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
3 06/08/2016 Business Finance for Basic Scientists
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
4
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
5
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
06/08/2016 Business Finance for Basic Scientists
Revenue and Costs – how enterprises measure performance
6
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?
06/08/2016 Business Finance for Basic Scientists
Types of Financial Statements
7
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
06/08/2016 Business Finance for Basic Scientists
8 06/08/2016 Business Finance for Basic Scientists
Types of Financial Statements
9
• 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
06/08/2016 Business Finance for Basic Scientists
Overview of Income Statement
10
(in millions, except per share amounts)
06/08/2016 Business Finance for Basic Scientists
Types of Financial Statements
11
Income Statement
• Assets, Liabilities, and Equity • Snapshot at a period of time • At 12/31/15
Balance Sheet
Cash Flow Statement
06/08/2016 Business Finance for Basic Scientists
Overview of Balance Sheet
12
Assets = Liabilities + Equity
06/08/2016 Business Finance for Basic Scientists
Total Assets
Liabilities (Debt)
Equity
Assets – Consolidated Balance Sheet
13
• Cash & Equivalents • Accounts Receivable
• Equipment • Land
(in millions, except per share amounts)
06/08/2016 Business Finance for Basic Scientists
Liabilities + Equities
14
• Debt • Retained Earnings
(in millions, except per share amounts)
06/08/2016 Business Finance for Basic Scientists
Assets = Liabilities + Equities
15
Total Assets 51,839
Total Liabilities 32,726 Total Stockholder Equity 19,113
Total Liabilities + Equity 51,839
*In millions
06/08/2016 Business Finance for Basic Scientists
Types of Financial Statements
16
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
06/08/2016 Business Finance for Basic Scientists
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 )
17
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
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 )
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 )
06/08/2016 Business Finance for Basic Scientists
Months of Cash
18
• 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
06/08/2016 Business Finance for Basic Scientists
Months of Cash: an Example
19
PORTOLA PHARMACEUTICALS, INC.
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)
PORTOLA PHARMACEUTICALS, INC.
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
PORTOLA PHARMACEUTICALS, INC.
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
06/08/2016 Business Finance for Basic Scientists
Summary Financial Statements
20
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
06/08/2016 Business Finance for Basic Scientists
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
21 06/08/2016 Business Finance for Basic Scientists
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?
22 06/08/2016 Business Finance for Basic Scientists
23
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
06/08/2016 Business Finance for Basic Scientists
24
Forecasting
• What is forecasting? • Why companies do it? • Predict future use of cash to achieve corporate
or academic project goals
06/08/2016 Business Finance for Basic Scientists
Why Forecast?
§ Cash Management § Strategy
§ It’s an Art & Science
25 06/08/2016 Business Finance for Basic Scientists
Example
26
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
06/08/2016 Business Finance for Basic Scientists
The forecast reflects both the long term and short term organizational goals
27
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
06/08/2016 Business Finance for Basic Scientists
28
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
06/08/2016 Business Finance for Basic Scientists
29
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
06/08/2016 Business Finance for Basic Scientists
30
Cost of Capital
• How do I evaluate and prioritize my projects • How will my projects be assessed financially • How to compare projects financially
06/08/2016 Business Finance for Basic Scientists
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.
31 06/08/2016 Business Finance for Basic Scientists
Cost of Capital in Drug Development
32
Cost of capital
Probability of Success
06/08/2016 Business Finance for Basic Scientists
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
33 06/08/2016 Business Finance for Basic Scientists
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
34 06/08/2016 Business Finance for Basic Scientists
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
35 06/08/2016 Business Finance for Basic Scientists
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
36
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
06/08/2016 Business Finance for Basic Scientists
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?
37
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.
06/08/2016 Business Finance for Basic Scientists
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.
38 06/08/2016 Business Finance for Basic Scientists
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?
39
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.
06/08/2016 Business Finance for Basic Scientists
Summary of methodologies
40 06/08/2016 Business Finance for Basic Scientists
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
41 06/08/2016 Business Finance for Basic Scientists
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.
42 06/08/2016 Business Finance for Basic Scientists
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.
43 06/08/2016 Business Finance for Basic Scientists
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
44 06/08/2016 Business Finance for Basic Scientists
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
45 06/08/2016 Business Finance for Basic Scientists