Following the Money in Medical Devices

Article preview reprinted from IN VIVO -  January/February, 2010

Venture capitalists might cry poor, but, in fact, many leading firms have raised new funds over the past year, pooling more than $1.5 billion for medical device investments. The only question facing entrepreneurs and executives is: are they buying what you're selling?

Following the Money in Medical Devices

Article preview reprinted from IN VIVO -  January/February, 2010

Venture capitalists might cry poor, but, in fact, many leading firms have raised new funds over the past 12 months, pooling more than $1.5 billion for medical device investments. The only question facing entrepreneurs and executives is: are they buying what you're selling?

By Tom Salemi

** Even after the fiscal crisis, limited partners have stood fast behind their favorite general partnerships although some have had to settle for smaller funds.

** Device VCs smell blood—or at least opportunity—in the water, and they'll be in the market for cheaper prices in this difficult market.

** Late-stage companies will need to have minimized regulatory and reimbursement risk to receive funding. Early-stage ventures will need to present a clear path to both.

** If executed well, this crop of venture funds could deliver strong returns in the years to come.

The financial crisis that rocked the global economy from the second half of 2008 through much of 2009 hit venture investing hard, and particularly so the medical device sector given how robust device investing had been in the years leading up to 2008. Indeed, after seeing dramatic growth from 2005 through 2007, when the total dollars invested in medical device start-ups went from $2.2 billion to just over $4 billion, venture capital in devices went over a cliff in the last year, falling to $2.87 billion.

Long-time device investors argued that some retrenchment was appropriate and even necessary, that in fact the sector had gotten over-heated in the run-up to the financial collapse, with valuations and dollars-invested reaching unrealistic proportions. And, they argued, there were worrying signs on the horizon—a regulatory and reimbursement environment that's getting tougher, punitive measures in health care reform, including an industry tax, and a significant drop-off in exits, as the IPO window remains shut and M&A in devices has retrenched considerably.

Such considerations alone would account for the damper on device investing. But some investors—and the companies that look to them for capital—worried that the financial crisis of 2008 represented less a correction from which the economy would rebound than an event that would usher in a fundamental restructuring of the venture world—that there will be, in effect, many fewer dollars available to fewer venture firms, backing fewer companies. In short, they wondered, even with a rebound in the economy, would venture investing—and for the purposes of this article, investing in medical devices—ever be the same?

Well, the storm isn't over, but medical device venture capitalists appear to be weathering the post-economic collapse well enough. Yes, we have seen companies shut down from lack of capital or commitment from their existing investors. True, a good number of venture capital firms are among the so-called "walking dead," existing in a limbo state, with no capital for new investments and no returns upon which they can raise a new fund. But if one focuses on those firms that drive the industry, the picture isn't nearly as bleak.

Since the start of 2009, venture capital firms that count life sciences among their investments have closed on more than $7 billion. In some cases, like New Enterprise Associates $2.5 billion fund, the majority of the capital will be invested in companies outside the life sciences. But firms investing only in health care and life sciences have also enjoyed success including Essex Woodlands Health Ventures, Domain Associates and Aisling Capital. An examination of past investment histories and interviews with general partners suggest that these firms intend to invest more than $1.7 billion in medical device companies over the next four years. General partners warn that those allocations are never set. Market conditions might ultimately force them to steer more—or less—capital into devices. But interest in medical devices remains strong and venture firms have the capital to invest.

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Companies mentioned in this article

Abbott Laboratories Inc.

Abbott Medical Optics Inc.

Visiogen Inc.

Endosense SA

Johnson & Johnson

Ethicon Inc.

Acclarent Inc.

Medtronic Inc.

Kyphon Inc.

Medtronic Ablation Frontiers LLC

Medtronic CoreValve LLC

ReGen Biologics Inc.

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