Many life sciences companies, particularly early-stage firms, share certain characteristics which come into play when one is valuing their stock. Perhaps this can be best illustrated by contrasting some of the value drivers of, say, an early-stage biotech entity with those of a garden variety manufacturing firm.
- The manufacturing company has a historical sales stream; the biotech company has only a future sales stream.
- The manufacturing company has a history of profits; the biotech company has a history of losses.
- The manufacturer has many paying customers; the biotech firm relies on Medicare and other third party payers.
- The manufacturing company has a plant; the biotech firm has a manufacturing licensing agreement.
- The manufacturer may or may not rely on patent protection; to the biotech firm, patents are critical.
Looking at the Future Outcomes
The appraiser who is valuing a start-up life sciences company often makes use of a “scenario based” valuation analysis in order to determine the value of the company at a certain moment in time. This involves the preparation of cash flow projections under different possible alternative outcomes. The likelihood or probability of various outcomes is considered. The end point of this analysis is the calculation of an expected net present value of the future cash flows of the company.
Complex Capital Structures
Early-stage companies, because of the history of their financing, often have complex, “legacy,” capital structures. It’s not uncommon for a company to have several layers of preferred stock outstanding. There are a number of valuation approaches that can be undertaken to value the individual stock issues of a company with a complex capital structure. Further details can be found here.
Start-ups Often Make Use of Stock Options
Because of the need to attract high-skilled employees at a time when cash is in short supply, life science start-up companies will often make generous use of employee stock options in their compensation programs.
For both accounting (FAS 123R) and tax (Sec. 409a) reasons, it’s important that these options be valued accurately, and in a manner that will withstand scrutiny should the valuation later be challenged by the company’s auditors, by the IRS or by the SEC. The best way to accomplish this is to have a valuation performed contemporaneously with the issuance of the options, by a party who is independent, and is qualified by skill and experience to perform the valuation.
Our firm has had extensive experience performing valuations of companies in the field of life sciences. We would be happy to be of service should you have a need of valuation advice.
