Given the amount of uncertainty that exists in the medical device industry’s landscape, as well as the direction that current market trends within it appear to be pointing, it’s really no surprise that med-tech investors are, at best, hesitant.  After all, hospitals are exerting ever-increasing power via their group purchasing organizations in medical device price negotiations while continuing to hone their ability to garner support from their physicians in an effort to drive supply cost savings.  Throw in imminent comprehensive health care reform, the fact that the FDA is reviewing the 510k approval process, physicians’ relationships with medical device manufacturers are under scrutiny, consumer driven health plans are becoming more popular, and that bundling of reimbursement payments is under serious consideration by CMS and you have a veritable ‘perfect storm’ of risk for med-tech investors and entrepreneurs to contemplate.  However, in spite of all of this or perhaps as a direct result of this, investors and med-tech veterans, alike, are adapting, and a relatively new operating model is gaining traction and evolving in the medical device industry: the virtual medical device firm.

Often employed in the information technology industry, the virtual firm’s success heavily relies on a lean, well-thought-out and skillfully executed operating model.  On the one hand, the key drivers of the firm’s valuation and how those drivers will be developed into a core competency (i.e. a specific sales channel) must be predetermined and, on the other hand, the non-core activities that will be handled by area experts via strategically outsourced relationships (i.e. product development) must also be carefully weighed.  This plan, its inherent value and its specific benefits must then be persuasively communicated to potential investors.  A few of the general benefits of this approach for the firm are:  intense emphasis on developing and maintaining a core competency to drive valuation, keeping management teams small and focused on achieving milestones, relatively low overhead costs, ability to leverage experts in required fields without employing them, and the ability to orchestrate and build scalable products on limited dollars over relatively short periods of time that have exceptional quality.  For investors, the appeal of this model, aside from some of the aforementioned, is its inherent ability to turn resources that are associated with key milestones on, when appropriate, and off, when not required.  This type of approach allows for effective management of the burn rate, thereby achieving capital efficiency:  the effective and dynamic management of the cost needed to efficiently produce upside valuation for a firm, thus maximizing return on investment upon exit.

While managing the cost side of medical device development is certainly one way to increase confidence that an exit will be relatively attractive, it isn’t the only consideration, of course.  Assuming an exit by acquisition, corporations that are interested in acquiring technologies are becoming increasingly selective.  More (as detailed in an earlier post) are walking away from deals unless the firm can convincingly illustrate how the device has:  an unmet clinical need; the ability to solve this need; solid, broad IP protection; a well-defined and explicit reimbursement strategy; evidence that it is cost- or comparatively-effective; a clear, unambiguous FDA path; and been developed under a certified quality system.  While the rationale for most of these may be self-explanatory, the last point-developing a device under a certified quality system-may not be completely intuitive.  Aside from assuring compliance with stringent FDA requirements, firms who are acquiring medical devices must integrate the purchased technologies into their companies.  If the device has issues relating to the comprehensiveness of its design history file or device master record, for example, this is expensive and time-consuming to fix and, as one can surmise, decreases-or worse, eliminates-the likelihood of the device becoming an acquisition target.  Additionally, and more importantly, the FDA and hospitals have made risk management a priority in medical device design.  With more deaths occurring in hospitals-due to medical errors-than highway accidents, breast cancer or AIDS, the rationale for this emphasis on safety is easy to comprehend.  One of the ways by which the FDA is addressing this issue is by providing guidance on human factors (to learn more see: http://www.fda.gov/MedicalDevices/DeviceRegulationandGuidance/PostmarketRequirements/HumanFactors/ucm119185.htm).  The thought is that if devices are easier and more intuitive to use, less errors will occur when physicians use them.  The FDA has approved ISO 14971-1 2007 as a recognized standard for human factors but only a handful of medical device design firms are actually certified.  [Here’s the gratuitous Devicix pitch…]  However, Devicix is 13485 and 14971 certified to 1) address these concerns head-on, 2) illustrate our commitment to patient safety and to the physicians treating them, and 3) provide our clients with devices that only those who strive to lead the industry in quality and service can provide.

