Case Study

Case Study: Purinex, Inc. Introduction The case asks for evaluation of different financing options. Gilad Harpaz is Purinex’s CFO and he needs to determine which one from the three options provides lowest risk, highest company value, and short term cash for operations. Purinex is a biotechnological company that has 35 patents pending in pharmaceutical field. It is one of the raising stars that may develop new drug for specific use in diabetes and sepsis. Company has 14 employees. Monthly burden is $60000; company has available cash of $700000 which will last up to 12 months. Solution Company should proceed with two options at the same time, of course, if this is possible. Those are pursuing the partnership with a “Big Pharma” company and get additional cash from Angel investors. 1. Ultimate solution out of those available is to increase the value of the company to its maximal potential. Not only the company would increase its value to $25 mil, but also gets the financing for funding the operations. Therefore, partnership seems to be the way to go. Partnering with a larger company seems to be the market trend, whereas, VC funding seems be declining. Purinex will need some additional cash to fund R&D and other daily operations. When it comes to deciding which partner to choose, CFO should look not only at the proceeds from the partnership, but also at the portion of business that Purinex will be giving away. In this case, it is more lucrative to partner with sepsis partner. It provides comparable cash as the diabetes partner, but promised cash flows are much smaller. Diabetes drug sales are estimated at $4 billion, whereas sepsis drug sales would be only 0.5 billion. Diabetes drug therefore seems to be a lot stronger “cash cow” and giving up large portion of future proceeds would not be smart solution. Purinex is in need of relatively small cash, when compared to future cash flows. Upfront cash of 5 million dollars should be good at least for 24 months. If sepsis drug passes the Phase II testing, there will be additional revenue out of milestone portion of the deal.

2. It is quite risky to solely rely on the partnership deal. If the company waits six months and the partnership deal would not go through, value of the company would drop tremendously to $8 million or less. To hedge the risk and avoid possible downround scenario, Purinex should raise additional capital from Angel investors. $2 million should provide enough cash for additional 12 months of operations. Perhaps it would be enough to raise only one million and wait until the partnering deal goes through. This would give the company enough security not to worry about future R&D expenditures, and at the same time, it does not lower the value of the company as much. If Purinex could raise additional one million from its Angel investors and at the same time initiate the deal with sepsis partner, the value of the company would be somewhere between 20 to 24 million in six months. Partnering gives angel investors assurance of repayment, or preferred right to IPOs. In case that the partnering deal will not go through, Purinex has to secure additional funds

from angel investors and risk the value at $17.5 million. It is still better and less risky solution than the VC option.

. CASE FACTS Purinex was a drug-discovery and -development company based in Syracuse, New York, that sought to commercialize therapeutic compounds based on its purine drug-development platform. Purine was a naturally occurring molecule that played an important role in numerous biochemical processes. Purinex had developed a process for creating small molecules that acted as selected agonists (activators) or antagonists (blockers) for specific purine receptors in the cell membrane. Purinex’s goal was to develop products that evoked a receptor-specific pharmacodynamic effect without producing undesirable outcomes that could result from interactions with other receptors. The company had 14 employees and maintained a chemistry laboratory a few miles from its main office. Purinex’s intellectual-property portfolio consisted of more than 35 patents pending or issued in the purine field. The company planned to take its new receptor-selected drugs into clinical trials to address a broad range of potential indications. In June 2004, the company with several clinically and commercially promising drugs in development had reached a turning point. Sometime in the next four to twelve months, the company stood an excellent chance of establishing a partnership with a major pharmaceutical company. That partnership would enable Purinex to develop one of its leading compounds into a drug for the treatment of the world’s deadliest and most widespread diseases. Gilad Harpaz, Purinex’s chief financial officer believed that if a partnership deal came through, the company would be in an excellent position to carry out its mission. Moreover, securing a deal was practically a prerequisite for any eventual initial public offering, which was an attractive exit strategy for many of the company’s investors. Harpaz also believed that the company could either attempt to secure financing now or wait until it struck a partnership deal. He has three options to consider for the company which he... Analysis of alternatives 1.

