CLEVELAND – Even in the best of times, being a start-up company on the hunt for funding in the healthcare field can be challenging. Now try looking for money when by all accounts, the U.S. has slid into a recession that no one sees ending anytime soon.

A panel at this year's Cleveland Clinic Medical Innovation Summit consisting of venture capitalists and start-up CEOs attempted to give fledgling healthcare companies some guidance to work with in this difficult funding environment.

Panel chair Harry Rein, a general partner of Foundation Medical Partners (FMP; Rowayton, Connecticut), provided some comfort to attendees involved in the med-tech sector when he noted that medical devices "are looking pretty good over the last four years compared to the other sectors of healthcare, which would be biotechnology and specialty pharmaceuticals."

While Rein characterized the overall healthcare market as "relatively stable," he said when VCs and entrepreneurs start thinking about taking companies public "it's not an overnight process — it takes roughly five to 10 years after a company is formed."

He said that while there has been lots of talk about how VCs, entrepreneurs and venture capital investors can get wealthy from a successful healthcare investment, in looking at the exit value of companies in this space, "they're not at the $700 million or $2 billion level, they're substantially lower," between $32 million and $255 million on average.

Rein said this really speaks to the issue of "the need for capital efficiency when you're building a [healthcare] company."

Michael Greeley, a general partner at Flybridge Capital Partners (Boston), expressed his firm's preference for compiling a syndicate of investors and providing funds to companies in smaller tranches as opposed to larger lump sums, thus spreading out the risk and financial outlay for the parties involved. "My rule of thumb when talking to entrepreneurs is, 'let's build the syndicate and get you three or four years forward. You may not draw the capital today, but know that you are fully funded to meet a series of important milestones.'"

Not surprisingly, Peter Klemm, PhD, CEO of Predictive Biosciences (Lexington, Massachusetts), a developer of diagnostics for cancer management, and a recipient of tranche funding from Flybridge and other syndicate investors did not express the same amount of enthusiasm for the small tranche.

"I think that sometimes the tranche has certain milestones associated with it which were defined at a time when everybody thought the company was going to go in a certain direction," he said. "As data occur, as markets change, as opportunities arise, you sort of drive management toward a certain direction – [that] everybody is going to deliver on this. But at the time, perhaps overlooking other [good] areas which we might have looked into if we hadn't been looking in one direction."

Jan Garfinkle, a managing director of Arboretum Ventures (Ann Arbor, Michigan), said her group does more non-tranched deals than tranched ones, but noted that in either case, "it requires a great amount of trust between the CEO and the board to ensure that if there is a tranche that the milestone is going to be hit and that everyone is working towards it."

She characterized her group as "very capital-efficient," primarily investing in companies seeking to go the easier, and generally cheaper, 510(k) route toward FDA approval rather than the more onerous route of the PMA, though she said they have invested in companies going that direction if they are truly compelling.

Richard Emmitt, a general partner of the Vertical Group (Summit, New Jersey), said his firm prefers tranches, particularly in the early funding rounds, for new med-tech companies. "We like the companies small and we want to minimize the investment until we know that we have something."

Rein queried the panel on what their expectations are for the FDA, especially with most people in the industry expecting more rigorous scrutiny from that agency and possibly a shift to require more products to undergo the tougher PMA route rather than the more streamlined 510(k) process.

Mike Connolly, CEO for Miribalis Medica (Bothell, Washington), a company developing a non-invasive treatment for uterine fibroids that employs focused ultrasound under guidance via imaging ultrasound said that while the 510(k) would be nice since it usually means a faster approval for a device, he noted that much of the legwork required for a PMA is required to get reimbursement in place anyway, "so I don't see it as that much more incremental to have to go the PMA route."

Garfinkle concurred with Connolly, noting that to get physicians to buy any new technology, "You need a lot of data. So you either collect the data via a PMA or you collect the data via a post-market study, but in either case, they want to see a lot of follow-up now."

With the markets being as tight as they are, Rein asked the panel what are the prospects for new funding in the future, especially in the next year or so.

Greeley said that while he would not discourage an entrepreneur from starting a new company in light of today's funding conditions, "I think you need to moderate or change the way you've done it historically, and I don't mean to sound like a broken record but I think that investors in this market want a second bite of the apple sooner, so it's incumbent on the teams to develop milestones that will be within 12 to 18 months instead of 18 to 36 months."

He said that he does worry that his group may have to make unexpected "inside investments" rounds in existing portfolio companies, and there may be a great deal less capital floating around to fund the next new exiting technologies.

"So if you need to raise capital at the end of next year, I think you need to start [looking] today ... because people will be unnaturally distracted right now," Greeley said.

Rein asked the panelists what their stance was this time in light of the potential changes coming to the healthcare field, for good or ill depending on one's political bent, because of the way the just-completed election went.

Greeley said his group is erring on the side of caution, "waiting to see what the smoke signals will be" from the new administration and Congress. "I think the assumption is it will be more expensive than it has been historically, which is hard to believe, but I think for us it's still a little early to be definitive."

Emmitt said that his group also is interested in capital efficiency, which he characterized as just a code word for "rate of return," so they haven't really changed their operating strategies of their companies both big and small.

In looking at the big picture, he said his firm "was more affected by what's going on with the financial markets now than what the president may or may not do a year from now. We're not doing many new deals. We're keeping our powder dry."

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