Valuing Startups: A Real Option Model for Binary Outcomes

I enjoyed this conversation with Adrian Rubstein, founder of Ax3.bio, as he opened my eyes to different approaches to valuing startups. Make sure you listen to the full episode. I promise you will learn something valuable.Adrian inspired me to do some research on my own. So any errors in this description are mine. (A little knowledge is a dangerous thing). But let’s try anyway…Most biotech companies are destined to fail. That’s no secret. Biology is full of uncertainty. Outcomes in biotech are binary. A device or a therapy is approved for use or it is not, making valuations challenging. Even after approval, there is the challenge of gaining market share. It’s fair to assume, that growing the market for most therapies is not possible except by encouraging unhealthy behavior which is probably not part of your brand strategy.Adrian talked about understanding and evaluating the science in addition to assessing the size of a potential market. Ax3.bio employs a modified Real Option framework, modified for binary outcomes, for evaluating potential investments. This is way above my pay grade but I found this article from McKinsey helpful to get a sense of how this works. The article goes beyond using the framework for valuations to how it can be used strategically to understand the levers available to maximize value.If you just want the TL;DR, industries that require a lot of R&D, manufacturing and marketing investment can benefit from this framework. The example they give is drilling for oil and gas in the North Sea. Once a company has the right to explore blocks of the sea bottom for oil, they still need to figure out which ones might have oil, how much, and what it will take to get it out. All while the price of oil fluctuates over time. There is a lot of uncertainty at each step, not unlike developing new therapies. The model values the flexibility to make decisions about investment at each step while taking into account the possibility of changing market conditions.…as my economist friend says, “Models, they don't work it out, but they give you a compass on what may happen.” That's why we do sensitivity analysis and we say those are the different scenarios, right? The first one is that, okay, you get approval from the FDA, and then what is the probability for you to get acquired?The probability for you to hit a milestone? The probability that, okay, right now the KOLs like your product. What is the probability for you to get exponential sales? Or not. They're totally different scenarios and each scenario has a probability for it to happen. So that's a huge decision tree analysis. Not subscribed yet? Can we fix that right here?Thanks for listening to the podcast and sharing this post.As in the McKinsey article, this analysis can also be used as a strategic guide for the things you can do to raise the probability of success or a higher evaluation at each step. Many of these are familiar: Relationships with KOLs, publishing articles, letting people know about your progress and milestones through newsletters, podcasts etc. As has been mentioned several times on Life Science Marketing Radio, you can’t wait for approval to start telling your story. At that point, it’s too late.This got me thinking about the relationship between uncertainty and stories about a company’s journey over time. Many stories are based on uncertainty. Every athletic competition is a story because of the uncertainty of the outcome. And the more uncertain, the better. Presumably, each milestone on the company’s journey reduces uncertainty by some amount. This can be compared to a team’s progress toward a championship over the season. Just as you resolve one question, attention turns to the next victory (milestone) to be achieved. There are also individual stories within a team story that can be captivating. Every one of these milestones and individual stories is an opportunity to get people interested in your company. Would it be a stretch to say that stories themselves can increase the value of your business at any point? I don’t think so.Your deepest insights are your best branding. I’d love to help you share them. Chat with me about custom content for your life science brand. Visit Life Science Marketing Radio to learn more about how I help companies tell their stories.Ax3.bio Adrian’s Newsletter on LinkedIn, BioBusiness, This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit cclifescience.substack.com