Valuation in Bioventures Flashcards
1
Q
What is finance?
A
Finance is a field that concerns itself with allocation (investment) of assets over time and space.
2
Q
Why care about finance?
A
Finance attempt to construct models so that we can make predictions
Predictions allow us to:
- Outcompete competition
- Secure our assets
- In short: make more money
–> Make better decisions
3
Q
What is finance not?
A
Finance is NOT an exact science
Any predictions made in finance is often grossly simplified
Any tools finance offer only a simplistic view
–> “It depends…”
4
Q
Finance covers?
A
- Prices, interest rates, cash flows and the financial markets
- More industry or company specific
- Study of cash
5
Q
Economics cover?
A
- Is the study of production, consumption and distribution of goods and services.
- More “Big Picture” in nature
- Study of wealth
6
Q
Accounting covers?
A
Is recording, processing and communication of financial information
- External users; such as investors, potential investors & creditors
- Internal users; such as board members, employees
Primarily deals with the past
7
Q
What subsectors of finance are there, and what have we specialized in?
A
1) Public Finance
2) Personal Finance
3) Corporate Finance
a. Entrepreneurial Finance <- Focus of this course
8
Q
What is the difference between corporate and entrepreneurial finance?
A
Corporate:
1) Corporations can fund projects through allocation of internally generated funds.
2) Corporations can diversify their risk.
3) In corporate finance, we consider the strategic position of corporations, the competition, alliances and market strengths and weaknesses.
Entrepreneurial:
1) Entrepreneurs and start-ups don’t have any money. They need to “raise money” constantly.
2) Fundraising is the nature of the game.
3) Usually only have one product and the development is more akin to product management and project management than strategic management.
9
Q
What is accounting and what are the two most important reports?
A
Tracking expenses and estimating revenue streams.
- The balance sheet and the income statement.
10
Q
What is a balance sheet?
A
A sheet that shows assets (& capital) & liabilities of a business at a certain time (snapshot in time)
Shows: Liabilities, Equity and assets
11
Q
Assets are?
A
Things of positive economic value (including cash).
- Anything that can be converted into cash or is cash (Property, Equipment, IP, Invested Cash)
12
Q
Explain the difference between fixed and current assets
A
Current Assets are assets that can be converted to cash within a year (Cash, Inventory etc)
Fixed Assets are assets that are harder to convert to cash (land, buildings etc.)
13
Q
Liabilities are?
A
An economic obligation that will cost money
- Loans, mortgages, Expenses, Wages
14
Q
Explain the difference between fixed and current liabilities
A
Current Liabilities are things that are due within one year
Fixed Liabilities are long term payments that are not due within one year.
15
Q
Equity in accounting is?
A
Equity = Assets - Liabilities
E = A - L
16
Q
Equity is used in two situations.
A
Accounting + Equity is used as a term of ownership too
17
Q
Equity carries what?
A
The risk and benefit
18
Q
Equity is also known as?
A
Summed ownership
19
Q
What is an income statement?
A
Revenue / Sales (money earned in the time period)
always related to a period like a month or year
usually not including loans or investments as both give cash but gives debt (loans) or dilutes shares (investments) and more
20
Q
What does an income statement consist of?
A
1) Revenue / sales
2) Variable cost / Total Cost of Goods Sold / Total Costs of Sales (the price to buy/make the goods you’ve sold)
3) Result 1: Gross profit (Revenue – Variable cost)
4) Fixed costs
a. Marketing
b. SG&A Expenses (often divided into Sales and G&A)
5) Result 2: Operating Profit
6) Interests (10% on debt)
7) Taxes and other deductibles (often set to 30%)
8) Final result: Net income
21
Q
How is the Income statement built logically?
A
1) Find gross profit
2) Find operating profit
3) Find net income
22
Q
What is fixed cost?
A
Fixed costs are defined as not varying with the revenue
23
Q
What is SG&A?
A
Selling, General & Administrative Expenses
24
Q
What is Gross profit?
A
The sales profit after variable costs.
Gross Profit = Revenue – Variable Costs
25
What is operating profit?
Operating Profit = Gross Profit – Fixed Costs
26
Net income is?