Venture Capital

If Purinex decided to raise a one time round of financing from a venture capital firm there would be a significant amount of restrictions. There would be preferences for things like board appointments, anti-dilution rights, liquidity, participation, and positive and negative covenants. If Purinix decided to go with a venture capital round they would first have to decide which type of venture capital they wanted for their one time round. In the case of Purinex company they are looking for mezzanine financing which is basically one step above ground floor, or start up financing. In terms of the amazing strides Purinex was making in the biochemical field, adding a venture capital firm would be sure to put a restriction on some of its process’. Going with a venture capital one time round would make Purinex an all equity firm that was still unable to make decisions without the approval of the venture capital firm.

2.

Wait six months

If Purinex decided to wait six months to see if either deal for a partnership would go through it would put the company in a very risky position. This is because if neither deal went through the company would be forced into a down round. If however one of the deals went through it would put Purinex in an excellent position. For the purpose of the case lets say that one of the two deals did come through. What kind of position would that put Purinex in? first if the sepsis partnership came together Purinex looked to gain 5 million up front, milestone payment undiscounted at 108 million and royalties of 10 percent of revenues. Lets evaluate the deal with sepsis.

urinex Case Study new Given the structure we developed to capture the value of available options for the Purinex case, we have determined the angel investment option for Purinex’s sepsis or diabetes drugs maximizes the value of the firm today. That firm value with the angel options we have calculated to be $41,981,505. The first step we had to take was to value the partnership deals. There’s a 75% change Purinex will land a partnership deal in the next 4-12 months. Out of that partnership there’s a 60% chance the partnership will be for the Sepsis medication and 40% chance for the Diabetes medication. To determine the value of each mutually exclusive partnership we took the value of the upfront value of Sepsis and Diabetes, $5 Million and $8 Million, respectively. Each deal had a large sum for undiscounted milestones. Since milestones are portions of the total sum paid out throughout the drug development process, we decided to span out the milestone sum across the timeline provided in exhibit 1 from the book on page 430. We determined that FDA review and approval would be completed in approximately 10 years for the Sepsis drug, and 13 years for the Diabetes drug (started from the median of preclinical trial time length for diabetes) as each drug was in a different phase of development. We set the milestone cash flow evenly across both time periods to discount the cash flow of each payment to get a proper Milestone NPV. The deals also incorporated royalties. To value the royalties, we were told that the Sepsis annual sales would be $500 Million annually, and the Diabetes would be $4 Billion annually. On average 5-10% of drugs entering clinical trials are approved by the FDA, so we attributed a 10% chance (understandably on the high end) that each drug would receive royalties from the annual sales. We then calculated the NPV of each perpetuity and discounted it by 10 years for Sepsis and 13 years for diabetes, as the revenue wouldn’t occur until after FDA approval. The value of the Sepsis drug with $5 Million up front, $108 Million in milestone payments spread out and discounted over 10 years, and 10% royalties of the $500 Million given a 10% chance of occurrence and discounted over 10 years is $48.566 Million. The value of the Diabetes drug with $8 Million up front, $80 Million in milestone payments spread out and discounted over 13 years, and 12% royalties of the $4 Billion given a 10% chance of occurrence and discounted over 13 years is $45.077 Million. Given the

