- There are several approaches to valuing early-stage life science companies with potential products but no revenue, including discounted cash flow and real options pricing models. - Intellectual property is a major driver of value for these companies. Valuing development costs can estimate IP value. - Due to many uncertainties, experienced analysts use judgment to determine reasonable valuations based on potential market opportunities and outcomes.

1. Life Sciences
EAC VALUATIONS LLC
The Art and Science of Valuation of an Early-Stage Life Science Company
Background
Early-stage Life Science companies are start-up businesses with potential products, know-how, and
intellectual property, with little or no revenue. In a life science company, it can take years to translate
potentially great ideas into approved products that can generate an income stream.
Valuing a company which does not have a steady flow of income but offers great potential for future
revenues raises the following questions:
 What are the best methodologies for valuing a company with a rich pipeline but no approved
products?
 Can valuation methods utilized for companies generating revenues from a portfolio of products
and a rich pipeline also be used for such early-stage companies?
These are important questions for which there are no definitive answers, as no single valuation
methodology can be applied to all early-stage companies. However, it is important that a value be
determined for raising capital, possible mergers, and developing strategic alliances, for example. Investors
need to know the value of a pre-revenue company to understand the potential of the product pipeline and
the ultimate value going forward.
To develop a valuation for an early-stage company with potential assets, it is necessary to look at the
market potential of the products. This can be done for individual products, and a final valuation derived for
the portfolio of products. However, due to potential unique industry factors, valuation is complex, and
certain risk factors must be estimated, requiring judgments to be made in the face of uncertainty.
An important driver of value in any start-up company is the value of the intangible assets such as patents,
in-process R&D, and know-how. For most early-stage companies, the value of intangible assets are likely
to be much greater than the value of the tangible assets. Therefore, it is important to understand the unique
features of intangible assets so that the correct valuation methodology is applied.
Because business valuation is as much an art as science, a skilled BV professional with in-depth
knowledge of the specific industry is not only able to provide valuation for the total business, but also value
the contribution of intellectual property to the enterprise value. In effect, the valuation professional provides
an independent third party analysis with the insight of an in-house employee.

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Valuation Methodologies
Valuation is both an art and a science. The ability to judge which valuation method is best suited to a
company’s needs and apply it to get an accurate picture of value requires experience and skill.
In general, there are three (3) approaches to valuing a business - market, income and cost approaches.
The market approach relies on historic transactions or stock valuations of comparable businesses. The
asset or cost approach looks at all the tangible assets owned by the company, and the historic costs
incurred to develop the intellectual property being valued. The income approach uses past performance
and the expected value of future performance to calculate a future income stream, discounted to present
value. Each method used appropriately has its benefits. Values generated from each method are judged
by the experienced appraiser as to its reliability, defensibility, and completeness, then weighted to provide
a final valuation.
The market and cost/asset methodologies may not be easily applied to valuing a start-up company. One
notable exception to this is the value of intangible assets owned by the company (intellectual property),
where, using the substitution principle (What would it cost me to get to the same commercialization stage?),
development costs can be used to determine the value.
The income method typically works well for companies with positive cash flows. However, for start-up
companies with little or no revenue, discounted cash flow (DCF) methods may also be used to estimate
the intrinsic value of products in development. The DCF technique (referred to as risk-adjusted net present
value method (NPV)), when applied to a product development project, involves estimating cash flows over
the forecasted life of the product, including costs of development and projected revenues from
commercialization. The cash flows are discounted to estimate the total present value in today’s currency.
There are complex factors and assumptions involved in making these calculations, therefore, the calculated
business value is subject to the uncertainties in the assumptions.
Alternative Valuation Methodologies
As noted above, start-up companies can be difficult to value because they are high-risk in nature and have
limited historical information. Valuation approaches that include using less common alternative methods
may provide more robust valuations for start-up companies.
Real option pricing methodology may be an appropriate way to value a pre-revenue business because it
treats the development portfolio of the business like a market call option. The presumed advantages of this
approach is that it captures value in the uncertainty of success or failure of the start-up company better
than a DCF/NPV income valuation approach. The Black Scholes OPM is commonly used because it is
relatively simple to estimate certain key values. However, the Black Scholes methodology may tend to
over-estimate value if the characteristics of the company and its portfolio opportunities (e.g. exclusivity) do
not fit closely with the assumptions of the option pricing method.
Another approach for valuation of pre-revenue companies and their underlying assets which may eliminate
some of the limitations of DCF or option pricing methods is PWERM. This method models potential future
expected outcomes and assigns a probability weighting to each scenario (e.g. outright failure, delay in
development of a candidate drug, moderately successful, etc). The resultant values can be used to discount
the potential outcomes and the value of the company associated with each outcome. As an extension of
these approaches, Monte Carlo simulations can be performed to estimate the probability weighting for each
outcome.