What the owners “get out of it” in the end, what’s left for them.
Net Income = Operating Profit – Interests & Taxes
27
How is the Net Income calculated?
Net Income = Operating Profit – Interests & Taxes
28
What is RoA?
Return on Assets.
Operating profit / assets = RoA.
High RoA = Good
29
What does RoA show you?
Should tell you how good a company is at operating its assets (gaining returns from it’s assets)
It shouldn’t include taxes, as it is independent of the country of residence for the company (it might be higher or lower in other countries).
30
What are interests? Are they on the income statement?
Payments of interest rates on loans
Note: while loans are not present on the income statement – the interests are!!
31
What is the pre-tax income and what is it also known as?
All profit before taxes are paid – also called Gross Income.
32
What is RoE?
Return on Equity
Net income / Equity = RoE
Is done on net income because as an equity holder you are interested in you return after expenses and taxes.
33
What could be a reason that RoE is calculated on net income?
You want to look at return after taxes and other deductables.
34
What does RoE show you?
Should tell you what earnings shareholders get for their shares
35
How do you find good RoE and RoA?
Look at industry standards! Other comparables.
36
Why is the life science industry unique?
1) Long development cycle
2) No positive cashflow for most products, preceded by a long negative cashflow period before launch.
3) Inherent risk that the product just doesn’t work = fails… (so the successful once have to pay for the development of these)
4) Limited lifetime due to the limited patent protection (limited lifecycle – lifecycle management in super important)
5) High regulatory affairs aspects make the industry difficult to navigate (and therefore costly)
6) To get your product to market, you have to show that your product is better than the rest of the treatments.
7) A lot of insights to build on in regards to finance. Like: PoS for different indications in different stages, Average and median sales in different disease areas, Cost estimates for different development stages.
37
What sources of income does a biotech startup have?
1) Personal Capital
2) Friends and Family
3) Angel Investors
4) Foundations
5) Venture Capital
6) Partnerships
7) Institutional Debt Financing
38
Which sources of income is the most common for a biotech startup?
1) Angel Investors
2) Foundations
3) Venture Capital
4) Partnerships
39
How can the financing stages in biotech be lined up with the development stages?
Investment and development stages do align in life science starting from pre-seed/seed (discovery) through phase I to III and launch
40
What are the financing stages of biotech startups?
1) Start-up or Pre-Seed (Discovery)
2) Seed Capital (Discovery)
3) Early Stage / Series A/B (Pre-clinical/Phase I)
4) Mid-Stage / Development Stage / Series C/D (Phase II/III)
5) Later Stage / Expansion Capital / Series E/F / Outlicencing or acquisition (Phase III)
6) IPO or Acquisition; Exit (NDA/Market) (Phase I/II/III clinical trials and FDA)
41
How does the founder equity develop over time in a biotech startup?
“You end up with a little piece of a big cake”
Equity decrease quite dramatically in the beginning (Seed-Series A) ending with a small percentage.
This will still be a lot of money!
42
What is the paradox of valuation?
Stuff has value because we add this to them. Is a bottle of water worth more than a diamond right now and here, what if you’re in a dessert. The value is determined in the transaction and only in that moment.
43
What is a valuation?
An estimation of the value of something, as carried out by a professional valuer
Usually based on business settings:
1) A company's capital structure (debt & equity)
2) The value of the companies future earnings
3) The market value of its assets
4) Market cap
44
Is valuation an exact science?
There is no ”true” value in a valuation - Valuation is not a science, and more of an art form.
There are no correct answers
There are however, a lot of wrong ones
45
What are some downfalls off attempting valuation?
1) Valuation is based on assumptions, we don’t have all the information
2) Information asymmetry - some parties know more than others.
3) The value achieved in a valuation, is only to be used as a tool not an ultimate truth, and so is the valuation itself. - This can be difficult for people from a science background to get, and it is important to realize.
46
Who does valuations and why?
1) Project managers negotiating budgets – Justifying what is favorable and identifying key parameters.