75% chance of occurrence that either of these deals would occur, the value of these two deals combined is $47.17 Million. Harpaz believed that there was a 25% chance that the partnership would fall through. He thought if the deal didn’t go through that there was a 60% chance that they could secure a third partnership for the Sepsis drug and 40% for the Diabetes drug. The option to wait was a limited option. We broke down three options for the Sepsis drug; wait 6 months, find angel investors, or go to a VC firm for money. We decided the VC approach would be our last choice for investment due to the possibility of a down round of financing and loss of control for our company. Our first choice was waiting six months which gave us an updated value of $ 37,377,800 which values the option to wait at $ 4,603,705. The only issue with waiting was that we would lose the opportunity to find angel investors, and if we couldn’t secure a third deal, we would have to go to a VC firm and estimated the company value at $8 million for both the Sepsis and Diabetes drug. Our next choice was the Angel Investors. By Harpaz’s estimates the angel investors would give us a 95% chance of securing half of our original value of the Diabetes drug deal, $22.539 Million, and a 5% chance that they wouldn’t secure a deal for the diabetes drug. Receiving angel investments would ensure a $17.5 Million dollar estimated value by Harpaz’s estimates; for both diabetes (5% chance) and Sepsis. The value of the Angel Investment option was $2,853,705 and raised the total company value to $41.98 Million. Our last choice was to find a venture capital firm for investment. The premoney valuation of the firm was estimated at $15 Million. Harpaz believed that a round of VC funding would increase the value of each Big Pharma deal by 10%, but we decided that we would use a dilution multiple of 10% for the significant restrictions attributed to the VC funding. The value of this option was negative in our model. After careful analysis and consideration of each option, the Angel option is the best to finance the firm and maximize the value of the firm today. A strong consideration was Purinex’s 11 months worth of cash and need to be well funded. I addition if the firm were well capitalized it would have a better chance of securing a collaboration with a major pharmaceutical firm and getting a better deal due to “credibility value.” (p. 429) This is presented as the ultimate goal of the firm. The Angel investment would be enough to float the company for nearly two years given the current cash burn rate of $ 60,000 and government subsidies. That would certainly be enough time to secure a third party deal for either drug. Though the venture capital deal could possibly increase the value of a pharma deal by 10% if would also change the ownership of the company which was built into our model. There would be no down round investments, and all shareholders would retain their value and control of the company. While waiting 6 months to see what happens with the current deals doesn’t cost any real money, there is a major opportunity cost of such a decision. This is viewed as a riskier way to capitalize the company as securing funding is a major threat to the company. Purinex, Inc., a pharmaceutical company with several clinically and commercially promising drugs in development. The problem facing by CFO Gilad Hapaz is expects

to secure a partnership with a major pharmaceutical company sometime in the next 4 to 12 months, would enable Purinex to develop one of its leading compounds into a drug. The company is insolvency because the company has no sales or earnings, and there is only 11 months' worth of cash on hand. The expenses is more than income, they need a high R&D costs to develop an antagonists program for the treatment of diabetes and sepsis. Purinex, Inc is young and growth company seeking capital to expand through partnership with large pharmaceutical company or venture capitalists. Purinex had a done a development process for preclinical stage antagonists program for the treatment of diabetes, sepsis that had completed a phase 1 clinical trial. Two of which had an appropriate partnership deal with larger pharmaceutical company. Harpaz thought it unlikely that Purinex would form partnership deal for both sepsis and diabetes. Harpaz be......

Executive Summary 1. Statement of Problem This study is commissioned to analyze the Purinex, Inc. financing plan, which is related to determine the best financing alternative for the company in securing additional cash needed to establish a partnership with a large-capitalization pharmaceutical firm. Gilad Harpaz, Purinex’s chief financial officer believes a partnership deal could bring the company to execute its mission, developing drugs for the treatment of sepsis and diabetes. However, the problem facing Purinex is that—while there is a chance for Purinex to secure a partner in the next four to twelve months, Purinex just has available cash to last around 11 months; furthermore, there is still a very strong chance that a different partnership would occur about one year later. In short, Purinex is now facing the challenge of the lack of capital to reach the partnership deals. According to the case, Gilad Harpaz is considering three options for Purinex to solve the problem. To help identify the feasibility and attractiveness of these financing alternatives, this study is based on the decision tree approach to evaluate the options. 2. Discussion As described in the case, firstly, the partnership deal would entitle Purinex to receive a combination of up-front fees, milestone payments, and royalties for the treatment of either sepsis or diabetes (see Appendix 1 for the detailed information). Secondly, due to the lack of capital, there are three financing options: 1) raising a one-time round financing from a Venture Capital (VC) firm, 2) simply waiting in the expectation that either sepsis deal or the diabetes deal would come through, and 3) undertaking another one-time round financing from a number of angel investors. It is needed to note that when Purinex seeks external funding investments either from VC firm or angel investing, the investors will acquire certain equity in Purinex (see Appendix 2 for the expected ownership percentage). Nevertheless, if...

