1 / 31

Development Path and Capital Structure of Belgian Biotechnology Firms

Development Path and Capital Structure of Belgian Biotechnology Firms. Bastin Véronique Gestion Financière – ULG. Séminaire de Gestion 10-06-2003. Outline. Objectives and motivation Firms’ investments viewed as real options Real options in biotech firms

gad
Download Presentation

Development Path and Capital Structure of Belgian Biotechnology Firms

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Development Path andCapital Structure ofBelgian Biotechnology Firms Bastin Véronique Gestion Financière – ULG Séminaire de Gestion 10-06-2003

  2. Outline • Objectives and motivation • Firms’ investments viewed as real options • Real options in biotech firms • Interaction between development path and financing needs • Empirical study: data and methodology • Empirical results • Conclusions and further research Séminaire de Gestion

  3. Objectives • Study interactions between investment and financing decisions • On the investment side: identify creations and exercices of real options • On the financing side: analyze consistency of financing decisions with respect to investment pattern in real options • Application to a specific sector: bio-industry Séminaire de Gestion

  4. Why bio-industry? • Specificities of the investment process: importance of R&D decisions • Specificities of the financing process: long path to profitability => important to have sufficient and adequate financing sources Better understanding of financial challenges in the bio-industry Séminaire de Gestion

  5. Options in finance • The right but not the obligation… • to buy or sell a specified asset (underlying asset)… • at a prespecified price (exercice price)… • at a prespecified date or during a prespecified period in the future (maturity date) Value of options (premium): • due to asymmetry in the contract • increases with uncertainty about the future Séminaire de Gestion

  6. Real options in corporate finance • Investment projects often have strategic and operating options embedded • Underlying asset : investment opportunity • Exercice price : investment cost • Time to maturity : time until opportunity disappears • Valuation: almost like financial options (Trigeorgis, Dixit and Pindyck) Strategic NPV = Standard NPV + Option premium Séminaire de Gestion

  7. Examples of real options (1/2) • Waiting-to-invest option Wait before investing to see if market uncertainty resolves positively • Option to abandon Option to exit the investment project and sell off assets if market conditions decline • Time-to build option (compound option) Staging investment as a series of outlays => option to abandon in midstream if bad new information Séminaire de Gestion

  8. Examples of real options(2/2) • Option to alter operating scale Expand or contract the scale of production in response to changing market conditions • Option to switch outputs (inputs) Option to switch production to respond to changing demand • Growth option Early investment as a perequisite to a chain of interrelated projects Séminaire de Gestion

  9. INVESTMENT in R&D Very uncertain Sequential nature Option to market innovative products BIOTECHNOLOGY R&D Long, high failure rates Ex : develop drugs Ex: Building up technology platforms Real options in bio-industry: related to R&D investments TIME-TO-BUILD option GROWTH option Séminaire de Gestion

  10. Implications for biotech financial management • Investment projects often have multiple real options embedded • Need to identify creation and exercise of real options along firms’ development path Integrate growth and time-to-build options in a scenario tree describing firms’ development path Séminaire de Gestion

  11. Firms’ development path Stage 3: Profitability Stage 2: Commercialization Stage 1: Research & Development P P= R= R+ C+ C C= C+ R+ C- R&D R= R+ CF R- C- Failure R&DF R- Séminaire de Gestion

  12. Real options along firms’ development path P P= R= Time-to-build R+ C+ C C= C+ R+ C- R&D R= R+ CF R- C- R&DF Growth R- Séminaire de Gestion

  13. Real option creation and consumption along the tree • « Success » : consumption of 1 stage of time-to-build option increases total option value of assets… … BUT decreases option volatility value of assets • « Failure » : consumption of 1 growth option decreases total option value of assets… … BUT increases option volatility value of assets What implications for financing policies? Séminaire de Gestion

  14. Debt versus equity:the trade-off theory • What lowers the target debt/equity ratio? • Costs of financial distress • Agency costs of debt: underinvestment and asset substitution problem positively related to the volatility of future Cash Flows Séminaire de Gestion