2) Business developers and licence managers that are negotiating a licence or collaboration deal – value of project and value of license deal
3) Portfolio managers reviewing the pipeline – comparing different projects allocate resource, pause or stop
4) Investors making investment decisions, buying or selling – worth investing? What equity should we have? How much should we invest for what price (valuation)
5) Business Analysts reviewing companies – value signle projects to get value of company
6) Founders seeking investments – how much money can we demand
47
Do everybody doing valuations get the same results?
No! They get different results based on their wishes (bias).
48
Is it hard to do valuation in all industries? Life science?
There is NO CONSENSUS on how to do valuation in life science!
In some industries, this is relatively easy: Stock market, Oil prices, Commerce based companies
49
What are the 4 ways of valuating a company according to Lasse and what he want to hear at the exam?
1) Valuation by Market Cap
2) Sunk Cost
3) Comparison based
4) Cash flow based
50
Explain valuation by market cap valuation
Stocks * price = market cap
The combined Value of all the companies Stocks.
51
What are the advantages and disadvantages of market cap valuations?
Advantages:
- Is an easy and effective way of estimating the value.
Disadvantages:
- It can be challenged; some companies are “overpriced” or “underpriced”.
- For a small drug development company this value is achieved when they go IPO and not before.
- Only works for companies on the stock market.
- Not for projects or early-stage companies.
52
Explain sunk cost valuation
The value is determined from the combined amount already invested in the company. (if you’ve invested 10 million in research, maybe it’s worth 10 million in research efforts already)
53
What are the advantages and disadvantages of sunk cost valuations?
Advantages: Easy, quick.
Disadvantages: Unprecise, generally assumed wrong, does the previous investment go to value adding? + The “Sunk Cost Fallacy”: When investing, one should not consider what has already been paid.
54
What is sunk cost?
A cost that has already been incurred and cannot be recovered.
55
Explain comparison-based valuation
Compare to similar products/companies.´
You find an asset (or assets) where you know the value, and then you compare it to your own asset.
Can use average or median and modify value as you please based on arguments.
56
What are the advantages and disadvantages of Comparables Valuation?
The ”Quick and Dirty” – Method’
Advantages: Quick, Easy to understand, Few assumptions needed, Gives a good understanding of market.
Disadvantages:
- Difficult to get data - very dependent on data and assumptions.
- Not very representable of the actual value - Any drug candidate will have to be unique, to be competitive, thus there is not something truly comparable
- Arguments play a key role in determining the value
- It is difficult comparing different achieved values
- For investors, this could potentially lead to indiverse portfolios
57
What is the multiples approach to comparables valuation?
Uses factors representative to the company to estimate the value. Find IPO companies and base on their values and you own forecasted sales.
Used outside of pharma most often.
Common factors
- Earnings Based Multiples - P/E Ratio – Price per Earnings
- Sales Based Multiples - P/S Ratio – Price per Sales
- Asset Driven Multiples - P/B Ratio – Price to Book (shares – liabilities)
58
What are some problems trying to use standard multiples for comparables valutation in pharma?
- Pharma projects has no sales to forecast. Hence, the normal ratio’s (P/E & P/S) do not work
- The assets of a Pharma are the potential success drug candidates
- Another common problem is that most companies IPO very late in drug development phase --> Hard to find comparables IPO companies.
59
Is the multiples approach used in pharma?
No, most often used outside of pharma in industry with sales forecasts.
The problems with multiples approach in Biotech and Pharma has lead to people not using it – not proper multiples in any case.
60
Since the multiples approach to comparables valuation is not used in pharma, what is the focus instead on?
- Comparisons in life science rely on either deal values or IPO values, which are then extrapolated backwards through time to reach a desired value.
- For larger companies, approximate market values for individual products are often known.
- This is more of a ”classical” comparables approach.
61
Explain cash flow based valuation
Valuation based on what the cash in the future is worth today
You take numbers from the future and discount them back to the present.
62
What are the advantages and disadvantages of Discounted Cash Flow Valuation?
Discounted Cash Flow – A little more complicated, but better for comparing valuations. Also reliant on data.
63
NPV is?
Net Present Value (the result you get from the method DCF)
64
Where does the DCF method work well and worse?
