Contributing Editor

Josh Makower, MD, MBA, is CEO and founder ofExploraMed Development, a medical device incubator based on the West Coast, and also is a venture partner with New Enterprise Associates, where he supports investing activity in the medical device arena. He also serves as a consulting associate professor of medicine at Stanford University Medical School and co-founded Stanford's Biodesign Innovation Program.

Among the companies he has founded through the ExploraMed incubator are Acclarent, a company focused on developing novel ENT therapies, acquired by Johnson & Johnson earlier this year; TransVascular, a company focused on the development of a completely catheter-based coronary bypass technology, acquired by Medtronic in 2003, and EndoMatrix, a company focused on the development of a novel therapy for incontinence and GI reflux, acquired by C.R. Bard in 1997.

Josh holds more than five dozen patents for various medical devices in the fields of orthopedics, ENT, cardiology, general surgery, drug delivery and urology.

BB&T: The med-tech industry in the U.S. is widely seen as facing a “perfect storm“ of threats that include a depressed economy, tighter availability of investor funds, higher regulatory hurdles for both product approval and reimbursement, and an array of other looming problems. As a venture investor and a medical entrepreneur, how do you characterize the situation currently as opposed to say the middle of last year?

Makower: I think the situation is as dire as it was; it's possible it might be a little worse. It definitely is a challenging time for small companies and the med-tech industry overall, brought on by the secondary effects of the global financial meltdown, which has had a resultant effect on the venture capital industry. Venture capitalists have become much more conservative and concerned about cash burn and timelines, and unfortunately the new conservative direction that the FDA is taking, the increased challenges to navigate the Centers for Medicare & Medicaid Services and our private reimbursement system, and the delay in obtaining patents have combined to result in a great deal of uncertainty for medical technology companies. It is a challenging time.

BB&T: Is the fact that venture investors now are having to go longer with their companies of choice making it more difficult for new companies to get their foot in the door?

Makower: There still is a market for investors at the earliest stages, but the problem is that most of the venture capitalists have been put in a situation where they have had to do inside rounds to “feed their own,“ and that has stretched them in their ability to support the mid to late stage of companies that they haven't worked with before. There are an increasing number of companies that are running out of their lifeline from their existing investors. And I'd say that probably applies to the venture capital industry as well – there is a small group of firms that have been able to finance and raise new funds, but the more common story is that many funds have quite a full portfolio of medical investments and are finding that liquidity is not coming as soon as they had hoped, and their ability to raise their next funds is therefore delayed. The economic recovery has not happened fast enough to allow for a more vibrant IPO market to get some more liquidity into the system. Thus, many of these funds are finding themselves pretty stretched out.

BB&T: Some of the VCs I've talked with recently have been referring to this almost being a phenomenon where you have these companies where it isn't necessarily a question of having poor clinical results, but simply because they have been out there so long, and because the path is visibly longer into the future, that they kind of are running aground. That's almost despite what they might be able to do with their technology.

Makower: Yes, that's absolutely right. There are a lot of good companies out there that have technologies that work, that are really improving patients' lives, but for some reason or another – the FDA delays being a big part of it, but also other issues such as challenges obtaining reimbursement – these issues combine for that perfect storm that you mentioned. The goalposts are getting moved out, but the access to capital is becoming more constricted, so there is becoming a greater divide between concept and reimbursed commercialization. That is what is happening to us at the moment.

BB&T: For the true start-up, the other side of the really difficult situation for them is that, whether it's angel investors or family investors, a great many simply don't have access to the capital that they might have had in the past. Even an entrepreneur himself can't go to home equity, as might have been true in the past, because those loans aren't as available as they were, or not in the amounts they once were, and lenders also are putting some severe restrictions on how they can use it.

Makower: Absolutely. I have been exceptionally fortunate to have as my financial partner New Enterprise Associates, which is a tremendously successful and strong venture fund that really has a long-term view and the ability to put substantial capital forward for projects that they believe in. But many of my colleagues are not as fortunate, and the funds that they are working with are smaller and they have limitations in the size of investment that they can make. Therefore, when these timelines get extended, these companies start looking for other VCs to join in the rounds and they are finding it very difficult to get access to capital outside of the existing syndicate.

The syndicate issue is another thing to bring up. All you need is one firm to buckle within the syndicate and it makes it even more challenging for companies to finance. The traditional model, where it was good to have, say, five small- to medium-sized VCs around the table no longer truly works. Now, if you lose one of those firms, the impact is substantial on your ability to raise capital, and the other investors find it even more difficult to continue to support the company because they are carrying the water for more than the share that they signed up for when they made the initial investment.

