Drivers of Value in Pre-Revenue Biotech Companies: Introduction
Article Summary
The value of a pre-revenue biotech company can be approximated by all the profits that the company will generate in the future. Various factors – drivers of value – define and impact the likelihood of potential future profits materializing and, therefore, company valuation.
A relatively small number of drivers are the strongest determinants of value for a biotech company: pipeline potential, scientific and clinical data, market opportunity, competitive landscape, and leadership team.
The pipeline potential of a biotech company encompasses a set of important drivers of value, with the stage of drug candidate development and the pipeline breadth being two of the most important aspects.
Scientific data describe the mechanism of action of a drug candidate and often provide the basis for drug candidate development. New scientific data can be obtained at any stage, increasing or decreasing the perceived value of the drug candidate. The stronger the scientific data behind the drug candidate, the higher the perceived value is likely to be.
Clinical data determine if a drug candidate is safe and efficacious and are directly related to the pipeline potential. Clinical data define the likelihood for regulatory approval and market entry, both required for future profits to materialize. As a corollary, clinical data can create or erase perceived value overnight.
Other drivers such as strategic partnerships, financial health, regulatory environment, and macroeconomic conditions can also impact perceived value, albeit likely to a lesser extent than the primary drivers discussed.
What is Company Valuation and Why is Biotech Company Valuation Important?
Knowing what a biotech company is worth in financial terms, i.e. knowing a company's value, is critical for any financial transaction or strategic decision involving the company.
Company valuation is the process of determining the company’s worth by evaluating its financial performance, assets, and potential for future profits in the context of an ever-evolving market conditions.
Thus, unsurprisingly, understanding company valuation, particularly for pre-revenue biotech companies, is essential across finance, investments, and the biotech and pharmaceutical sectors.
In my previous post, I introduced key company concepts of value and valuation and overviewed key aspects of biotech company valuation, including:
The importance of company valuation for growth, acquisition, and investment.
The value of a biotech company in terms of future profits and the likelihood of these profits materializing.
Intrinsic and relative approaches to company valuation and their advantages and limitations.
The relationship between risk and value.
In this article I overview the main factors that influence valuation in the context of biotech companies.
What are the Drivers of Value in a Biotech Company?
The value of a pre-revenue biotech company can be approximated to all the profit that the company will generate in the future. From this perspective, there are a number of factors that can impact these potential future profits and therefore company valuation.
The drivers of value refer to the key factors that influence the valuation of a biotech company. These drivers determine the potential of a company to generate future profits, and consequently, they affect the company's valuation and decisions made for growth, acquisition, and investment.
To a first approximation, as overviewed in a previous post, value in biotech is inversely proportional to the risk of failure of drug candidates, and reducing this risk, also known as derisking, generally increases value. Thus, unsurprisingly, many drivers of value in biotech have something to do with reducing the risk of failure and increasing the likelihood of success of drug candidates.
Below, I overview the drivers of value for a pre-revenue biotech company, focusing on the drivers that are often perceived as the strongest determinants of the future success of a biotech company: pipeline potential, scientific and clinical data, market opportunity, competitive landscape, and leadership team.
Pipeline Potential
The pipeline potential of a biotech company encompasses a set of important drivers of value, with the stage of drug candidate development and the pipeline breadth being two of the most important aspects of the pipeline potential.
Development Stage. The stage of development of a drug candidate can be regarded as one of the main determinants of value. This is because a more advanced drug candidate has a lower likelihood of failure (lower risk), and thus an increased likelihood of future profits materializing, increasing the perceived value of the company.
Example
The probability of success associated with the different phases of clinical trials can be estimated to 63% in Phase I, 31% in Phase II, 59% in Phase III, and 86% in regulatory review process. Thus, the success rate associated with clinical trials and FDA-approval for a biotech company developing a new drug that is yet to enter clinical trials is
63% x 31% x 58% x 85% = 9.6%
Successful Phase I trials and entry in Phase II trials bring the success rate to:
31% x 58% x 85% = 15.3%
The value of a biotech company can be estimated by taking the product of the potential future profits after FDA approval of its drug candidate and the probability of FDA approval and market entry. If we omit discounting to the present for simplicity, the present value of a drug candidate with $10 B in estimated future profits but yet to enter clinical trials can be estimated to be:
$10 B x 9.6% = $0.96 B
On the other hand, again omitting discounting for simplicity, the present value of the same drug candidate entering Phase II clinical trials after successful Phase I can be estimated to be:
$10 B x 15.3% = $1.53 B
More advanced drug candidates make a company more valuable. In other words, derisking by successfully completing clinical trials increases the value of a biotech company. In our example, completing clinical trial Phases I increased the value of the biotech company by roughly $0.6 B. As a corollary, failure to meet the primary endpoints of a clinical trial (i.e. an unsuccessful clinical trial) is often associated with significant loss of value. Indeed, a study that analyzed the factors associated with the acquisition value of 313 biotech companies acquired between 2005 and 2020 found that companies with lead products in pre-clinical stage had a median acquisition value of about $88 million, $354 million for Phase I, $638 for Phase II, $1761 million for Phase III, and $2469 million for approved lead products.