Companies that have revenues, works worse on companies that have long development timelines.
65
What is rNPV/rDCF?
Risk-adjusted Net Present Value / risk-adjusted Discounted Cash Flow
66
How do you calculate success rate/percentage for moving through phases?
CP1: 70%, CP2: 50%, CP3: 80%, Approval 96% - Chances moving from each phase to the next
Meaning we can calculate the chance going from Discovery to phase 2 by saying 70%*50%.
Multiply the probabilities
67
What is the discount rate?
The discount rate is basically the increase in value I should expect for any venture with a comparable risk
For Example:
US treasure bonds are considered risk free and give an annual return of 4%.
That means if someone else promises me an investment with 4% return I would want it also to be risk-free.
68
High risk = what discount rate? And what NPV?
High risk = High discount rate = A low NPV.
69
What is a usual discount rate for a DCF/NPV? (NOT risk adjusted)
VC want a discount rate of 70% because they want a 70% return - Gives a RoI of 8 after 4 years and 14 after 5.
70
What is the problem with discounting with 70%? How do we fix this?
- If you discount anything with a discount rate of 70% - the value approaches zero very quickly.
- This basically means that start-ups are worth nothing – which we know is not true.
--> Use the Risk-adjusted DCF – Resulting in Risk Adjusted NPV (rNPV)
71
What are some aspects the discount rate captures?
We compare cash flows that:
- Occur at different points in time
- Occur with uncertainties - Uncertainties regarding the predictability of size of the cash flow (Competition or external factors could lead to change in cash flows) - Uncertainties regarding the likelihood of the cash flow
- The cash flows might not occur at all, leading to the value of the cash flow being zero
72
What are the different ways of finding a discount rate?
- There is a consensus these ways are not applicable in pharma and biotech (or any deeptech). Like CAPM or WACC. REMEMBER, THESE DON’T WORK IN LIFE SCIENCE!
- Rely on market derived data and the beta, which is very irregular for startups.
73
Capital Asset Pricing Model (CAPM) is what?
Return of assets = Risk free rate + Beta * (Stock market return - risk free rate)
Beta = Covariance with the stock market
74
Where is CAPM used?
CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.
75
What does the CAPM show?
Describes the relationship between systematic risk and expected return for assets, particularly stocks.
Higher systemic risk -> Higher expected return.
76
What are some problems with CAPM?
CAPM = Capital Asset Pricing Model
1) Working with Beta assumes that the risk can be measured by a stock volatility
2) Market portfolio is only a theoretical value. - Assumptions: All investors optimize perfectly, everyone is capable of borrowing and lending at the risk free rate, there are no transaction costs.
3) Economists have proven the CAPM is historically not true…
77
What does the WACC show?
How easy it is for a corporation to raise money.
78
What is WACC?
Weighted Average Cost of Capital – How costly the capital is to obtain, proportionately weighed.
WACC = Weight of debt * Cost of debt * (1 - tax) + Weight of equity * Cost of equity
79
The higher the WACC the higher what?
The higher the WACC, the more expensive it is for a company to raise money.
If the returns of a company are less than the WACC, they are loosing money.
80
When is WACC used?
WACC is used as the discount rate for companies that operate steadily.
NOT for projects or startups.
81
WACC and CAPM for exam?
If we are grilled on it, you can tell them that we’ve been introduced but didn’t spend much time on it.
82
Is NPV and DCF the same thing?
The terms are sometimes used a bit interchangeable – theoretically DCF is the method and NPV is the result.
83
What is the assumption behind DCF?
“A dollar today is worth more than a dollar tomorrow”
The Time Value of Money – is 10.000DKK better today or in a year? In DCF we investigate the opportunity cost of making an investment.
84
WACC can be used as?
The discount rate in big corporations with steady operations.
85
How do you calculate PV?
PV=Ct / (1+rd)^t
Ct = cash flow at time - t = time - rd = discount rate
86
What is discounting the cash flow back to the present?
Calculating the current value of a future promised cash flow.
Think: 1000 USD promised in 5 years, if I decide to use the discount rate of 4% will today only be worth - 𝑃𝑉=1000/〖(1+4%)〗^5 =821,93 𝑈𝑆𝐷
87
How do you calculate NPV?
