The Venture Capital Method for Conducting Valuation Guillem Laporta, CFA Principal, Ysios Capital Istanbul October 18, 2019
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Initial Remarks Guillem Laporta, CFA Experience 2018-Currently Principal, Ysios Capital (Barcelona, Spain) 2013-2018 Associate, Edmond de Rothschild (Paris, France) 2011-2013 Analyst, Caixa Capital Risc (Barcelona, Spain) Education Chartered Financial Analyst (CFA) BSc, MSc, Biotechnology, Universitat Autònoma de Barcelona BA, MA, Business Administration, Universitat Pompeu Fabra Ysios Capital 3
Introduction to Venture Capital Venture Capital Is an Alternative Form of Investment with High Risk and High Reward Potential Investable Markets Venture Capital (VC) Type of alternative investment whereby financing is provided by funds to small, early- Corporate Stocks Indices stage, emerging firms in exchange for a Public … Equities portion of their capital General Characteristics Bonds (Corporate, Government) • Lack of liquidity Money Markets Fixed Asset Backed Securities Income • High risk, difficult to estimate … • Low/No revenues • Growth through subsequent funding Real Estate • Weak asset base Private Equity • Low leverage Alternative Venture Capital • New team Investments Commodities • But…High potential reward Derivatives Distressed Assets … Source: Own Analysis Ysios Capital 4
Introduction to Venture Capital “No Hay Duros a Cuatro Pesetas” Risk-Reward Line In efficient markets, all investments are in the risk/reward line Return Time and arbitrage eliminate outlier opportunities Hence it is very difficult to consistently obtain outsized risk- adjusted returns Risk Source: Own Analysis Ysios Capital 5
Introduction to Venture Capital Venture Capital in Biotech Involves Very High Risk Investments with Block Buster Potential Assets on the Risk-Reward Line Biotech VC Characteristics • Binary outcomes (safety, efficacy…) • High scientific specialization • Blockbuster potential Return • Intangible assets (R&D) VC • Dealing with animal & human lives (positive Biotech externalities, but also costs/regulations) VC Public Equities Fixed Income Risk Source: Own Analysis Ysios Capital 6
Introduction to Venture Capital VCs Mitigate Risk by Investing in a Handful of Companies Example of Portfolio Performance Company 1 Company 2 Company 3 Company 4 5x 0x 3x 2x Company 5 Company 6 Company 7 Company 8 1x 10x 2x 0x Company 9 Company 10 Company 11 Company 12 1x 6x 0x 5x Company 13 Company 14 Company 15 Company 16 8x 2x 0x 4x Source: Own Analysis Ysios Capital 7
Discounted CF Method The Price of an Asset Depends on the Future Cash Flows It Can Generate Asset Pricing: Discounted CFs Method (dCF) The price of an asset can be determined by the “utility” it will provide in the future Price Today If such utility can be measured in cashflows (CF), then a price can be established TODAY ASSET 1 ASSET 1 CF 1 CF 2 CF n t=0 The translation of future utility to current price t=n needs to account for at least 1) the passing “ Rational ” Price of time, 2) the risk involved in the realization Today of the CFs Future Cash Flows ALERT! plus Account for passing of time Future Asset Value There’s no such thing as an “objective price”. and risk All we can do is calculate a “rational price” “ discount ” based on assumptions, which will always Source: Own Analysis involve a degree of subjectivity Ysios Capital 8
Discounted CF Method The Problem of Assets in R&D Stage Is That CFs Are Difficult to Estimate Asset Pricing: Discounted CFs Method (dCF) When CFs are difficult to measure, dCF can still be used, but many more assumptions will Price ? need to be made, leading to a worse price ? ? ? Today estimate ASSET 1 ASSET 1 CF 1 CF 2 CF n When can be CFs difficult to measure? t=0 t=n • CFs occur far in the future “ Rational ” Price • CF amounts are not easily predictable Today • Risk cannot be estimated Future Cash Flows plus Then What? Account for passing of time Future Asset Value and risk ? dCF is still a useful method. It is a powerful tool used in corporate negotiations Source: Own Analysis Alternative methods based on the same concept: Venture Capital Method Ysios Capital 9