While it is difficult to assess just how well virtual medical device firms are performing as compared to their traditional brick-and-mortar colleagues, there are plenty of companies who are using this model convincingly, obtaining funds, entering markets and exiting successfully.  One example, OrthoAccel Technologies, Inc-a firm that was initially engendered by licensing university-based research at the University of Illinois, Chicago under the direction of Jeremy Mao, DDS, PhD-adopted a virtual model.   OrthoAccel used Devicix as their design and development partner, attained CE Mark, is currently selling product in the UK, achieved clearance in Australia, and is undergoing clinical trials in the US in pursuit of FDA clearance.  To learn more about them visit: http://article.wn.com/view/2010/06/09/OrthoAccel_Technologies_Inc_Selected_to_Pitch_at_the_2010_WB/

“A man who has committed a mistake and doesn’t correct it, is committing another mistake.” – Confucius

In light of the last blog entry, we now appreciate what VCs and corporations are looking for and how they aim to reduce their exposure to risk when making their investment decisions. As a start-up company, it is imperative to your success to illustrate how you have identified, addressed and planned to deal with these inherent risks. In the list below, we hope to help you understand some of the potential sources of this risk, in the hopes that this knowledge will empower you to think critically about them and, as a result, will increase the likelihood that you impress your potential funding partners enough to obtain your desired level of funding. (If you’re interested in knowing what the current funding environment looks like, visit www.pwcmoneytree.com, register, and start mining this invaluable resource. If you have other sources of great info that you’ve come across, please share it with us by leaving a Comment below.)

1. Executives don’t research appropriate funding sources, i.e. are pitching to VCs who either don’t fund medical device OR don’t fund the stage that the firm is currently in. Here’s a great site where you will find Angels, VCs and government grants with a significant focus in funding medical device as well as links to the respective firm so you can understand whether they fund your particular stage (click on the FUNDING link on the right hand side of the site): www.strategyinc.net.
2. Neglecting to ask the deal-breaking or -making questions. Any investor that plans to keep their job is going to do a tremendous amount of research (due-diligence) before investing in your company; so should you. Understanding and communicating how your device will implore physicians to change their existing behaviors, what they will react positively/negatively to is crucial to adoption and adoption rate. Be sure to engage with physicians early and often both at the ‘key opinion leader’ level and at the ‘in-the-trenches’ level to obtain feedback on your device.
3. Making unrealistic or uneducated financial projections. Experts suggest that you should apply sensitivity analysis (meaning, have a low, mid and high estimate) to your projections and focus on average sales price and adoption in your target market. Including what it will take to reach break-even is often helpful, as well.
4. Stating that limited competition exists for your product. Competition is not just limited to your direct competitors. A thorough analysis of your indirect competition is warranted and the better you understand them, the better you will understand your unique selling proposition. Illustrate this through a competitive matrix and be honest about the strengths and weaknesses of each alternative, including your own. You can be assured that any investor will be doing this, so show them that you’ve done your homework so they can feel confident in your intellect.
5. Underestimating time and expenses from now until launch. Granted, there is absolutely no way to predict the future but a clear understanding of what the costs will be (burn rate) and how you came up with those costs (are they based on professional service firms’ estimates, professional consultants’ proposals, etc.?) will put you ahead of the game. Also, mapping out the steps required and any contingency plans in the event something goes wrong prior to key milestones will not only help your investors visualize the path but will help keep you focused on being proactive rather than reactive.
6. Failing to communicate your exit strategy/strategies early on. Remember that this isn’t an academic exercise. Real money and time are being invested in this for essentially one reason only: RETURNS. If you forget to communicate what’s in it for your investor, you’ve lost the battle even before you’ve begun to fight. Be sure to have a crystal clear strategy developed and if you can, start the process of courting potential acquirers NOW and be sure to communicate those activities and perceived level of interest in your presentations.
7. Failure to include critical component of business plan. You can use this as a checklist: Name of technology, description of technology, market opportunity, competitive position, advantages of technology over standard of care/competitive offerings, reimbursement, verification of clinical efficacy, intellectual property, required product development, development/management team. Finally, how much money do you need and how will it be used (what will it be spent on specifically)?
8. Being naïve about how the device will be reimbursed and what the current reimbursement landscape looks like for similar products/solutions. Be sure to communicate your understanding that reimbursement is dependent on: product design, clinical indication(s), setting of care and provider type. Don’t make the mistake of looking in to reimbursement issues later on. Start with a strategy that highlights reimbursement so you can deal with those issues early, thus facilitating product launch and reducing hurdles that will ultimately affect your adoption rate.
9. Setting an unrealistic regulatory path. With the amount of overhaul that is happening in this area right now, it is crucial that you have up-to-date information on how to best proceed. Having a regulatory professional that is experienced in the area of your clinical application is mandatory.
10. Ignorance of changing health care reform initiatives. More and more, there is increasing pressure that new devices must be superior to existing ones, not merely non-inferior. Be sure that you take into consideration the move towards having data on comparative effectiveness. It is critical that the new technology improves outcomes, reduces cost OR-best case-both.
11. Setting prices based on competitive offerings, rather than thinking through the spectrum that exists between cost-based pricing and value-based pricing. Prices are going to be under tremendous downward pressure. Allow this to inform your average sales price and the financial models you develop with it.
12. Neglecting to remember that there are multiple stakeholders in the healthcare industry who very often have competing interests/priorities: patients, physicians, hospitals, pharmaceuticals, medical device manufacturers, and insurers. Be sure that you can communicate how your device will appeal to each of these and create win-win situations for all or most of the involved stakeholders.

