Problem
Corporate finance theory works OK for established companies (Read: Discounted Cash Flow).
The most fun, however, is to value a company that has no current earnings, but if things work out well, could have substantial earnings in the future. This is particularly relevant to most biotech companies with a market cap of less than $300 million.
Identifying such a situation is how a really good investment is made--think like a venture capitalist! The market/book ratio is one effective tool to use for projections; 3:1 would mean that the company is worth $3 for every dollar invested--not bad. Of course, 1000:1 would be better. So to get this right, we have to estimate the growth rate, the gross margin, and the capital intensity (i.e. how much we have to spend).
Example:
EyeGlue has a new product that allows ophthalmologists to glue incisions for cataract surgery (presently they are left open).
Medicare is the chief payer.
One million cataract surgeries are performed per year in the US
The IP is licensed from a major university at a cost of $100k per year.
The cost of the production of one unit is $10. The company plans on charging $100/unit.
The safety profile is good; FDA approval seems likely.
The CEO is a star.
The company has 10 employees and overhead is $1 million per year.
There are no competitive products on the market.
What is your valuation of this company? If you are a professional investor, observe the conflict. You want to buy as much of the company as possible because you like its prospects. In that regard, a lower valuation would help you. BUT, since other investors also are part of the deal, you certainly don't want them involved at an extremely low valuation. Also, if the company is not properly funded, it hurts everyone. What is fair? As a hint, a recent transaction with another surgical sealant company closed for $100 million, but this other company had $1 million in sales.