3. Fair Value of Financial Instruments

The Company’s financial instruments consist of cash and cash equivalents, investments, accounts payable, debt and its related debt conversion feature liability. The carrying amounts reported in the accompanying balance sheets for cash and cash equivalents and accounts payable approximate fair value because of the short-term maturity of those instruments. Further, the Company believes the fair value of the debt approximates its carrying value based on relatively stable interest rates and short-term maturity of this instrument. Fair value measurements are classified and disclosed in one of the following three categories:

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

Level 2 —Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 —Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

As of June 30, 2017 and December 31, 2016, all of the Company’s financial assets that were subject to fair value measurements were valued using observable inputs. The Company’s financial assets valued based on Level 1 inputs consist of money market funds and certificates of deposit. The Company’s financial assets valued based on Level 2 inputs consist of corporate debt securities, which consist of investments in highly-rated investment-grade corporations.

The Company’s financial liability that was subject to fair value measurement consisted of a debt conversion feature that has been recorded as a liability based on Level 3 unobservable inputs.

The fair value of the debt conversion feature, current as of June 30, 2017 and December 31, 2016 required management to estimate fair value based on the Black-Scholes-Merton option valuation model. The Black-Scholes-Merton option valuation model was adopted as a result of the Company’s entry in January 2016 into the second amendment to the Loan and Security Agreement, which amended the conversion terms of the Ligand Note issued pursuant to the Loan and Security Agreement.

The debt conversion feature embedded in each tranche of the Ligand Note is accounted for under ASC Topic 815 – Derivatives and Hedging. At each issuance date, the fair value of the debt conversion feature was determined. The fair value of the debt conversion feature was allocated from the gross proceeds of the Ligand Note with the respective discount amortized to interest expense over the original term of the Ligand Note using the effective interest method. The Company is required to mark to market the value of the conversion feature liability.

The Company’s investment strategy is focused on capital preservation. The Company invests in instruments that meet the credit quality standards outlined in the Company’s investment policy. This policy also limits the amount of credit exposure to any one issue or type of instrument. As of June 30, 2017, the Company’s investments were in government money market funds, certificates of deposit and corporate debt securities.

The fair values of the Company’s financial instruments are presented below:

			Fair Value Measurements at June 30, 2017
	Total		Level 1		Level 2		Level 3
Financial assets carried at fair value:
Cash equivalents:
Money market funds	$	2,966,071	$	2,966,071	$	—	$	—
Certificates of deposit		500,395		500,395		—		—
Short-term investments
Certificates of deposit		189,780		189,780		—		—
Corporate debt securities, available-for-sale		8,499,850		—		8,499,850		—
Total financial assets	$	12,156,096	$	3,656,246	$	8,499,850	$	—
Financial liabilities carried at fair value:
Debt conversion feature - long-term	$	894,152	$	—	$	—	$	894,152
Total financial liabilities	$	894,152	$	—	$	—	$	894,152

			Fair Value Measurements at December 31, 2016
	Total		Level 1		Level 2		Level 3
Financial assets carried at fair value:
Cash equivalents:
Money market funds	$	2,519,322	$	2,519,322	$	—	$	—
Short-term investments
Corporate debt securities, available-for-sale		10,075,058		—		10,075,058		—
Total financial assets	$	12,594,380	$	2,519,322	$	10,075,058	$	—
Financial liabilities carried at fair value:
Debt conversion feature - current	$	731,048	$	—	$	—	$	731,048
Total financial liabilities	$	731,048	$	—	$	—	$	731,048

The table below presents a summary of changes in the Company’s debt conversion feature liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2017 and 2016:

	Three months ended June 30,						Six months ended June 30,
	2017			2016			2017			2016
Debt conversion feature:
Beginning balance	$	453,350		$	1,698,671		$	731,048		$	2,370,903
Adjustments resulting from modification of debt		1,011,478			—			1,011,478			(575,685	)
Adjustments resulting from changes in fair value recognized in earnings		(570,676	)		(412,050	)		(848,374	)		(508,597	)
Ending balance	$	894,152		$	1,286,621		$	894,152		$	1,286,621

The following table sets forth the Company’s valuation techniques and significant unobservable inputs used to determine fair value for significant Level 3 liabilities:

	Fair Value					Significant
	Assets		Liabilities		Valuation Technique(s)	Unobservable Input	Range
Debt conversion feature liability
June 30, 2017	$	—	$	894,152	Black-Scholes-Merton option valuation model	Volatility	65%
						Risk Free Rate	1.24%

December 31, 2016	$	—	$	731,048	Black-Scholes-Merton option valuation model	Volatility	61%
						Risk Free Rate	0.57%

Level 3 Fair Value Sensitivity

Debt Conversion Feature Liability

As of June 30, 2017 and December 31, 2016, the fair value of the debt conversion feature liability includes the estimated volatility and risk free rate. The higher/lower the estimated volatility, the higher/lower the value of the debt conversion feature liability. The higher/lower the risk free interest rate, the higher/lower the value of the debt conversion feature liability.