taking with their investments.

BIOTECH/PHARMA INDUSTRY VALUATION STANDARDS

Importantly for you as an entrepreneur to have some understanding about – what is used in the industry for evaluations of biotech and pharma projects along the discovery/development stages? Hartmann & Hassan, 2006 collected empirical data regarding the application evaluation tools in the pharmaceutical sector by analysing the internal view from the pharmaceutical companies themselves and the external view from the health care responsible departments of financial service firms (Table A+B). As seen from the tables, discounted cash flow (DCF) models together and real options provide together with more simple scoring models the major tools utilized for valuations of early-stage opportunities (% gives percentage of cases utilized). DCF models calculates the net-present value (NPV) of a project and takes the time value of money and cost of capital into account. The major tool utilized for estimation of project viabilities within and without the biotech sector. Internal Rate of Return (IRR) (table A+B) denotes the annual return on investment providing a cero NPV. rNPV, risk-based NPV – inclusion of risk factors (%success) for calculation of NPV. Decision trees, scenario+sensitivity analysis accounts for the major analysis of the valuation models generated (see also resources for an introduction to these tools).

 

Evaluation_FinancialSector-300x170

Table A. Valuation methods and risk analysis methods used by pharmaceutical companies for financial evaluations of R&D projects and biotechnology companies. Table modified from Hartmann and Hassan, 2006.

Evaluation_PharmaSector-300x170 Table B. Valuation methods and risk analysis methods used by financial service companies for financial evaluations of R&D projects and biotechnology companies. Table modified from Hartmann and Hassan, 2006.
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PAPERS & ONLINE RESOURCES*

 

ONLINE RESOURCES

A fantastic free ressource for online materials on financial aspects of valuations (DCF, comparables and option pricing applications on valuation) is provided by Dr. Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University:

 

DCF MODELS WITH rNPV (WITH SPECIAL FOCUS ON R&D PROJECTS)
Stewart, J.J., Allison, P.N. & Johnson, R.S. (2001) Putting a Price on Biotechnology. Nature Biotechnology 19, 5-9
Stewart, J.J. (2002) Biotechnology Valuation for the 21st Century. Milken Institute, 27, 1-12

 

REAL OPTION PRICING APPLICATIONS

Hartmann, M. & Hassan, A. (2006) Application of real options analysis for pharmaceutical R&D project valuation—Empirical results from a survey. Research Policy 35, 343–354

Kellogg, D. & Charnes, J.M. (2000) Real-Options Valuation for a Biotechnology Company. Association for Investment Management and Research, 76-84

*Note that the most of the mentioned papers are covered by copyright issues. We therefore only refer to a corresponding search engine result or directly to the journal publisher.

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BOOKS ABOUT VALUATION OF R&D PROGRAMMES

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By McKinsey & Company, Coller, Goedhart & Wessels

Core company valuation techniques – with derivation of FCF, WACC, NPV´s, financial forecasting etc. Highly recommended although no specific focus on biotechnlogy/life-science valuations.

BIOTECHNOLOGY VALUATION

By Keegan

Biotechnology Company/R&D project valuation including data collection, DCF models, decision trees, real options, VC valuation methods for early-stage Technologies.

VALUATION IN LIFE SCIENCES- A practical guide By Bogdan & Villiger

DCF, decision trees and real option models with sensitivity analysis for biotech ventures explained. Especially recommended for topics on valuation of potential licensing and deals and IPR.

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