The pie chart in Figure 2 indicates the unadjusted shares of the $1 billion deal based on the cash flows in the previous chart,
which assumes that the deal succeeds. Clearly, the partner appears to be getting the better deal. But when we performed the
"hard-way" calculation, which included the probability of the project moving forward from each phase to the next, we came
up with a chart that told a different story.
Figure 5 shows the year-by-year probability of success as a line set on top of the cash flow bars from Figure 3). Note that
the probability that each year's cash flow will actually occur drops quickly during the first half of development, then begins
to stabilize as the project survives Phase II.
Terms of the Deal
The graph in Figure 6 shows the series of cash flows. But in addition to figuring in the year-by-year probablility of success,
we also have discounted them to account for loss of value over time due to inflation and other factors. There's a very different
outlook now—note, for example, how the upfront payment looms large.
Figure 7 shows the risk-adjusted deal value split. We can clearly see that the deal structure tilts in favor of the originator.
It's interesting to note, however, that even with this skewed structure, the risk-adjusted value to the partner still provides
a nominal rate of return of 13.4 percent, which clears the rate-of-return hurdle at most biopharma companies.
Two parties contemplating a deal could adjust the values for different payments within this model to arrive at a deal-value
split that seems equitable. For instance, if they moved $18 million from the upfront payment to the Phase III milestone, and
reduced the launch milestone to $20 million, they would split the value evenly. Of course, not every equitable deal results
in a 50/50 split of financial value, as other factors and value drivers, such as the potential value of the molecule or the
marketing niche, are likely to come into play.
Risk and Value Shifts
Now that we have demonstrated that risk shifts over the course of a deal, let's examine how the share of value in this deal
shifts over time. Figure 8 depicts the split of value at each phase of development. Note that the partner picks up value over
time. This is justified by the fact that the partner is carrying the risk by covering the costs of development and facilitating
the development process. And ultimately, the partner's commercial expertise provides the post-launch value.
A product increases in risk-adjusted value as it moves through the trial phases, because the probability of success increases
after each successful trial, in particular after Phase I. The value of the product can be thought of as the NPV of the deal
times the probability of success at a given stage of development—that is, risk-adjusted NPV calculated the hard way at that