Breadth of the Pipeline. The breadth of a pipeline refers to the range and variety of drug candidates and the different therapeutic indications each drug is being developed for, encompassing both the number of distinct drugs and the multiple indications targeted, whether by a single drug or across multiple candidates.
Multiple Drug Candidates in Development
Having multiple drug candidates in development is often more valuable than relying on a single candidate. This is because relying on a single drug candidate is associated with more risk than relying on two or more drug candidates, which reduces the company’s dependency on a single drug. For a company that develops a single drug candidate, development failure of this drug often leads to failure of the company. For a company that develops two (or more) drug candidates, failure of a single drug candidate will likely lead to loss of value but not to a failure of the company as the other drug candidate(s) could still be successful. Different drug candidates that represent distinct drug modalities with distinct mechanisms of action often have likelihoods of success (or failure) that are largely independent of each other. Thus, having multiple drug candidates could reduce risk and increase the likelihood of success for a company.
Example
All else being equal, a company with two drug candidates in Phase II trials will be more valuable than a company with a single drug candidate in Phase II trials. If we omit discounting to the present for simplicity and assume that each of the drug candidates targets a market with similar size and is expected to generate similar future profits of $10 B, the present value of each drug candidate to enter Phase II trials can be estimated to:
$10 B x 15.3% = $1.53 B
To a first approximation, the value of a company with a single drug candidate is $1.53B, while, all else being equal, the value of a company with two drug candidates is double that:
2 x $1.53 B = $3.06 B
In practice, companies developing multiple drug candidates often target different markets and anticipate capturing different fractions of each market, so different drug candidates typically increase the value to a different extent, and some programs can be valued higher than others. An analysis of biotech acquisitions between 2005 and 2020 found that company valuation increased with about 15% on average for each additional product under development.
Single Drug Targeting Multiple Indications
Drug candidates that target pathways inherent to multiple diseases could constitute future treatments for multiple indications. As a consequence, a single multi-indication drug could potentially penetrate multiple markets, target more patients, and lead to increased future profits relative to a single-indication drug. In addition to higher potential future profits from accessing multiple markets and more patients, a single multi-indication drug decreases the risk of overall company failure relative to a single-indication drug: a multi-indication drug candidate might fail in certain indications but succeed in others. Finally, multi-indication drugs can have significant advantages over single-indication drugs in terms of early development costs since these costs are incurred only once.
Indeed, the analysis of 313 biotech acquisitions between 2005 and 2020 found that the valuations of biotech companies developing multi-indication drugs were significantly higher relative to single-indication developers in Phase I ($594 vs $230 million) and Phase II ($1058 vs $522 million).
Clinical Data
Clinical data determine if a drug candidate is safe and efficacious and is directly related to the pipeline potential. Clinical data are more often obtained during and at the end of clinical trials, with positive and negative data leading to clinical trial success and failure, respectively. Thus, clinical data define the likelihood for regulatory approval and market entry, both required for future profits to materialize. As a corollary, clinical data can create or erase perceived value overnight.
Example
Company A develops a drug candidate with estimated $10 B in future profits after FDA approval and market entry. If the drug candidate is in Phase II trials (and omitting discounting for simplicity), the present value of the drug candidate can be estimated to be:
$10 B x 15.3% = $1.53 B
If Phase II studies are successful, the likelihood of the drug getting FDA approval will become 49.6% (success rate of Phase III trials and regulatory approval), bringing the perceived value to:
$10 B x 49.6% = $4.96 B
On the other hand, if the Phase II studies are unsuccessful, the likelihood of the drug candidate being approved by the FDA virtually vanishes, with the perceived value assigned to this drug development program often dropping to zero. It is important to note however, that sometimes biotech companies can redesign their clinical trials or repurpose the drug for a different indication, enabling them to eventually regain some or all of the perceived value if the newly designed clinical trials are successful.