  15. Debt versus equity:the trade-off theory • What increases the target debt/equity ratio? • deductibility of interest expenses : creates a tax advantage for debt over equity BUT less relevant for young biotech firms with losses H1 Success: higher leverage Failure: lower leverage Séminaire de Gestion

  16. Internal vs external financing:The pecking-order theory • Internal financing: retained earnings BUT often not available for biotech firms • External financing: • Straight debt; private (banks) and public (bonds) • Convertible debt • Outside equity: private (FFF, VCs,…) and public Séminaire de Gestion

  17. Choice of private financing vehicles (1/4) • Venture Capital financing • Better monitoring of firms than outside equity • Monitoring is valuable in presence of serious information asymmetries, like for R&D intensive biotech firms H2 Failure: lower equity ownership by VCs Success: higher equity ownership by VCs Séminaire de Gestion

  18. Choice of private financing vehicles (2/4) • Debt maturity • Long maturities: can be better renegociated • Ability to renegociate: important source of financing flexibility • Short-term refinancing: never competitive • Need for more flexible financing when consumption of growth options H3 Failure: longer debt maturity Success: shorter debt maturity Séminaire de Gestion

  19. Choice of private financing vehicles (3/4) • Leasing • Provides immediate guarantee to the lender in case of problems • Often used when shortage of funds H4 Failure: more lease financing Success: less lease financing Séminaire de Gestion

  20. Choice of private financing vehicles (4/4) • Hybrid financing like convertible debt • Debt with an option embedded to convert it into equity: Option-related security • Solution when debt becomes too expensive after some failures • But avoids to send a negative signal to the market (like equity) H5 Failure: more convertible financing Success: less convertible financing Séminaire de Gestion

  21. The role of patenting • Patent issue: • Decreases volatility value of existing options, by transforming intangible research into a more « tangible » asset • But creates an additional option to WAIT • Permits longer-term and less exigible financing devices H6A Patenting: more long-term debt H6B Patenting: more convertible debt Séminaire de Gestion

  22. Empirical study : data • Gross sample: 80 belgian biotech companies (2001) • Cleaning: subsidiaries, very young firms, data availability • Final sample: 40 companies, 9 years old on average, 364 observations (year-firm) • Accounting data: • R&D, tangible assets, revenue and profitability • Financing variables (scaled by external financing) Séminaire de Gestion

  23. Empirical study : methodology • Position observations on the tree: Set of rules derived from accounting dummies Ex: not profitable, no increase in tangible assets and reduction in R&D investments => failure in R&D stage • Group observations across nodes & branches • Hypotheses tests: Test for mean differences in financial ratio evolution between « failure » and « success » observations Séminaire de Gestion

  24. Means of capital structure ratios (whole sample & stages) Séminaire de Gestion

  25. Means of capital structure ratios (tree branches) Séminaire de Gestion

  26. Capital structure hypotheses tests: success vs failure (1/2) Outcome: X ? ? ? > < < < Séminaire de Gestion

  27. Capital structure hypotheses tests: success vs failure (2/2) Outcome:     > > > > Séminaire de Gestion

  28. Capital structure hypotheses tests: role of patents Outcome:   Séminaire de Gestion

  29. Main empirical results (1/2) • Most capital structure hypotheses: confirmed • Successes: harmonious decisions BUT • Failures: not always consistent with theoretical expectations • Financial consequences of patenting: • Good approach, use of more flexible and long-term financing Séminaire de Gestion

  30. Main empirical results (2/2) • Heavy recourse to debt financing in case of failure: • Lack of a well-developed equity capital market? OR/AND • Too large and easy availability of cheap debt financing? • Convertible debt financing: • Used in the right situation … • … But still very scarcely used Séminaire de Gestion

  31. Further research • Role of venture capital in financing of other types of R&D intensive firms • Detect more accurately firms’ positioning on the scenario tree • Model dynamic capital structure evolution with real option evolution Séminaire de Gestion

More Related