Entrep Finance and Private Equity 4

The first case discussed this week was Angstrom Medica, about the company that discovered the ways to build much better medical implants. The details of the product are quite difficult to understand for the non-medical person, while the details of the industry are also difficult for non-Americans.

One of the points made by the professor was that in these kinds of ventures it is the progression through the scientific milestones that matters, not through financial. In plain language, it was their progress with the FDA filing that mattered most. In the same way as our polymer tests went: we had a great product and we knew that it worked, but only after the big customer made his tests we could sell something.

An extremely interesting point was made by one of the students: in relation to the discussion of the beta of biotech firms (which turned out to be very low 0.2 – 0.4) he mentioned that with the biotech firms the risk is mostly idiosyncratic (structural or behavioral characteristic peculiar to an individual or group – wikipedia) so thats why their beta is low. In other words, their success so much depends on their own workings, that it needs not be dependent on the general moves of the stock market. However, that applied to pretty much all VC deals – success of all of them depends on their specific products or actions, not on the general market or even broader economy. So does it mean that they deserve (the biotechs) the lower discount rate? No, but then the conclusion is that the CAPM is not a good model for estimating the cost of capital for biotech firms or VCs. A more general question how the business risk (in the most simple terms defined by the operating leverage) is incorporated in the DCF analysis? DCF analysis is blind to the fixed / variable cost relations, therefore it doesnt incorporate it in no way. No conclusion here, just food for thought…

The sector EBITDA multiple stood at 17.5, which indeed looked outrageous. The point is that you have to take the sector-specific multiples, and not just what feels good.

In this particular case the negotiated deal was too hard on management: they were making too little money in relation to the level of the innovation that they created. One of the key takeaways is fairness to all constituencies, because without it and in the conditions of the competition you will not get the deal.

The second case, Apex Investment Partners was about their investment in AccessLine Technologies, a single phone number service provider. One thing that was a problem was the discrepancy between the ambition of the firm to be the lead investor and its abilities (didn’t have enough money). It is insane to invest more than 10% of your fund in one deal, and here the ratio was closer to 20%.

In terms of the deal structure, both Round A investors and Apex (Round B) were overpaying, so it was very important for Apex to protect their investment from dilution, because the Round C was imminent and it was not gonna happen that somebody does the numbers worng for three times in a row…