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ROUNDTABLE leaders LIFESCIENCELEADER.COM APRIL 2014 38 present value, discounted cash flow analysis typically done. But it's all about looking at other companies in the market — both companies that you've financed yourself at similar stages as well as other companies for which you have good data — and comparing, through a myriad of adjustments for the various risks involved, how a particular company compares with a pool of similar companies. Your initial question has the word "calculated," as in how market cap is calculated, but ultimately, it's really negotiated. You start with the best information that you can collect at that stage, looking at comparable companies, and then it's a negotiation. KOBERSTEIN: I used "calculated" some- what as a red herring, knowing I'd probably get a reaction. But when you say valuation or market capitalization, it does sound like something a financial person sat down and calculated, with formulas and so forth. SHAW: We could even have an interesting conversation about "what is market cap?" What do you mean by market cap? Is it simply the price of the share, the last price paid times all fully diluted shares outstanding, or is it ultimately the value of the company — what someone would buy for the whole enterprise? KOBERSTEIN: Right. So there are the tan- gible assets, and then there is the actual price it might be purchased for, which could include intangibles. EXPECTATIONS MANAGEMENT Do some companies get ahead of the game in boosting their market caps based on unrealistic hopes about later stages of development? Or is ÒjudgmentÓ an inevitable and necessary part of early investing? KOBERSTEIN: There has been much public discussion recently about a few companies that have achieved enormous market caps based on early, conditional approval in one narrow indication along with a strategy of subsequently expanding approved indica- tions for the same product into much larger markets. It seems market cap can sometimes just the environment at the time. SHAW: Absolutely, and it also strikes me that there's a disconnect between valuations of established companies that have been operating in this space for a period of time versus some nouveau companies that have recently come to market. It speaks to some of the qualitative differences, because the new companies haven't had time to disappoint yet. By and large, they haven't had any notable clinical failures. Some of these qualitative factors transform themselves into the market valuation. KOBERSTEIN: Yes, I encountered a relevant situation yesterday. I interviewed the head of a company that had basically reinvented itself after a Phase 3 failure. It's been in business for 12 years, but now it's like a new company, with new management and all new products in new areas. I asked him, "How does that affect your valuation?" He said, "We are really undervalued because of what happened in our past, even though it has nothing to do with what we're doing now." He said when the company goes public, its cur- rent state may be a factor, but at this point it's not boosting the value. PURCELL: No company proceeds like you think they're going to proceed. We were an investor in Intercept in a different indication than the one it announced. (Lots of laughter.) GUZMAN: That underscores the importance of management. FORD WORTHY: From the venture perspective, valuation is very much an art, as Dennis says. There is no net KOBERSTEIN: You raised an interesting point about the scientist-business executive and the various personalities you encounter. So it's not just a matter of the prestige of the scientist or the purported value of that person's work, but one factor is the ability of that person to interact with and understand the business side, right? GUZMAN: Absolutely. Even though someone believes in the science, they might not be willing to invest in a particular person because they don't know how many other people will understand what the CEO is talking about. Investors don't want to be the only ones in the pool. The CEO won't get very far without being able to get their message across in a clear and concise manner. KOBERSTEIN: Allan, we have been talking mainly about starting up a company and the role that valuation and market cap plays at that stage. What are some other factors that can influence it at that point? ALLAN SHAW: I'd like to build off the comment Dennis made, "It's more of an art than a science." There are many qualitative considerations that you need to take into account. We touched on the management team. There is also the therapeutic focus. Like platform shoes, therapeutic areas or targets go in and out of fashion; cancer is the flavor of the day right now. Also, time- to-market or development timelines are not inconsequential. There is increased emphasis on orphan drug development and focused drug therapies right now, and developers are trying to bypass Phase 3 studies and use Phase 2 trials as the pivotal stage studies to achieve registration. To underscore these dynamics, the spirit of the times is very important. Right now, everyone's taking capital market happy pills, and the word risk seems like a distant dream. That has a real psychological impact on access to capital and the underlying valuations at the end of the day. When everyone is feeling good about themselves, the relative valuations will inevitably expand — a high tide raises all boats, and a low tide lowers them. KOBERSTEIN: So one factor is very general, THE ART OF OPTIMIZING SMALL BIOTECH MARKET CAPS— FROM SCIENTIFIC DREAMS TO STRATEGIC REALITY By W. Koberstein B i o _ I n v e s t o r _ F o r u m . i n d d 5 Bio_Investor_Forum.indd 5 3 / 2 4 / 2 0 1 4 3 : 5 7 : 3 6 P M 3/24/2014 3:57:36 PM