Medical Device Daily Executive Editor
MINNEAPOLIS — While venture capitalists are expected to be calculating in making decisions on how and where to invest the monies they manage, they're also known for being pretty passionate about the spheres within which they operate.
Both were in evidence during a session of the 7th annual IBF Med-Tech Investing Conference at the Radisson Plaza Minneapolis Hotel in mid-May co-presented by International Business Forum (IBF; Massapequa, New York) and Upper Midwest industry association LifeScience Alley (St. Louis Park, Minnesota) that featured four VCs responding to "Lightning Round" questions posed by one of their brethren.
Behind deft prodding by moderator Bill Harrington of Three Arch Partners (Portola Valley, California), the panel hewed to the "lightning" aspect of its theme, with quick, brief responses the order of the day.
On the optimistic/pessimistic question, which he posed at the end of the hour-long session, asking the panelists for their views toward the sector over the next couple of years, Harrington made the "optimistic" straw poll unanimous, telling the overflow audience: "You've heard a lot of concerns [about the state of the sector], but the consistent theme for this panel is that they're optimistic."
There is, he said, "a general buoyancy among those doing these deals."
As the panel discussion got under way in the wake of a previous session that bounced between cautious optimism and substantial pessimism for the sector (see below), Harrington's panel featured a dash of the latter, but a whole lot more of the former.
"We just heard a sobering overview of our sector," he said, asking the panelists if they were doing more, fewer or about the same number of med-tech venture deals in light of the overall struggling economy.
Two Rich Ferrari, co-founder and managing partner of De Novo Ventures (Palo Alto, California), and Gordie Nye, general partner in Prism VentureWorks (Needham, Massachusetts) said they were doing about the same number of deals, with Ferrari adding, "but we're much more selective" about which deals his firm does.
The other two panelists Kristine Johnson, president and managing general partner of Affinity Capital Management (Minneapolis), and Mark Brooks, managing director of Scale Venture Partners (Foster City, California) said their firms are doing fewer deals these days.
Noting that in such uncertain times, VCs are finding that "there's too much money chasing too few good deals," Harrington asked the panel the key factor applied in deciding which deals to pursue.
For Nye, familiarity breeds comfort. "We like to talk with people we know well," he said.
Brooks said, "The clinical pathway and regulatory pathway are not getting any shorter, so you have to be willing to put $15 million or $20 million into a company" to see it through those processes.
Johnson said that a lot of focus at her firm has been on reimbursement, while Nye added: "We spend a lot of time on setting milestones. We have a bit of a 'taffy pull' over time to exit."
Harrington chimed in with the observation that at Three Arch, "we spend a lot of time finding answers for the question, 'Why is this technology going to be adopted?'"
For Brooks, the key question to be answered is, "How are you going to raise the next round of financing?"
Ferrari said the most important element "is time to exit, the amount of money needed to get there and how risky it is to get there."
Saying that "at the end of the day, how we get there is the most important specific factor," he drew laughter and knowing nods from the audience in declaring: "I hate PMAs [pre-market approval applications]."
Noting that really game-changing technology has to take the much more rigorous and costly PMA route to FDA approval, Harrington asked Ferrari, "Can you afford to ignore PMAs?"
The firm doesn't ignore PMAs, Ferrari said, just favors those firms going the less-stringent 510(k), or "me too" route. With PMAs, he said, "you don't have predictability as to the outcome, and the risk factor is huge. It can take $30 million to do your clinicals."
Johnson also isn't big on having to take the PMA route. "PMA companies make sense only if the [potential] markets are huge. Part of the judgment we make is really understanding the degree of unmet need. If there's an unmet need, there's room for novel technologies that address it."
Nye said management teams at companies his firm and other VCs invest in "need to have the ability to manage these long trials. The experienced ones know how; the inexperienced don't know what hit them."
Ferrari agreed, adding: "Most management teams tend to underestimate the time needed to complete trials." So, "I'll always back experienced guys."
He said that, particularly in today's economic climate, "You need to be extremely capital-efficient. CEOs need to run the leanest, tightest ship possible."
After hearing Ferrari's observation that "throwing money at some of these problems is not going to solve the problem," Brooks added, "That can be as true of 510(k) companies as PMA companies."
After Ferrari noted that the average time to market now is in the 7- to 9-year range, Johnson chimed in: "And the amount of money has gone up accordingly."
Nonetheless, she added: "There still is opportunity to get good returns" on a firm's investment.
The panel discussed changes in M&A strategies, especially among the traditional "big company" acquirers who for the most part are on the sidelines now.
"We're seeing some unusual acquirers step up these days," said Harrington.
Nye noted that "we used to see company plans based on being acquired by Johnson & Johnson, Medtronic or Boston Scientific Boston Unscientific, or whatever they're called these days."
