Introducing a valuation methodology for deal making and fund raising in a biotech company
As our partnerships &, licensing month continues, Romain Lalandes discusses the practical issues in implementing a valuation methodology within a biotech company.
During the life cycle of a biotech company, early stages are usually dedicated to the development of the technology and / or drug candidates. The goal is to bring the compound further through the value chain to demonstrate its safety and efficacy: in other words, the potential to become a commercial success. Moreover, the ultimate goal is to attract potential partners, especially large pharmaceutical companies. As small biotechs are often in a need of cash to pursue developments, the survival of the company is jeopardized if the management team is not able to attract investors and / or partners. Valuation methods should be used as a tool to prepare negotiations, especially de trade-offs between cash now and getting rich later.
Introducing valuation methods as a tool in a small biotech company is an epic job. The introduction / adoption of the methodologies follow a step-by-step process. The first step is to make the management team realize the critical importance of valuation and the benefits to the company. The second step is to implement a valuation tool adapted to the management team’s requirements: it should be as flexible as possible, easily manageable for the valuation of new projects or when new data on the existing projects is made available. The third step is to get the management team getting familiar with the tool, by using it in training mode and role playing.
“As small biotechs are often in a need of cash to pursue developments, the survival of the company is jeopardized if the management team is not able to attract investors…”
Making the management team understand the critical importance of valuation can be fastidious, especially for teams mainly composed of scientists and without any previous experience in the field. As the compound / technology in development successfully complete clinical trials, and the team collects more and more data on efficacy and safety, its value increases. Why? Because the technical risk and remaining length of exposure diminish as the compound gets closer to potential approval and commercialization. With a valuation tool, new data on the product, on its potential market or any other relevant feature is easily transferred to the calculation of value. The management team then decides whether or not license the product, continue the development or abandon the project. This represents substantial improvement in the decision-making processes e.g. prioritization of R&,D portfolio of projects, and from a financial and business perspective as a strategic tool for deciding on the fund raising strategies, e.g. which development for which fate (licensing, own development, hold or stop).
Finally, during licensing negotiations, it is important to be credible and demonstrate to your partner that you have realized a serious valuation work. The methodology used for developing value estimates has extremely useful spin-off applications: all the care and thoughts that went into defining key hypothesis and developing estimates for key factors will prove useful arguments in defending your position in the negotiation process
The second step is to build and implement the valuation tool. The constraint is to design this tool to be as flexible as possible, and make it easily manageable for new projects valuation or when new data on the existing projects will be available. Two different approaches were used. The first one is the DCF (Discounted Cash Flow). Thanks to its relative simplicity and accuracy, this method is the gold standard in the biopharmaceutical industry. The second one is the Real Options method, which is conceptually more related to financial optimization than product development and therefore can be perceived as odd, but is still manageable without any previous experience. This method is known to yield higher values than the DCF, and will set the upper limit value.
“…during licensing negotiations, it is important to be credible and demonstrate to your partner that you have realized a serious valuation work.”
The third step is to get the management team familiar with these two methods: you need to practice before going to the play field. Both of them are based on assumptions and the estimation of these assumptions represents the hardest part of the valuation process. The critical parameters are: discount rate, sales forecasts (market size, market penetration, growth and price), cost of goods sold, time and delays. Obviously, experience is extremely important to assess those parameters. The first valuation exercises could be tricky and expectations should be managed a priori. It is not usual but hardly recommended to undertake a sensitive analysis during a valuation process, in order to analyze the impact of variations in the key hypothesis. This analysis will help the managers developing early warning information processes and decision making systems. Alongside all these financial and mathematical parameters, which represent the “quantitative” part of a valuation, “qualitative” parameters should be taken into account, for example experience of the management team or solidity of the intellectual property.
In many biotechnology companies, especially the smallest ones, valuation methods are not only insufficiently known but also rarely used. Many barriers to its implementation exist, like the apparent complexity of these methods, or misunderstandings on the potential benefits for the company. Moreover, managers tend to rely on simple solution such as “comparables”. But then, why use comparables when you claim the unicity of your compound, platform or other assets?
About the author:
Romain Lalandes holds a Pharmacy Degree from the University of Montpellier, France. His strong interest in Business Development and Strategy led Mr Lalandes to undertake a Master Degree in “Management of biotechnology companies” at the Grenoble School of Management (GSM). GSM appears on a regular basis in the Financial Times’ Business School rankings for its MSc and MBA programs. As part of business studies, Mr Lalandes published a professional thesis entitled “Use of new approaches in project valuation for business development”.
This article was co-authored by Jean-Louis Roux Dit Buisson. Jean-Louis is the author of several pharmaphorum articles:
How can biotech companies implement a value methodology?