Venture Capitalists Advise Device Companies to Run Lean

Article preview reprinted from Start Up - October/November 2009

Venture capitalists speaking at the Medtech Insight IN3 Medical Device Summit in San Francisco in October stressed that they need to know how much capital a company will need to break even or turn a profit. Read more...

Venture Capitalists Advise Device Companies to Run Lean

Article preview reprinted from Start Up - October/November 2009

Venture capitalists speaking at the Medtech Insight IN3 Medical Device Summit in San Francisco in October stressed that the final dollar they're going to invest in a device company is just as important as the first dollar, particularly in this capital market. In a series of 15-minute presentations, more than a dozen active investors laid out their plans for investing in this market. To a person, they stressed that they need to know how much capital a company will need to break even or turn a profit. Without an accurate—and palatable—number in place, venture investors likely will divert their capital to other more predictable projects.

What's palatable? At the lower end of the range, early-stage investor Jan Garfinkle, managing director at Arboretum Ventures, told executives and entrepreneurs in the audience at the Mark Hopkins InterContinental Hotel that she'd like to find companies that can get the job done for $40 million or less. Others set the ceiling a bit higher, at $50 million, $60 million, or slightly more, but device investors say this economic environment doesn't allow them to commit to projects requiring $100 million or more. Certainly, the exit opportunities available—some mergers and acquisitions, no initial public offerings—aren't going to produce the exits that will reward a huge bet.

"The next couple of years will be challenging for everyone," says Peter K. Shagory, partner at Baird Venture Partners. "That leads us to make sure that we have a very strong syndicate in place and a very strong understanding of capital needs." But securing those co-investors might be more difficult than finding quality companies in which to invest. Mark Brooks, general partner at Scale Venture Partners, presented a series of data points that showed the venture capital industry in a state of deep decline. The number of venture dollars invested in all industries as compared to the nation's gross domestic product is at a 30-year low. "We find there are fewer funds ready to write a check," Brooks says. "I don't see how we're going to put more than $60-$70 million in a deal unless we get some partners."

Where will those partners come from? Medical device companies are looking across industries and oceans for new sources of capital. (See "Device Companies Look Far and Wide for New Capital," IN VIVO, October 2009.) Charles Warden, general partner at Versant Ventures, says his firm encourages companies to speak to corporate partners as early as possible, even when raising a Series A. Scott Wolf, formerly of Prospect Venture Partners and Frazier Healthcare Ventures, appeared on the venture capital panel representing Covidien Ventures, one of the newer corporate venturing programs. He said it's clear fewer dollars are available to medical device companies.

Speaking at the IN3 Medical Device Summit, the panel's concerns over costs developed into a conversation about the risk-reward trade-offs of companies going the more rigorous and costly PMA route, or following the easier (although increasingly challenging) 510(k) track.. One panelist, Nathan Every, MD, general partner at Frazier Healthcare Ventures, suggested that FDA requirements for PMA approval are prohibitively expensive for venture capitalists if they want to see venture style returns on their investment. "The FDA is a big problem," agreed Glenn Reicin, general partner at Skyline Ventures. "Probably a bigger problem than reimbursement."

Venture capitalists face a dilemma because the truly successful investments largely go into companies pursuing PMA approval for a device. "PMA companies are the ones that turn into new businesses," that go on to be acquired for big dollars, Wolf said, citing Ablation Frontiers and Evalve as two recent examples. Medtronic Inc. paid $225 million for Ablation Frontiers, a cardiac ablation company, in January. Abbott Laboratories Inc. bought Evalve, a heart valve company, in September, for $325 million plus earn-outs. "In general it's true that PMAs are a more difficult value proposition," says Sami Hamade, partner at Aberdare Ventures, speaking on a panel. "But they are not all alike and the difference between one PMA and another is whether or not you can buy down some of the product development risk." Hamade invested in Ablation Frontiers while he ran Guidant Compass, the venture/business development program at the former Guidant, and sat on the company's board. Ablation Frontiers was able to validate the technology in European clinical trials, assuring investors that its technology stood a good chance with the FDA. Hamade says VCs need assurances and won't be eager to invest $70 million in a company and then cross their fingers hoping the technology works. "We were all involved in some of those deals and they're not being done as frequently because money is not plentiful. No one wants to drill a hole in their portfolio."

Venture firms presenting at the conference had capital to invest. In almost every case, the venture capitalists had raised funds just prior to the economic collapse of September 2008. Fundraising wasn't simple before that date, but it was certainly easier than it would be today. Venture capitalists hope that the limited partners will gain an appetite for new investment in 2010, but there are certainly no guarantees in this economy. Glenn Reicin, of Skyline Ventures, which raised a $350 million fund in 2007, says the firm is roughly halfway through investing its current fund. Reicin says the firm's partners anticipate raising its next fund could be difficult, admitting what most venture capitalists feel in this market.

--Tom Salemi

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Companies mentioned in this article:

Abbott Laboratories Inc.

Boston Scientific Corp.

Glaukos Corp.

MAKO Surgical Corp.

Medtronic Inc.

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