Now, he said, development-stage firms eyeing the exit have to "make yourself bite-sized in order to be acquired make sure it works for a more modest exit."
The good news, Ferrari said, "is that M&As are not going away. What is drastically changing is the premium involved."
With large companies having been stung by deals that went bad, he said, today's buyers tend to be smaller. But, said Ferrari, "there are a lot of mid-cap companies out there" doing deals.
"Some 75% of deals now are $150 million and under," he said, "but that's still a good outcome."
Optimism, pessimism share podium
So the outlook for med-tech as a sector of interest to investors is pessimistic, right? That depends on who you're talking with or listening to.
The opening session of the 7th annual IBF conference featured alternating waves of optimism and pessimism.
In the leadoff position and taking an optimistic stance was Jay Hare, partner in the Technology Industry Group at PricewaterhouseCoopers' Minneapolis office, who cited findings from the firm's MoneyTree Survey, a quarterly study now in its 13th year.
In Hare's view, the outlook for the industry, even in troubling times for the overall economy, "is a mostly sunny forecast." He supported that view with snippets from MoneyTree surveys past and present, including $4.1 billion in national medical device venture capital investments in 2007, up from $2.9 billion in 2006.
Another significant figure is the percentage of overall venture capital investment going to medical device companies a very healthy 13.5% in 2007 that nudged even higher to 14.3% in the 1Q08 survey. That's more than double the percentage of just a few years ago.
Playing to his local audience, Hare noted that medical device investment in Minnesota grew to $244.2 million in 2007, continuing a growth trend in place since the bursting of the dot.com bubble at the beginning of this decade. "Medical devices has been the No. 1 venture investment sector in Minnesota since 2001," Hare said.
Overall, the state attracted 5.9% of all U.S. medical-device investments last year, placing it third behind California and Massachusetts in that category.
As usual, California was the runaway winner in the "total dollars invested" category, garnering $2.02 billion in device-related deals, or 48.9% of the total invested nationally. Massachusetts' total was $346 million, or 8.4%, and Pennsylvania and Washington rounded out the top five. All told, those five states accounted for 72.8% of U.S. medical device funding.
He also cited the growth in average size of med-tech investment deals nationally, hitting $10.5 million last year compared to the traditional range of between $7 million and $8 million. In Minnesota, the average deal size exceeded the national figure, topping out at $12.1 million.
As for where the industry is headed, Hare said venture firms are looking more at development-stage companies, and forecast that the positive momentum for the sector will continue, at least in the near term. He said the industry "should see a very good year in the remainder of 2008, and that may extend into 2009 as well."
Clearly on the opposite side of the spectrum was Phil Nalbone, managing director for equity research at RBC Capital Markets (San Francisco), who cited numerous "big challenges" facing public companies in the sector in a fast-paced presentation that was coated in pessimism.
Nalbone, who has more than 15 years of experience as an analyst covering the medical technology sector, cited "the slowdown in growth for the big players and generally disappointing results among newcomers" as reasons for the decidedly disapproving looks being given the sector by both large and small investors.
While acknowledging that "there is plenty of good science and products out there," he said the path to an initial public offering (IPO) "is a lot less clear" these days. In fact, Nalbone said he expects to see "a lot more deals to sell [companies], rather than waiting for an IPO."
Noting that the past three years have been "very difficult for the major players," he said cardiovascular and spinal markets two traditional high-growth sectors "have slowed down a lot."
Nalbone said one of the reasons for the poorer financial performances by many public med-tech companies is that "reimbursement and product approvals have gotten a lot more challenging," which in turn has meant that there has been "no big surge in new, game changing-type products."
As an example, he said that the U.S. market for implantable cardioverters defibrillators (ICDs), once just about the hottest of hot new device markets, now is growing in the low single digits. He characterized ICDs as "a $5.5 billion-a-year market that is moving sideways."
As for drug-eluting stents, the go-go growth market of the early part of this decade, Nalbone said that now is a static, $2 billion-a-year market in which "an increasing number of players are duking it out for market share."
He cited the aesthetics market, long regarded as one of the honey pots for med-tech because it is a largely self-pay field not influenced by the foibles of reimbursement policy, as providing graphic evidence of the industry's problems.
"The party for aesthetics companies ended abruptly with the economic downturn," Nalbone said.
An accompanying slide headlined "The Economy Trumps Vanity" underscored that view.
"There really are no safe havens" in the present economy, Nalbone said. Noting that he has been keeping records on IPOs in the med-tech sector since 1991, he said that only two IPOs have been done in the sector thus far this year, with another six or seven postponed because of market conditions.
