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RNA Insights

Client Success: Mandatory Adoption of ASC 842 – Incremental Borrowing Rate Analysis for Private Biotech

By Jeff Suchocki, CFA

The Situation:

Adoption of ASC 842 – Lease Accounting is mandatory for all private companies for fiscal years beginning after December 15, 2021. To comply with this mandatory adoption requirement, a privately held, clinical stage biotech company needed to understand a reasonable discount rate for multiple lease agreements. The company requested an estimated borrowing rate from its bankers to serve as a proxy for the discount rate. However, the company’s auditors did not believe that this solution was adequate to comply with ASC 842 and requested that the company obtain a more robust analysis.

The Solution:

RNA conducted an analysis to determine an incremental borrowing rate (“IBR”) that suited the company’s profile. In this case, multiple IBRs were required to serve as the discount rate across a number of distinct lease agreements when performing various present value calculations. The present value of the various lease agreements is needed in order to determine the fair value of the company’s liability under ASC 842.

To start, we analyzed dozens of comparable venture debt financings for companies in the biotech and life sciences industry. We further selected a subset of the venture debt financings for more detailed analysis based on the similarity in stage of the product development lifecycle of the underlying comparable companies to that of the subject company. These venture debt deals included ranges for term to maturity, principal amount, interest rate, warrant coverage, closing fees and final payment fees.

RNA adjusted each comparable venture debt deal’s base interest rate for term to maturity, financing initiation timing (relative to the valuation date), and for venture debt deal specific warrant coverage, final payment fees and closing fees to estimate a normalized comparable interest rate on a standard term loan equal to each of the subject company’s lease terms. We further calculated estimated normalized implied internal rates of return on each of the selected comparable venture debt deals based on careful detailed reviews of related public disclosures contained in various SEC filings, press releases, and other publicly available information.

After careful consideration, RNA was able to select appropriate IBRs that matched the company’s risk profile and the term of each lease that were subsequently deemed acceptable by the company’s auditors in meeting the standards required by ASC 842.

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