Going concern disclosures are common in biotech and should be clearly explained to stakeholders.
Financing structures may include freestanding instruments that require separate valuation.
Early consideration helps with budgeting, resource allocation and financial reporting timelines.
As the biotech funding environment continues to challenge growing organizations, those who understand the corresponding audit and accounting implications can equip themselves to budget and allocate resources appropriately and maintain financial reporting timelines.
Brian Winne, RSM US LLP assurance senior manager and life sciences senior analyst, and Brianna Ferriero, RSM US LLP life sciences audit policy leader and assurance senior manager, joined RSM’s “The Audit Statement” to discuss what life sciences companies need to know about those accounting issues.
They covered the following topics (time stamp noted in parentheses):
Below is a transcript of their eight-minute conversation, which has been edited for clarity and length.
Brian Winne: Over the last two years, we've seen a lot of biotech companies struggling to raise money, taking a little bit more time, maybe not raising as much as they would have liked to. And we saw a little bit of an uptick in the IPO market in 2024 compared to 2023, but still only about 20 IPOs closed. Similarly, private offerings seem to be smaller, lots of times feeling like bridge financings.
So, what should biotech companies be thinking about regarding going concern analysis and disclosure, given this funding environment? Because I would imagine we're going to continue to see a fair number of going concern disclosures in financial statements as we get into the 2024 audit cycle.
Brianna Ferriero: Companies really need to be analyzing and assessing their expected cash needs, both their inflows and their outflows, for a period of 12 months from that expected issuance date for their financial statements, not the balance sheet date.
They need to take a close look at this and see, with realistic goals and expectations and achievable targets, whether the amount of cash that they have on hand today will be able to sustain their business and continue operations for a period of at least a year.
Sometimes, depending on how small those financings are that are being received, obtaining a new round of financing might not get companies over that going concern hurdle.
One important thing to note here is that this analysis can't consider any funding that's not already secured. So, for example, if a client thinks that they're going to receive another round of funding a few months after issuance in the financials, that can't be included in their going concern analysis since it's not legally binding and it's not guaranteed that they're going to be receiving that cash.
What that means in this current environment is that many companies that are in this position will either issue their financials with a going concern, or they might hold on to the release of their financial statements until a financing closes and then release the financials. Assuming that the new financing can sustain the company for at least a year and that it will alleviate that going concern issue.
BW: When we talk about holding the financial statements, that's often done because financial statement disclosure and an audit opinion that discusses substantial doubt regarding a company's ability to continue as a going concern—it seems daunting, but it's kind of common in biotech, and I think compared to other industries, it's not as big of a hurdle.
I think it's important that management is able to explain this to investors and other stakeholders who might be looking at the financial statements that a going concern opinion is not the end of the world and is not overly unusual, especially compared to their peer group.
BF: Exactly. I mean, it's very common practice in this industry. We see it so often with clients that are issuing going concern opinions, and their board members and their investors are not surprised at all or alarmed at all by it.
BW: Seems like we're seeing more tranched financings, especially when it's venture capital or private equity money, whereby a portion of the funds is coming in up front, but then the remainder is paid at later dates, often contingent on the achievement of a clinical milestone or something else. This could be enrollment of a certain number of patients in a trial, or announcement of positive trial results. This financing structure impacts liquidity and going concern.
But does it also have some additional technical accounting issues that people should be thinking about when they're considering engaging in one of these financing structures?
BF: Yeah, definitely. We're seeing this more and more frequently, as you noted. Because the initial issuance of the stock and that future tranche of additional financing are entered into at the same time between the same parties as part of one agreement, there are multiple contractual agreements that are executed at the same time.
Companies have to perform an analysis to determine if that tranche right is a freestanding instrument that must be separately valued under the guidance. Guidance defines a freestanding instrument as something that is entered into either separately and apart from any other financial instruments, or something that's entered into in conjunction with another transaction but is legally detachable and separately exercisable.
So, the company has to do an analysis and look at that legal language that's in the stock agreement in order to determine if that future tranche right is legally detachable and separately exercisable under that guidance. And if it doesn't meet either of those criteria, then it's likely considered to be a feature that's embedded in the initial stock transaction, so it wouldn't require any bifurcation or separate valuation.
However, if it does meet that criteria, then it probably does need to be separately valued under the accounting guidance. And whenever you have to bifurcate something and separately value it, it involves getting a valuation firm to analyze and fair-value that derivative liability at each reporting period.
Of course, that's going to take time. It's going to take money. It's going to take resources. So it's something you'll want to get ahead of if you think it's going to apply to your company.
We see it so often with clients that are issuing going concern opinions, and their board members and their investors are not surprised at all or alarmed at all by it.
BW: In addition to these tranched equity financings, I feel like we're also seeing a fair amount of convertible debt transactions taking place—another area that has some significant accounting conclusions. These instruments often have embedded derivatives as well.
What should companies be thinking about when they're talking about issuing convertible debt from an accounting standpoint and a reporting standpoint?
BF: Convertible debt is similar to the tranche financings, and it often contains those embedded conversion features that need to get bifurcated and separately valued under the guidance as well.
So, again, if companies are taking on this convertible debt or are thinking about it, they need to start considering whether they need to hire some outsourced technical accountants to do this analysis for them in addition to engaging a valuation firm to fair-value that embedded conversion feature within the debt, just like the tranched financing.
Thinking about these types of things early can help companies with budgeting, resource allocation, and making sure that they remain on track with their timelines when it comes to financial reporting—all of that.