Scientific Data
Scientific data describe the mechanism of action of a drug candidate. Scientific data typically, but not always, provide the basis for drug candidate development and new scientific data can be obtained at any stage of development, increasing or decreasing the perceived value of the drug candidate and the company as a whole. Scientific data from preclinical studies provide initial safety and efficacy insights, and are required to file an Investigational New Drug (IND) application before any clinical trials can be authorized by the FDA. Regulatory approval relies heavily on robust scientific data. Additionally, scientific data indirectly define the target market and thus the basis for competition, as companies that develop drug candidates targeting the same or similar pathways using the same or similar mechanisms of action and drug modalities are more likely to compete for the same market. Finally, scientific data are the basis for any intellectual property. The stronger the scientific data behind the drug candidate in development, the higher the perceived value is likely to be.
Example
Company A develops a drug that blocks the function of a protein in a newly identified signaling pathway that is involved in the development of the targeted disease condition.The new pathway appears highly promising, contributing to the perceived value of the company. While the drug is in development, new scientific data are published and show that the signaling pathway is also central to the functioning of healthy cells. These new data suggest that interfering with the new pathway is likely to cause undesired long-term effects in humans. The new scientific data indicate that patient will likely suffer from side effects, decreasing the perceived value of the drug and the company as a whole.
Market Opportunity
Market opportunity encompasses a set of important drivers of company valuation. Market opportunity defines the potential future profits a biotech company can generate from its drug candidates, based on the size and growth of the target market, the level of unmet medical need, the potential market penetration, the pricing power of the drug to be marketed, and the extent of reimbursement by insurance companies.
Market Size. Market size refers to the total potential revenue a drug could generate within a specific market. For a pre-revenue biotech company, the projected market size of their drug candidate(s) is an important aspect and directly impacts its perceived value. A large, growing market might indicate high potential for future profits, which could drive up the company's perceived value. Conversely, a smaller or stagnating market might limit growth prospects and negatively affect perceived value. Factors such as the prevalence of the disease, the cost of treatment, and the number of potential patients contribute to the market size.
Market Penetration. Market penetration refers to the potential extent to which the company's future therapy could be recognized and adopted within the target market. Although the company has not yet generated revenue, projecting strong market penetration can significantly increase its perceived value. High market penetration prospects imply that once the drug is approved and launched, it will capture a substantial share of the target market, leading to more potential future profits and thus to higher valuation.
Market Share. Market share refers to the percentage of total sales in a market captured by a company's drug product relative to its competitors. Unlike market penetration, which measures the adoption rate of a drug product within its target market, market share specifically compares a company's sales to the overall market sales. For a pre-revenue biotech company, projecting a significant market share can enhance its perceived value by indicating the potential market dominance of its drug candidate once approved. High market share projections suggest strong competitive positioning and the potential to capture substantial future profits, which can increase the company's valuation. Achieving a substantial market share can also lead to greater bargaining power with payers, further boosting the company's financial prospects and perceived value.
Unmet Medical Need. Unmet medical need refers to conditions or diseases for which there are insufficient or no effective treatments available. In the context of a pre-revenue biotech company, addressing an unmet medical need can dramatically enhance the company’s perceived value. When a drug candidate targets a significant unmet medical need, it indicates a high potential for market demand and acceptance once the drug is approved. This can increase the perceived value of a company because it can facilitate market penetration and the likelihood for reimbursement by healthcare insurance, as healthcare systems are often more willing to cover innovative treatments that address unmet medical needs. Furthermore, drugs addressing unmet needs can benefit from accelerated regulatory pathways and orphan drug designations, which can accelerate time to market and reduce development costs.
Pricing Power. Pricing power refers to a company's ability to set and maintain prices for its products without significantly losing customers to competitors. In the context of a pre-revenue biotech company developing a drug, pricing power is an important determinant of future profits and can influence company valuation. Strong pricing power indicates that the drug, once approved, has the potential to command a premium price due to factors such as high unmet medical need, superior efficacy, or unique benefits compared to existing treatments. Strong pricing power can significantly boost the company’s perceived value.
Reimbursement. Reimbursement refers to the process by which patients and hospitals are compensated for the costs of medical treatments by insurance companies. In the context of a pre-revenue biotech company, favorable reimbursement prospects can enhance its perceived value: if a drug is expected to receive broad and favorable reimbursement coverage, it indicates that the drug will likely be financially accessible to a wider patient population, thereby driving higher adoption, sales, revenue, and eventually profits. Reimbursement decisions often hinge on factors such as the drug's clinical efficacy, cost-effectiveness, and the severity of the condition it treats. Effective reimbursement strategies can significantly impact the drug's market penetration, pricing power, and overall market opportunity, leading to higher perceived value.
Examples
Company A is developing a gene therapy for a rare genetic disorder with no current treatments. Despite the small patient population, the high unmet need, market penetration, and potential for premium pricing result in significant potential future profits, adding to the perceived company value.
