The foundation of any transaction is a negotiation between a buyer and seller around the fair value of an asset. The key to maximizing value in any transaction as a seller or buyer is a robust understanding of an asset’s underlying value. A valuation model is a quantitative tool that attempts to objectively measure value by evaluating the opportunity, cost, and risks associated with the asset. A valuation model is only as robust as its assumptions, and therein lies the crux of negotiation — information asymmetry.Gathering information is important for both buyers and sellers. The first component of any valuation is the opportunity, or revenue potential for the asset. The key revenue assumptions should be based on market-based intelligence for how physicians, payors and patients will adopt and pay for the product (to read more about the importance of a commercial assessment in deal-making, please refer here). While it is recommended to set baseline expectations conservatively, it is also important to consider various commercial scenarios the asset may experience such as :
upside potential for additional markets or indications
as well as downside risk that may result from competition or a weaker product profile
A commercial assessment often provides robust, independent assumptions and scenarios for a product’s potential.
Following revenue, consideration of costs should be laid out and will generally include development, regulatory, sales force and commercialization, marketing, manufacturing cost of goods sold (COGS), any outstanding royalties and overhead costs directly associated with achieving the commercial potential for the target asset. The timing and likelihood of incurring these costs should be taken into consideration. Similar to the commercial potential of the assets, costs are likely to vary and setting up scenarios for the potential cost of the program will help better assess the range of costs that are likely to be incurred.
The final, and most critical component of a valuation model, is an assessment of the asset’s risk. There are many forms of risk for biopharma assets, but the two most broad categories are:
risk associated with the asset itself, regulatory and developmental risk, and
risk associated with the company and its ability to maximize the commercial opportunity of the asset
It is recommended to treat these two types of risk separately. A number of resources exist that evaluate historical probability of asset approval across therapeutic area and product types and provide an objective assessment of the risk of regulatory and commercial success. While any seller can come up with a number of ways their asset is de-risked vs. benchmarks, it is critical that an objective stance is taken. The second component, company risk, is usually measured by the weighted average cost of capital, or return that would be expected from the company’s investors.
The net result of these components is a stream of risk adjusted cash flows which are discounted to achieve the asset’s valuation. This value essentially serves as the “pie” in a negotiation. While there is a definite science to defining the size of the pie, it is “art” that determines how the pie is split. How to split the pie is the second aspect of a negotiation and will differ depending on deal tension and how the deal is weighted, e.g. back-ended vs. front-loaded economics. Ultimately, a valuation model places deal terms in context.
Written by Chris Baird