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Case Study
Valuation of biotechnology companies
Valuation of a biotech company is said to be more art than science.
It certainly is a complex and difficult task, especially for
early-stage, biotech companies. The so-called pre-money valuation
(which takes place before a company is financed) dictates how equity is
divided amongst a company's investors and entrepreneurs.
A company's value lies in its potential to generate a stream of profits
in the future. Profits can be generated from sales of drugs, services
but also from up-front, milestone and royalty payments. All valuation
exercises are based on 'visioning' a company's future, relying almost
entirely on educated guesses. To generate these assumptions feedback
must be solicited on three factors: first, the state of the market
targeted;
second, the company's science and technology; and third, the ability of
management to deliver on the business plan.
There is no 'silver bullet' when it comes to valuation: it remains a
subjective task. Nevertheless, it is recommended that every valuation
start with a systematic and rigorous testing of a company's economic,
technological, and managerial hypotheses in combination with the
following two key approaches:
- Primary valuation, which is based on such fundamental information as
projected future free cash flow (FCF) and costs of capital> Decision
tree analysis is often used with probabilities for the success of each
clinical phase and estimates for development cost, up-front and
milestone payments, royalties, costs and sales of the product on the
market as well as the form collaboration with licensing partner.
- Secondary valuation, which is based on comparable information, where
valuation is done by analogy to another similar companies. For public
companies value information is available from the stock exchange. For
private companies, information of the last financing rounds can be
utilized.
The various valuation approaches are likely to provide different
figures, since they all capture different drivers of value in the firm.
Reconciling these figures requires an extensive understanding of these
drivers. Finally, although the valuation methods described here are
routinely used by investors, we offer three important cautionary remarks
to help the newcomer to watch for typical pitfalls:
- Pay attention to pre- and post-money valuation; this can make a big
difference
- Know your figures before you enter negotiations
- There is more to a deal than valuation
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