Note 3. Fair Value Measurements

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Company applies the guidance in ASC 820, Fair Value Measurement, to account for financial assets and liabilities measured on a recurring basis. Fair value is measured at the price 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 is determined based on assumptions that market participants would use in pricing an asset or liability.

The Company uses a fair value hierarchy, which distinguishes between assumptions based on market data (observable inputs) and an entity's own assumptions (unobservable inputs). The guidance requires that fair value measurements be classified and disclosed in one of the following three categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each reporting period. There were no transfers between Level 1, 2 and 3 during the years ended December 31, 2019, 2018 and 2017.

Note 3. Fair Value Measurements (Continued)

The table below presents the assets and liabilities measured and recorded in the financial statements at fair value on a recurring basis at December 31, 2019 and 2018 categorized by the level of inputs used in the valuation of each asset and liability.



	December 31, 2019
(In thousands)	Total		Level 1		Level 2		Level 3
Assets
Cash	$	250	$	250	$	—	$	—
Money market funds		39,769		39,769		—		—
Short-term investments – commercial paper		2,774		—		2,774		—
Total assets	$	42,793	$	40,019	$	2,774	$	—
Liabilities
Warrant liability	$	3,241	$	—	$	—	$	3,241
Future tranche right liability		46,436		—		—		46,436
Total liabilities	$	49,677	$	—	$	—	$	49,677


	December 31, 2018
(In thousands)	Total		Level 1		Level 2		Level 3
Assets
Cash	$	8,446	$	8,446	$	—	$	—
Money market funds		61,177		61,177		—		—
Other cash equivalents – commercial paper		1,808		—		1,808		—
Total assets	$	71,431	$	69,623	$	1,808	$	—
Total liabilities	$	—	$	—	$	—	$	—

The Level 1 assets consist of money market funds, which are actively traded daily. The Level 2 assets consist of commercial paper whose fair value may not represent actual transactions of identical securities. The fair value of commercial paper is generally determined based on the relationship between the investment’s discount rate and the discount rates of the same issuer’s commercial paper available in the market which may not be actively traded daily. Since these fair values may not be based upon actual transactions of identical securities, they are classified as Level 2.

Changes in Level 3 Liabilities Measured at Fair Value on a Recurring Basis

Warrant Liability and Future Tranche Right Liability

The reconciliation of the Company's warrant and future tranche right liability measured at fair value on a recurring basis using unobservable inputs (Level 3) is as follows:


	Warrant		Derivative
(In thousands)	Liability		Liability
Balance at December 31, 2018	$	—	$	—
Issuance of redeemable preferred stock and warrants (1)		2,643		35,472
Change in the fair value of liability		598		10,964
Balance at December 31, 2019	$	3,241	$	46,436

(1)

Represents fair value of freestanding warrants and the future tranche right related to the December 2019 Private Placement on the issuance date.

Note 3. Fair Value Measurements (Continued)

Assumptions Used in Determining Fair Value of Liability-Classified Warrants

The Company utilizes an option pricing model to value its liability-classified warrants. Inherent in the valuation model are assumptions related to volatility, risk-free interest rate, expected term, dividend rate, and other scenarios (i.e. probability of complex features of the warrants being triggered).

The fair value of the warrants has been estimated with the following weighted-average assumptions:


	December 23,		December 31,
	2019		2019
Risk-free interest rate		1.82%		1.79%
Expected dividend yield		—		—
Expected term (years)		7.00		6.98
Expected volatility		80%		80%
Exercise price (per share)	$	1.52	$	1.52

Assumptions Used in Determining Fair Value of Future Tranche Rights

The Company utilizes a binomial lattice model to value the Series B2 (tranche 2) and B3 (tranche 3) tranches and a Monte Carlo simulation to value the Series B4 (tranche 4) future tranche rights. The Company selected these models as it believes they are reflective of all significant assumptions that market participants would likely consider in negotiating the transfer of the Future Tranche Rights. Such assumptions include, among other inputs, stock price volatility, risk-free rates, redemption and early exercise assumptions, cancellation and conversion assumptions, and the potential for future adjustment of the conversion price due to a future dilutive financing.

The estimated fair value of the Future Tranche Rights is determined using Level 2 and Level 3 inputs. Significant inputs and assumptions used in the valuation models are as follows:


	December 23,		December 31,
	2019		2019
Risk-free interest rate for warrants		1.82%		1.82%
Risk-free interest rate for preferred stock		1.86% - 1.89%		1.84% - 1.88%
Expected dividend yield		—		—
Expected term (years) of call option on preferred stock		1.18 - 2.18		1.16 - 2.16
Expected term (years) of warrants		8.18 - 9.18		8.16 - 9.16
Expected volatility		80%		80%
Exercise price (per share) for common stock equivalent for preferred stock and warrant	$	1.52 - 1.82	$	1.52 - 1.82

As of December 23, 2019 and December 31, 2019, the Company deemed it probable that shareholder approval would be obtained, on or prior to December 31, 2020, with respect to increasing the Company’s authorized shares of common stock in an amount sufficient to cover the conversion of all potential convertible securities issuable upon exercise of the Future Tranche Rights. See Note 7 for further details on the such required shareholder approval.