Reference no: EM132324

Question:

You are a professional accountant who has been employed to provide advice to a small start up biotech company with the given details given by the client in the first meeting

The pre-IPO company called GEN-X-TYPE Corporation has been operating for the last 4 years since 2007 but has not had the possibility to form an accounting department and has been working on a cash only basis since inception.

The company has now decided to offer itself for sale provided the difficult 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 approximately $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 although 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 certain 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 process of being filed and there is a good probability that they can be issued for Gen-X-Type Corp

$5M on corporate and administration 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 follows

Patent # Cost     Used in Research

100-45   $1M      Yes -actively used

100-46 to 10-51 $7M      Yes - actively used

Random others $2M      No - potential

product protection

The company is need to spend considerable amounts of money on the maintenance and protection of its current and future IP portfolio. These costs are estimated to run in excess of $3M each year for the next 10 years.

The company currently licenses certain technologies but cross licenses its technologies so there is minimal cost although upon commercialization of both Xp1 and Xp2 and any future products, there can be royalties of 1.5% payable annually, in arrears, on recognized revenues for each of these products off set by technology license revenues. These technology licenses are owned by the company although it is unclear what costs were related with their development as they were part of the original work that was the genesis of the company. Off setting license technology income is estimated at $250,000 in 2011

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

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

Other operating expenses are likely to increase substantially 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 calculated but no revenues have been generated in the last 4 years.

There are current 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 are likely (85% probability) to hit the market in the next 2 years and are to relieve sick patients of certain diseases. These patent protected products are approved, new and are likely to evaluate revenues as below

Xp1 2013 projected revenues of $40M (67% margin). Growth rate of 12% early

Xp2 2012 projected revenues of $25M (81% margin) Growth rate of 32% early

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

1. Your client does not know how to view its historical financial profile and has turned to you with the given information for help and advise

2. Your client is make sure how to treat the various outflows of expenses and specifically, does not understand the accounting for research and development, future development and patent related costs

3. Your client is unsure how projected revenues would impact future financial profiles and financial statements

4. Your client has requested your opinion of how to sell the business or assets to prospective investors or acquirers and does not understand how a company is valued or how historical activities shown.

5.  Your client is very value sensitive