BioTransplant is a biotechnology company at its early stage of development. It must come up with a decision on how to finance its activities such as research. This case study analysis deals with the advantages and disadvantages of public offerings in comparison with other financing sources.
Paul A. Gompers; Alexander Tsai
Harvard Business Review (297095-PDF-ENG)
March 24, 1997
Case questions answered:
- Why does BioTransplant need to go public?
- What are the advantages and disadvantages of being a public company?
- How do we think about underpricing if we were Elliot Lebowitz? An investor? The investment banker?
- Does Elliot have any choice in going public?
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Case answers for BioTransplant, Inc.: Initial Public Offering, January 1996
This case solution includes an Excel file with calculations.
Question 1: Why does BioTransplant need to go public?
The major reason why BioTransplant (BT) needs to pursue an IPO is the need for additional funds required for the company’s extensive future research and development expenditures. This need is highlighted by Elliott’s indication that the cash balance of $2.5m (based on year-end 1995) will only suffice until 1998.
However, since BT’s EBIT and operating cash flow are both projected to be negative until 1999 we challenge this estimate. From our calculations in appendix I, you can see that the cash can be expected to last until early 1997 only, hence increasing the funding need. Also, in the long-run, financing growth in a highly capital intensive industry like biotechnology purely by operations seems unlikely. The need to raise cash is additionally reinforced by the competitive, dynamic, and uncertain nature of the industry.
At the same time, BT only has few subordinate alternatives in raising the required cash: the company has previously raised funding from VCs in three consecutive financing rounds already and has given up 49.9% of its ownership to HCIC, thereby making itself less attractive for additional VCs.
Moreover, the cash needs of BT seem too large in order to be financed once more by a VC. Institutional investors, while only minimally interfering with management, only provide a limited market and would not offer a high degree of publicity for an IPO.
Lastly, an alliance with a major corporation has already been carried out by BT in the past and is, due to the unlikely prerequisite of BT introducing another interim product, no longer desired by Elliott.
Question 2: What are the advantages and disadvantages of being a public company?
Going public comes with both general as well as BioTransplant-specific advantages and disadvantages. First, an IPO increases the company’s presence and public perception. A major financial benefit of IPOs is the ability to accumulate a larger influx of capital (compared to other funding alternatives) from a broader investor base at one time. Besides obtaining funding, an IPO establishes prestige both towards customers and potential employees, thereby allowing for access to superior personnel.
In addition, by setting up employee compensation plans linked to their own shares, public companies face a greater chance of retaining employees and can furthermore better incentivize them. An IPO also involves diversification of funding sources and establishes increased financial flexibility for a firm while also possibly reducing its cost of capital.
Finally, after an IPO a company has a credible valuation, determined by the market rather than by a VC firm. This, in turn, enables a company to conduct M&A activities with shares instead of cash. For BioTransplant specifically, the company currently has low bargaining power against new research partnerships as it is…