Here are some other resources that may be of help to you. Brought to you by Medtech Resource Alliance, one our industry affiliates.  So to date, we now have four video presentations of our events on their site:

• “Due Diligence – Deal Preparation from All Angles,” September 29,2009
• “The Economy – How Investors & Management Teams of Life Science Companies are Reacting,” February 25, 2009
• “How Big is My Market? – Evaluating the attractiveness of Med-Tech Opportunities,” October 23, 2008
• “How Virtual are You? – Virtual Companies and Outsourcing in Med-Tech,” February 28, 2008

To view them, click the link: http://www.medtechresourcealliance.com/events.html

“Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security.” — John Allen Paulos

Devicix helps start-up companies with product development and provides strategic consultation on how to best navigate the numerous challenges that are inherent to this process.  In light of this, I thought it might be a good idea to start talking about some of the recent developments occurring in this industry.  In today’s post, we’ll share some corporate and investor (largely Venture Capital) perspectives that were gleaned from some recent national conferences that we attended.

One thing is for sure:  the Obama Administration’s desire to reform healthcare has a lot of people standing on the sidelines wondering “What’s next?!”  People are uncertain but, in all fairness, when is any investor certain?  Almost never.  After all, uncertainty is tantamount to risk and we all know that if you take on increasing risk, you should expect increasing returns.  However, this community is facing:  an environment where mergers and acquisitions are responsible for the majority of the exits, as IPOs are almost at a stand-still; the amount of time to these liquidity events are lengthening to 7-8 years, whereas they used to be about 3-4 years; the amount of investment, on average, is increasing due to increased regulatory pressures and the average acquisition price is trending down putting a tremendous amount of scrutiny on capital efficiency and causing diminishing returns for their funds.  This has, what should be, some of the riskiest investors wondering whether they can afford to make new investments in firms, as they may have to keep some cash around to ensure success for their current portfolio firms.  Some people are saying that VCs are starting to look more like bankers:  funding firms at later stages, becoming conservative, etc. and it’s definitely a buyer’s market for corporations, so their requirements are becoming more and more selective as well.

Below is a ‘top ten’ list of what VCs and corporations appear to be looking for in potential investment opportunities or acquisitions (some are obvious, others are not but should probably be addressed in the presentations you make to investors):

1. Solid, broad, proven and disruptive technology/intellectual property or if similar to existing ‘standard of care’ then faster, cheaper or “better”
2. Addresses a real, unmet clinical need
3. Small, experienced management team with appropriate track record
4. Large market opportunities; greater than $500 million
5. Clear, unambiguous FDA path
6. Cost- or comparatively effective and explicit evidence that it is
7. Existing revenue streams OR less than 3 years to revenue
8. Well defined and explicit reimbursement strategy
9. Capital efficiency (keep management teams small and focused on managing attainment of key milestones; raise less than $40 million over life of the firm, prior to exit)
10. Established quality system in place

More to come…PLEASE COMMENT ON THE ABOVE WITH YOUR PERSPECTIVES

What we strive to accomplish with this new feature on our site is the formation of an online forum where people working in the medical industry can participate in value-added discussions.  We will provide summaries of some of the key events that we attend, as well as some of the take-home messages from these events, as we understood them, to serve as a topic. What we hope you, as our readers, will do is provide related comments and feedback from your own experiences, whether personal or professional, that will serve to enhance the content and perhaps spark a broader discussion.

While Devicix is a contract engineering services firm that works exclusively for the medical device industry, we are interested in hearing from individuals from the entire spectrum of the medical industry i.e. health insurance, healthcare providers (nurses, dentists, doctors, pharmacists, etc.), hospital administrators and staff, manufacturers, employers, governmental regulators, executives of start-ups, etc.

We recognize that our perspective simply cannot reflect the vast diversity of perspectives in this industry so we also welcome and encourage guest bloggers.  If you have a topic that you¹d like to post to this blog, please contact Anil Asrani (aasrani@devicix.com) with a brief pitch.

Also, the classic disclaimer for these types of communication channels applies: the views expressed in this blog in no way reflect the opinions of Devicix, its management team or its employees.