Lab results: hot issues in biotech & life sciences.

• Author: Gunn, Rich
• Position: Cover story

The biotech industry in the San Francisco Bay Area traces its roots back more than 30 years to when Stanley Cohen and Herbert Boyer's DNA experiments ventured into a new frontier. Their research lead to the use of DNA to diagnose and combat disease, not to mention the founding of Genentech.

Today, biotech is big business in California and CPAs find themselves advising these economic stalwarts from within the industry giants and as their external trusted advisers. Among the major issues that biotech is grappling with today, and where CPAs provide the most value, are structuring of private and public offerings, merger and acquisition advisory work, valuation activities and tax issues.

CAPITAL IS KING

In the biotech and life-science industries, taking a new therapy or medical device through the testing and regulatory process, and then bringing it to market, is impossible without a deep pocket. The development process can take years, and biotech companies need a constant influx of capital at every stage.

The terms of a biotech investment often trigger complex accounting issues, especially in the area of stockholders equity transactions.

Public biotech companies that are constantly raising capital usually do so by entering into private securities offerings and later registering these securities with the SEC. These offerings typically involve the issuance of warrants to both the investors and the placement agent. Also, the placement agent often receives a fee equal to 6 percent to 8 percent of the funds raised by the offering, which requires the biotech company to account for the stock, warrants and the placement fee.

Generally, the net proceeds from the offering are recorded as common stock and additional paid in capital. Since the placement agent fee is considered a cost of the capital raising transaction, it is charged to additional paid-in capital. The warrants offered as a sweetener to the transactions are required to be valued and accounted for at their grant date fair value. Thus, the company often will use the binomial or Black Scholes option pricing models to value these warrants.

Typically, these warrants are considered a cost of capital and charged to additional paid-in capital. However, the company must have enough authorized shares available to cover these warrants if they are exercised. If the company does not have sufficient available authorized shares, it may trigger accounting under EITF 00-19: Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.

The requirements of EITF 00-19 indicate that the balance sheet classification of the warrants in this instance should be classified as liability as opposed to equity, and should be measured at fair value. The changes in fair value are reported in earnings and disclosed in the financial statements, as long as the contracts remain classified as a liability.

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REVENUE RECOGNITION

Staff Accounting Bulletins 101 and 104, Revenue Recognition in Financial Statements, and Revision of Topic 13, respectively, provide public companies guidance on when to recognize revenue. For example, if a biotech company was to sell its intellectual property, it may want to consider the following issues before recognizing revenue on such a transaction:

Persuasive evidence of an arrangement exists. Biotech companies are generally diligent about having written purchase agreements for the sale of intellectual property. Thus, if such an agreement is reduced to writing, it is generally evidence that an arrangement exists.

Delivery has occurred or services have been rendered. Typically, if a biotech company has legally transferred title to intellectual property and passed the risk and rewards of ownership to the buyer, the transaction will...