business concepts for life scientists: finance - … finance...business concepts for life...

Business Concepts for Life Scientists:

Finance JeShaune Jackson, MBA, MS Christine Siu, MBA

Content Contributors Michael Penn, MD, PhD Aimee Kao, MD PhD Carlos Solorzano, PhD Lazar Dimitrov, PhD Sharon Lee, PhD

Business Concepts for Basic Scientists

Strategy

Finance

Business Development

2 06/08/2016 Business Finance for Basic Scientists

Finance course objectives

By the end of class you will be able to:

1.  Identify the 3 different financial statements and how companies use them

2.  Read and identify parts of a P&L statement

3.  Calculate burn rate

4.  Explain and apply concepts such as opportunity cost, cost of capital, and net present value

5.  Apply these concepts in financial planning


Defining finance

§ Corporate finance deals with the sources of funding and the capital structure of corporations

§ The purpose is to increase the value of the firm to the shareholders

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In biotechnology…

How the company will fund itself and allocate its financial resources

In academia… How the lab will budget for its operations and manage expenses

06/08/2016 Business Finance for Basic Scientists

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Agenda

Revenue & Costs

What the enterprise earns and

spends

Forecasting

Estimating the funding of the

enterprise

Cost of Capital

Required rate of return to

make an investment


Revenue and Costs – how enterprises measure performance

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Revenue and Costs

•  Overview of financial statements •  How much revenue did Gilead have in 2015? •  What was their annual burn rate for 2015? •  At the current burn rate, how many months of

cash are remaining?


Types of Financial Statements

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Income Statement

Balance Sheet

Cash Flow Statement

All public companies must file their financial statements with the SEC. They can be found on www.sec.gov/edgar/searchedgar/companysearch.html



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•  Revenue & Costs •  Net income over a period of time •  Also known as Profit & Loss (P&L)

Statement •  Year ended 12/31/15

Income Statement

Cash Flow Statement

Balance sheet


Overview of Income Statement

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(in millions, except per share amounts)



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Income Statement

•  Assets, Liabilities, and Equity •  Snapshot at a period of time •  At 12/31/15

Balance Sheet

Cash Flow Statement


Overview of Balance Sheet

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Assets = Liabilities + Equity


Total Assets

Liabilities (Debt)

Equity

Assets – Consolidated Balance Sheet

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•  Cash & Equivalents •  Accounts Receivable

•  Equipment •  Land



Liabilities + Equities

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•  Debt •  Retained Earnings



Assets = Liabilities + Equities

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Total Assets 51,839

Total Liabilities 32,726 Total Stockholder Equity 19,113

Total Liabilities + Equity 51,839

*In millions



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Income Statement

Balance Sheet

•  Operating, Investing and Financing activities

•  Use of cash over a period of time •  Year ended 12/31/15

Cash Flow Statement


Cash Burn

PORTOLA PHARMACEUTICALS, INC.

Consolidated Statements of Operations (In thousands, except share and per share data)

Year Ended December 31, 2015 2014 2013

Collaboration and license revenue $ 12,070 $ 9,625 $ 10,531 Operating expenses:

Research and development 200,376 123,639 79,286 Selling, general and administrative 38,869 23,552 15,423

Total operating expenses 239,245 147,191 94,709 Loss from operations (227,175 ) (137,566 ) (84,178 ) Interest and other income, net 305 441 826 Loss before taxes $ (226,870 ) $ (137,125 ) $ (83,352 ) Income tax benefit $ 365 $ – $ – Net loss $ (226,505 ) $ (137,125 ) $ (83,352 )

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An approximation of how much money a biotech company or project is using over a period of a time, e.g. monthly, quarterly or annual cash burn. In biotech, operating loss is a good approximate for cash burn














Months of Cash

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•  A back-of-the-envelope calculation of how much time a biotech company has left before its funding runs out

•  Public biotech companies generally want to have more than 12 months of cash

•  Simple calculation:

Current cash Annual operating loss

x 12 months


Months of Cash: an Example

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Consolidated Balance Sheets (In thousands, except share and per share data)