"I expect the public markets to be more receptive [to such offerings] later this year," he said, "but the companies going public will need to be more mature, since public investors just aren't willing to take VC-type chances."
That's because, according to Nalbone's statistics, of 26 deals done over the past 24 months, 60% were priced below their original range.
And from the investors' perspective, even worse news is that in looking back, "the average deal has a company now trading at 18% below its offering price. Obviously, those investors aren't happy."
Backed by another slide titled "The Land of No Second Chances," Nalbone said that quarterly financial performance "is imperative," especially with the average holding period by an institutional investor now being just over six months.
"We have seen tremendous changes in volatility and turnover," he said.
Raising $$ is the challenge
While "there's plenty of good science and innovation going on," as Shelly Wall Lanning put it in introducing a panel discussion she was moderating during the conference, getting the funding to bring that science and/or innovation to market is the key challenge.
Lanning, managing director of HealthCor Partners (New York), moderated the panel on "Creating Innovative Device Companies," which included a mix of small-company CEOs and venture capitalists who shared a wide range of thoughts with a near-overflow audience on how to make such companies happen.
John Deedrick, co-founder and managing director of Accuitive Medical Ventures (Duluth, Georgia), is in on the start-up of companies via his firm's symbiotic relationship with The Innovation Factory (also Duluth), a growing medical-device incubator.
"We look for unmet clinical needs and unmet markets," he said. "That doesn't always work out, but, as one of my partners says, 'That's when the magic happens.'"
Making great sense himself, Deedrick said, "We just look for things that make common sense."
For John Sullivan, an associate with Foundation Medical Partners (Rowayton, Connecticut), unmet clinical needs are a "must have" for anyone hoping to take an idea from a few scribbles on a pad of paper to a flesh-and-blood company to commercial reality.
"You need a large enough market to give yourself some wiggle room" in trying to get a new company and new technology established, he said.
Sullivan said the current difficult economy isn't a deterrent to VCs looking for ideas to get behind. "The needs are still there," he said. "In turbulent times, there are opportunities."
Mike Berman, who describes himself as a "medical device venture catalyst," said his Berman Medical (Minnetonka, Minnesota) firm looks 1) to invest in "a space that has potential," and 2) works with people "who will be solid and capable when you hit the inevitable bumps."
As for investing in later-stage companies, he said "you're much more focused on the technology at that point."
Deedrick noted that in working with start-up and early-stage firms, the regulatory and reimbursement challenges need to be thought through. "You don't need to have all the answers, but do need to be thinking about it."
For Sullivan, "IP [intellectual property] is very important; you need to have the idea that you're going to be able to get there" in terms of appropriate patent protection for the technology being developed.
Jerome Edwards, founder and CEO of Veran Medical Technologies (St. Louis), brought the perspectives of what he referred to as "a first-time entrepreneur and first-time CEO" to the discussion. "At my core," he said, "I'm an engineer and an inventor."
Veran is developing a platform technology for 4-D image-guided delivery that can be applied in different markets. Its initial application is for lung biopsy, to help diagnose and treat patients earlier.
Formerly in product development for Medtronic's (Minneapolis) Surgical Navigation Technologies and Sofamor Danek business units, Edwards said, "People are what make ideas and companies successful."
He noted that raising "angel" financing to get his company started was "a difficult process, but I was able to raise more than most companies do." He added, "If you're a first-time entrepreneur, don't waste your time with VCs until after you have angel money and proof of principle to show those VCs."
John Seaberg, CEO of NeoChord (Minnetonka, Minnesota), a company focused on developing less-invasive solutions for mitral valve regurgitation, said the path to building the company started with licensing technology developed by two Mayo Clinic (Rochester, Minnesota) physicians.
Perhaps the most important step, he said, was in making a key hire John Zentgraf, a former colleague at Guidant (Indianapolis). "John's strengths are in areas where mine are not as strong, and vice-versa," he said. And "our timing was great," Seaberg said, "because a lot of our former colleagues were available to us" in the wake of Guidant's acquisition by Boston Scientific."
From Seaberg perspective, "We have found it surprisingly easy to raise money from some very savvy med-tech people."
Berman, who co-founded Velocimed (Maple Grove, Minnesota), which was sold to St. Jude Medical (St. Paul, Minnesota) in 2005 for $82 million plus $180 million in earn-out payments, said the most significant mistakes made by start-ups "generally have to do with underestimating the time and difficulty of doing clinical trials."
Edwards talked about building momentum to drive adoption of new technologies. "You have to get to know your key opinion leaders. You have to survey the markets and pick the docs you want to work with you have to see how their peers respect them."
He said he and others involved with his company have devoted considerable time to attending medical meetings in the appropriate specialty areas to identify physicians that met those criteria. "And then you need to build a relationship with them."