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Focus on Life Sciences & Technology: Considerations for the Valuation of Early Stage Entities – Part 1

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You’ve probably heard this before, but valuation is both an art and a science. The type of asset, the nature of the valuation, and the purpose of the valuation will dictate how much of that blend is weighted towards art or science.
February 2, 2015

You’ve probably heard this before, but valuation is both an art and a science. The type of asset, the nature of the valuation, and the purpose of the valuation will dictate how much of that blend is weighted towards art or science. Valuation can be a quick-and-dirty exercise or a full-blown deep dive analysis. The blend of art and science and level of intensity will depend on a variety of considerations and factors. This is especially true for early stage and emerging companies with little or no financial track record to base an analysis upon.

Before delving into the exercise of valuing a company or asset, there are a variety of factors to consider that will help dictate what type of valuation techniques to use and how intensive the effort needs to be. Some of these considerations include the following.

What is the purpose of the valuation?

Is your valuation going to be used internally to help existing owners assess the next financing round OR will it be used to comply with IRS regulations (e.g., IRC 409(a) for equity based compensation)?

A valuation performed for internal purposes will have significantly more flexibility in the valuation approaches utilized and the level of due diligence and analysis required relative to a valuation for tax compliance or financial reporting.

Whose perspective matters?

Is the owner heading into a negotiation for a potential sale of the company to another industry participant OR is the valuation being performed for tax compliance purposes?

For an owner heading into a negotiation the appropriate perspective is the owner’s, which is typically a very specific and unique perspective. If the valuation is for tax compliance purposes, it is more likely than not that a generic market participant perspective is warranted. The difference in perspective can lead to very different value conclusions.

Who is the intended audience?

Again, is this for internal purposes, will it be used externally to help raise funding, OR will it be submitted to external auditors (for example, to support fair value reporting) or the IRS for tax compliance (a 409(a) valuation)?

The requirements and sophistication of the intended recipient will help determine the nature of the valuation needed.

While those and similar questions are interrelated, they should each be addressed individually as they can help determine the type and intensity of the valuation required. Once these questions have been addressed, the specific type of valuation required can be identified and the level of due diligence and analysis required to support the valuation can be determined.

All else equal, valuations for external parties or compliance purposes will:

  • Require a higher level of due diligence and supporting analysis
  • May need to follow one or more of the three standard approaches commonly utilized and accepted within the valuation profession
  • Will have higher documentation requirements

Part 2, forthcoming, will look closer at framing the valuation analysis and specific valuation approaches.

RubinBrown has a dedicated Life Sciences and Technology Services Group specializing in serving life sciences and technology based companies, including: advising startup and early stage companies; performing valuations for internal purposes, financial reporting, and tax compliance; and consulting on IP value, management and strategy.

 

Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.

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