Valuation in Bioventures Flashcards
What is finance?
Finance is a field that concerns itself with allocation (investment) of assets over time and space.
Why care about finance?
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
What is finance not?
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…”
Finance covers?
- Prices, interest rates, cash flows and the financial markets
- More industry or company specific
- Study of cash
Economics cover?
- Is the study of production, consumption and distribution of goods and services.
- More “Big Picture” in nature
- Study of wealth
Accounting covers?
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
What subsectors of finance are there, and what have we specialized in?
1) Public Finance
2) Personal Finance
3) Corporate Finance
a. Entrepreneurial Finance <- Focus of this course
What is the difference between corporate and entrepreneurial finance?
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.
What is accounting and what are the two most important reports?
Tracking expenses and estimating revenue streams.
- The balance sheet and the income statement.
What is a balance sheet?
A sheet that shows assets (& capital) & liabilities of a business at a certain time (snapshot in time)
Shows: Liabilities, Equity and assets
Assets are?
Things of positive economic value (including cash).
- Anything that can be converted into cash or is cash (Property, Equipment, IP, Invested Cash)
Explain the difference between fixed and current assets
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.)
Liabilities are?
An economic obligation that will cost money
- Loans, mortgages, Expenses, Wages
Explain the difference between fixed and current liabilities
Current Liabilities are things that are due within one year
Fixed Liabilities are long term payments that are not due within one year.
Equity in accounting is?
Equity = Assets - Liabilities
E = A - L
Equity is used in two situations.
Accounting + Equity is used as a term of ownership too
Equity carries what?
The risk and benefit
Equity is also known as?
Summed ownership
What is an income statement?
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
What does an income statement consist of?
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
How is the Income statement built logically?
1) Find gross profit
2) Find operating profit
3) Find net income
What is fixed cost?
Fixed costs are defined as not varying with the revenue
What is SG&A?
Selling, General & Administrative Expenses
What is Gross profit?
The sales profit after variable costs.
Gross Profit = Revenue – Variable Costs
What is operating profit?
Operating Profit = Gross Profit – Fixed Costs
Net income is?
What the owners “get out of it” in the end, what’s left for them.
Net Income = Operating Profit – Interests & Taxes
How is the Net Income calculated?
Net Income = Operating Profit – Interests & Taxes
What is RoA?
Return on Assets.
Operating profit / assets = RoA.
High RoA = Good
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).
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!!
What is the pre-tax income and what is it also known as?
All profit before taxes are paid – also called Gross Income.
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.
What could be a reason that RoE is calculated on net income?
You want to look at return after taxes and other deductables.
What does RoE show you?
Should tell you what earnings shareholders get for their shares
How do you find good RoE and RoA?
Look at industry standards! Other comparables.
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.
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
Which sources of income is the most common for a biotech startup?
1) Angel Investors
2) Foundations
3) Venture Capital
4) Partnerships
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
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)
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!
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.
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
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
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.
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
Do everybody doing valuations get the same results?
No! They get different results based on their wishes (bias).
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
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
Explain valuation by market cap valuation
Stocks * price = market cap
The combined Value of all the companies Stocks.
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.
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)
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.
What is sunk cost?
A cost that has already been incurred and cannot be recovered.
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.
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
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)
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.
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.
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.
