How to read a biotech company's filings: a plain guide for investors

A biotech company with no product revenue is, in financial terms, a pile of cash, a set of experiments and a promise to raise more money later. Its filings tell you how big each of those is. Press releases are written to persuade; filings carry legal liability, so they say the uncomfortable parts plainly, if you know where to look.

This guide is general education about documents, not investment advice, and it does not discuss any particular company or security.

Where the documents live

US public companies file with the Securities and Exchange Commission through EDGAR. You can search by company name or ticker on EDGAR full-text search, which covers filings back to 2001, and the SEC publishes a short bulletin on how to read a 10-K. Both are free. If a company points you to a paid service or a private portal for "the real numbers," treat that as information in itself.

The forms you will meet

Smaller companies file the 10-K within 90 days of the fiscal year end (larger filers sooner) and file a 10-Q for each of the other three quarters. Form 12b-25, filed as an "NT 10-K" or "NT 10-Q," announces that a report will be late. One late filing can be an accident. A habit of them is a signal.

What to read first in a biotech 10-K

The document can run past 150 pages. This order reaches the important parts quickly.

1. The pipeline (Item 1, Business)

Find the pipeline chart and write down, for each program, the indication, the stage and who owns the rights. Then check the text against the chart. A program shown in "Phase 2" should have a matching registration on ClinicalTrials.gov with a start date and a status; our guide to why most drugs fail between phase 2 and approval explains why the stage matters so much. Also look for whether the core technology is owned or licensed in. Licensed technology usually comes with milestone payments and royalties owed to a university or another company, and with conditions that can end the license.

2. Risk factors (Item 1A)

Much of this section is industry boilerplate. The useful part is what is specific: a single manufacturing supplier, an FDA clinical hold, a disputed patent, a license that can be terminated. Compare it with last year's version; new paragraphs are where the news is.

3. Liquidity (Item 7, MD&A)

The "Liquidity and Capital Resources" section usually contains a sentence of the form "we believe our existing cash, cash equivalents and investments will be sufficient to fund our operations into" a stated quarter. That sentence is management's own runway estimate. Check whether it includes trials that have not started yet.

4. Going concern language

Under US accounting rules, management must evaluate whether there is substantial doubt about the company's ability to continue as a going concern for one year after the financial statements are issued. If there is, the notes say so, and the auditor's report usually adds an explanatory paragraph. For an early-stage biotech this is common and does not mean collapse is near. It does mean new money is needed within about a year, which usually means selling more shares.

5. Collaborations and milestones

A headline that says a partnership is "worth up to" a large sum usually adds together an upfront payment, development milestones, regulatory milestones, sales milestones and royalties. Only the upfront payment is certain. Read the revenue recognition note and the agreement itself, often filed as an exhibit, to see how much has actually been paid and what has to happen for the rest. How licensing deals fit into company financing is covered in how biotech startups are funded.

Runway math, a worked example

The numbers below describe a hypothetical company. They are invented to show the arithmetic.

Hypothetical Company H reports $48 million in cash and short-term investments at the end of its fiscal year. Net cash used in operating activities over the past four quarters was $36 million, or $9 million a quarter on average.

Simple runway: $48 million divided by $9 million a quarter is about 5.3 quarters, or roughly 16 months.

Now adjust. The 10-K says a Phase 2 trial will start next quarter, and the MD&A estimates it will add about $3 million a quarter in costs. Burn becomes about $12 million a quarter, and runway drops to 4 quarters, or 12 months. That puts the company right at the one-year line that triggers going concern evaluation.

Then look at what a fix would cost existing holders. Suppose Company H has 40 million shares outstanding and raises $30 million by selling new shares at $2.00 each. That is 15 million new shares. Total shares become 55 million, and a holder who owned 1 percent of the old company now owns about 0.73 percent (40 divided by 55). If warrants are attached to the new shares, the eventual dilution is larger. The raise buys about 2.5 more quarters, or seven to eight months, at the new burn rate, and the existing holder owns a smaller slice of what comes next.

The cover page of each 10-K and 10-Q shows the number of shares outstanding. Lining up the last four or five cover pages is the fastest way to see how much dilution has already happened.

OTC-traded micro-caps: extra risks

Many small biotech stocks trade over the counter rather than on Nasdaq or the NYSE. OTC Markets Group sorts them into tiers (OTCQX, OTCQB and the Pink market) with different disclosure standards. Since SEC amendments to Rule 15c2-11 took effect in September 2021, securities without current public information have mostly moved to a restricted "Expert Market" where ordinary retail quoting is limited.

Risks that show up again and again in this part of the market:

• Thin disclosure. Some OTC companies are not SEC reporting companies at all and publish only what their tier requires.
• Steady dilution. Proxy proposals to raise the number of authorized shares, resale registrations for financing partners, and shares issued to consultants in place of cash.
• Reverse splits. Combining shares (say, 1 for 50) raises the price per share without changing the company's value. Exchanges such as Nasdaq set a $1 minimum bid price, and a reverse split is the usual way to restore it. Repeated reverse splits mean the share count keeps growing back.
• Toxic convertible notes. Some lenders buy notes that convert into stock at a discount to the recent trading price. When the price falls, each conversion produces more shares, the lender sells them, and the price falls again. Look for "variable conversion price" in the debt note.
• Promotional press releases. Frequent releases about letters of intent, memoranda of understanding, "breakthrough" preclinical results or new advisory board members, with no trial data. Paid stock promotion has to disclose the payment, often in small print at the bottom of the promotional material.

The SEC publishes investor alerts on microcap fraud and pump and dump schemes on sec.gov. An honest company can still carry every risk above.

Red flags worth a second look

• A change of auditor, especially to a small firm, or an auditor resignation disclosed in an 8-K.
• Going concern language year after year with no change in the plan for fixing it.
• Related-party transactions: loans from executives, rent paid to a director's company, consulting fees to insiders' relatives.
• Revenue from a business unrelated to the drug pipeline, used to make the company look active.
• A pipeline described as "clinical stage" with no matching trial registrations.
• Frequent name changes or pivots between fashionable topics.
• Patent claims that turn out to be pending applications, or licenses that have lapsed.

A checklist to keep beside the filings

Partnerships with universities and hospitals often appear in these filings as "translational" collaborations; our page on translational medicine explains what that work involves and how long it takes. More pieces on money and the life sciences are collected under business and investing.

One habit pays off more than any other: read the 8-Ks from the past twelve months in date order before you open the 10-K. They show every financing, every new agreement and every departure as it happened, and by the time you reach the annual report you will know which of its sentences to check.