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

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On the Brink of Generic Biotech Drugs, What’s the Cost to Innovation?

In a recently published report, the Federal Trade Commission suggested that the current allotment of a 12- to 14-year regulatory exclusivity period for product innovation to develop products at biotech companies is“too long to promote innovation.”

The same report, published June 4, also indicated that developing generic biotech drugs would help bring down the cost of U.S. health care. These less expensive versions are expected have prices discounts that are “between 10 and 30 percent of the pioneer products’ price,” the FTC said in its report, available here.

Shortly after report’s publication, President Barack Obama mentioned in a speech to the American Medical Association that creating a pathway at the FDA for approving generic biotech drugs would save the United States “billions of dollars.” But, as Arlene Weintraub was quick to point out in BusinessWeek, “How many billions? And how fast would those savings be achieved?”

With the advent of biotech generics, or follow-on biologics (FOBs), an impact on the economy is guaranteed, albeit unquantifiable. Industry insiders highlight that the biotech sector also stands to undergo some immeasurable changes itself.

“I am worried that the generic biotech companies make it less attractive to innovate,” said Mouli Cohen, entrepreneur and founder of Voltage Capital, a private equity innovation fund. Cohen’s firm invests in biotech startups and added, “Innovation and the ability to drive the process towards quantifiable outcomes is the hallmark of business in the U.S. Cannibalizing this process could reduce us to a mediocre player.”

Indeed, as PharmaTimes noted in reporting on the June 11 hearing by the House Energy and Commerce Subcommittee on Health, concerns have risen as to whether or not innovator biotech companies will be able to recoup their Research and Development investments, were FOBs were permitted to “come speedily to market.”

“R&D is increasingly expensive,” Cohen said. “The major pharmaceutical companies have reduced their efforts. This shifts the burden onto biotech and academia. In the end, someone or some entity has to sponsor the work. The cost will shift, but just like the medical system, the industry will break down if the compensation and the regulatory constraints become increasingly unfavorable.”

This means that biotech, although recently predicted by EvaluatePharma to achieve the largest growth of the any drug industry over the next five years, faces some massive obstacles in terms of funding.

“Two thirds of the future clinical pipeline for patients resides in small biotech companies – companies without profits, companies relying heavily on

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