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Entrepreneurs and companies involved in the commercialisation of new biotechnologies will need to raise funds several times during development and will often target a licensing or acquisition deal as part of their ‘exit’ (or monetisation) strategy. Each of these events requires a valuation.

Many deals take place years before the product is on the market, and therefore valuations must take into account R&D cost, risk, time to market, the size of the future market and market penetration.

New biotechnologies are uniquely characterised by the presence of distinct R&D phases that allow for the quantification of risk at key value inflection points. The R&D process is essentially a sequence of gambles. Success in the first (e.g. a Phase I trial) permits you to move onto the next (e.g. a Phase II trial), with the end goal being an approved drug. 

In a valuation, this type of risk is modelled through the use of a discount rate in addition to the ‘Stage Gated Risk Adjustment of Cash Flows’. It involves applying success rates (or probabilities) to future cash flows at key value inflection points (i.e. key R&D milestones) to account for technical and regulatory risk at different stages of development.

Success rates may be derived from market comparables or from internal estimates based on experience. The numbers describing the success of the projects have historically been closely guarded by the pharmaceutical industry. However, there are a now a number of well-regarded publications on the topic, which are based on voluntary surveys and publically available data.

The following diagram shows the average clinical development success rates (for all drug indications) that may be applied along the R&D pathway. The cumulative probability of success implied by the discrete success rates is 10%.

Biotech 1


Source: Clinical Development Success Rates 2006- 2015, Biotechnology Innovation Organisation (BIO), Biomedtracker, Amplion.

By using Stage Gated Probability Adjustment of Cash Flows in addition to a discount rate the total risk adjustment for a valuation is thus substantially higher than simply using a discount rate.  The following table contains the aggregate target rates of return which may be expected when conducting a valuation at different stages of a drug’s development:


Stage of development

Typical target rates of return (Discount Rate + Risk Adjustment to Cash Flows)



Phase I


Phase II


Phase III





Importantly, by adjusting for risk in this stage gated manner, the step-up in value at key value creation milestones may be more easily assessed than by having to calculate and apply multiple discount rates over the course of development.

The following chart illustrates the impact of clinical trial success on value. The Phase II clinical trial (being the first true test of a drug’s efficacy) is often regarded as the highest risk and highest return, with many small-cap companies targeting lucrative deals with big pharma pharma at the end of this phase of development.

Biotech 2


Understanding the impact on value at different stages of a drug’s development allows researchers, IP owners and investors to more effectively allocate resources and plan for realistic exit strategy.  

If you have any questions or require expert advice, please don't hesitate to contact us

Author: Robert Burnside, Tim Heberden and Stephen Sharp



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