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Summary
 Approaches to valuing a start-up company can be the same as those used for more mature
enterprises with positive income with some important exceptions.
 The market and cost methods are not easily applied because much of the value lies in the future
potential of products in development rather than assets and historical prices.
 Intellectual property holds value for pre-revenue companies.
 The income approach is performed by estimating the risk-adjusted NPV across the portfolio of
projects.
 Other valuation approaches that may be used to value pre-revenue companies include real option
pricing, PWERM, and Monte Carlo simulation.
Conclusion
Due to the complex nature of valuing a start-up company, it is important to fully understand the nature of
the industry and specific risk factors that might be unique to the company and the industry. Because
business valuation is as much art as science, a skilled BV professional with industry experience can help
business owners arrive at a valuation more accurately than could be done on their own. If the business
owner is planning to sell a business, a professional BV can provide a valuation before it is on the market
that may help the owner to understand what the business is worth and to determine if it could be made
more attractive. EAC Valuations LLC offers business valuation services to companies throughout the Life
Science, Healthcare, and Chemical process industries.
About the Author: David Abercrombie, Ph.D., Senior Business Analyst
David joined EAC Valuations in November 2013 as a Senior Business Analyst specializing in business
valuation services for Life Science and Healthcare businesses. David has served in the bio/pharmaceutical
industry in various technical and management positions since 1989.
David received his Ph.D. degree in Biochemistry from the University of Maryland in College Park, MD. He
subsequently completed a post-doctoral fellowship in membrane biochemistry and biophysics at
Massachusetts Institute of Technology. David is currently completing training as a Business Certified
Appraiser from International Society of Business Analysts.
About EAC Valuations LLC
EAC Valuations LLC has provided in-depth and trusted appraisals and valuation reports since 1971.
Located outside of Philadelphia in the city of West Chester, our assignments have taken us around the
world, and next-door. We have completed more than 10,000 appraisals for clients ranging from
multinational, multi-billion dollar Fortune 100 companies and financial institutions, to privately held local
manufacturing and services companies. Our highly qualified, certified and experienced appraisers can
exceed expectations for a wide range of appraisal needs meetings IRS, FASB, IFRS, USPAP, and FIRREA
requirements.
EAC Valuations pharmaceutical business experience encompasses working with over 40 companies in 32
states and 8 foreign countries. From generic, prescription, and OTC drugs to medical devices and
cosmetics, we have learned, appraised, and grown over the entire constantly changing pharmaceutical
landscape. Over the years, we have worked with everything from start-ups to multi-national global firms
and have journeyed with them through mergers, acquisitions, and spin-offs.

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(610) 687.5855 | Fax: (484) 887.8703
BUSINESS VALUATION BEST PRACTICES
What is a Business Valuation?
 The act or process of determining the value of a business enterprise or ownership interest therein.
Why do I need a business valuation?
 Corporate Planning
 Key Person Insurance
 Sale of Business
 Financial Reporting
 Merger and Acquisition
 Transfer of Business
 Buy/Sell Agreements
 Estate Planning
 Goodwill Impairment
 Litigation
Who uses a Business Valuation?
 A Business valuation is a valuable tool for any business, large or small, public or private, that
needs to adequately and professionally address any of the needs listed above.
What information is needed for a Business Valuation?
 The information required varies and is dependent upon the purpose and scope of the assignment.
 Typical information requested will include:
o History & Description of Subject
Business
o 3 to 5 years Audited Income Statements
o Purpose & Intended Users of the
Valuation
o Industry Overview
o Ownership Structure
o 3 to 5 years Balance Sheets
o 3 to 5 years Projections
o Description of Competition
How is a Business Valuation performed?
Three Approaches to Value:
 Asset Approach
 Market Approach
 Income Approach
Typical Discounts:
 Lack of Marketability
 Minority Interest (Control Premium)
Will a business valuation tell me the value of the Real Estate and Machinery & Equipment?
 No. The contributory value of the real estate and machinery & equipment must be derived in a
separate and distinct tangible asset valuation.
Who should you select to do your Business Valuation?
 A Certified Valuation Expert or firm that has multiple appraisal disciplines should an assets valuation
(Tangible or Intangible) be needed.