Useful Advices - Business

The IRS recently threw down the gauntlet and placed pressure on private companies to get their valuations right at no matter what stage of development they are. The Service has back

According to USFDA, a combination product is one composed of any combination of a drug and device; biological product and device; drug and biological product

ed up this gesture by exposing private companies to substantial tax liabilities and penalties if they do not.

Since the enactment of Section 409(A), non-public companies have strug

; or drug, device, and biological product and fixed dose combination would include two or more combinations of drug.

Examples of combination products may in

led with how they should establish that the exercise price of a stock option or a stock appreciation right (SAR) was determined reasonably to be fair market value. Up to this point,

lude drug-coated devices, drugs packaged with delivery devices in medical kits, and drugs and devices packaged separately but intended to be used together.

most private companies did not worry about valuing their stock very often, if at all. Private company valuations were needed usually for an imminent transaction, for an ESOP, or for

here is enormous increase in the number of combination products entering the market in the recent years. Combination products have proven advantages but fixe

estate and gift tax purposes. One could also throw in serious IPO candidates who obtain a valuation to avoid a "cheap stock" issue with the SEC.

Many private companies do not quali

d dose combinations are still in the process of convincing regulatory authority on their advantages over the single ingredient formulations.

Combination pro

y for any of these scenarios; therefore they have not needed valuations in the past. As a result, companies and management that issue stock options could be somewhat unenthusiastic

ucts have become life saving products for the pharmaceutical companies who doesn’t have many innovative molecules in their product pipeline and have been inc

about this development. However, although a valuation in this situation can appear fairly cumbersome and superfluous, it's not all bad - just ask auditors.

Auditors have expressed

easingly used in the product life cycle management. Even the companies having product patents are trying to extend their product life cycle through the combi

desire for this to be done for years. They are cognizant of this development because valuing stock options is a financial reporting issue under FAS 123 and they want to know how a

nation products and maximize the revenues. But the companies involved in this practice are overlooking that they are burdening the patients both economically

rivate company established the strike price of its options. There is some liability risk attributed to auditors when they sign off on this standard, and a professional valuation pro

and physically. They need to rightly judge the benefits of the combination products and they have to even look at the risks involved when combining the produ

ides them with a level of reasonableness and reassurance that they desire. Considering this, there is a potential for tax and financial reporting synergy here.

With a good valuatio

ts. Some of the combination products were well accepted by physicians while others suffered. Companies involved in development of combination products are fi

report on hand, both issues could be satisfied simultaneously - two birds with one stone if you will. First, let's examine the code and regulations driving this change.

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ding difficulty in defining their combination products and facing various challenges from selecting a combination to marketing it.

Following aspects would a

to the Culprits: IRC Section 409A requires private companies which award stock options that have exercise prices below fair market value to withhold income taxes on these grants. Si

dd to the challenges in developing combination products:

Which markets to tap where the combination products can do fairly well?
Which combination prod

nificant penalties on non-complying option grants have placed private or closely held companies under increased pressure to be able to support and defend the fair market value deter

cts are meaningful and rational?
Which therapeutic categories to select?
Which Combinations can address unmet needs of the patients?
Do combin

inations.

FASB 123, Accounting for Stock-Based Compensation, provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-base

tions increase the patient compliance?
What would be the developing cost?
How to tackle the risks encountered during combination product developmen

employee compensation. FASB 15X (Working Draft - issued October 21, 2005), Fair Value Measurements, established a framework for measuring fair value under a wide variety of account

t?

As combination products don't fit into the traditional categories of drugs, medical devices, or biological products, the USFDA is in the process of devel

ng pronouncements that require fair value measurements.

In developing FASB 15X, the Financial Accounting Standards Board considered the need for increased consistency and comparabi

ping new procedures for reviewing their safety, efficacy and quality.

Professional from academic institutions, pharmaceutical industries, health care indust

lity in estimates of fair value and enhanced disclosures about the estimates.

In most cases, when company management determines value and option pricing using an informal, internal

y and representatives from various regulatory agencies are working out to design the regulatory requirements for manufacture and sale of combination products

y generated valuation, the tax burden will be on the company to prove to the IRS that the fair market value of the equity is reasonable. In light of the recent regulatory changes an

.

As there is an increasing trend of the combination products companies manufacturing such products should be able to tackle the problems involved in the de

ounced over the past year, many private companies are proactively adopting one of the "presumptive" stock valuation methods set forth in the proposed regulations.

Procuring a quali

elopment. They need to be wiser in analyzing the market trends and the regulatory requirements.

Companies that provide selfless information through particip

ied independent appraisal will cause the burden of proof to shift to the IRS and may only be rebutted by the IRS if the application of the method is found to be grossly unreasonable

tion in industry events and feedback to regulatory authorities would be able to face the challenges and will be successful in developing combination products

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Useful Advices - SECTION 409(A) and its Regulatory Cousins - What it Means for Private Companies

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