Reference no: EM132841

Question :

You are a professional accountant who has been employed to provide advice to a small start up Biotech Company with the subsequent details provided by the client in the first meeting.

The pre-IPO company called NewBio Corporation ("NewBio") has been operating for the last 4 years but has not had the chance to form an accounting department and has been working on a cash only basis since inception.

The company has now decided to provide itself for sale given the tricky market for raising additional financing to fund continued research and development.

The company has been researching potential treatments for several fungal diseases and has collected roughly $45M over the last 4 years from equity financings. The company has no debt other than a convertible note for $5M used for building a research facility for its employees.

The company has no financial statements though has provided the given details of how money was spent over the last 4 years.

$23M on researching and developing patents for the treatment of assured fungal diseases

• $12M on salary and related expenses
• $5M on capital equipment (all purchased)
• $1M rent and facility costs
• $4M on sundry research expenses
• $1M Other expenses including legal defense fees for various patents

The research activities have led to 10 new patents that are in the procedure of being filed and there is a good probability that they can be issued for NewBio.

$5M on administration and corporate expenses

• $2M on corporate officer expenses
• $1M travel and such related expenses
• $1M Legal
• $1M Corporate and business development

$10M on acquiring intellectual property rights from 16 external patents. The cost of the patents was as given

Patent # Cost     Used in Research

100-45   $1M      Yes -actively used

100-46 to 100-51               $7M      Yes - actively used

Random others $2M      No - potential product protection

The company is probable to need to use considerable amounts of money on the protection and maintenance of its existing and future IP portfolio. These costs are evaluated to run in excess of $3M every year for the next 10 years.

The company presently licenses certain technologies but cross licenses its methods so there is minimal cost although upon commercialization of both Xp1 and Xp2 and some future products, there can be royalties of 1.5% payable yearly, in arrears, on recognized revenues for each of these products off set by technology license revenues. These technology licenses are owned by the company though it is unclear what costs were related with their development as they were part of the unique work that was the genesis of the company. Offsetting license technology income is estimated at $250,000 in 2012.

A state of the art research facility was custom build with the proceeds of a $5M senior note, which is convertible to equity upon any liquidation occurrence. Interest is accruing at 6% yearly payable upon the commercialization of Xp2. The holder of the note is the Chairman of the Board of Directors who also owns 7 percent of the net outstanding shares of the company.

The founder also owns key intellectual property that is given by the company with an annual payment of $250,000 with royalties due of 0.25% payable yearly in advance on projected revenues of Xp1.

Other operating expenses are likely to increase considerably over the coming years although the client expects this growth to be from the run rate of the last 4 years.

Any remaining funds collected are liquid and cash investments, earning negligible interest income.

Total operating losses have not been evaluated but no revenues have been prepared in the last 4 years.

There are existing 12 shareholders with the angel investor owning 45% of the outstanding shares. Other shareholders are officers, employees and the founders.

The first of two products (Xp1 and Xp2) are probable (85% probability) to hit the market in the next 2 years and are to get sick patients of certain diseases. These patent protected products are approved, new and are likely to prepare revenues as below.

Xp1 2014 projected revenues of $40M (67% margin). Growth rate of 12% yearly

Xp2 2013 projected revenues of $25M (81% margin). Growth rate of 32% yearly

Other products are further downstream and not probable to have any important financial impact for the next 3 years after which there is a 25% probability that the pre-commercialized products can generate in excess of $150M in an annual revenues based on very capable clinical trials. Should the company wish to pursue these products throughout to final development and commercialization there would be an estimated $424M in additional commercialization and development costs through to gaining final market approval. The company is not sure how to fund these additional costs or how to determine the potential value or accounting treatment for such future development efforts.