NPV = Summing all PV of a project
NPV = C0 + Sum(Ct / (1+rd)^t)
88
The difference between PV and NPV is?
NPV takes into account cash flows in all years of the period, it’s the summation of the different present values minus the initial investment.
89
The discounted cashflow for each year in a NPV calculation is calculated how?
Discounted future cashflow = PV =Ct / (1+rd)^t
90
What does the risk-adjusted DCF take advantage of?
- The basic idea is to apply success rates for various phases – and use this to argue for a lower discount rate.
91
What are some good standard numbers for PoS + Discount Rate for rDCF?
- My recommendation is to implement a risk of failure of 80%- 90%.
- And then go for a discount rate of 15%
92
How is the Risk Adjusted CF calculated?
Net Cashflow x Probability for Succes
93
What do you do with the Risk Adjusted Cash Flow in a rDCF?
Calculate the PV using the Discount Rate and Risk Adjusted CF in the NP formula
PV =Risk adjusted Ct / (1+rd)^t
To get to the rNPV all you do is summarize these risk adjusted PV’s
94
What 4 primary inputs go into a rDCF?
1) Discount Rate
2) Success Rates
3) Costs
4) Sales
95
How do you estimate sales?
Three basic methods:
1) Customer build up – counting the number of users that fit a particular profile suitable for your product and then multiplying the number with price per user.
2) Sales analogies – or using existing similar products to estimate sales
3) Estimate market share – Estimating that you will achieve a share of a total market. Potentially this could be a share of total users multiplied by price (reminiscent of method 1).
-> All bout the arguments when choosing one and what you can find of data (like median and average sales).
96
How can you further estimate sales for pharma products?
Using a Peak Sales Curve!
- Once you have some estimates, whether market size, costumer number etc., it is relatively easy to fit a sales curve on top of it.
97
How do you know what your costs will be?
Costs (you Capital Need) can be derived from your development plan, and can be:
1) CRO estimates.
2) Development process costs.
3) Discovery, preclinical development & clinical development.
4) Regulatory review costs.
5) Expansion of team.
6) Formulation / scale up costs.
7) Launch, manufacturing and marketing costs.
98
Does pharma have a high or low operating margin?
The percentage of profitability of a company, project, etc.
- Operating margin for most development projects is quite high: ~30%
- But for pharmaceutical projects, and Biotech, it is estimated to between 55% - 75%
99
What are launch costs?
- Costs incurred at the launch of a drug, once it is about to enter market
- Primarily include initial marketing costs and construction of production facilities.
100
Can, and should you, include market growth in a DCF valuation? And how?
You can, easily. However, Growth in market does not necessarily translate to growth in sales and can lead to increased competition.
- Added growth can really balloon a valuation
Implementation in DCF: Multiply market peaks on your sales curve with growth rate
101
If you have a company with 30.000 debt and 70.000 equity. How big are your assets then?
30K + 70K = 100K
102
Valuation is used for?
1) Valuation of startups
2) Raising capital
3) Comparing projects
4) Arguing we are worth more than others.
103
What is a common sought after discount rate in the life science industry for a rDCF discount rate?
10-16%
104
Is the risk adjusted discount rate higher or lower then the normal discount rate?
Lower, since you’re adding the risk.
105
What is a benefit of NPV?
If you do it on multiple projects, you can compare them in contrast to comparable etc.
106
What is Pos?
Probability of Succes!
107
What is a strength of DCF compared to the other valuation methods?
IF the value of multiple projects are calculated with the same method, we suddenly have something that is comparable.
- Deficits: all the background data still has to come from somewhere.
108
What is the best valuation method?
There is no true one as it is not an exact science.
109
What is an exit?
A concept within entrepreneurial finance – When Investors will start converting their equity to cash.
- An “Exit” implies that the startup exists from the entrepreneurial phase – it does not necessarily imply that the company ceases to exist.
110
What kind of exits are there primarily for biotechs/medtech?
1) IPO
2) Acquisition
3) Establishing permanent income - Sales or License Deals
111
What is an IPO?
