Table 1. Structure and function.

Simulated performance comparing an all-equity structure (using no debt financing); an RBO structure using a senior and junior debt tranche paying 5 and 8% annual coupon rates, respectively; and a second RBO structure with a single guaranteed senior tranche. The senior tranche is paid before the junior (mezzanine) tranche, which is paid before the equity holder. In the event that the fund defaults or fails to meet its debt obligations, the guarantor will pay the difference. Each structure acquires only preclinical compounds, with a target goal of reaching phase 3 within a maximum horizon of 11 years. Dashes indicate cases in which the corresponding type of financing and/or guarantee is not used. IRR, internal rate of return; ROE, return on equity.

 Simulation results All equity(similar equity) Research-backed obligation (RBO) RBO with guarantee(no mezzanine) Number of compounds Preclinical or IND-enabling 9 16 16 Research impact Number sold in phase 2 0.4 1.9 1.6 Number sold in phase 3 3.4 5.3 5.6 Liabilities Capital ($millions) 230 420 420 Senior tranche ($ millions) — 105 189 Junior tranche ($millions) — 84 — Equity tranche ($ millions) 230 231 231 Guarantee ($millions) — — 100 Equity tranche performance Equity tranche performance 3.25 5.14 5.32 Average IRR 26.7% N/A N/A Average MIRR (0% financing) 18.3% 21.6% 22.7% Average annualized ROE 11.6% 14.7% 15.4% Probability (equity wiped out) 1.3 bp 0.52% 0.34% Probability (return on equity <0) 8.0% 6.2% 5.1% Probability (return on equity >10%) 61.9% 76.8% 78.6% Probability (return on equity >25%) 2.2% 10.4% 11.0% Debt tranches performance Senior tranche: default probability, expected loss (bp) — 0.1, <0.1 <0.1, <0.1 Junior tranche: default probability, expected loss (bp) — 50, 15 — Guarantee performance Probability (cost of guarantee >0) — — 0.3% Expected cost, 2% discount ($) — — 65,000 No-arbitrage cost of guarantee (\$) — — 110,000