VC Valuation Concepts Pre-Money and Post-Money Pre-Money Valuation Value given to the company before the investment Post-Money Valuation Value given to the company after the investment. It equals the pre-money plus the amount invested Pre-money + = Post-Money Valuation Value of the Company “new value” Total Amount Invested Ysios Capital 10
VC Valuation Concepts Post-Money Determines the Ownership Individual Amount Invested = % in a Company Post-Money Valuation 5 (individual investment) = 10% ownership 20 (pre-money) + 30 (total investment) Ysios Capital 11
VC Valuation Concepts Ownership Determines Return on Investment Ownership 10% 40% 20% 30% Ysios Capital 12
VC Valuation Concepts Ownership Must Be Considered on a Fully-Diluted Basis 10% 6% Instruments that affect capital structure • Employee Stock Options (ESOP) • Warrants • Convertible Loans • Convertible Interest • Discounts to Conversion Individual Amount Invested % in a Company Post-Money Valuation Ysios Capital 13
VC Valuation Concepts Ownership Must Be Considered on a Fully-Diluted Basis $10M = Non Diluted % = 20% $20M + $30M Investment Pre-Money $20M $30M + $10M x 90% = 15% Fully Diluted % = ESOP $20M + $10M + $30M Individual 10% Investment + $10M Convertible Loan $10M Ysios Capital 14
The VC Method 3 Steps Define Risk and Target Return Determine Exit Values by Comparables Calculate Pre-Money to Achieve Target Return Ysios Capital 15
The VC Method The Venture Capital Method (1) Risk/Return Assessment Given the risk of an investment, we Ex: Company A is very risky, we need a determine the minimum return by multiple of 8x to compensate the risk which that investment is worth doing (2) Comparables Ex: Company A is very similar to We analyze the values at which similar company B, which was recently companies have been acquired acquired for $400 M Ex: If we invest $30 M in Company A, we need $240 M in proceeds at (3) Determine the Pre-Money and exit ($30 M x 8x), which means we need to own 60% of the company Post-Money ($240 M / $400 M) We determine the pre-money valuation $30M (example individual investment) that yields a multiple of 8x given the 60% = amount of our investment and Pre-money + $30M (we are the only investors) assuming that Company A will be acquired for $400 M Pre-money = € 20M Ysios Capital 16 Post-money = € 50M
The VC Method Pre-Moneys Increase as Assets Risk Decerases Ysios Capital 17
Practical Example: Chase Pharmaceuticals Donepezil Is the Standard-of-Care Treatment for Alzheimers ’ Disease Ysios Capital 18
Practical Example: Chase Pharmaceuticals High Doses of Donepezil Help Slow Down the Disease, But This Comes with Side Effects Ysios Capital 19
Practical Example: Chase Pharmaceuticals Innovation: Combination of Donepezil with a Peripheral Cholinergic Blocker Ysios Capital 20
05 Practical Example: Chase Pharmaceuticals SWOT Is a Useful Tool to Assess Risk Strengths Weaknesses • • Simple and robust scientific and First time working with the team medical concept • Company’s headquarters not • Abbreviated and less costly close regulatory development Opportunities Threats • • Unmet medical need and huge Perceived risk of generic market opportunity challenge at exit • • Potential for a slowdown in disease Disappointing clinical results progression • New CEO may not fit in the • Concept can be extended to other company’s athmosphere combinations of AChEIs and antidotes Source: Own Analysis Based on Non-confidential Data from Andera Partners Ysios Capital 21
Practical Example: Chase Pharmaceuticals Comparables Help Assess Return Potential Source: Andera Partners Average = $150 M Upfront Ysios Capital 22
Practical Example: Chase Pharmaceuticals Returns Analysis Based on Potential Upfront Values Base Case Upfront Value $50 M $125 M $150 M $200 M $250 M $300 M Multiple 1.9x 4.6x 5.6x 7.4x 9.3x 11.1x Source: Own Analysis. The figures above are just an example for explanatory purposes only. They do not correspond to the actual analysis for this investment Ysios Capital 23
Practical Example: Chase Pharmaceuticals Chase Pharmaceuticals Was Acquired by Allergan in Nov 2016 for up to $1 Billion Source: PharmaLive Ysios Capital 24
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