2 The market approach

Imagine that you created a new type of apple that is purple yet tastes like pineapple. You would like to determine the price at which to sell your invention. You may go to your local fruit and vegetable market and find as many apple sellers as possible and determine how much they sell their apples for. At this point, you can then determine the average price of these apples and use that value as a proxy for the value of your new apple variety. This approach is the basis of the market approach to valuation. IP owners seek out recent relevant trade deals for IP comparable to their own in terms of maturity, application area, benefits and other features. They then use the values collated to determine a reasonable value for their IP.

The market approach can be used to value individual IP assets or entire companies. By understanding the importance of comparing recent relevant deals and extracting useful data, one can effectively utilize the market approach to value early-stage drug candidate assets. You are encouraged to consider the following factors when applying the market approach.

Importance of comparing recent relevant deals

Comparing recent relevant deals is essential because it provides real-world transactional data that reflects the value of similar assets. By examining deals that have recently taken place within the biotechnology industry, innovation professionals can gain valuable insights into market dynamics and investor expectations. These comparisons allow for a more accurate estimation of the value of their own early-stage drug candidates.

Types of deals to compare and sourcing of information

When employing the market approach, innovation professionals must focus on comparing deals that involve similar early-stage drug candidates. These deals can encompass a range of transactions, including licensing agreements, partnerships, acquisitions or investments in companies operating within comparable technologies or therapeutic areas. To source the necessary information, professionals can leverage their network contacts, such as venture capital providers, who often possess valuable data from their investment portfolios.

Furthermore, thorough research conducted by analysts can uncover publicly available information on recent relevant deals, which may include regulatory filings, industry reports, news articles and investor presentations. To ensure comprehensive data collection, IP valuators must cast a wide net, exploring various sources such as:

• Industry surveys and publications: Industry-specific surveys and publications, like the Licensing Royalty Rates by Battersby and Grimes, offer compiled licensing data from multiple sectors and are regularly updated.

• Professional networks: Collaborating with peers in the industry provides access to valuable sanitized data, shared specifically to facilitate robust valuation models.

• Company disclosures: Publicly traded companies may disclose significant deals that have a notable impact on their profit or loss statements. Additionally, biotechnology and pharmaceutical companies often publish press releases to highlight major completed transactions.

• Disclosures to regulatory bodies: Disclosures made to regulatory bodies, such as the US Securities and Exchange Commission, can serve as a valuable source of information regarding deals of significance.

• Subscription and proprietary databases: Several data providers offer subscription-based access to licensing and acquisition information, which can be a valuable resource for gathering relevant data.

• Court judgments: In many countries, the resolutions of IP infringement cases are published and can provide insights into comparable deals.

• Industry associations: Associations focused on innovation and technology transfer, such as the Association of University Technology Managers, ⁽¹⁾https://autm.net/surveys-and-tools/databases often manage data repositories containing information on deals completed by their members. This information is typically available to members for free and accessible to others for a fee. (For example, the Licensing Executives’ Society International ⁽²⁾https://lesi.org/publications/les-royalty-rates-and-deal-terms-surveys periodically publishes a survey of user data on biotechnology and pharmaceutical royalty rates.)

By exploring and leveraging these diverse sources, IP valuators can collect comprehensive data to inform their market approach valuation. These sources offer a wide range of deal-related information, facilitating a more accurate assessment of the value of early-stage drug candidates within the biotechnology industry.

Extracting useful data toward economic truth

To extract the most useful data from the gathered information, innovation professionals must adopt a critical approach. They should focus on key deal terms and financial considerations that directly impact valuation. Such data may include upfront payments, milestone payments, royalties, equity stakes, deal structures and contingent considerations. (Over the past 10 to 15 years option rights in license agreements and contingent value rights in firm acquisitions have become relatively common in life science deals.) It is important to consider the specifics of each deal, such as the stage of development, therapeutic potential, market size, competitive landscape and the involvement of reputable industry players. By carefully evaluating this information, professionals can uncover patterns and trends that bring them closer to economic truth.

Let us look at Case study 1 to consider how BioTech may use the market approach to value the cystic fibrosis (CF) project.

With these data, BioTech can determine how the CF project compares to recent deals and determine reasonable terms for its negotiations with Pharmacorp. The deal structure they produce should be similar to the trade deals they are comparing against. The following steps may be helpful.

Step 1: Assess the specific attributes of BioTech’s drug candidate – BioTech’s drug candidate is a phase I CF project. It is a proposed cure for CF, which would be the first of its kind. The market potential for the CF treatment is estimated to be around USD 6 billion per year globally. The rNPV estimated earlier in the income approach chapter is USD 70.45 million.

Step 2: Compare attributes with comparable deals – Based on the comparable deals provided, deal 1 (licensing agreement in oncology) and deal 3 (acquisition in rare genetic disorders) are relevant in terms of therapeutic area and development stage. These deals can provide insights into the potential valuation of BioTech’s CF assets.

Step 3: Adjust values based on differences seen in comparable deals (deal 1 and deal 3) – In this step, we need to consider the specific attributes of BioTech’s CF project asset and adjust the values of the comparable deals. Here are some potential adjustments to consider:

• Uniqueness: Since BioTech’s CF asset is a proposed cure and the first of its kind, it may be considered more valuable than other comparable deals in terms of its potential market impact and competitive advantage. Therefore, we can apply a scaling factor to increase the valuation estimates derived from the comparable deals.

