Sector News

Biotech companies explore alternative strategies to fund growth

April 2, 2019
Life sciences

Biotech companies with a promising product pipeline may seek to finance growth in 2019 and beyond by accessing the public markets, collaborating with partners or, using share-based payment arrangements with nonemployees, among other alternatives. Such financing alternatives come with various financial reporting challenges, some of which have been recently addressed by regulators and standard setters.

Initial Public Offerings (IPOs)

In the biotech industry, 2018 was an active year for IPOs, with nearly 60 companies filing IPOs and raising a record-setting $6.3 billion, according to Renaissance Capital research.1 In fact, biotech and biopharma startups made up nearly all of the 42 percent of US IPOs in 2018 by deal count, representing the highest percentage of any sector, with many qualifying for emerging growth company (EGC) filing status.2

An EGC is a category of issuer that was established in 2012 under the Jumpstart Our Business Startups Act (JOBS Act). EGCs were granted additional accommodations in 2015 under the Fixing America’s Surface Transportation Act (FAST Act). The less stringent regulatory and reporting requirements for EGCs are intended to encourage such companies to undertake IPOs to help fuel innovation, job creation, and economic growth in the country. Some of the benefits afforded to registrants that file an IPO as an EGC include, but are not limited to, the need to only provide two years of audited financial statements in an IPO of common equity, the option to elect to adopt new or revised accounting standards until they become effective for private companies (i.e., nonissuers), reduced executive compensation disclosures, and the submission of a draft IPO registration statement to the Securities and Exchange Commission for confidential review.

The regulatory relief afforded by the JOBS Act has significantly stimulated IPO activity in the biotech space, triggering a 270 percent increase since its enactment, according to the Biotechnology Innovation Organization (BIO).3 The majority of life sciences IPOs in 2018 were by biotech companies, in large part because many qualified for EGC filing status.

Collaborative Arrangements

A collaborative arrangement involves a joint operating activity of two or more parties that contractually agree to work together on a set of shared business activities that are primarily conducted pursuant to a contract and not through a separate legal entity created for those activities. Such arrangements are common in the biotech space, enabling the sharing of costs, risks, and rewards with a collaboration partner. For example, a biotech entity focused on developing an innovative new drug or treatment might enter into a collaborative arrangement with an established pharmaceutical company that can provide expertise, experience, and resources in key areas ranging from development and regulatory approval to marketing and commercialization.

The economic sharing of costs and risks between participants of a collaborative arrangement can vary among arrangements. However, it is not uncommon for such arrangements to involve the exchange of upfront consideration at the onset of a collaborative arrangement, subsequent cost-share payments, or milestone payments triggered throughout drug development and commercialization, as well as future royalties and profit- or loss-sharing provisions.

Although collaborative arrangements are common in the biotech industry, authoritative accounting guidance for such arrangements has been limited until recently. As a result, various accounting policies have been established across the industry, in particular when such arrangements are accounted for as revenue arrangements. In an effort to address some of the diversity in practice, the Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2018-18, which provides new guidance to clarify when transactions between participants in a collaborative arrangement should be accounted for as a contract with a customer and hence within the scope of its new revenue standard.

The new guidance helps determine which elements of a collaborative arrangement should be separated and accounted for under the new revenue standard. It also specifies that certain transactions between the parties in a collaborative arrangement, that are not directly related to third-party sale transactions, should not be presented as revenue from contracts with customers if the counterparty is not considered to be a customer. In addition, it clarifies that transactions between collaborative participants that are not in the scope of authoritative guidance (including the new revenue standard) should be accounted for either by analogy to other authoritative literature or, when warranted, a reasonable, rational, and consistently applied accounting policy election.

Share-Based Payment Arrangements with Nonemployees

The FASB also recently issued ASU 2018-07, which provides new guidance with respect to share-based payment arrangements with nonemployees. In the biotech industry, such guidance will be applicable when entities seek to finance goods or services provided by consultants, contractors, R&D partners, and other nonemployees through the use of share-based payment arrangements in lieu of traditional “cash for goods or services” payment arrangements. The new guidance simplifies the accounting for such payment arrangements and is also closely aligned with the requirements biotechs currently follow for share-based payments granted to employees. Prior to the issuance of ASU 2018-07, the accounting for share-based payment arrangements was subject to different accounting models, depending on whether the arrangement was with an employee or nonemployee. The FASB has since concluded that awards granted to employees are economically similar to awards granted to nonemployees and, therefore, that two different accounting models were not justified.

Currently, guidance for employee share-based payment arrangements is provided in Accounting Standards Codification (ASC) 718, while nonemployee share-based payments issued for goods and services are accounted for under ASC 505-50. ASC 505-50, before the amendments made by ASU 2018-07, differs significantly from ASC 718. These differences include (but are not limited to) the guidance on (1) the determination of the measurement date (generally the date on which the measurement of equity classified share-based payments becomes fixed), (2) the accounting for performance conditions, (3) the ability of a nonpublic entity to use certain practical expedients for measurement, and (4) the accounting for (including measurement and classification) share-based payments after vesting. ASU 2018-07 supersedes ASC 505-50 and expands the scope of ASC 718 to include all share-based payment arrangements related to the acquisition of goods and services from both nonemployees and employees. As a result, most of the guidance in ASC 718 associated with employee share-based payments, including most of its requirements related to classification and measurement, applies to nonemployee share-based payment arrangements.

Final Thoughts

Adoption of new digital technologies and real-world data have helped fuel a robust biotechnology sector, resulting in record funding and investor interest as new biotech innovations offer the promise of life-saving medical advances. In connection with funding such growth potential, biotech finance and accounting professionals must clearly understand how to apply updated rules related to IPOs, collaborative arrangements, compensation, and other related disclosure requirements to help companies execute these growth strategies.

By Jeff Ellis and Dennis Howell, Deloitte & Touche LLP

Source: Deloitte via Fierce Biotech

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