Archive for the ‘Valuing Early-Stage Technology’ Category
Early-Stage Valuation
New Risks Emerge During Economic Downturns for Valuing Early-Stage Technology
New Risks Emerge During Economic Downturns for Valuing Early-Stage Technology
Actually, there aren’t really any new risks, just those that become enhanced during economic downturns. While recently valuing an early-stage medical technology I realized that two risks I would have previously ignored had a powerful impact on the assignment. The assignment involved valuing a new implantable medical technology. The enhanced risks related to funding and clinical trials.
Valuing embryonic technology requires addressing concerns not typically associated with established technologies and products. Some include:
1. Proving the efficacy and safety of the technology.
2. Gaining market acceptance.
3. Obtaining approval from the Food & Drug Administration and
4. Obtaining insurance reimbursement approvals
At the time of the valuation, the technology had proven itself in laboratory and animal studies. The medical community was aware of the success and eager to adopt the new therapy. The new therapy was sure to be a success once it got to the marketplace. Large scale human clinical trials were the next step.
A significant risk for early-stage medical therapies is found in clinical trials. Failure of the technology may come in the form of failure to provide benefits to patients, side effects and even patient death. These can often been accounted for by reference to failure rate statistics that are incorporated into a valuation model.
The risks associated with clinical trials are nothing new but the unique risk regarding clinical trials for this assignment went beyond the typical. In this case, the hospitals that had been recruited to participate in the studies were experiencing financial stress and withdrew from the program. Alternate hospitals, also experiencing the same financial pressures, were proving difficult to recruit. Normally a technology that had proven itself to the extent of the technology being valued would not have difficulty finding a place to conduct clinical trials. In fact, there might have even been competition among the hospitals. Not now. A risk that would never receive any consideration in the past was now threatening to kill the technology. Even if new hospitals were recruited, the path to commercialization would be delayed by at least two years. This delay impacts the value conclusion dramatically and hopefully delay would be the best case scenario.
The other risk was funding. Once again, finding funds for the clinical trials would never have been difficult given the proven success of the technology at the time of the valuation. In fact, there would likely have been competition among venture capitalists in any other environment. Not now.
An example of funding scarcity is the market for Initial Public Offerings (IPO). At the time of the valuation a Fortune article dated August 26, 2008 indicated that “2008 has been one for the record books in the sheer paucity of companies that have made it out the door – 43 so far, down a stunning 75% compared to the same time last year”. It stated further that 2008 had been a disaster in terms of both the number of companies able to go public and also in terms of the amount proceeds they were able to obtain.
A Business Week article dated July 1, 2008 echoed the Fortune report. In its article Business Week stated “The market for initial public offerings is on ice. In the second quarter of 2008, there were no IPOs for companies with venture capital financing, according to the National Venture Capital Association. (NVCA)”. That was the first time a quarter has passed without an initial public offering since 1978. The situation was so dire that representatives from the NVCA made a press tour and called it a "capital market crisis" for the startup community. The article also reported that venture capitalists didn’t see the climate improving anytime soon.
A poor market for IPOs makes venture capitalists worry. If they invest in new companies and technologies, where is their exit strategy if IPOs are stalled? Venture capital had dried up.The Wall Street Journal reported on January 5, 2009 that “It’s now taking VCs an average 6.5 years to see returns on their investments, compared with just two years in 2001… Many insiders project 2009 will continue to be a very rough year for VC-backed companies and those looking to attract VC money. The IPO climate shows no signs of improvement, giving investment companies little leverage to negotiate better acquisition prices with potential buyers… That means start-ups looking for private equity will be hard-pressed to find it.”
So, the value of the early-stage medical therapy I was valuing faced new, or more accurately, enhanced risks not typically worth noting for such a successful technology. Funding to complete clinical trials was nowhere to be found and even if funding was obtained, there was no place to conduct the trials. Sadly, the best assumptions that could be made required delayed commercialization. This meant delayed cash flows and when high discount rates are used the present value of even a short delay dramatically impacts value. Another real possibility was that continued development might never happen. The lack of funding could easily cause the team of development experts to seek opportunities elsewhere abandoning the project and outright killing the technology.
A difficult economic environment has lessons to teach us. It forces us to question long-held assumptions. It also forced us to consider that just when you finally think you know what you are doing its time to embrace humility.
1- Initial public offering (IPO), also referred to simply as a "public offering", is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.
2- Will the IPO season end with a whimper?, Fortune, By Michael V. Copeland, senior writer, August 26, 2008.
3- The Worst IPO Market on Record? Business Week, Spencer E. Ante, July 1, 2008
4- Venture capital (also known as VC or Venture) is a type of private equity capital typically provided to early-stage, high-potential, growth companies. Venture capital is most attractive for new companies with limited operating history that are too small to raise capital in the public markets and are too immature to secure a bank loan or complete a debt offering.
By Russell L. Parr, CFA, ASA
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