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Raising Capital in a Cool Investment Market

With proper preparation and presentation, medtech companies can still get the attention of venture capitol investors.

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From its first quarter onward, 2007 achieved record highs in venture capital (VC) investment in life science companies, including biotechnology, medical device, and healthcare services firms. These levels were maintained until the first quarter of 2008; but then, venture investing began to slow.

Since then industry analysts have noted that some of the capital that once flowed freely into life science sectors has been redirected toward other promising industries. But in today's competitive VC climate, venture capitalists are still deploying cash, and substantial opportunity remains for medtech manufacturers to capture those funds.

VC investments are generally long-term undertakings, and there's been a widely held perception that the medtech industry is relatively recession resistant. But in today's economic downturn, venture capitalists are clutching their wallets tighter. The dry market for initial public offerings (IPOs) and a general hesitancy among potential acquirers have also helped create a wait-and-see attitude.

According to experts, competition among medtech manufacturers seeking to obtain investment funding will be heated in the months to come. To be successful, companies will need to sharpen their strategies for attracting investor interest.

Declining VC Investment

During the first quarter of 2008, VC firms invested $2.2 billion in 229 life sciences companies (see Table I). But in the second quarter, these figures dropped to $1.9 billion invested in 209 companies.1 Biotech backings were particularly hard hit, with the number of financings plummeting by nearly 50%, and the dollar amount falling by 40% to $1 billion.

Year
Q1 Investment
($billions)
Q2 Investment
($billions)
Q3 Investment
($billions)
Q4 Investment
($billions)
2006
1.7
2.0
2.0
2.0
2007
2.7
2.3
2.0
2.3
2008
2.2
1.9
Table I. Venture capital investments in life sciences companies, 2006–2008, by quarter. Source: 2007 and 2008 MoneyTree Report by PricewaterhouseCoopers and National Venture Capital Association.

On a year-over-year basis, investment in medical devices and equipment companies dropped from $1 billion invested in 109 companies in the second quarter of 2007, to $833 million invested in 98 companies in the second quarter of 2008.

According to venture capitalists and medtech manufacturers, the recent decline in life sciences investing has been fueled by a number of factors. Among these are the increasingly demanding and complex requirements for FDA market clearance or approval, which are slowing the development of new technologies. In turn, late-stage financing is requiring twice as much capital as might have been required just a few years ago. And there's increasingly more risk involved in getting reasonable returns on investment.

The process for medtech companies to complete financing is slowing, prompting them to plan further ahead. From start to finish, it's not unusual for a financing deal to take six months or more, according to Gary J. Kurtzman, MD, vice president and managing director of the life sciences group at Safeguard Scientifics Inc. (Wayne, PA), a holding company with interests in growth-stage life sciences businesses. Two years ago, says Kurtzman, it would have taken a lot less time.

"There's hesitancy among investors," Kurtzman says. "They're hanging out on the sidelines longer. Investors who traditionally fund ideas are scrutinizing more, being more diligent, and demanding better data."

"It's critical for entrepreneurs to be extremely cash efficient, and achieve technical and business milestones on limited capital," says Matt Rieke, MD, a partner at Quaker BioVentures (Philadelphia), a venture capital investment firm.

"Specifically, at Quaker, we're interested in companies developing new diagnostics and devices for unmet medical needs, where the company already has some human clinical experience and where they can realistically demonstrate clinical proof of principle with $20 million to $40 million in venture capital," he explains.

Finding the Opportunities

Although investment in life sciences companies has declined in recent quarters, there is a bright spot on the horizon. Venture capitalists and industry analysts agree that the outlook for medtech funding will improve in the near future.

But that's not to say the path for raising capital is free of obstacles and setbacks. Take the recent example of Molecular Biometrics (Chester, NJ). Two years ago, the company began raising funds in order to develop an instrument to assess the reproductive potential of embryos for in vitro fertilization procedures. The company was well aware that working in such a niche market would be challenging. But soon, Molecular Biometrics discovered that potential investors were demanding greater due diligence than ever before.

"I wouldn't say people were cavalier about their investments in the past, but surely now there's a lot more vetting of the technology and deeper due diligence slowing the process," says James Posillico, PhD, president and CEO of Molecular Biometrics. "Investors are looking for all kinds of ways to reduce risk or determine if risk is too great to proceed."

Posillico's strategy called for rigorous clinical data, deep market knowledge, strong management, and a novel technology—all presented to investors in a 'dissertation-like' format. To make the case, he also needed a substantial amount of face time with investors.

"We presented loads of information during the negotiation process to ensure investor confidence and to preserve valuation as much as possible," Posillico says.

Attracting Investor Interest

While cases like Molecular Biometrics' are common in today's medtech investing climate, venture capitalists and analysts are confident that solid medtech ideas will continue to come to fruition.

And more than ever before, venture capitalists have a clear sense of exactly what they're looking for when investing in and partnering with medtech companies. Key elements that venture capitalists seek include those described in the following sections.

