For some months now a particularly controversial issue brewing in the healthcare reform debate is a proposal to tax startup and other small medical device companies on revenue rather than on profits. Last week Medical Device Daily spoke with Leslie Bottorff, general partner in Onset Ventures' (Menlo Park, California) medical technology practice, who says the proposed tax would make it harder for ongoing companies to survive and even tougher for startup companies to raise venture capital.
Bottorff, who has been in the VC business for 12 years and prior to that served in various sales and marketing positions in the medical device industry since 1979, told MDD that she fears the device tax issue is getting "lost in the shuffle" of all the other hotly-debated healthcare reform issues. She said that the proposed tax, combined with changes being kicked around at the FDA where device approvals are concerned, reimbursement issues, and patent changes has created "the perfect storm" in the device industry that could ultimately have a very adverse impact on innovation.
"It's been interesting for me," Bottorff said. "This healthcare reform bill has got so many aspects to it and so many moving parts."
Bottorff said she is afraid "people don't realize what kind of an impact" a tax on device revenue could have, if it is enacted, particularly for smaller venture-backed companies.
"This tax is going to hit those companies before they're profitable," Bottorff said. "They're going to have to raise venture capital and before they're profitable give it right back to the government."
Because venture capital firms need to make a higher rate of return for a high risk, Bottorff explained that it will be hard for VCs to invest in a startup company only to see it go towards government mandated taxes. "I'm afraid that it's going to be yet another thing to discourage investors from investing in this area."
And of course without VCs backing startup device companies, the impact on innovation would be "pretty substantial," she said.
While the tax proposal varies a bit from the Senate bill to the House bill, the general idea is the same.
"The way it's going to work is the companies are exempt up until they have $5 million of revenue. Then this tax kicks in at half rate up until $25 million of revenue. Companies over that get taxed the full boat," Bottorff said. "There are no startup companies that are profitable at $25 million. Sometimes they're not profitable until they have $50 million or $100 million in revenue."
The problem is, Bottorff said, that those years of sales when these smaller companies have between $10 million and $25 million in revenue – when, according to the proposal they would be paying the "full boat" in terms of the device tax – is exactly the time when they really need the cash flow. "Cash is king then," she said.
But Bottorff emphasized to MDD that the tax proposal is just "another straw on the camel's back." Other "straws" that the industry should be concerned about are changes being kicked around at the FDA – namely, changes to the 510(k) process (Medical Device Daily, Sept. 25, Oct. 15, and Nov. 17, 2009) – as well as reimbursement issues and patent changes.
What it all adds up to, Bottorff says, is "more time and more money has to be spent for startup companies to be profitable or have an exit event and it adds up."
Bottorff is certainly not alone with her fears of how this device tax could impact the industry. Bill Cook, CEO and chairman of the Cook Group (Bloomington, Indiana) expressed similar concerns recently during an interview that will appear in the January 2010 issue of MDD's sister publication, Biomedical Business & Technology. Citing the combination of a device tax and the increasing burdens from dealing with the FDA's regulatory maze, he forecast, "Most small companies are going to die, or never get started," (MDD, Dec. 9, 2009).
According to Bottorff, "Congress and the Administration both are looking at this in broad strokes and their saying 'gee, we're going to increase the number of people that have insurance,'" therefore the taxes levied on medical device companies will be offset due to an increased pool of insured beneficiaries receiving treatment. "That's a vast generalization ... they're using a blunt instrument to do something that's incredibly complex – the blunt instrument being 'let's just tax revenue.'"
"It's a complete lack of education about the complexities of the industry," Buttorff said. "They're messing with some things ... that could have a really big impact on the American public and their health for the next 20 to 30 years." Then, using a well-known Biblical phrase, she added, "They know not what they do."
In November, Stephen Ubl, president/CEO of the Advanced Medical Technology Association (AdvaMed; Washington), issued a statement after providing written comments to bipartisan leadership on the House's healthcare reform bill, voicing similar concerns regarding the proposed tax.
In the statement, Ubl acknowledged the decision by House leaders to limit the amount of the tax on medical devices, and that the proposed tax is transparent and deductible and would be implemented beginning in 2013 instead of 2010. However, he said, "A number of additional design features are important."
"We recommend that the tax be differentiated by FDA product class to recognize the diversity of medical device products and the thousands of companies that develop and manufacture them," Ubl said. "Small manufacturers with less than $100 million in annual gross receipts should be exempted from the tax, perhaps through a rebate mechanism."
Ubl also noted that, "with diverse companies of all shapes and sizes that produce as many as 80,000 unique products, protections should be put in place to make adjustments if the 2.5% tax rate generates more revenue than anticipated."
The AdvaMed statement followed an earlier statement issued in October by the Medical Device Manufacturers Association (MDMA; Washington) in which that organization said its board had unanimously voted to oppose "any device tax as part of the healthcare reform bills moving through Congress."
MDMA Chairman Joe Kiani, CEO and chairman of Masimo (Irvine, California), said that, "If enacted, this tax will stifle innovation, harm patient care and weaken the position of the U.S. as the global leader in medical device innovation."
Amanda Pedersen, 229-471-4212;