It's a challenging time, there is no doubt about it – and we haven't seen the true fallout yet. Right now, many of these businesses still are on a certain degree of life support from their original investor syndicates, but the real test is going to be what happens this year as those companies now go out for financing or are forced to bring in outside capital.

BB&T: You bring up syndication, and that's a point I was going to raise. Is there a point where there is some element of whether you really have a belief that the other syndicate partners are going to be able to be there for the long haul?

Makower: These are real economic factors that are impacting us right now. The venture capitalists that are investing these days should be encouraged by some of the recent exits, but they also have to recognize that those exits were achieved with a substantial commitment of capital. So the models of venture capital investing where one can come in early and take a larger piece up front, and then dwindle one's support for the company over time, letting later-stage investors take over, is a model that truly is being challenged at the moment. We're going to have to revisit the possibility that funds are going to have to pick their winners early and then stick by them for a longer period of time before they can really get the benefit of liquidity.

BB&T: With healthcare reform as we knew it at the beginning of 2010 still more rumor than fact, do innovators and those who invest in their ideas have reason to breathe a little more easily about such legislation's possible future impact on medical technology, or is it simply a matter of waiting for the other shoe to drop in the form of enacted laws that could make healthcare a less-attractive field in which to invest?

Makower: For the most part, my perspective on healthcare reform is that many of the provisions and ideas being proposed were going to have neutral or positive impact on the medical technology industry. However, a few of the provisions have the potential to be devastating – such as the medical device tax. I think many people don't understand the reason why that particular tax was such a threat to the medical device industry. It had to do with the fact that the tax was not to be on profits, but actually was to be on sales. In the med-tech industry, small companies could have revenue of $80 million dollars or more in sales and still not be profitable. Because of the tremendous costs of the regulatory, reimbursement process, training, development, sales and marketing, it is not unusual for a medical device company to only become profitable after sales approach $100 million in revenue. That is what many people, and certainly I think the people who proposed this legislation, did not realize at the time that proposal came forward.

One can only imagine the impact on a venture investor if they're told, not only do you have to invest in this exceptionally long regulatory and reimbursement cycle, but you're also going to have to pay money to the government just to allow companies to be in the marketplace, regardless of whether they're profitable or not. One of the changes that many of us supported and the Medical Device Manufacturers Association has been pushing is a carve-out so a company's first $100 million in U.S. revenues would be exempt from the excise tax. In addition, sales between $100 million to $150 million in U.S. revenues would pay half the rate. It's important for people to have access to healthcare, and many of the ideals make sense to us. The challenge is that that an excise tax aimed at revenue only, not taking into account whether a company is profitable, could be a devastating thing for any early-stage company.

It is uncertain whether these changes will be included in the final version of the bill. This is a very, very important part of the bill that needs to be included, to protect small med-tech companies. The fact is that much of the innovation in medical technology comes from small companies, and it's big companies buying small companies that really drives this industry and investors. If we are going to inappropriately tax very small companies, making them basically raise money from venture capitalists to be able to pay the government until they are profitable, that's going to be a very challenging economic scenario for small companies.

The other element which scares us is the comparative effectiveness research component. Everyone would agree that it would be a good idea to compare therapies and provide information for patients about different therapies, but where this becomes a concern is if new technologies or new therapies that are just beginning to find their footing are compared to existing therapies that are fully established. It's a set-up for really killing innovation in the industry.

Very rarely is it possible that new technologies can be introduced without some aspects requiring improvement or refinement – even something like fine-tuning the best patient population. That's just the way it is – it's always an iterative process with these technologies. The biological system that we're trying to address unfortunately isn't well-described and new discoveries are made all the time. We're still learning as we develop a new product. Every new product solves a problem and also introduces new problems – it's been this way since the beginning of medicine. We're continuously trying to address those problems, but we just can't stop and wait until it is perfect . . . it may never be perfect.

So we have to be able to have a system that allows for new technologies and new procedures to find their footing and their place amongst the array of existing alternatives before we subject them to comparative assessment. Otherwise we will wind up validating that the way we have always done it is the way we should always do it, and we will see no improvements in therapy.

BB&T: The IPO window, which has been all but nailed shut over the past couple of years, seems to be opening ever so slightly. Is that a highly positive development for venture investors, or is merger and acquisition still the overwhelmingly dominant area of exit?