At December 31, 2015

Assets Current assets:

Cash and cash equivalents $ 186,488 Short-term investments 257,713 Restricted cash (Development Partner) 341 Receivables from collaborators 1,000 Prepaid research and development 16,976 Prepaid expenses and other current assets 3,059

Total current assets 465,577 Property and equipment, net 6,243 Intangible asset 3,151 Long-term investments 15,960 Prepaid and other long-term assets 11,993

Total assets $ 502,924

•  Current cash from balance sheet = $444.2 M

•  Annual operating loss for 2015 = $227.2 M

•  Months of cash remaining at current burn rate = 23.4 months ($444.2/ $227.2 x 12)
















Summary Financial Statements

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Cash Flow Statement

Income Statement

Cash From: Operations Investing Financing

Revenue -Expenses

Net Income

Balance Sheet

Total Assets

Liabilities (Debt)

Equity

January 1st Balance Sheet

Total Assets

Liabilities (Debt)

Equity

December 31st

Point in Time Point in Time Summary of a Period


Operating Evaluation Metrics

§ Gross Margin (Profit)

•  Revenues – Expenses = Gross Profit

§ Net Income (Cash to Company)

•  Revenues-Expenses-Taxes = Net Income

§ Solvency – Financial Health of the Company

•  Cash in Bank/Monthly Expenses = Number of Months Left


Parallels to Academia: Q&A with Aimee § How is your lab like a small business?

§ How is the lab budget like a balance statement?

§ Do you think about burn rate?


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Revenue & Costs

What the enterprise earns and

spends

Forecasting

Estimating the funding of the

enterprise

Cost of Capital

Required rate of return to

make an investment


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Forecasting

•  What is forecasting? •  Why companies do it? •  Predict future use of cash to achieve corporate

or academic project goals


Why Forecast?

§ Cash Management § Strategy

§ It’s an Art & Science


Example

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2015A 2016A 2017E 2018E 2019EUnits 500 750 1,125 1,688 2,531 50%

Price $ 1.00 $ 1.50 $ 2.00 $ 2.50 $ 3.00 $0.50Sales $ 500 $ 1,125 $ 2,250 $ 4,219 $ 7,594 COGS 150 200 267 356 474 33%

Gross Margin 350 925 1,983 3,863 7,120 Operating Expenses 100 200 400 800 1,600 100%

Taxes & Interests 50 100 200 400 800Net Income $ 200 $ 625 $ 1,383 $ 2,663 $ 4,720


The forecast reflects both the long term and short term organizational goals

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Short-term Budget (1 year): •  Monthly - Tactical, Focused, Detailed

Mid-term Forecast (2-3 years): •  Quarterly - Directional, Estimates

Long-term Finance (3+ years): •  Annual - Aspirational

Annual goals and objectives


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Forecast Example: cash requirements for stages of a drug development company

Phase 2 clinical trial $40M

Phase 3 clinical trial $100M

Commercial launch and sale $100M

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

FDA Approval

Short-term Strategy: Demonstrate proof of

concept in patients

Mid-term Strategy: Achieve FDA approval

of lead drug

Long-term Strategy: Build sales force and achieve

over $800M sales


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Revenue & Costs

• What the enterprise earns and spends

Forecasting

• Estimating the funding of the enterprise

Cost of Capital

• Required rate of return to make an investment


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Cost of Capital

•  How do I evaluate and prioritize my projects •  How will my projects be assessed financially •  How to compare projects financially


Cost of capital

§ Cost of capital is the rate of return required to persuade an investor to make a given investment

For example, Biotech XYZ wants to raise equity to fund a clinical trial of its lead drug. Equity investors require a 30% rate of return to make the investment. Therefore, the company’s cost of capital (for equity) is 30%.

§ The cost of capital is dependent on the perceived risk of the company/investment. The less risky an investment is, the lower the cost of capital will be.