Initial Public Offering
- The company is offering shares to the public in a stock insurance.
- The company transfers from a private company to a publicly traded one.
Used to be common for Biotech companies, but the trend is falling.
112
What are advantages and disadvantages of an IPO exit?
Advantage:
- It offers a company the chance to raise a lot of money, giving greater ability to expand and grow
- Increased transparency and share listing credibility can also be a factor in borrowing money.
Disadvantage:
- Only quite mature companies goes IPO.
113
What is an Acquisition?
The company or it’s technology is bought by a larger corporation
- Dividends on all shares are paid to VC’s and founders
- This is possible for companies even at early stages
- Strategic compatibility increases this likelihood
More common these days than IPO
114
What two types of permanent income are there for biotechs?
A pipeline of drugs that they either sell or out-license to Big Pharma.
--> That means these companies will rely on a pipeline of “micro-exits”.
115
What are license deals?
- The company or its founders license the technology developed to a larger corporation
- The company can exist in some form, further developing the technology.
116
What are advantages of licensing deals?
- Provides a steady income to the company and the shareholders
- Often, VC’s will sell their shares back to the company at this stage
117
Why is licensing great for innovation in big pharma?
Small biotechs are innovation hubs.
Most large pharma players have their own inhouse R&D departments. However, the best ideas are not necessarily born here, but out in smaller, more innovative biotech companies.
118
Why is a licensing deal great for small biotechs?
Many biotech companies do not have the capabilities to
1) Capital need covered
2) Forming alliances with partners that can progress the development of the technology to take it to market.
3) Forming alliances with partners with manufacturing capability.
4) Forming alliances with partners with marketing and distribution capability.
5) Exploitation in a different field of application.
6) No commercial capability.
7) Access to innovative projects
119
What is a licensor and a licensee?
Licensor: Has the technology, and gets payments from the licensee
Licensee: Gets access to the technology
E for easy access 😉
120
What are the typical licensing payment types?
1) Upfront Payment. - Money received upon signing the deal. All biotechs would want this, and as much as possible.
2) Milestones - The Licensor is paid lump sums sequentially, when passing certain stage-gates. Good for derisking for the licensee
3) R&D Funding - The Licensee pays for the R&D Costs
4) Redemption - R&D Costs are paid backwards, upon reaching milestones
5) Royalties - The Licensee pays royalties, percentages on the sales upon launch. Can sometimes vary depending on sales volume. Always included, otherwise it’s not a license.
Often it will be a combination of the above.
121
The value distribution of a licensing deal often depends on what?
The stage of the project.
The later the project the higher the percentage the licensor (giving out the license) keeps as they have carried more risk.
122
How do you do valuations with a license deal?
Do a DCF with licensing by:
Valuations are performed the same ways as in normal DCF’s --> but now we have to find two rNPV’s:
- One for the licensee
- One for the licensor.
These rNPV’s follow the deal structure (meaning if a value split of 40/60 was agreed, these rNPV should be 40/60)
123
What are the earnings for the licensor in a rNPV based on a license deal?
The earnings of the licensor are the payments of the licensee – the royalties or other payments from the deal like milestone payments etc.
124
How long does a licensee pay royalties for?
The licensee only pays royalties as long as there is a patent. Unless otherwise stated ofc.
125
What is the assumption behind decision trees?
“managers are not paid to be dummies”
126
What are decision trees?
Trees defining different scenarios and the percentages/probability to enter each branch of these scenarios.
127
How do you calculate the NPV using a decision tree?
1) Calculate PV for all the end forks
2) Calculate NPV by putting the (Scenarios value X their PoS) / (1+discount rate)^t
(remember to include initial investment and the first PoS)
128
How can you add an assumption to decision trees and the NPV calculation?
We assume managers will not keep going in a negative scenario (as they are smart), so these are put to zero in the NPV calculation.
129
What are some downsides to decision trees?
1) Decision Tree approach to DCF is supposed to be able to add value to any analysis by removing the negative scenarios
2) Main issue is that this require more detailed knowledge about how the project is going to be developed – more data is just more factors that need to be estimated.
