Case study 2: Dividing up equity
By zceie01, on 1 June 2014
Assessing funding needs and the value of equity in entrepreneurial cell therapy projects
Assessing funding needs for early-stage cell therapy companies and the equity distribution among new investors and existing owners in these companies, constitute a critical challenge for stakeholders involved in creating successful companies around individual cell therapy projects. The BRITS tool provides stakeholders guidance in dealing with these challenges. Specifically:
– The cash flow statement produced by the tool helps stakeholders in assessing the funding needs associated with various development stages.
– The NPV calculation can be used to support negotiations surrounding the distribution of equity among investors and novel investors in cell therapy companies.
We use the case study of company X, which is seeking funding to develop a new allogeneic cell therapy in the oncology market space as a case study. The company completed preclinical studies and has regulatory approval to proceed with a phase I/IIa study to assess the therapy’s safety and to collect preliminary data on the therapy’s efficacy. In addition, managers use the following assumptions about the therapy they are developing and the commercialisation trajectory they will follow:
|The product and its market
|Clinical trials costs
|Manufacturing set-up costs
|Cost of capital
Using the inputs listed above, the tool produces the following cash flow statement that projects the financial in- and out- goings for the firm for the coming 15 years (see screenshot 1).
Assessing the firm’s development path and funding needs
Based on our data on allogeneic anti-cancer cell therapies entering phase 1/2a trials, we estimate that the duration of phase 1/2a trials will be 2 years, the duration of phase 2b trials will be 4 years, and the duration of phase 3 trials will be another 4 years (see costs boxed in red in Screenshot 2).
Row 20 consolidates all in- and out- goings and highlights yearly in- and out- goings in the form of Earnings Before Interest, After Tax (EBIAT). Adding up the projected outgoings during phase 1/2a trials, the tool projects a funding need of $3.0 Million + $2.6 Million = $5.6 Million (see costs boxed in red in Screenshot 3).
In addition, by adding up the discounted, risk-adjusted cash flow projections of row 28 in the spreadsheet, the tool provides a valuation for this cell therapy project of $8.5 Million (see amount boxed in blue in Screenshot 3).
Accordingly, a $5.6 Million investment to fund clinical trials 1/2a studies, would be worth a $5.6 Million/$8.5 Million = 67% ownership stake.
The tool allows stakeholders to play around with various assumptions underlying the firm’s business planning and assess the implications for these assumptions for the company’s funding needs, valuation, and equity distribution. One example would be for the firm from our example to arrange with managers and R&D workers that 50% of salaries will be paid in equity rather than cash during phase 1 clinical trials. This would significantly reduce the cash burn rate, and increase the valuation of the company. Screenshot 4 presents the cash flow statement and NPV for the same firm and assumptions as before, but reduces salary outgoings by 50% for managers and R&D workers during phase 1 clinical trials.
The revised funding need of the firm to finance clinical trials 1/2a is $2.5 Million + $2.0 Million = $4.5 Million, and the project valuation is $9.3 Million. Accordingly, the value of the $4.5 Million cash, investors would bring in is $4.5 Million/$9.3 Million = a 48% ownership stake.
In addition, the $562,500 of foregone yearly salary of managers and R&D workers for the two years that it will take to complete clinical trials 1 (calculated by subtracting from the amount in cell C10 of the baseline case cash flow statement, the amount in cell C10 of the cash flow statement in Screenshot 4), paid out in equity rather than in cash would be worth (2 x $562,500)/$9.3 Million = a 12% equity stake for these staff members.