Why you should not misconstrue your financial capability with the valuation of your company?
The subject may sound strange but it is true that one encounters such instances in day to day business deals. I was part of one of the out licensing deals of my Client A, a biotech company that was interested in either licensing out or co-developing its product for Phase 2. One of the prospective partners, Company B was interested to fund the Phase 2 clinical trials. The company B was a start up with 200 K Euro revenues but maintained that they would fund not only phase 2 but also phase 3.
The next question was – Show me the Money!!
The management of company B argued that we should not under estimate them as for a start-up, accounting numbers mean nothing.
Fair enough!!
However, let us understand this in the context of financial balance sheet of a company.
Any company has the following assets:
- Existing assets:Developed products, property, plant etc that generate cash flows. Most of the value of a matured company is derived from existing assets. In case of company B, the existing assets generate 200 K Euro in revenue
- Growth assets:R&D, patents, products under development etc that could generate cash flows or even change the fortune of the company in future. Most of the value of a high growth company is derived from growth assets. In case of company B, the growth assets could be their early stage products under research and development or patents with options embedded in it and so on. However, these assets are built on hope and expectations. That’s the reason, taking debt to fund these growth assets may not be a great strategy for a start-up as you cannot pay the interest expenses with great hopes
In sum, the clinical trials for Phase 2 cannot be funded with future expectations of company B but with real money. In order to finance it, the company B has to raise equity which has risks associated with it. Whether the company B would fund it, will depend on their financial capabilities and not based on the valuation of the company/assets.
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