Introduction: Problems of Purinex The problem facing by Purinex Inc. CFO’s Gilad Hapaz is to establish a partnership with a major pharmaceutical company that would enable the company to develop one of its leading compounds into a drug for the treatment of one of the world’s most widespread diseases. Purinex Inc is currently facing financial problems.

The company did not generate sales or earnings and had only $700,000 of cash in hand. The expenses of the company are more than its income. Monthly expenses of the company are about $60,000. Cash level that Purinex holds would only enable the company to survive for another 11 months. Moreover, Purinex need to spend a huge amount of money on Research and Development (R&D) in order to develop an antagonists and agonists program for the treatment of diabetes and sepsis. Early-stage biotechnology firms need excessive access to capital for R&D. According to a study of Tufts University, in order to develop a new human-therapeutic compound, it will cost a company total of $897 million. A successful deal of partnership between Purinex and a major pharmaceutical company is crucial. If the company is able to secure the partnership, it can solve the financial problem that company is currently facing. Purinex will receive milestone payments, royalties, front fees and co-promotion rights and have enough access of capital for R&D funding. However, there are two partnerships available, one wants a deal for treatment of sepsis while another sought for treatment of diabetes. The first deal for treatment of sepsis, enables Purinex to receive $108 million milestones. The other deal is to give Purinex $80 million milestones. It is believed that there is 60 percent probability that the first deal of partnership will occur. In order for Purinex to go for initial public offering (IPO), securing one of the deals was practically a prerequisite. Besides that, the drug development and approval process is lengthy and risky. On average, it took 10-15 years to move a drug from preclinical testing to marketing approval. In other words, even if the company has enough access of capital for the drug-development process, there are still some approval problems that need to be addressed by the company. Absence of partnerships and external financing might cause the company to give up developing the drugs that might be bringing potential annual sales to the company. Comparison among the options: The CFO is planning to undertake external financing now in case the company fails to establish any partnership which will then put the company into a big trouble. There are three options that considered by Hapaz which are venture-capital round, angel round and wait for the partnership deal in six months and each option came with its own risks. Hapaz need to make decision on which options the company should go for and he need to choose the option that will bring the highest benefits to the company. Firstly, venture-capital round could secure Purinex Inc $10 million in a one-time round, which enables Purinex Inc to survive another 166.67 months or 13.83 years (10mil/60000), and it just takes 3 months to complete the process. Still, $10 million is definitely adequate for Purinex Inc to continue the research and development on diabetes and sepsis. In addition, Venture capital firm would grant a pre-money valuation of $15 million for Purinex Inc. Therefore, Purinex Inc will still maintain a good reputation and image.. Nonetheless, there are still some risks which Harpaz (CFO) needs to concern with. Since investing in an uncertainty business is highly speculative, venture capitalists will basically come with a significant number of restrictions such as preferences for board appointments, anti-dilution rights and so on. As a general rule, venture capitalists require controlling about 30-40 percent of the equity in the company which they invested; hence it might to bring a certain impact to the company structure and decision. Then, if either one of sepsis and diabetes successfully launch in the future, Purinex Inc will have to share its earnings with venture capital firm based on the agreement On the other hand, Harpaz believed that round of venture capital has the possibility to increase the value of pharma deal by 10 percent.