Company B is creating a novel oral treatment for diabetes, targeting a vast global market. Despite existing solutions and competition, the market is large enough that even capturing only a fraction of the market ensures substantial profit potential, elevating the company's valuation due to the significant market opportunity.
Competitive Landscape
The competitive landscape refers to the external environment of competing companies in which a biotech company operates. Competition can impact a number of valuation drivers including the size of the market that the company could capture (market share), the extent to which its drug would be adopted by the market (market penetration), the extent to which a company could benefit from premium pricing for its drug, and the likelihood of benefitting from accelerated regulatory pathways and orphan drug designations, all of which impact the potential future profits and perceived company value in different ways.
Types of Competitors. Competitors can generally be classified as direct and indirect. Direct competitors are typically companies developing therapies to treat the same condition, and could be using similar drug modalities or similar mechanisms of action. The presence of numerous direct competitors can dilute market share and decrease market penetration, negatively impacting perceived company value. Indirect competitors are typically companies that offer alternative treatments for the same condition. While these therapies might use different mechanisms of action, they can still impact market penetration and pricing strategies. Demonstrating superior efficacy, safety, or cost-effectiveness compared to competitors can significantly boost a company's perceived value by establishing a competitive edge.
Differentiation. Differentiation describes how a drug candidate stands out from existing treatments in terms of efficacy, safety, mechanism of action, or other unique features. It is crucial for establishing the drug's competitive edge and market potential. Strong differentiation can significantly increase a drug candidate's perceived value by highlighting its unique benefits over current therapies. This can lead to greater market share, pricing power, and increase the perceived company value.
Patent Landscape. The patent landscape encompasses the intellectual property rights and patents held by the company and its competitors. A strong patent portfolio protects the company’s innovations and provides a competitive advantage by preventing other companies from developing similar drugs. This exclusivity can lead to higher market share and pricing power, positively impacting the company’s valuation.
Examples
Company A is developing a novel drug with several direct competitors for the same patient population. With a strong set of patents covering all aspects of the drug, the company ensures that other direct competitors will not be able to easily develop similar drugs, increasing the likelihood of capturing a larger market share with more pricing power, increasing the company’s perceived value.
Company B is developing a drug with a novel mechanism of action that offers superior efficacy and fewer side effects compared to existing treatments. This strong differentiation increases the drug's perceived value and competitive edge. While the drug is in development, new data show that competitors are developing similar drugs with comparable benefits, potentially diminishing the company’s differentiation and perceived value.
Management Team
The management team can be an important auxiliary driver of biotech company value. Experienced and reputable leadership often indicates a higher likelihood of successful drug development and therefore positively impacts the perceived company value.
Leadership Experience. Leadership experience refers to the collective expertise and track record of the company's executives in the biotech and pharmaceutical industries. A team with a history of successful drug development, regulatory approvals, and market launches is expected to have a higher likelihood of bringing a new drug to market and can increase the company’s perceived value.
Scientific & Clinical Expertise. Scientific and clinical expertise within the management team ensures that the company’s strategic decisions are grounded in solid scientific and clinical knowledge and experience. Leaders with strong backgrounds in relevant scientific fields can effectively guide early research and development and pre-clinical development, making informed decisions that enhance the drug candidate's development prospects. Leaders with strong clinical background can effectively guide clinical studies and clinical trial design, ensuring that the drugs in development have the highest likelihood of showing efficacy and safety, which are ultimately needed for regulatory approval.
Example
Company A is led by a team with a proven track record of bringing multiple drugs to market successfully, taking companies from pre-clinical development to clinical trials and regulatory approvals. This experience increases the likelihood that the team will be successful in developing a new drug, taking it from pre-clinical development to FDA approval and increasing the perceived value of the company.
Conclusion
In summary, the valuation of pre-revenue biotech companies depends on several key drivers, including pipeline potential, scientific and clinical data, market opportunity, competitive landscape, and the management team. These factors collectively determine the likelihood of future profits and overall company value. Additionally, other drivers such as strategic partnerships, financial health, regulatory environment, and macroeconomic conditions can also impact perceived value, albeit likely to a lesser extent than the primary drivers discussed. Understanding these elements is crucial for informed investment and strategic decision-making in the biotech sector. Ultimately, company value is determined by investors, and perceived value can be influenced to different extents by these drivers.
References
Michaeli, D. T. et al. Value drivers in development stage biopharma companies. Eur J Health Econ. 2022.
Michaeli, D. T. et al. Valuation and returns of drug development companies: lessons for bioentrepreneurs and investors. Ther Innov Regul Sci. 2022.
Mullard, A. Parsing clinical success rates. Nature Reviews Drug Discovery. 2016.
Richard, M. How to calculate the value of drug and biotech companies. Bay Bridge Bio website. 2022.
