NOTE 7: FAIR VALUE MEASUREMENTS

The Company follows accounting guidance on fair value measurements for financial assets and liabilities measured at fair value on a recurring basis. Under the accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability.

The accounting guidance requires fair value measurements be classified and disclosed in one of the following three categories:

Level 1: Quoted prices in active markets for identical assets or liabilities.

Level 2: Observable inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace.

Level 3: Unobservable inputs which are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques,

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

Certain of the Company’s financial instruments are not measured at fair value on a recurring basis but are recorded at amounts that approximate their fair value due to their liquid or short-term nature, such as accounts payable, accrued expenses and other current liabilities.

Placement Agent Warrants

In connection with the Company’s Class A Preferred Stock offering (see Note 15), the Company will issue upon a Qualified Financing (an external financing of $25.0 million or greater) to the placement agent warrants (“the Placement Agent Warrants”) to purchase 5% of the shares of common stock into which the Class A Preferred Stock converts. The Placement Agent Warrants have a term of 5 years.

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At September 30, 2021, the value of the placement agent warrants was deemed to be $0.5 million. In connection with the Company’s IPO the company issued 111,567 shares of common stock in related to the conversion of all of the warrants.

Contingent Payment Derivative

In connection with the DFD Agreement, the Company agreed to pay DRL additional consideration upon either an initial public offering of the Company’s common stock (“IPO”) or an acquisition of the Company, the agreement further specifies that only one payment can be made. The contingent payment associated with an IPO of the Company’s common stock, is deemed to be achieved if upon the completion of an IPO the Company’s market capitalization on a fully diluted basis is $150 million or greater at the close of business on the date of such IPO. The payment due for the achievement of the IPO criteria is a follows: (a) issue to DRL a number of shares of the Company’s common stock equal to $5.0 million as calculated using a fifteen (15) day volume weighted average price (“VWAP”) of the Company’s closing price, measured fifteen (15) days following the IPO; or (b) make a cash payment to DRL equal to $5.0 million. In connection with the Company’s IPO on November 16, 2021, calculated using a 15-day VWAP of $9.1721 per share, we issued 545,131 unregistered shares of common stock in the Company to DRL. The restrictions on the unregistered shares of common stock are governed by the terms set forth in the DFD Agreement and applicable securities laws.

In the event the IPO contingency was not satisfied, and the Company or its affiliate executes a definitive agreement for an acquisition event during the period beginning on June 29, 2021 and ending twenty-four (24) months after the regulatory approval of DFD-29 (“Acquisition Event”), the Company shall pay to DRL: (a) 20% of the value of DFD-29 attributable to the acquisition event, if such acquisition event occurs between closing and New Drug Application (“NDA”) approval; or (b) 12% of the value of DFD-29 attributable to the acquisition event, if such acquisition event occurs within 24 months after NDA approval. However, since the IPO contingency was satisfied on November 12, 2021 there is no further obligation to make a payment to DRL in the event of an Acquisition Event.

The Company valued the contingent payment discussed above utilizing a Probability Weighted Expected Return Method (PWERM) model. A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in measuring the Company’s derivative liability that are categorized within Level 3 of the fair value hierarchy as of September 30, 2021 were as follows:

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At September 30, 2021 the value of the contingent payment warrant is $3.8 million, and was recorded on the unaudited condensed consolidated balance sheet. No liability was recorded at December 31, 2020.

The following table classifies into the fair value hierarchy of the Company’s financial instruments, measured at fair value as of September 30, 2021:

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The table below provides a roll-forward of the changes in fair value of Level 3 financial instruments as of September 30, 2021:

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During the nine-month period ended September 30, 2021, no transfers occurred between Level 1, Level 2, and Level 3 instruments.