Unmet Medical Need. Medtech manufacturers with strong, innovative ideas will continue to find funding, venture capitalists say. And the likelihood for success is even greater when the idea serves an unmet medical need.

According to Safeguard's Kurtzman, the rapidly expanding field of regenerative medicine will increasingly attract interest from investors. New technologies aiming to regrow organs and tissues address critical problems facing organ failure pa­tients, including shortage of donor organs, the risk of organ rejection, and toxicity of immunosuppressant medications. In this burgeoning field, scientists and manufacturers are developing such technologies as a regenerative powder to regrow severed fingertips and a device aiming to conduct regeneration of the bladder.

"From a medical standpoint, regenerative medicine enables the human body to restore its natural functions," Kurtzman says. "From an investor's standpoint, this space is interesting because it will provide real results in the near term."

Technologies that target neuro­degenerative disorders, such as Alzheimer's disease and Parkinson's disease, also address a sizable area of unmet medical need. Among aging populations, neurodegenerative disorders are being identified at an increasing rate, and there is a strong need for innovative technologies that provide early detection and treatment. Because the development of therapies in this area is the focus of so many companies, including big pharma companies, there remains substantial opportunity to revolutionize the industry.

Point-of-care diagnostics is another hot investment sector. Companies in this field are moving the healthcare process out of the central lab, and making it more convenient for consumers.

"There has been very little innovation in this space in the past decade," Kurtzman says. "However, that will continue to change and evolve as we head into 2009."

Another major unmet medical need is the development of effective ways to treat obesity. In nearly every U.S. state, 20% of adults are obese, according to the Trust for America's Health (Washington, DC).2 Consumer-focused technologies that target obesity, such as new bariatric surgery devices, gastric stimulation devices, devices aiming to disable the vagus nerve, and obesity-related drug developments, are high on investors' wish lists.

Strong Management Team. Management teams that understand these specialized areas and have been successful with their business models in the past are critical players in the marketplace right now.

"Investors are putting a premium on management teams that truly understand the field and have demonstrated this over time," Kurtzman says.

Data. Within the past two years, investors have begun to review clinical data much more critically than at any time in the past. To have a greater chance of being considered for investment, medtech companies need to present investors with a larger amount and higher quality early-stage research data. Such data include extensive R&D information, pivotal trial results, and more.

It's also valuable to prove to potential investors that the clinical development timeline can be accelerated, so long as it doesn't compromise the quality of the technology.

"If you can accelerate the development program to reach the next milestone on the same amount of money it would have taken following the standard pathway—while still obtaining the appropriate clinical data to support your target indication—you'll reduce risk and increase the value of the program," says Alan Carpenter, PhD, vice president of Avid Radiopharmaceuticals (Philadelphia).

Commercial Opportunity. In today's investing climate, there's also an increased emphasis on commercial opportunity. "As a specialty pharmaceutical company, we're finding that we have to be product focused, not just research focused," says Jane Hollingsworth, CEO of NuPathe (Conshohocken, PA). "This requires a real understanding of the marketplace. You can't just be advancing science; you have to understand the commercial opportunity of the product for patients, physicians, and payers."

Conclusion

Developing new technologies with an eye for the elements discussed above should help medtech firms raise funding. Equally important, however, is the need for companies to evaluate whether potential investors will be suitable partners for their team.

It is essential to find investors that understand the medtech firm's mission, goals, and technology. Such an investor will be more likely to have the experience and knowledge to support the firm and help bring its product to market. The best partners will also be adept at helping companies avoid pitfalls, work through struggles, and overcome obstacles.

Medtech companies should never overlook the value in what some venture capitalists refer to as "a good fit." Large investment funds may be able to offer more financial support, but size in itself is not necessarily always the right attribute. Medtech companies must also evaluate a fund's investment profile, and determine whether it aligns with their company.

It's also the medtech company's responsibility to conduct the due diligence necessary to learn about who the investors are, and how they've served and supported companies in the past.

As for future outlook, much remains to be determined. But venture capitalists, analysts, and medtech companies predict that when activity begins to pick up in the public markets, it should trickle down to the private market.

"The pendulum will continue to swing back and forth," says NuPathe's Hollingsworth. "But signs are pointing to a brighter outlook for medtech investing over the coming years."


References
  1. "Q2 2008 U.S. Results," MoneyTree Report [online] (New York: PricewaterhouseCoopers and National Venture Capital Association, 2008 [accessed 22 October 2008]); available from Internet: http://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/MoneyTree%20-%20Q2%202008%20final.pdf.
  2. F as in Fat 2008: How Obesity Policies are Failing in America (Washington, DC: Trust for America's Health, 2008 [accessed 22 October 2008]); available from Internet: http://healthyamericans.org/reports/obesity2008/Obesity2008Report.pdf.

Renee DeFranco is a writer based in Pennsylvania.

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