THE CLIENT AND THE ASK:
- A pharmaceutical company (the “Acquirer”) acquired a biotechnology company (the “Company”) in exchange for an upfront payment and certain payments contingent upon successful achievement of future regulatory and sales milestones for certain product candidates being developed by the Company (the “Contingent Consideration”). The Contingent Consideration was deemed to be “golden parachute” payment under Internal Revenue Code (“IRC”) Section 280G.
- The scope was to estimate the fair market value (“FMV”) of the Contingent Consideration for the Company as requested by our client (the “Client”).
- The milestones were contingent upon the achievement of regulatory approvals and certain amounts of sales in a calendar year. As such, there were an infinite number of possible future outcomes.
- There were two products associated with the revenues; however, the first three sales milestones were based on only one product.
- Revenue from the first product were further tiered based on lines of treatment. For example, the first line approval was contingent on the commercialization of the second line and third line.
- The first product targeted two indications.
- Worldwide sales were considered with different approval timelines in the United States (“US”), European Union (“EU”) and Japan.
- Regulatory milestones were only dependent on the US sales.
DATA PROVIDED BY THE COMPANY:
- Deal document and deal terms, to understand the nature of the Contingent Consideration.
- Product development, approval, and commercialization timelines.
- Sales estimates for the first product for both the indications and different lines of treatment, including sales proportion of EU and Japan.
- Guidance on the type of operating costs and cost estimates.
BRIEF BACKGROUND OF THE COMPANY:
- The Company was a clinical-stage biotechnology company engaged in discovering and developing small-molecule cancer.
SOLUTION – PROBABILITY SIMULATION:
- We studied the development timelines of the candidates for the different target indications being pursued, studied the mono and combination therapy development plans and timelines, and the development timelines of competitive drugs and therapies in the industry.
- We selected certain success probabilities for achieving each of these milestones, the probability of technical success (“PoTS”) selection was based on research publications available for various indications.
- Given the infinite number of possible future outcomes and interdependencies between the first-line approval and second-line and third-line commercialization, we simulated the selected PoTS for the two candidates at various stages of development.
- Using a simulation software, we ran 25,000 simulations for PoTS (Yes/No simulation) for both the product candidates.
- For one product, the Company was targeting two indications (including second- and third-line treatment for the second indication) and was performing Phase II clinical trials as of the assessment date.
RISK-ADJUSTED NET PRESENT VALUE (“RNPV”) ANALYSIS
- Using the simulated probabilities, we calculated the probability-adjusted revenues for all lines of treatment, for the two indications and both the products.
- The forecasts were developed based on research of comparable products in the industry, study of their market penetration, and years to achieving peak sales.
- Risk related to the achievement of milestones, which was not captured in the discount rate, was captured by adjusting the estimated cash flows for the resultant PoTS (from simulations) and then calculating the net present value of the cash flows.
- We analyzed the cost of capital by region and stage of the companies and analyzed the discount rates from various published studies.
- Based on the above probability-adjusted revenues and associated milestones, we calculated the RNPV of the total Contingent Consideration (for all products and indications).