# Financial due diligence on a biotech or MedTech target
A clinical-stage biotech shows you a balance sheet with $180 million in "intangible assets" and a tidy net loss that shrank last year. You feel good. Then you dig in: the shrinking loss came from moving R&D spend off the income statement and onto the balance sheet, and $95 million of those "assets" are tied to a drug candidate that just failed a Phase 2 readout. The deal you were about to price at a premium is worth a fraction of that.
This lesson is a due-diligence checklist for exactly that trap. We stay in the finance lane: how the numbers get dressed up, what regulation lets them, and the concrete checks that protect your capital.
Most companies sell things and book revenue. A clinical-stage biotech usually sells nothing. Its value sits in pipelinepipelineAll active sales opportunities across the stages of the sales process, together with their combined potential value and probability of closing.View full definition → assets (drug or device candidates in development) that may or may not reach market. That makes the financial statements unusually dependent on judgment, and judgment is where games hide.
Two accounting frameworks govern what you will see:
The single biggest difference for biotech: R&D capitalization.
Under US GAAP, internal R&D is almost always expensed as incurred. Little room to play games there.
Under IFRS (IAS 38), development costs *must* be capitalized once technical and commercial feasibility criteria are met, while research is expensed. This is the fault line. A European medtech firm can argue its device passed a feasibility threshold and start moving costs to the balance sheet, cutting reported losses.
What to check:
Worked calculation (illustrative): A target reports a 2025 net loss of $40M, down from $55M in 2024. You find they capitalized $20M of development costs in 2025 versus $3M in 2024.
Restated 2025 loss = $40M + ($20M - $3M) = $57M.
The loss did not shrink. It grew. The "improvement" was an accounting choice.
Biotech deals run on milestone payments: cash owed to a partner or licensor when a candidate hits a development, regulatory, or sales trigger. A target may have licensed its lead asset and owe, say, $75M on FDA approval plus royalties on sales.
These obligations are often contingent (they only trigger on an event), so they may sit in footnotes rather than on the balance sheet, especially under GAAP where contingent payments in a licensing deal are frequently disclosed narratively.
What to check:
A device or drug that looks profitable at the gross level can be uneconomic once 15 percent of sales flows out in stacked royalties. Model it.
For biotech, intellectual property (mostly patents) is the moatmoatA lasting edge over competitors: a resource, capability or position they cannot easily replicate, letting a firm earn above-average returns over time.View full definition →. A patent cliff is the date exclusivity ends and generics or biosimilars can enter, collapsing revenue.
What to check:
A target whose lead product loses composition-of-matter protection in three years is a melting ice cube, regardless of current sales.
The USPTO's Patent Public Search lets you verify claimed patents and expiry math yourself for free.
Most clinical-stage biotechs burn cash and have no revenue. The question is not *if* they need more money but *when*, and whether auditors have flagged doubt.
A going-concern qualification is a statement in the audited financials that there is substantial doubt about the company's ability to operate for the next 12 months. It is a serious flag and often depresses the stock, which can also be why the target is for sale.
Cash runway calculation (illustrative):
If a pivotal trial readout is 14 months out, this company must raise capital (dilution) or strike a deal before it has data. That is your leverage, and their risk.
What to check:
🎬 [VIDEO: "How to Read a Biotech Balance Sheet" - youtube.com - walkthrough of cash runway, R&D lines, and pipelinepipelineAll active sales opportunities across the stages of the sales process, together with their combined potential value and probability of closing.View full definition → value for non-specialists]
If the target actually sells a device or approved therapy, apply standard revenue scrutiny with sector twists.
Knowledge check
1. Why do the financial statements of a clinical-stage biotech depend more heavily on judgment than those of a typical product company?
2. A company reports a shrinking net loss primarily because it moved R&D spending off the income statement and onto the balance sheet as an intangible asset. What is the correct interpretation of this improvement?
3. Under which framework is a European medtech firm most able to argue that development costs should be capitalized rather than expensed?
4. Select ALL correct answers about the difference between US GAAP and IFRS treatment of R&D for biotech/medtech targets.
Select all the correct answers.
5. Select ALL correct answers describing why capitalized intangible assets on a biotech balance sheet warrant close scrutiny during due diligence.
Select all the correct answers.
Loss-making biotechs accumulate net operating losses (NOLs) that can offset future taxable income. Buyers sometimes overvalue these.
Two cautions:
Ask your tax advisor to model the Section 382 limitation before assigning any value to NOLs in your price.
Small biotechs often have tangled relationships: founders who also own the licensing entity, consulting contracts to insiders, or IP held in a separate holding company.
What to check:
Sequence your diligence to kill the deal fast if it deserves killing:
1. Cash runway and going concern (is there time?).
2. IP cliff and composition-of-matter status (is there a moatmoatA lasting edge over competitors: a resource, capability or position they cannot easily replicate, letting a firm earn above-average returns over time.View full definition →?).
3. Capitalized R&D restatement (are the losses real?).
4. Milestone and royalty liabilities (what do you truly owe?).
5. Revenue quality, NOLs, related parties (clean-up).
The first two can end the process in an afternoon. The rest set your price.
This lesson is educational and not investment, legal, or tax advice. Confirm all regulatory periods and tax rules as of your deal date with qualified advisors.