You can find my simple model for your use below:
Drawing on past licensing deals in the biotech space, one can see a major shift in licensing deals strategy. Big pharma is placing large bets on early-stage assets that could potentially provide pharma with long-term growth. A major challenge that licensors and licensees face is valuation of such assets. How do you ensure a “fair” value sharing?
The main challenges in developing a licensing deal model for early-stage products are:
- Clinical Development Costs and Time-frame: to estimate the time needed for completion of the clinical trials is difficult. You would need to be clear on the time needed for: recruiting patients, completing the trial, evaluating and interpreting results. In terms of costs, you would need to estimate the number of patients to be participate in clinical trials as well as any labour costs and overheads.
- Sales Forecast Profile: it is very difficult to develop sales forecasts for a product that is currently at the research or pre-clinical stage for various reasons including: uncertainty of the status of the market (competitors, disease status etc.) when the product is approved, pricing of the product upon approval and estimating the exact target patient population.
As a result, a flexible licensing model is needed that can incorporate different scenaria based on the assumptions above. In the deal model, three scenaria have been developed: base case, best case and worst case.
In the sample deal model I developed, the following assumptions have been made (which can be changed in the inputs tab):
- Sales forecasts: Blockbuster sales forecast profile (peak at ~$3 b.) in the base case scenario.
- Success rates: based on past attrition rates of oncology products
- Discount Rate: ~10% for the licensee and ~20% for the licensor, given the high risk involved.
- R&D expenses (Licensee): Phase I – $10 m., Phase II – 30 $m., Phase III – $75 m.
- Operating expenses (Licensee): COGS – 15% of sales, SG&A – 20% of sales.
- Upfront payment: $25 m. in line with average upfront payments in early-stage licensing deals
- Milestones (development) payments: Phase I – $20 m., Phase II – 35 $m., Phase III – $70 m. (no sales milestones have been assumed), in line with average milestone payments in early-stage licensing deals
- Tiered Royalty rates: 3% – 7%
Based on the scenario selected value sharing changes. In the best case scenario the licensee receives 72% of the value, in the base case he receives 60% and in the worst case he receives 21%. The value that is shared to the licensee drops as the scenario gets worse. The reason is that missing sales forecasts mainly harms the licensee, as it is the licensee that usually incurs the R&D expenses but receives nothing back (milestone and royalty payments) until the product is commercialised. Even upon commercialisation, the sales forecasts are risk adjusted based on probability of success rates. Therefore, if actual sales do not meet expectations licensee’s value in the deal is minimised.
In opposite, the licensor should be worried about meeting the milestones rather than future sales. More than 90% of the value to licensor comes from upfront and milestone payments, while royalty payments account to less than 10% of the value attributed to the licensor. That is because, royalty payments are too far in the forecast period and therefore, their risk-adjusted present value is really low.
In conclusion, a simple but flexible model is a key tool for understanding the value of your products as a biotech start-up. Using a multiple-scenario deal model allows companies to track the changes in the NPV sharing structure, which can be leveraged during deal negotiations with big pharma.