• Development stage: As BioTech’s CF asset is in phase I, it is relatively early in the development process compared to comparable deals. This introduces additional risk and uncertainty. We can apply a risk adjustment to reduce the valuation estimates of the comparable deals to account for the higher risk associated with BioTech’s assets.

To adjust the values of the comparable deals, we may apply scaling factors or adjust based on these factors. A scaling factor, in the context of valuation, is a multiplier used to adjust or normalize the values of comparable transactions or assets. It is applied to aligning the characteristics of different deals or assets, making them more comparable and suitable for analysis.

Step 4: Perform rNPV analysis for each comparable deal – This can be carried out by considering the expected cash flows, discount rate and risk factors associated with each therapeutic area and development stage. The process is described in the income approach.

Step 5: Incorporate the rNPV of the CF asset – Incorporate the rNPV of the CF asset obtained through the discounted cash flow model, which is estimated at USD 70.45 million, into the valuation analysis. This reflects the expected value of the CF asset based on its projected cash flows and risk considerations.

Step 6: Conduct sensitivity analysis – To ensure robustness of the valuation, it is crucial to conduct sensitivity analysis by varying key variables such as peak sales estimates, discount rates, development timelines and regulatory risks. This analysis will help assess the impact of different scenarios on the valuation estimate and identify the key drivers of value. Below, we expand briefly on the parameters you might consider varying to conduct a sound sensitivity analysis.

Growth rate: Vary the projected sales growth rate of the CF asset. Increase or decrease the growth rate to assess its impact on the valuation. Higher growth rates may lead to higher valuations, while lower growth rates may result in lower valuations.

Discount rate: Vary the discount rate used to calculate the present value of future cash flows. Increase or decrease the discount rate to understand its effect on the valuation. A higher discount rate would reduce the present value and result in a lower valuation, while a lower discount rate would increase the present value and lead to a higher valuation.

Success probabilities: Adjust the probabilities assigned to the occurrence of milestones in the rNPV analysis. Increase or decrease the success probabilities to evaluate their influence on the valuation. Higher success probabilities would increase the expected cash flows and lead to a higher valuation, while lower success probabilities would have the opposite effect.

Scaling factor: Modify the scaling factor applied to adjust for the uniqueness of BioTech’s CF asset. Increase or decrease the scaling factor to assess its impact on the valuation. A higher scaling factor would amplify the valuation, reflecting the higher value placed on the unique nature of the asset.

Considerations when using the market approach

The market approach, specifically the comparables method, offers valuable insights when valuing early-stage biotechnology IP assets. This approach is especially valuable if values for truly comparable transactions can be obtained, despite the challenges that are involved. This approach is favored by investors due to its reflection of real-world transaction values. It is relatively straightforward to calculate and can be justified by comparing the IP under review with several recent deals. However, there are several considerations and challenges associated with using the comparables approach in this context:

The uniqueness of IP poses a challenge

IP assets are inherently distinct, making it difficult to find direct comparables that closely match the IP under evaluation. The scarcity of similar transactions limits the availability of precise benchmarks for valuation purposes. For instnce, pharmaceutical technical data is not disclosed in deal summaries or press releases, and superficially similar compound assets may have different developability characteristics; in addition, some deals may include back-up compounds that are not mentioned in public statements and other deals may not.

Maturity is another critical factor to consider

Trade deals can occur at various stages of development, ranging from the discovery phase to preclinical and clinical trial phases. The value of an IP asset can significantly vary depending on its stage of development. A deal completed during the preclinical stage is likely to be valued lower than one concluded at the end of phase II trials. The disparity in risk burden and time to market between these different stages affects the valuation outcomes.

The negotiating parties involved in trade deals also influence the valuation process

Stakeholders can include universities, investors, biotechnology companies, and pharmaceutical companies. Universities often contribute at the upstream end of the development process, focusing on discovery and preclinical stages. In contrast, biotechnology and pharmaceutical companies have a more extensive downstream reach, including clinical trials and market access. Consequently, deals between universities and biotechnology companies may tend to be smaller compared to those between biotechnology and pharmaceutical companies.

Consideration of the macroeconomic environment is vital when examining comparable deals

It is crucial to limit the analysis to a common macroeconomic context. Deals conducted during challenging economic conditions such as recessions, pandemics or wars may not be directly comparable to those conducted during periods of economic growth and stability. Economic factors can significantly influence the terms and values of transactions, and comparisons across different economic environments may lead to inaccurate valuations. Also, the type of buyer may also have an effect: sometimes a firm may have an undisclosed reason for acquiring, e.g., an impending firm sale or restructuring, and this may affect the price that it is willing to pay.

In summary, while the market approach and comparables method have their merits in valuing early-stage biotechnology IP assets, various factors must be considered. The uniqueness of the IP, the stage of development, the negotiating parties involved and the macroeconomic environment all play a significant role in determining the appropriate comparables and ensuring accurate valuation outcomes.

In general, it is advisable to use more than one valuation technique; the combined use of rNPV and the market approach (comparables) might be a good default choice in many circumstances and is a common practice.