Valuation Of Start-Up Life Science Companies
Valuation of a start-up life science company that offers little more than the promise of success in the future can be very difficult. Stellar results in the basic research laboratory rarely directly result in a cure of disease. Considering biotech, the drug development process requires many years to determine whether all the effort will translate into monetary returns for a company. Although valuation of the start-up may appear to be more guesswork than proven algorithm, the investment community has a generally accepted approach to valuing biotech companies that are years away from product approval. The generally accepted approach to valuation relies on discounted cash flow (DCF) analysis, which I will explain below.
Valuation of Portfolio
Biotech companies are often valued as a collection of one or more experimental drugs, each drug representing a potential market opportunity. The idea is to treat each promising drug independently within a portfolio. Using DCF analysis of all the promising drugs in the portfolio, one can determine the value of a company.
That is, using DCF one determines the forecasted free cash flow of each drug to establish each drug’s present value. Then the net present value of each drug, along with any cash assets, are added to determine the net value of the company.
Start-up biotech companies often have several drugs in their developmental pipeline. Not all drugs should be included in the valuation. In general, only those drugs in phase I, II, or III are included for valuation. A drug candidate that is in the discovery or non-clinical stage is not a good bet, with less than a 1% chance of reaching the market. Therefore drugs in the non-clinical stage are usually assigned zero value by professional investors.
Sales Revenue Forecasting
The most difficult and most important estimate needed in valuation is that of the sales forecast. Here a determination of expected peak sales is estimated based on the assumption that the drug candidate successfully progresses through clinical trials to FDA approval. The forecast of sales is typically for the first 10 years of the drug’s life.
To forecast sales, start by making assumptions about the drug’s market potential. Use information provided by market research reports to determine the size of the patient group that will use the drug for a given indication. Data are utilized only for those markets were patients will pay market price for the drugs, usually those markets in industrialized countries.
To determine a drug’s potential market penetration one must consider many factors. If the candidate is entering a competitive drug market, with limited advantage offered by the candidate drug in terms of
