Archive for November, 2017

Companies developing a variety of anti-bacterial and virus infection prevention vaccines and similar products form a large portion of the rapidly growing biotech industry. Such firms are classified under SIC code 2836 and NAICS 325414.

Currently, there are some 2,010 competitors in this technology intensive industry sector. Together these biotech firms generate over $188B in annual revenues while employing some 248,400 staff.

Given the amount of investment required to succeed, the average company revenue in this industry tops $93M per year. Biotech firms are very efficient generating about $758,000 in annual sales per employee. The average employment head count per company is 123.

While the average revenue per company has been going up in recent years, the employment count is edging downward. The biotech companies are able to get more revenue per employee in order to meet their profitability targets while keeping the labor costs in check.

Valuing businesses in the biotech industry

Mergers and acquisitions are a fact of live in this highly competitive industry sector. As a result, there are plenty of comparable business sales to consider when valuing your company.

Business market comps offer a compelling way of estimating business value. The typical tool is the valuation multiples that relate business value to some form of its financial performance. The valuation multiples are ratios you can use to estimate the value of your target company. Here are some examples of multiples used by business owners, investors, and appraisers in the biotech sector:

  • Enterprise value (EV) to gross revenues or net sales
  • Enterprise value to net income
  • EV to EBIT or EBITDA
  • EV to total business assets
  • EV to book value of owners’ equity

Example: Estimating business value with multiples

To show how you can use such valuation multiples, let’s consider an example of a typical biotech company with these financials, in $1,000:

  • Net sales: $90,000
  • Net income: $23,500
  • EBITDA: $32,300
  • Total business assets: $36,700

Now let’s apply a set of reasonable valuation multiples to estimate the company’s market value, in $1,000:

Multiple Multiple value Business value
EV to net sales 0.4485 $40,365
EV to net income 8.5797 $47,188
EV to EBITDA 5.1670 $45,211
EV to total assets 3.2193 $53,762
Business Value Average, in $1,000 $46,632

Depending on the multiple you use, the resulting business value may be higher or lower than the average figure. Reason? No two companies in the industry are the same. Since the valuation multiples are derived from similar, but unique competitors, your results may vary.

For example, if your firm is more profitable, the business value result based on net income may be higher than the industry peers. On the other hand, net sales may be a better indicator of business value for a firm that is growing sales rapidly while trailing in profitability.

Higher valuation multiples?

You may wonder if a given biotech company can sell for higher multiples. The answer is yes. In our example, we have chosen a set of conservative multiples, applicable to a firm with an average performance track record.

Exceptional companies can surpass their peers in value by a significant amount. The reasons are better competitive position, unique technology or protected market niche the company can easily defend such as with a strong patent portfolio.

Business Valuation using Multiples

Employee stock ownership plans or ESOPs for short, are a popular way to transfer business ownership while enjoying significant tax advantages. Current owners cash out in a planned, orderly way, while the company’s employees become the new business owners.

On the other hand, business owners can sell the company to a third party. Which option is the best? Before making a decision, consider these points:

If the company is a pass-through entity, such as the US S-corporation, you may need to switch to a C corporation in order to take advantage of the Internal Revenue Code 1042 rollover. But if you later decide to sell the company to another C corporation, you waive the benefit of treating the assets in accordance with IRC 338(h)(10) election. This prevents your buyer from stepping up the business asset base for future depreciation, a potentially significant cost.

Unsurprisingly, S corporation business values often carry a hefty premium over their C corporation counterparts.

Many business appraisers assign a lower discount for lack of marketability (DLOM) when valuing a business for ESOP than a third party sale. This is because the ESOP by its very nature provides a limited market and is shielded from abuse by the controlling owners.

ESOPs are more costly to run than other employee retirement plans. This extra cost reduces the business value.

There is strong market evidence that the companies implementing an ESOP tend to perform better than their peers. The reason may be that the owner employees are more motivated having the business ownership at stake. Firms using ESOPs have statistically higher sales growth prospects, better trained workforce and better key employee retention. All this increases the business value.

Selling to an ESOP also helps you avoid the capital gains tax on personal returns.

However, there are some benefits of selling the entire company to outside investors. In particular, pass through companies, including S corporations, sell at a premium in value compared to C corporations. This additional premium can run in the 10% – 15% range, a significant addition to the firm’s fair market value.

So converting the company to a C corporation in order to implement an ESOP plan may backfire should you choose to sell the company to a third party instead.

Most people are familiar with the public stock market. The players are buyers and sellers who are individuals, mutual funds, and financial institutions. Most trades of public company stock are so-called minority ownership transfers involving a small portion of a company’s stock pool.

The public stock market is highly liquid, investments are held for a relatively short time, and investor risk tolerance tends to be robust as the markets are very efficient and unloading unwanted investment is quick and low cost. You can easily finance investments through banks and brokers at lower short term interest rates. Investors tend to be passive and look to diversify their risk by building a broad based investment portfolio.

The situation is very different in the private company investment market. This is where the ownership interests in whole companies change hands. Buyers and sellers strike high stakes bargains for controlling ownership interest. The players in this market are often professional investors, corporate M&A teams, and private equity investment shops.

Risks of making a bad judgment call are higher, so short term risk tolerance is lower than in the public stock market. Business sales are financed by the market participants themselves through cash and stock deals as well as investment banks using long-term financing. Given the higher risks and complex deal structures, private company investors tend to take an active role in the companies they buy.

Be careful when applying control premiums derived from the public stock market, such as tender offers, to private company valuations. If a guideline public company’s stock trades at market prices way above the intrinsic value of the firm, the public business value is potentially misleading.