3) It is also time consuming to add different branches to trees and estimate the path that one is going to take. Requires “manual work”.
4) You can add any scenario you want no matter how complicated the PoS will be.
130
What does real options attempt to?
Attempts to create mathematical decision trees without the need to do scenario planning. It builds a binomial decision tree “automatically”.
131
What are financial options?
In finance, an option is a contract which gives the owner the right, but not the obligation, to either buy or sell an asset at a specific price.
- An option to buy a specifc asset is called a call option
- An option to sell a specific asset is called a put option
Options lessens risk.
132
How are the binomial trees in real options created?
By calculating 4 values:
Value up: u
Value down:d
Probability up:pu
Probability down:pd
σ:Volatility, μ:growth, t=time
133
Do all real option trees converge?
Trees can be both recombinant and non-recombinant
Though by far most (all) trees I have seen are recombinant
134
How do you make a real options binomial tree? And calculate NPV
1) We assume we have our current market state at year 0
2) We then span out a binomial tree with the 4 values calculated before (Value up, value down, prob. Up, prob. Down)
3) For each end node we will have a new market state and a probability
4) Calculate a NPV for each market state
5) “Pull” these market states back trough the tree using our probabilities and a discount rate
6) Do abandonment of negative scenarios (the entire point)
7) Get a real options rNPV
135
What is the volatility (covariance) often set to in real options?
Volatility (covariance) often just set to 30%
136
What are some downfalls of real options?
They add value – but only if you understand them.
- They add another factor (the volatility) and A LOT of extra complexity.
- Hard to understand - Too often people misunderstand them.
- Often, they add extra little value to rNPV, as compared to other initiatives like reducing costs.
- Take a lot of time and work and often add little difference to the non-real option NPV value. Changing costs is a bigger driver on the NPV.
- Maybe not always worth it, even if it does take into account decision-making.
137
What is the peak sales curve?
A curve that is used to estimates sales (can differ from model to model and depend on assumptions) – can be somewhat standard.
138
What type of drug is especially susceptible to patent cliffs?
Small molecule drugs, easy to replicate and not as much regulatory involvement as biosimilars.
139
What influences the high vs. low scenarios in a real option calculation?
A lot of things, external market factors, macroeconomics?, efficacy of the drug (which can dictate price).
140
When would be a reasonable time to evaluate abandonment decisions in a rNPV using real options?
At the starts of the clinical trial phases (but you could also do it each year, even if this is unlikely to happen irl).
141
Sometimes in real options, people argue to use the risk free rate (4% the US treasurer bonds) – what is the issue?
In financial options, you can ”hedge” options to reduce your risk. This effectively allow you to create a portfolio of options.
You can do this in financial options as you use these in your portfolio, you cannot do this with real life assets.
142
Real options is built on?
A binominal decision tree calculated via math “automatically”.
143
Decisions trees are built on?
Evaluating chances for different scenarios. Every time it splits, you have to try to calculate a chance, but you can add everything and try to get a chance. You can add 1 indication, 2 indications, 100 indications, recession, “our plant is bombed” etc….
Decision trees are more subjective!
144
When would a decision tree make sense?
If you think you can add another indication, it would make sense. It’s not just a spread in the market, it would be a big value driver that you have insights intro.
You could also do two DCF calculations (but remember that the 2nd indication would be cheaper).
145
Equity carries the risk and benefits, what does that mean?
A decrease in assets will have a bigger percentual decrease in equity than the assets.
An increase in assets will have a bigger percentual increase on equity than in the assets.
146
What happens when the discount rate goes up? Goes down?
Discount up = NPV goes down.
Discount down = NPV goes up.
147
When does cost allocation make sense?
When the company grows, it doesn’t make sense in a 5 man team.
148
What is dilutive capital?
Capital where you give away equity (stock) for capital
149
What kind of VC funds are there?
Evergreen funds (Novo Nordisk Foundation)
Closed end fund (10 year)
Strategic venture fund (companies making funds to invest in early-stage that can be absorbed into the company later)
150
What are warrants?
Like a stock option that allows the investor to buy shares in the company over an extended period of time.
