Building a Biotech Valuation

Most early stage biotechs rely on private funding to support early asset development during pre-revenue operations. With a typical market submission period of eight years and high failure rates of drugs and devices through clinical development, early-stage biotechs are often seen as risky investment ventures.

Thankfully, enthusiasm remains from a wide range of investors who recognise the long-term value of delivering innovative technologies, therapies, diagnostics, and services to those in need. These investors provide the essential financial support that help promising biotechs navigate the complex development process in the lead up to drug and device approval.

At Deloitte, we are often approached by small cap biotechs seeking guidance on how to robustly value their company at key developmental milestones and to identify the right investors to support their development. To answer these questions, it is essential to understand the unique intrinsic value of each biotech and the motivations that investors prioritise when evaluating investment opportunities. In this blog, we will share our experience of some of the key considerations that will help biotechs to understand their true value, and effectively communicate that value to potential investors.

What type of business is the biotech creating?

To determine an appropriate valuation, early-stage biotechs can first identify whether the value of the business is primarily based on its pipeline of early assets, or the technological platform that underpins them. We have supported biotechs at either end of the spectrum, defined either as:

• Therapeutic Companies: Biotechs developing novel therapeutic assets in aid of unmet need indications.
• Service Companies: Biotechs selling service platforms driven by its technological IP often to support the identification, allocation, and generation of a wide range of therapies.

Most biotechs, however, exist somewhere in between, offering a combination of platform services and therapeutics either through internal resources or external partnerships. When assessing the value of a biotech, it is essential to have a clear understanding of the type of business being created in order to realise its long-term vision.

How will the business model create revenue?

Identifying how the biotech will generate commercial revenue is key to unlocking long term value. This requires an early assessment of the products being sold, the target demographic, and the available go-to-market strategies. Having a clear understanding of these elements will increase the likelihood of commercial success. 

1. Product: What are we selling?
   It is essential to accurately identify the type of business a biotech is creating in order to understand what is being offered. Service companies are likely to focus more on the intellectual property of the platform and the opportunities for fee-for-service, whereas therapeutic companies may focus more on the target product profile of the asset and its potential market share in set disease indications. To make a realistic assessment of the products being sold, factors such as the level of competition, market penetration curve, peak sales modelling, pricing, efficacy and safety in humans, associated costs, timelines to commercialisation and risk of failure must be considered.
2. Market: Who are we selling to?
   A definitive go-to-market strategy can establish who the biotech is selling to and determine the expected revenue potential driving the valuation. Key impact factors will include the disease incidence & prevalence, level of diagnostic capability of the therapy indication, the target geographic markets, risks to market access, including regulatory, patient and HCP adoption or engagement, and future opportunities of the therapeutic asset beyond the current indication 
3. Organisation: How are we selling? 
   An effective commercial strategy is paramount to a biotech's success in selling its services or products. This requires a comprehensive understanding of its’ potential revenue streams, level of market access, pricing, and medical affairs strategy. Platform-based biotechs can consider additional factors, such as the organisation's ability to commercialise the platform, collaborate with partners, and provide an effective and seamless service

Do we have a clear understanding of the risks and potential?

Valuing Based on the Core

It is helpful to view ‘true’ valuation as comprising of three components; the ‘core’, ‘adjacent’, and ‘future vision’.

Valuation should start with an examination of the ‘core’; those risks and opportunities of the biotech’s products known to the company that can be quantified. Crucial ‘core’ elements, such as an understanding of the product(s) being sold, the target market, and the organisational set-up for developmental and commercial success are all key factors that are central to valuation assessment and will be covered in greater detail.

The term "adjacent" risks and potential, referred to as "known unknowns," describe prospective risks, uncertainties, and potential that a biotech is aware of but is unable to anticipate or quantify with certainty. These may be harder to evaluate and manage than established risks and opportunities, yet they could significantly impact a company's worth. The overall value story being communicated to investors is made more certain by considering and outlining these more intangible factors. It demonstrates that the company is alert to how changes may affect their overall value and have definitive strategies in place to take advantage of opportunities and manage risks, if, or when these scenarios materialise.

Finally, we come to "unknown unknowns’’ or ‘future vision’. These are potential risks and opportunities that a biotech is not yet aware of and therefore cannot accurately anticipate or evaluate. It may not be feasible to forecast these risks and opportunities now, however, it is valuable to be aware of the potential impact on the company's worth, and to demonstrate this in the value narration.

What is the most compelling narrative to develop for the investor?

When building the value story for our clients seeking investment, we begin by working with them to understand the strategy and business model that they will employ to generate revenue. This may involve a multifaceted approach to secure multiple income streams, such as leveraging the versatility of platform technology via paid partnerships to fund the development of a core therapeutic asset offering.

We then focus our valuation modelling on the "core" value proposition, focusing on pipeline assets currently in development with a clearly defined commercial strategy. We calculate the intrinsic value of the company’s key assets using estimated probability-adjusted Net Present Value ("NPV"). To account for the many possible outcomes for the company’s value, we have employed Monte Carlo simulation to create a probability distribution with value ranges based on inputs, such as clinical trial success rates. We also recognise the role of future assets and novel therapeutic discoveries, made feasible by a developing platform architecture, as recommended growth opportunities that will affect potential exit valuations.