Do nothing and wait six months for the partnership deal is the second option. Purinex Inc could just do nothing and expect either sepsis or diabetes deal within 11 months. Assuming Purinex Inc has partnership deal for sepsis, its partner for that drug (larger pharmaceutical firm) need to pay the royalty to Purinex Inc as stated in the contracted term, which is 10 percent of its earnings. Next, Purinex’s current owners still retain the control of the company completely and preserve a $25 million for the company’s valuation, which is the highest compared to another two options. On the other side, since Purinex Inc’s cash on hand is just able to make them survive 11 to 12 months, the company could wait only six months before securing additional financing. But, if either the sepsis or diabetes fails during the following six months, it puts the company into trouble. Down round scenario would come to Purinex Inc’s investors, which would dilute the value of existing investors and make it worth much lesser or even nothing at all. By this, a premoney valuation for Purinex Inc possibly would drop till just $8 million or even worse than, as low as $5 million. So, the most crucial component is the short time period to seek for partnership. If no any partnership deal comes through, there is no doubt that Purinex Inc will face a financial distress. The last alternative is angel round. The similarity between venture capital and angel investors, which is the way they invest in the company. If the CFO chooses this option, the company is not able to raise as much funds as it could from venture capital round. Angel investors are just able to provide $2 million for Purinex Inc, which is just could making Purinex Inc survive to 33 months further, and about six months is needed to undertake this angel round. Compared to venture capital, the funds raise from angel investors are much lesser and take longer time to complete it. Furthermore, a higher valuation of $17.5 million will be allocated to Purinex Inc with those angel investors, slightly higher than venture capital but loIr contrasted to partnership. Similar with Venture investors, Purinex Inc has to share its earnings with angle investors after the product is gaining the marketing approval and sell in the market. Qualitative factors under consideration There are several qualitative factors that are under my consideration in structuring my decision among various alternatives. Practically, my consideration is revolving around the financing decision and the partnership option available. I have decided that the best possible decision is to secure financing in the near term through venture capital and seek for partnership deal in the sepsis drug. My consideration can be divided clearly by the financing options and partnership deal as stated in below: Financing Options 1).Control and Restrictions Issue The venture-capital round and angel round financing would both trigger the control issue and impose certain aspect of restrictions on the firm. Therefore, the choice between venture capital and angel round financing are both detrimental in the sense that it might alter existing owners share composition. In addition, both choices might also require the firm to adhere to certain claims inserted into the contractual term or face the eventual penalty. Nevertheless, I must also highlight the benefit that could possibly derive from those financing options namely a well capitalized firm. I believe that venture capital is the best option as it can offer $10 million in 3 months as compared to $2 million in angel round financing. In essence, venture capital can help to recapitalize the firm and help the firm possess more flexibility in selecting a suitable partnership deal.

