Stock and Warrant Off-Balance R&D (SWORD) financing is a special type of financing developed particularly for biotechnology companies. The main goal of SWORD financing is to subsidize a company’s biotech R&D activities.
Research and development activities are essential to the success of a biotechnology company. However, R&D activities come with a high degree of uncertainty because of issues related to a project’s viability and regulatory concerns.
In other words, there is a high probability that the R&D initiatives of biotechnology companies will not result in commercial success. Due to this uncertainty that leads to high investment risk, investors are not typically willing to accept conventional methods of financing in their investments in biotechnology companies.
Breaking Down SWORD Financing
SWORD financing is carried out through a separate entity established solely for the purpose of financing. It provides investors with partial rights to all technologies developed in the course of the company’s R&D activities that deliver additional value to potential financial returns.
This financing arrangement enables biotech companies to obtain the required funds to finance R&D projects that would otherwise be unaffordable. In addition, SWORD financing separates the company’s R&D expenditures from other types of liabilities and expenses. Therefore, the company’s financial performance will not be affected.
How Does SWORD Financing Work?
SWORD financing is a more sophisticated type of fundraising relative to conventional equity or debt financing. The process starts with the creation of a special purpose entity (SPE) that is separate from the parent company. The newly created venture acts as the middleman between the parent company and the investors.
After the creation of the entity, it obtains the technology license agreement from the parent company that allows the use of the parent company’s research materials that can be used in further R&D activities. The parent company usually receives the option to purchase the technologies developed by the special purpose entity in exchange for royalty payments.
The new venture also establishes a service agreement with the parent company. According to the agreement, the parent company provides all the necessary management and administrative services.
Then, the special purpose entity issues financial securities (units) to investors. Each unit includes one share of the special purpose entity’s equity with the call option for the parent’s company to buy back the shares, as well as one warrant to purchase the shares of the parent’s company. The investors use the warrants as a form of insurance for investors in case the parent company would not recall the shares.
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