Initio Diagnostics

INTRODUCTION

Initio Diagnostics, which has developed a molecular test for pre-natal identification of genetic diseases that could potentially replace the majority of amniocenteses carried out today, is at a critical juncture. The Company is currently in the middle of a proof-of-concept FDA clinical study evaluating the technology, but unfortunately, due to logistical delays, the Company will run out of money before the critical data are collected. Although initially expected to complete the studies with Series "A" financing of $10M (post-money valuation), the Company will have to analyze various options to raise the capital, license the technology, or do nothing. As the CEO of the company, I have determined that the Company will need $3M to complete the clinical studies and $5 to initiate commercialization. To edify the board members of the Company's current situation and decide which steps to take, I, with services from LEK consulting, have performed a decision-tree analysis to determine all of the Company's potential decision points and outcomes, the expected payouts for each outcome, and the decisions that best maximize the value of the Company as well as each stakeholder.

ANALYSIS OF STRATEGIC OPTIONS

License to Roche Now

Currently, the Company needs at least $3M to finalize the clinical study, and we estimate that there's a 60% chance that our clinical study will validate the results of the scientific founders' 2008 Nature Genetics article and allow the Company to progress onto market entry. At this present time, I have learned that Roche Diagnostics may be interested in in-licensing our technology and will take on all costs to finalize the clinical study and initiate commercialization. As shown in exhibit A, licensing to Roche at this present time will have four possible outcomes: 1) approval with no commercialization; 2) approval with commercialization and full market penetration; 3) approval with commercialization with lukewarm penetration; and 4) no approval. Among the outcomes, the lowest that the Company could expect to earn is $20M, which is double the current pre-money valuation and the upfront payment for entering the deal. However, our maximum potential return or NPV of the project is $71.93M, but licensing to Roche will decrease our potential return via 20% royalties. Our maximum potential return is therefore $45M, which is 4.5X of current pre-money valuation, but 62.5% of the maximum potential return (7.2X) if we were to complete the project without a partner.

Investment from Baja Partners

Recently, I have learned that Baja Partners on the west coast is interested in investing the cash necessary to complete the clinical studies and initiate commercialization. Baja's offer is an $8M flat round investment, with Baja providing $5M and BSV and BEP jointly investing $3M, pro rata. By accepting Baja's offer, our potential payoffs would therefore be: 1) $71.93M (7.2X of current pre-money valuation) if approved with full market penetration; 2) $7.19M (0.72X) if approved with lukewarm market penetration; and 3) $5M (0.5X) if not approved. The advantage is the potential 7.2X payout, but that would come at the expense of further equity dilution (see below). The risk is that two of the three outcomes will yield returns lower than current pre-money valuation, and there's a 70% chance that could happen (Exhibit A).

Capital from Existing Investors

Our final realistic option (not doing anything will have zero expected payout) is to raise money from BSV and BEP. If we raise $3M, we could complete the clinical study, leading to a couple options: 1) Acquisition at $20M or 2) Inquire Roche about licensing with a higher royalty percentage and an expected payout of $33.37M independent of market penetration. The risk is that the study could fail (40% chance), meaning zero potential payout.

RECOMMENDATIONS BASED ON STAKEHOLDERS

Maximizing Initio's value:

Seek Baja investments only if you have high expectations of clinical approval and full market penetration; otherwise license to Roche now.

According to the decision tree analysis and its assumptions, the choice with the greatest expected return for the Company as a whole is licensing to Roche now (Exhibit A), which has an expected return of $30.35M, or 3X of pre-money value. There are several probabilistic factors that could increase the yield to as high as $45M or as low as $20M, which is still 2X the pre-money value. One variable is the probability of approval; LEK estimated 60% chance of approval. As shown in the sensitivity analysis in exhibit B, if we expect the probability of clinical approval to be lower than 86.7%, licensing to Roche now will provide the greatest expected payout. However, if we expect a higher than 86.7% chance of approval, the greatest return for the Company would be to receive the investment from Baja. Another variable is whether Roche will commercialize the technology post-licensing and post-approval; designating this decision as a probabilistic node (due to information asymmetry), we conclude that licensing to Roche is our dominant strategy since its payoff is greater than or equal to any other decision's payoff (exhibit C). One variable that may make an impact is penetration of the product into the market. As shown in exhibit D, if we expect a greater than 63.2% chance of full market penetration, the greater expected payout choice is receiving investment from Baja Partners; if we expect anything less than 63.2%, the choice that best maximizes Company value is licensing to Roche. The last variable is whether Roche would be available to license if we completed the clinical study on our own. As shown in exhibit E, licensing to Roche now is the dominant strategy when incorporating Roche's future availability as this variable does not change the greatest expected payoff. However, if we are extremely optimistic about both clinical approval (P1>33%) and market penetration (P2>50%), the obvious decision would be to receive the investment from Baja. As shown in exhibit F, receiving investing from Baja will maximize the value of the Company