Makower: I am encouraged that we will see some more progress there. I think that the bar for companies reaching the point of being able to go public is still fairly high. There are a number of companies that have achieved critical mass and a level of financial performance that would allow them to go public, but there is still some uncertainty of what may be ahead. We are in a much better place than we were a year ago, there is no doubt about it. Things do seem to have stabilized, but I think it's going to be a slow process from here. I don't expect the window to swing open widely; I think it's going to be some special companies, and hopefully will be good companies that will lead the way and we will slowly step back into it.

BB&T: Let's use your company, Acclarent, as an example of the other exit side, the one that has been practiced far more often, especially in the past couple of years. The company sold last year for just under $800 million. Could you talk a bit about how that process went, and how that might apply to other companies that are in that position?

Makower: There is a lot that went into the Acclarent story, not the least of which is the tremendous leadership from Bill Facteau, the CEO there, and the fantastic team that he built. The products worked, and the technology really helped people – that was an important factor. And, quite honestly, there were several other elements that were a part of the Acclarent story that were fundamental to our success. We had a straightforward and predictable regulatory pathway that we executed on. We provided clinical data, we received a clearance, we were allowed to work with the physicians that helped us prove the technology. We were fortunate to have a favorable reimbursement situation where the technology had utility within an existing reimbursement scenario as a tool. And the clinical results were tremendously positive.

All those things came together to create a great opportunity for patients, for doctors, for creating jobs, and clearly a great opportunity for investors as well. It's an example of what we can achieve when the system works and we have an ability to execute on a predictable pathway and within a reasonable amount of time. That being said, before we reached a liquidity event, we had raised close to $100 million in investment capital. We still had a reasonable amount of that in the bank, but that's the type and magnitude of investment that it took to achieve that type of an outcome.

BB&T: Well, it's good for both investors and entrepreneurs to see that type of an exit be achieved, because it's spirit-lifting.

Makower: The great message about the Acclarent story is one for all med-tech investors, and for my colleagues at other medical-technology companies, that there is a light at the end of the tunnel. If your product works, your investors should be encouraged to stay with it, even if it takes more capital than they thought. If they continue to invest, if the product works and improves patients' lives, they will ultimately be rewarded for taking that risk.

BB&T: Your interests in medical innovation are broad, with patents held in areas as disparate as cardiology, drug delivery, orthopedics and urology. Could you describe how your interests in medicine and its enabling technologies developed?

Makower: I teach part-time at Stanford and co-founded the Biodesign Innovation Program with Dr. Paul Yock at Stanford, which is focused on teaching medical, engineering and business students a reproducible process that they can use to innovate in med-tech. Actually, we recently collaborated with Stefanos Zenios and several other authors to publish a book, Biodesign: The Process of Innovating Medical Technologies, and that is the exact process that I use.

I am not a “domain“ expert with respect to the field that I enter. After I work in it, I can become an expert, but I don't enter with a single domain expertise. My expertise is in the process, and that allows me to be confident about being able to deliver solutions to important medical problems; the key is always to understand the problem properly. As we lay out in the book, there is a sequence of steps that one ideally should pursue, which starts off with a very thorough and deep understanding of the problem.

Solving big clinical problems is what we love to do at ExploraMed. I went to medical school because I wanted to help people and solve medical problems, and that's what I'm doing today. I'm get a certain amount of enjoyment out of learning a new specialty and making good friends and relationships with physicians in that specialty, understanding their challenges, and working collaboratively with them to come up with new solutions. To us, the process is the one consistent theme that is the same throughout all of the ventures that we have pursued. It works.

BB&T: Let's talk a little bit about incubators. I love the concept, and I think it is especially good in the biomedical area. Could you talk a bit about how you have gone into it and perhaps what you may do differently than others who are involved with incubators?

Makower: We're fortunate to have a lot of good medical device incubators and entrepreneurs out there who are passionate about what they're doing and really want to improve the quality of life of people. In the U.S., we're fortunate to have a number of organizations like that. ExploraMed is one, but there also is The Foundry, Innovation Factory, several others that are fantastic. Each incubator is as different from one another as are the individuals that constructed it. We all have our own slight variations on theme. Some take ideas from academia and translate that into new companies, others have kind of a resident set of inventors that continuously produce the innovations and then they build teams to go execute on them.

Our model is a little bit different in two ways. One is that we build the business around a special individual that we call the project architect. This person really serves as the co-founder of the business and tends to be an engineer who has the capacity to not only dream and invent, but also lead. In the Acclarent story, that person was John Chang. John was my co-founder there, and he has stayed with the business, and is there today. That is really an important part of the model – to have an embedded individual, along with the project who is responsible for many of the early choices helps solidify the company's culture and history. That's a very important element.

