During this diligence process we can see another interesting shift. A gap appears between the acceleration of value and the development investment as the product survives the clinical trials. This is apparent in Figure 9 (page 31)— and don't be fooled by the scale of this chart. The value scale axis on the left is at 10 times the dollar scale of the development-spend axis on the right. The value creation is outpacing development investment starting in Phase I. This analysis is very useful in helping the originator determine the best time to do a deal. In this case, it is in the originator's best interests to wait at least until Phase II before doing this deal.

Figure 10 shows how risk-adjusted value increases faster than development spend during Phase I, while development costs outpace value gains during Phase II. In this case, a $61 million investment in development gets the product well into Phase II, increasing the value of the product by $321 million. Without going into the calculation, this comes to an annual investment return ratio (IRR) of 99 percent.

An originator is more likely to negotiate a large upfront payment and high royalties, if he can hold onto the drug well into Phase II, since the product would then be a more viable (and valuable) drug candidate. It is possible that a premium will be put on the deal, as there is a certain scarcity of quality Phase II compounds available for license. The difference between the IRR and the cost to fund the development can be retained by the originator's investors, should they pursue this approach—remembering, of course, the steep probability that the project will fail during this period. The decision must be based on the investor's capacity to put large sums of money at high risk.

We all are interested in comparing the deals we've done or contemplated to what deals others are making—if for nothing else but a sanity check. The problem is that the publicized terms of biopartnership deals are often difficult to compare because crucial information is left out. For instance, royalties are usually one of the largest value components of a deal in which the product is actually launched. But the value of royalties is rarely included in any amounts announced as part of the deal value—which primarily comprises upfront payments, milestone payments, equity investments, and reimbursed R&D expenses.

Determining the true value of these components can be tricky. For instance, some deal milestone-payment provisions may cause only a portion of all possible milestones to be payable even if the product is launched. The equity-investment component is often expressed as the total equity purchase, instead of premiums paid above the market value of the stock, which represent the actual transfer of value from one partner to the other. Furthermore, R&D expenses included as part of the deal value are typically part of complicated co-development arrangements, in which both parties create value.

However, R&D expense, when borne by the partner, is not usually included in deal value. This reporting inconsistency, among others, makes deal values difficult to compare. Throw in options and creative financial instruments, and it can be very difficult for an outsider to add up the true value of the deal for each side of a transaction. But even after all that, it's still interesting to check out the terms of other deals.

A couple of examples will illustrate this point. The pie chart in Figure 11 shows the proportion of the terms in our case-study deal as they would typically be publicized. Press releases and other community communications typically make the deal look like an equal partnership.

Figures 9-13