Chaos to Clarity - Finance discussion group

Biotech companies spend plenty of time worrying about clinical trials, regulatory approvals and whether they've got enough cash to reach the next milestone. Fair enough too. But there's another number worth keeping an eye on, and it's probably not getting much attention around the board table: the 10-year government bond yield.

Australia's 10-year bond yield is sitting at around 5.3%, up more than one percentage point over the past year. Some forecasts suggest yields could ease, but not everyone is convinced. Recent market analysis has pointed to the possibility of yields heading towards 7%.

Now, that doesn't mean we'll get there. But it does suggest that anyone banking on a quick return to cheap capital might want to think again.

So why does this matter for biotech?

When investors can earn more than 5% from Australian government bonds, the returns they expect from higher-risk investments naturally come under pressure.

And biotech is about as long-term as it gets. Most companies are spending money today in the hope of generating meaningful commercial returns years down the track. Clinical trials, regulatory approvals and commercialisation all take time, and none comes with a guarantee.

As bond yields rise, investors generally want a higher return to compensate for the risks they're taking. That puts pressure on what they're prepared to pay for a stake in a biotech business.

It's not an exact science. Valuations are influenced by plenty of other factors, particularly clinical results, the quality of the assets and investor appetite. But higher bond yields certainly don't make raising capital any easier.

The real issue is dilution

This is where things get interesting, and potentially expensive for existing shareholders.

Let's say a biotech needs to raise $20 million to fund its next clinical milestone.

• At a $100 million pre-money valuation, new investors get 16.7% of the company.

• At $75 million, they get 21.1%.

• At $50 million, they're taking 28.6%.

Same business. Same science. Same $20 million funding requirement.

The difference is how much of the company existing shareholders have to give away to get the money in the door.

Of course, bond yields alone won't account for that sort of valuation movement. But if the broader funding market becomes more difficult, companies may find themselves accepting terms they wouldn't have considered a couple of years ago.

And for those already running short on cash, there may not be much

room to negotiate.

What if yields do get close to 7%?

I'd be reluctant to make a firm prediction about where bond yields are heading. There's no shortage of economists who've got interest rate forecasts wrong over the years.

But the possibility of yields approaching 7% is worth considering, even if it remains a downside scenario rather than the most likely outcome.

At those levels, investors have some pretty attractive alternatives to putting their money into a biotech that's potentially years away from generating revenue.

That doesn't mean capital will dry up. Good businesses with compelling clinical data will still attract investment. But investors are likely to become more selective, with a stronger preference for companies that have clear milestones, manageable funding requirements and a credible path to commercialisation.

For earlier-stage businesses, that could mean longer fundraising processes, more challenging valuations and greater dilution.

It's also worth remembering that Australian biotechs increasingly compete for international capital. US bond yields and global investor sentiment can be just as important, if not more so, than what's happening in Australia.

What should boards be doing?

For me, this is really about being better prepared.

There's always a temptation in biotech to focus on getting through the next clinical milestone and worry about the funding afterwards. Sometimes that works. In a tougher capital market, it's a pretty risky strategy.

Boards and management need to be thinking about funding requirements well before the money runs low. Not just how much cash they'll need, but what valuations might look like when they go to market and how much dilution existing shareholders could face.

That means putting some proper scenarios around the funding plan, thinking carefully about the timing of capital raises and making sure expenditure is focused on activities that genuinely move the business forward.

It also means looking at other sources of funding, whether that's strategic partnerships, licensing arrangements, grants or other non-dilutive opportunities.

And importantly, there's a big difference between having 18 months of cash in the bank and having enough funding to reach a milestone that materially improves the value of the business.

The bottom line

None of this changes the underlying science. A promising treatment doesn't suddenly become less promising because bond yields have gone up.

But the cost of getting that treatment through development and into the market can change considerably, particularly when measured by how much equity shareholders have to give away along the way.

If bond yields ease, funding conditions might improve. If they stay around 5% or head higher, the pressure on valuations and dilution could continue. And if we do see something approaching 7%, some biotechs may find their next capital raise considerably harder than expected.

The point isn't to predict exactly where bond yields will land. It's to make sure the financing strategy can cope with a range of outcomes.

Good science creates value. Good financial management helps shareholders hang on to it.