2). Possible Impact to Partnership Deal Another major factor that I need to take into consideration in the financing options is the possible beneficial impact from the resulting financing option. Based on Purinex CFO Gilad Harpaz, he claims that a round of venture capital funding could possibly increase the value of a pharmaceutical deal by 10 percent´. From my computation, I found out that the value of the partnership for sepsis could be boosted by $11.3 million to $124.3 million from the initial $113 million. In this sense, I believe that the potential improvement in partnership deal value could help to offset the issue of dilution in control. 3). Uncertainty in Partnership Deal I must also access the success rate or finding a partnership deal in structuring my financing decision. Since it is more preferential in finding a partnership deal for sepsis, I need to be more conservative in my financing decision. The success rate of finding a partnership deal for sepsis is estimated to be lower as compared to diabetes. It is estimated that there are only 60 percent probability that it would be a deal for sepsis in the next 5 to 6 months and 95 percent probability that the diabetes partnership would occur a year later. The higher uncertainty associated with the partnership deal (sepsis) lead me to be more incline towards a conservative financial profile. I believe that having a well capitalized firm through venture capital ($10 million) will allow the firm to stand a better chance to compete against unexpected events. Partnership Deal 1). Potential Revenue and Financial Package The determinant factors in my evaluation for the best possible partnership deal rely upon the potential revenue that would be able to generate by the drug in the future. As illustrated in the text, Purinex CFO Gilad Harpaz has estimated that the annual sales for diabetes and sepsis would be $4 billion and $500 million respectively. In line with this, I believe that it is in the best interest of the company to retain the right for developing diabetes drugs while dropping the right for sepsis drug through partnership deal. Furthermore, I also need to take into account the financial package that offered for each partnership deal. The financial package offered for the sepsis partnership deal is $5 million upfront, $108 million milestones, 10% royalty while the diabetes deal stand at $8 million up-front, $80 million milestones and 12% royalty. Since sepsis drug is on a more advanced development phase, I believe that it is more likely to trigger the milestones payments in the near term. In addition, there is also a restriction on diabetes drug in which the value of the current financial package offered will be cut by half if the partnership for the diabetes occurs about a year later. From the financial aspect, I believe that it is in the best interest of the firm to keep developing the drug for sepsis while dropping the sepsis drug through partnership deal. 2). Biotechnology Development Risk Uncertainty in developing new drugs was staggering and this has contributed to skyrocket development cost, it was estimated by Tufts University that the cost to develop new humantherapeutic compound was $897 million (in 2000 dollars). This clearly implies that there is definitely a need to find a suitable partner to be able to develop the drug with a higher success rate. A larger pharmaceutical company has more expertise and the economies of scale to develop and market those potential drugs. In essence, I believe that having a partnership deal for sepsis is

beneficial for the firm as it can help to reduce burdensome development cost while offering lucrative financial package in the long-term. Moreover, it also can help Purinex to redirect it focus and its resources on developing single drug (diabetes) which will contribute to a higher success rate in developing the drug in the future. 3). Potential IPO or Buyout Deal A partnership deal for either drug was necessary as a means to instill much needed confidence into Purinex. Based on the text, Purinex only has sufficient cash to fund ongoing operation for the next 11 months, which clearly reflect the dire state of financial condition in Purinex. In this context, I believe that embracing the partnership deal will inject much needed fresh capital in Purinex while providing a springboard to Purinex as potential IPO or buyout candidate. This can be attributed to the financial stability provided by the partnership deal which will help to entice potential investors into the company. In this context, I believe that partnership deal for sepsis will gather lucrative financial package which is vital to provide financial solidarity required to get listed and help to enhance shareholder¶s value in the long run. 4). Long-term Development Cost Another major concern is the long-term development cost of a drug, as the cost of developing new drug might be inflated in the long-run. According to the text, the Tufts University has conducted a study and published in a 2003 report that it requires $897 million (in 2000 dollars) to develop a new human-therapeutic compound. On the other hand, Purinex burn rate was about $60,000 a month (after 100,000 research grant from the federal government) and I believe that this is an unrealistic projection and it does not reflect the true cost of developing new drugs. Moving forward, I believe that once Purinex drugs move into a more advanced phase of development, it might involve additional resources and the burn rate might increase substantially along the road. Likewise, it is a necessary and imminent measure to secure financing thorough venture capital and embrace the partnership deal for sepsis as it offers the most lucrative financial package to the firm. The lucrative financial package will help the firm shield away from the pressure of escalating development cost thus enabling to realize shareholder’s value in the long run. In conclusion, I believe that Purinex need to act fast to secure substantial financing through venture capital in order to recapitalize the firm and thus enable the firm to have a firmer financial footprint. This would then allow the firm to possess a stronger position to negotiate a better financial package in potential partnership deal for sepsis. Sacrificing the right to sepsis drug is imminent as this measure would enable Purinex to divert all its resources on diabetes drug which contain a higher revenue potential in the future. All these measure will help to open up the window for IPO opportunity or potential buyout offer which will act in the best interest of the shareholder’s.