The Select Biotech: How to Choose

Image: Erica P. Johnson Research scientists devote decades to learning how to evaluate complex chemical and biological systems. Once they master that, they may be asked to join a biotech firm. And that can thrust them into a new science--Wall-Street style analysis--to verify the firm's financial promise. Even for seasoned venture investors biotech is one of the more difficult industries to evaluate. Add to that the uncertainty raised by a rash of corporate accounting scandals in the past year, and assessment becomes all the more daunting. For most scientists an employer's financial prospects are first linked to job security, and many fail. An analysis of more than 600 biotech firms over six years, 1991 to 1997, by TSS Financial and Ernst & Young found that 11% had failed, 27% had merged and 62% were still in operation. But the potential value of stock options is also an important part of any biotech compensation package--and it is important to know how to gauge not only the options' value, but the firm's long-term financial health. GAMBLING CAREERS With most biotechs years away from profitability, companies use the promise of a long-term payoff to hire top scientists, yet conserve precious cash. And though options have lost some allure with the year's CEO scandals, they remain a biotech fixture. "There is more cynicism than a few years ago, but we still have people coming in all starry-eyed about options packages. People have to realize those options could be worth nothing," says Bill Lindstaedt, director of the University of California, San Francisco Career Center. The first step in evaluating an option package is to focus on the value of the options, not the number being offered. "What academics often overlook is the difference between the absolute number of shares under an option grant versus the percent ownership of the company both currently and projected," says Michael Hildreth, leader of Ernst & Young's life science practice in the Americas based in Palo Alto. It is important to consider the future value of the stock, he says, because the company may bring in more partners to supply capital to finance operations. New partners will also be paid in shares, and that will dilute the value of employee shares, Hildreth adds. Dan Wetzel, an executive in incentive pay at the consulting firm Watson Wyatt Worldwide in Los Angeles, says employees generally can expect options worth about a year's pay when they sign on to a biotech. The amount might be higher earlier in a firm's lifecycle and less as the company matures. Add bonuses and other incentive plans, he explains, and biotech employees can earn up to 85% of their compensation in noncash benefits. Since most biotech firms are privately held, it is difficult to value their shares, he observes. Even for large, publicly traded companies this is not easy, but a publicly quoted price on an exchange provides some comfort. Once a job seeker learns about the value of shares, the next consideration is the length of time an employee must hold on to options before they are vested or eligible to be sold. Typically, employees can sell 25% of their options after one year and the rest over the course of five years, Lindstaedt says. Job seekers should also ask if the company has a cashless exercise program, in which brokers can front money to an employee to cash in on the options. The next question, says Lindstaedt, is: "If I leave before I am vested do I lose everything?" David Jensen, principal consultant at Search Masters International, a unit of Kelly Scientific Resources, says that since many biotech options are now worth much less than the original price, employees are more willing to walk away from contracts that link options to time on the job. "In the past it was sometimes difficult to surgically remove a key employee because of his or her stock options," Jensen says. "Now so many options are underwater those conversations about new opportunities happen much easier." Option packages are relatively standard across companies, leaving little room for negotiation, however, Jensen cautions. IN FORTUNATE COMPANY Despite the financial complexities, scientists should have an edge over professional Wall Street analysts in their ability to evaluate a company's underlying science. But the science may be only as good as the company's management. "You have to know the science and the reputation of the company and the people in the company. You could have a good drug in promising early trials and shady characters running the company," says John Goldener, vice president of Bench International, a Beverly Hills pharmaceutical and biotech recruiter. Scientists also need to consider how all the companies' divisions may affect its stock price. Goldener also says job seekers should attempt to assess a firm's ability to get drugs or devices through the regulatory process. If the firm outsources regulatory matters, potential employees should get a sense of that firm's track record. They should also try to gauge the company's exposure to drug-safety problems that could sink the stock later. Dan DiPietro, vice president of equity research at SCO Financial Group in New York, makes a living evaluating biotech firms on Wall Street. DiPietro advises scientists to consider the overall investment climate when evaluating the potential value of their options. "If the company has a strong cash position and the sector is in the trough right now, then it's probably a good time to join," DiPietro says. "A lot of companies have been caught up in an indiscriminate sell-off of biotech. These options are going to be priced pretty attractively right now." If all that is too much to absorb, scientists can seek out third-party advice. Tax planners and accountants can help predict potential tax problems down the road. Scientists considering high-level jobs should try to speak to board members or venture partners to get a clear assessment of the company's health. Entry-level postdocs might consider calling a recruiter to get a sense of whether people are content at the firm, or bailing out. Hildreth says independent compensation consultants can provide some guidance. Law firms are also a good source of information, since they are often involved in setting up private companies. Certified public accountants working in a technology hotbed should also be able to give a read on a company's prospects fairly quickly, he says. The summer's corporate accounting scandals may lead to tightening up of option programs, especially if biotech firms are made to charge options as an expense, according to Wetzel. Regulators are considering whether to make the practice mandatory, he notes. But a requirement to expense options would hit biotech hard because of its long-term horizons and capital structure. "You're not going to see biotech at the forefront of voluntarily expensing options," Wetzel predicts. "At companies that do expense options, you'll see a dramatic shuffling of the compensation packages in the biotech and venture capital businesses." Hildreth agrees. "In today's environment, with all the scrutiny of executive compensation packages and on the amount of options that companies and their boards are willing to grant, I suspect there will be pressure to hold in check the number of employees who receive options and the actual levels of ownership those grants will transfer." But Hildreth's 20 years in Silicon Valley has shown him that despite the current concerns, stock options are a powerful tool. "Stock options have absolutely been one of the key pillars driving innovation in the US economy," he adds. "I worry that if there is a reduction in the number of employees that receive them, that could have a negative impact on the rate and pace of innovation." Susan Warner (swarner@comcast.net) is a Philadelphia freelance writer.

The Select Biotech: How to Choose

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