Cost of Capital in Drug Development

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Cost of capital

Probability of Success


Opportunity Cost

§ Opportunity cost is the cost of the next-best alternative that must be forgone in order to choose a desired plan

I can choose an apple or an orange. If I choose the apple, the opportunity cost is the orange

If I decide to attend graduate school, the opportunity cost is the value of the foregone wages if I had worked instead

§ Investors have multiple options to invest their capital and will demand a higher return, i.e. higher cost of capital, to invest in riskier companies


Opportunity Cost - example

Biotech A has a drug candidate that

is in preclinical testing and needs to raise money to

file an IND

Biotech Z has a drug candidate in phase 3 clinical

studies and needs to raise money to

file an NDA


Which company has the higher cost of capital?

Net Present Value (NPV)

Relies on the time value of money, the fundamental principle that a dollar today is worth more than a dollar in the future


Net Present Value (NPV)

§ NPV translates an investment’s value over time into today’s dollar

•  Future cash flows (inflows or outflows) are discounted to today’s dollar

§ NPV is an indicator of how valuable a project could be and whether it is worth investing in

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If... It means the investment would... NPV > 0 add value to the firm NPV < 0 subtract value from the firm

NPV = 0 neither gain nor lose value for the firm


NPV Example Calculation

Biotech X is considering developing a drug. It will cost $500M over 8 years before the drug is approved. Then the drug will produce $1,500M profit over 2 years. Should the biotech company invest in this drug?

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Year1 2 3 4 5 6 7 8 9 10

Annualcashflow ($10) ($20) ($30) ($50) ($50) ($90) ($100) ($150) $500 $1,000

Discountrate 25%

Presentvalueofcashflow ($8) ($13) ($15) ($20) ($16) ($24) ($21) ($25) $67 $107

NetPresentValue(sumationofallpresentcashflows) $32

The NPV is positive - the investment would earn money for the biotech company.


Internal Rate of Return (IRR)

§ Technical definition: the interest rate at which the net present value of all the cash flows (both positive and negative) from a project equal zero

§ Practical use: can be used to evaluate the attractiveness of a project or investment.

§ If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.


IRR Example

§ A venture capitalist is considering an investment in a biotech company developing a drug for Alzheimer’s disease. The company will require a $10M investment today and another $20M investment in 2 years. The venture capitalist expects to sells the shares for $90M five years from today. The venture capitalist’s hurdle rate is 25% for biotech investments. Should she make the investment?

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12/31/15 12/31/17 12/31/20Cashflow ($10) ($20) $90

IRR 33.5%

The discount rate at which the NPV all of the cash flows equals zero is 33.5%. The IRR is higher than the hurdle rate and the venture capitalist should invest in the company.


Summary of methodologies


Cost of capital

Used by all organizations

When assessing cost of funding

operations

NPV

Used mainly by companies

When valuing assets to acquire

IRR

Used mainly by investors

When evaluating an investment opportunity

Advanced Topics: Developing Finance Requires Analysis of the following areas:

•  Cost of debt and cost of equity (weighted average cost of capital -WACC)

•  Discount rate sensitivity

•  Multiple of capital

Use of the following skills sets:

•  Accounting

•  Understanding assumptions that go into forecasts

•  Analytical thinking


Parallels to Academia

§ What are examples of opportunity cost in the lab?

§ How do you decide which projects to invest in?

§ Have you calculated NPV in the lab?

§ Tell us about your near and long term financial strategies for your lab.


Case study

Break-out groups for discussion

§ Choose 1: Industry or Academia

§ Activity: Determine the current financial health of a company

§ Choose a note taker and a presenter.


Finance course objectives

You should now be able to:

1.  Identify the 3 different financial statements and how companies use them

2.  Read and identify parts of a P&L statement

3.  Calculate burn rate

4.  Explain and apply concepts such as opportunity cost, cost of capital, and net present value

5.  Apply these concepts in financial planning


Wrap Up Resources to learn business finance

§ Entrepreneurship Center courses

§ Coursera or iTunes University

§ Harvard Business Review (HBR)

§ FierceBiotech daily newsletter (or sister publications)

§ Earnings calls from public companies of interest

§ Life Science VC blog


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