Unconventional Comparables
Joseph W. Bartlett, Special Counsel, McCarter & English LLP, Co-Founder of VCExperts
McCarter & English LLP
2002-08-02
There is one often reliable, and almost never discussed, way to price early stage valuations and that is assessing comparable transactions. And, let me distinguish the method I suggest from the conventional 'Comparable Transactions' methods … let's call my suggestion the "Unorthodox" or "Maverick" Comparable methodology. With conventional comparables, the idea is relatively simple: Find a bunch of transactions involving companies which look like yours and draw obvious comparisons. If three bedroom apartments on Park Avenue are selling in the range of $2 to $2.5 million, then, when and if you are planning to sell your three bedroom on Park Avenue, you look at the data and price your property accordingly. The reason the method I am talking about is unorthodox is that private equity, being private, there is no published database for the entrepreneur to plumb. Seed stages deals are rarely announced … price and terms. And seed stage companies are inherently hard to put into discrete categories; they are formless, immature … capable of developing in any number of directions and assuming any number of different shapes. However, with some inside intelligence, it is possible to get a rough handle on what passes (albeit not on a business school exam) as comparable data. The trick is to network as diligently as possible and dig out what the professional investors who focus on seed stage deals are doing generally. The good news is that amongst professionals, including particularly those who are in frequent contact with their peers, valuation is 'monkey see, monkey do' … or, as behavioral economists like to suggest, 'investors 'follow the herd.' Lacking any other genuine and reliable indicia on value, a fund investing in early stage biotech companies will pick up as many cues as possible from colleagues and peers and, assuming, contrary to fact, that (almost) all biotech seed deals at a given stage are the same for this purpose, price accordingly.
Thus, let's hypothesize a company meeting the following criteria: Biotech; therapeutics; a patent is in place; successful completion of Phase One trials; experienced management; significant potential market. Ostensibly, pricing will depend on the fund's independent estimate of the size of the market, the existence of potential competitors and a number of other factors. But, given the items indicated in the example, the fact is there exists, if one can find it, a value standard or paradigm which defines the market, more or less as accurately as if all the data were compiled in an auction market like the NASDAQ. And the good news is that, given the "monkey see, monkey do" phenomenon, all one has to do to collect a couple of data points … VCs A and B give companies a given category a pre-money valuation of $3 million and … you have the problem solved. Most everyone else in the "club" is doing the same, and so can you.