The second differentiating factor is, because we are focused on a set process, we truly do start with a blank piece of paper. We don't start with a solution, or something that has been invented already or comes out of a university. We start with an area of medicine that has a big problem that we are particularly interested in and we dive in and deeply understand the need, and from there we invent. That's where it starts.

BB&T: The past several decades, and especially the past two, have represented a Golden Age for medical entrepreneurship, with the U.S. clearly leading that push. How do we keep that edge in these decidedly different times?

Makower: I'm glad you asked about that, because that is really the thrust of what I hope is the takeaway from our discussion. I believe the Golden Age of MedTech is absolutely sustainable, and compatible with our goals of reducing healthcare costs and bringing high-quality medical solutions to patients. All of us in the industry share the view those are the goals that get us to work in the morning. We want to deliver better care for patients and we want to lower healthcare costs. Every single company that I am aware of in this space has that as part of its mission. It is very important that we as a community understand the key fundamental things that are necessary to sustain the Golden Age of medical technology that we have enjoyed for the last 50-some years and that I hope will continue to enjoy well into the future.

These essentials include:

1) A strong patent system that allows the innovations that we create to be protected and strongly defensible

2) A predictable and reasonable regulatory process that allows us to know what is coming, raise the appropriate amount of funding and execute upon it, and then ultimately deliver products to the market place.

3) A clear, consistent and easily accessible reimbursement system that allows people to receive the therapies that we create, in a reasonable amount of time, and provide for a pathway for payment for early, new technologies even though they haven't been around as long as existing therapies.

If we do all of those things, then we will have the ability to retain the top talent and to attract the top engineers into the med-tech industry, retain investors' interest in our space, improve the quality of life for millions of people and will preserve the very valuable asset that we have in the U.S. as the leader of med-tech well into the future.

BB&T: My opinion is that it would only take some relatively modest changes in the direction, for instance, that the FDA is going in order to really encourage the investor community to believe that yes, they can get a return on their investment in this space.

Makower: I absolutely agree. In fact, the system we had before was for the most part working. There are always examples of where things did not work, but a wholesale change of the med-tech regulatory system is not necessarily required to address some of those issues. As a public, we need to recognize that anytime there is a technology that is new, there is uncertainty. But they should be allowed to have the opportunity to make that choice. The reality is that the existing therapies pose equal or greater risks. We cannot avoid all possible risk if we want to see innovation continue in this space.

BB&T: It's interesting that the consumer is so much better informed about the technologies that either already are out there or are on the way than they ever have been, making it possible for technology to find its way. You kind of have a blank slate to write upon, in a sense, because people are so much more interested in new technology than has ever been true in the past.

Makower: Absolutely right. People are very well-informed right now, so there really isn't a need to tightly constrict the flow of new therapies and technologies that reach patients. It's a new consumer healthcare economy that we are in. Patients are better-informed today than they ever have been, and many of them are now seeking therapies overseas that actually have been created in the United States. That's because of the delays in access to these technologies here, either through the reimbursement process or through the regulatory process.

Some small changes could be done to improve the system, but for the most part, what we had was working. What is most important is that we keep our position globally as a place where people have access to the very best medical technologies in the world. These technologies were created here, and we should keep the jobs here, and allow our own people to benefit rather than solely transporting all of this overseas. Ultimately we can spread those great benefits across the world but it would be a shame to lose our competitive advantage in a market we currently lead.

BB&T: Looking a bit longer-term, what does your crystal ball have to say about medical technology as an industry in 2025, and perhaps ahead to 2040?

Makower: I believe that there is always a pendulum that swings. I think we're on one side of the pendulum right now, and I'm doing everything I can to try get the pendulum back to a place where med-tech will thrive. That will eventually happen. I don't believe that Americans are going to accept yesterday's therapies for all time – that's not our culture. We value the quality of our lives way too much to give up access to new technologies that have a chance of improving or extending our lives. We'll come to the realization eventually that med-tech is a fundamentally important aspect of the American dream – to live longer, and to live better. I hope we can recognize this sooner rather than later, but it will happen eventually, so my outlook for the long term is still very positive.

What I'm trying to do right now is to make sure that the pendulum does not swing so far that we lose ground in our position globally as a leader in med-tech and that our field continues to be an attractive space for young people, for innovators, and for investors. My long-term view is that this will sort itself out and that in the long run we will continue to do great things in medical technology. We're just in a tight spot right now where we can use just a little bit of help from the FDA, from CMS, from the government, and probably from the financial community as well, to get us through and make sure that we have a vibrant med-tech economy in the near term.