VCs Warn New Device Tax Could Reduce Investments

Article reprinted from "The Gray Sheet" - April 2, 2010

Venture capitalists see the new medical device industry tax under health care reform as adding to mounting pressures on smaller start-ups that could lead to smaller VC investments. Read more...

VCs Warn New Device Tax Could Reduce Investments

Article reprinted from "The Gray Sheet" - April 2, 2010

Venture capitalists see the new medical device industry tax under health care reform as adding to mounting pressures on smaller start-ups that could lead to smaller VC investments.

Beyond the 2.3% device excise tax rate set to begin in 2013 under the recently enacted health care reform bill, VC's are concerned with potential changes in the regulatory and reimbursement environment as FDA considers revamping its 510(k) program and reliance increases on comparative effectiveness assessments (The Gray Sheet' Oct. 19, 2009).

President Obama signed the final health care reform fix-it bill on March 30. For each device sale made to a hospital or other customer, manufacturers or distributors will pay a 2.3% excise tax under the legislation (The Gray Sheet' March 29, 2010).

Investors view the tax and other looming changes as counterproductive in the effort to cost-effectively identify new technologies that address important medical needs and bring them from the idea stage to the marketplace.

But the tax in particular could lead to less investment in medical device industry startups, as well as cutbacks in investments already in play, some venture capital firms say.

"I have to worry about FDA, which is only getting tougher, and reimbursement. No one knows where this is ending up, and now, thank you very much, Washington, I have got a tax," said Guy Nohra, a managing director at VC firm Alta Partners.

"Eventually the dam is going to break, and people will just do less deals in medical technology," Nohra said in an interview.

Another venture capitalist, Terry McGuire, co-founder and general partner of Polaris Venture Partners, said the device tax would encourage his firm to rethink how much it invests in the medical device sector.

About 15% of Polaris' total portfolio focuses on device technology, but other investments run the gamut from other life science industries to information technology.

"There are other ideas that may garner our attention more readily because they are not burdened by a tax before a company becomes profitable," McGuire acknowledged. "It's just another financing hurdle you have to take into account."

Emerging medical device companies will be the most impacted by the tax because they are at an earlier stage in terms of achieving profitability than larger, more established firms, analysts say.

With more out-of-pocket expenses from the device tax, start-ups may have less capital for R&D, take more time to achieve profitability, or require more funds.

"You have to raise money to pay the taxes," said Leslie Bottorff, a managing director with Onset Ventures. "This is high-risk money and very expensive for companies to raise, because the return on investment needs to be high."

Industry stakeholders initially had sought revenue-based exemptions to the device tax to aid smaller firms, but the effort was unsuccessful (The Gray Sheet' Dec. 14, 2009).

Nevertheless, some device firms and venture capital investors remain hopeful that Congress will pass some sort of legislative fix to carve out such an exemption before the tax is enacted in 2013.

VCs Still See Opportunity In Device Field

Despite possible reductions, the device sector currently garners a considerable share of venture capital investment.

Among all industries, life sciences captured the largest share of venture capital in 2009 at 34%, including $2.5 billion for devices and $3.5 billion for biotech, according to a recent report by PricewaterhouseCoopers ('The Gray Sheet' Feb. 22, 2010).

In addition, VC investment in device firms grew 14% in the fourth quarter of 2009 compared to the same quarter in 2008, according to the report.

The sector benefits in part from inherent market opportunities, such as an aging population.

Some analysts and industry insiders acknowledge that some aspects of health care reform beyond the tax could help certain medical device companies, particularly since it expands health insurance coverage to help build the customer base.

Bottorff said the higher volume of insured patients could be a boon for device firms that make diabetes management products, for example.

Others are hoping that states might step in to offer a tax credit to compensate for the new federal assessment.

Thomas Sommer, president of the Massachusetts Medical Device Industry Council, told "The Gray Sheet" in an interview that he and other industry leaders recently met with Massachusetts Gov. Deval Patrick (D), who was sympathetic to their plight.

Sommer said that Patrick expressed a desire to help the industry and that a state tax credit might be a solution closer to the implementation of the federal tax in 2013.

But the tax and other government changes remain problematic, Nohra said.

"On the one hand there will be ... more procedures," he said. "But there will also be Medicare cuts coming to hospitals and doctors who are our clients."

- Mark Hollmer

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