Skye Bioscience, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Warrants and Derivative Liabilities

Warrants and Derivative Liabilities

9 Months Ended

Sep. 30, 2021

Warrants and Rights Note Disclosure [Abstract]

Warrants and Derivative LiabilitiesThere are significant judgements and estimates inherent in the determination of the fair value of the Company’s warrants and derivative liabilities. These judgements and estimates include assumptions regarding the Company’s future operating performance, the time to completing a liquidity event, if applicable, and the determination of the appropriate valuation methods.

If the Company had made different assumptions, the fair value of the warrants and derivative liabilities could have been significantly different (See Note 2).

Warrants

Warrants vested and outstanding as of September 30, 2021 are summarized as follows:


Source	Exercise Price		Term (Years)	Number of Warrants Vested and Outstanding
Pre 2015 Common Stock Warrants	$	1.00	10	1,110,000
2015 Common Stock Warrants	5.00		10	100,000
2016 Common Stock Warrants to Service Providers	1.15		10	40,000
2016 Series C Common Stock Warrants to Placement Agent	0.40		5	125,000
2017 Series D Common Stock Warrants to Placement Agent	0.25		5	480,000
2017 Common Stock Warrants to Service Provider	0.41		5	125,000
2018 Emerald Financing Warrants	0.10		5	3,400,000
Emerald Multi-Draw Credit Agreement Warrants	0.50		5	7,500,000
2019 Common Stock Warrants	0.35		5	8,000,000
2020 Common Stock Warrants to Placement Agent	0.08		4.99	8,166,667
2021 Inducement Warrants	0.15		5	21,166,667
2021 Inducement Warrants to Placement Agent	0.19		5	1,481,667
2021 Common Stock Warrants	0.09		5	77,777,779
2021 Pre-Funded Warrants	—		Indefinite	19,666,667
2021 Common Stock Warrants to Placement Agent	0.11		5	5,444,445
Total warrants vested and outstanding as of September 30, 2021				154,583,892

July 2021 Inducement Warrants and September 2021 Financing Warrants

In connection with the July 2021 Inducement (Note 5), the Company issued 21,166,667 common stock warrants and 1,481,667 warrants to the placement agent. The warrants were equity classified at issuance and the Company recorded the fair value of the common stock warrants and placement agent warrants of $2,790,884 and $192,224, respectively, as equity issuance costs related to the September 2021 Financing within equity. The warrants were vested at issuance and were valued utilizing the Black-Scholes Merton option pricing model with the following assumptions:


	Common Stock Warrants			Placement Agent Warrants
Dividend yield	0.00		%	0.00		%
Volatility factor	137.87		%	137.87		%
Risk-free interest rate	0.73		%	0.73		%
Expected term (years)	5			5
Underlying common stock price	$	0.15		$	0.15

In connection with the September 2021 Financing (Note 5), the Company issued 77,777,779 common stock warrants, 19,666,667 pre-funded warrants, and 5,444,445 common stock warrants to the placement agent. The warrants were equity classified at issuance and the Company allocated $3,265,676 and $943,489 of the gross proceeds to the common stock warrants and pre-funded warrants on a relative fair value basis, respectively. The common stock warrants issued to the placement agent were valued at $421,522 and recorded as equity issuance costs within equity. The warrants vested immediately and were valued utilizing the Black-Scholes Merton option pricing model with the following assumptions:


	Common Stock Warrants			Pre-funded Warrants			Placement Agent Warrants
Dividend yield	0.00		%	0.00		%	0.00		%
Volatility factor	136.02		%	135.06		%	136.02		%
Risk-free interest rate	1.01		%	1.55		%	1.01		%
Expected term (years)	5			10			5
Underlying common stock price	$	0.09		$	0.09		$	0.09

Derivative Liabilities

The following tables summarize the activity of derivative liabilities for the periods indicated:


	Nine Months Ended September 30, 2021
	December 31, 2020 Fair Value of Derivative Liabilities		Fair Value of Derivative Liabilities Issued		Change in Fair Value of Derivative Liabilities		Reclassification of Derivatives to Equity		September 30, 2021 Fair Value of Derivative Liabilities
Emerald Financing - warrant liability (1)	$	38,567	$	—	$	169,349	$	—	$	207,916
Current balance of derivative liabilities	$	38,567	$	—	$	169,349	$	—	$	207,916


	Nine Months Ended September 30, 2020
	December 31, 2019 Fair Value of Derivative Liabilities		Fair Value of Derivative Liabilities Issued		Change in Fair Value of Derivative Liabilities		Reclassification of Derivatives to Equity		September 30, 2020 Fair Value of Derivative Liabilities
Emerald Multi Draw Credit Agreement - compound derivative liability (2)	$	90,797	$	—	$	(90,797)	$	—	$	—
Emerald Financing - warrant liability (1)	276,024		—		(234,875)		—		41,149
Series B - warrant liability(3)	134,579		—		(108,016)		(26,563)		—
Total derivative liabilities	$	501,400	$	—	$	(433,688)	$	(26,563)	$	41,149
Less, noncurrent portion of derivative liabilities	(90,797)								—
Current balance of derivative liabilities	$	410,603							$	41,149

Emerald Financing Warrant Liability (1)

In connection with the August 2020 Financing, the exercise price of the warrants was permanently set to $0.10. The warrants contain a contingent put option if the Company undergoes a subsequent financing that results in a change in control. The warrant holder also has the right to participate in subsequent financing transactions on an as-if converted basis.

The Company reviewed the warrants for liability or equity classification under the guidance of ASC 480-10, Distinguishing Liabilities from Equity, and concluded that the warrants should be classified as a liability and re-measured to fair value at the end of each reporting period. The Company also reviewed the warrants under ASC 815, Derivatives and Hedging/Contracts in Entity’s Own Equity, and determined that the warrants also meet the definition of a derivative. With the assistance of a third party valuation specialist, the Company valued the warrant liabilities utilizing the Monte Carlo valuation method pursuant to the accounting guidance of ASC 820-10, Fair Value Measurements. Beginning March 31 2021, the Company changed its valuation approach for the Emerald Financing Warrant Liability to a Black Scholes valuation method, as it was determined that a more simplistic model such as the Black Scholes valuation method yields a substantially similar result as a Monte Carlo simulation due to the Company's current assumptions.

The warrant liability is valued at the balance sheet dates using the following assumptions:


	September 30, 2021		December 31, 2020
Dividend yield	0.00%		0.00%
Volatility factor	134.8%		90.9%
Risk-free interest rate	0.16%		0.14%
Expected term (years)	1.38		2.13
Underlying common stock price	$	0.11	$	0.04

Emerald Multi-Draw Credit Agreement Compound Derivative Liability (2)

On April 29, 2020, the Company entered into the Amended Credit Agreement which removed the change in control provision as an event of default for advances before and after the amendment. As a result of the modification, the contingent interest feature component of the compound derivative is no longer required to be bifurcated as a derivative liability.

Series B Warrant Liability (3)

During the nine months ended September 30, 2020, 312,500 Series B Common Stock Warrants with an intrinsic value of $26,563 were exercised for no consideration per share, which resulted in the issuance of 312,500 shares of common stock. Prior to exercise, these Series B Warrants were adjusted to fair value using a Black Scholes valuation method which considered the closing trading price on the exercise dates. Because the exercise price of these options had been reset to $0.00, the fair value derived from the valuation model approximated the market value of the Company’s common stock on the exercise dates.