May 23, 2011

Medical Device Daily

Funding gap is a continuing problem for start-up firms

Saying that there’s a funding gap for entrepreneur-driven, potentially innovative medical technology companies isn’t news. News outlets covering both med-tech and the venture capital business – this publication certainly among them – have been carrying that message for two going on three years now.

Things were no different leading up to this year’s edition of the annual MedTech Investing Conference, which marked its 10th anniversary in a blitzkreig of panels and other presentations last Thursday at the Graves 601 Hotel here.

Among the “state of investing” reports put forth recently was one showing that while the total amount of venture dollars invested in U.S. device firms was up somewhat in 2010, the percentage of total VC spending that went to medtech as an industry alarmingly skidded to 10.3% from the high-water mark of 13.6% in 2009.

Whereas medical technology has had a charmed life with venture investors, usually ranking second or third among all industries in terms of percentage of funds gathered in, the sector now ranks fourth, with no real sign of it getting back in favor.

Bill Harrington, partner in bellwether med-tech venture firm Three Arch Partners (Portola Valley, California), chaired a morning panel at the conference titled simply “The Funding Gap.” He was quick to point the finger at the FDA, saying in introductory remarks that “the uncertainty and
capriciousness at FDA has impacted technology investing.”

Panelist Mike Carusi, general partner with Advanced Technology Ventures (Palo Alto, California), jumped right in, although with uncharacteristic understatement. “The FDA has become more challenging, to say the least.”

He said that because of the ratcheted-up regulatory environment VC firms have a tendency to steer away from deals where the company involved seems likely to have to follow a tortuous regulatory path. “Ideally we’re looking for deals with a clearer path,” Carusi said.

Fellow panelist Allan May, founder of Life Science Angels and managing partner of Emergent Medical Partners (also Portola Valley), said that universities, the traditional breeding ground of new ideas of all sorts, “are getting the message that VC dollars just are not out there.”

That is having the ultimate effect of ideas being put on hold. “It isn’t uncommon for ideas to be around for one year, two years before getting an audience,”May said.

Hank Plain, another panelist who is a partner in Morgenthaler Ventures and heads up noted device incubator The Foundry (both Menlo Park, California), hailed “big ideas,” saying the firm’s strategy is to ride such efforts with larger, longer investments that reflect the increased amount of time it is taking to get new technologies to proof of concept and beyond.

“The cost to do a device trial is not enormous,” Plain said, “and doing a randomized trial will help regulatory requirements – we think there’s good value in that.”

Carusi was another who touted the gathering of good clinical data. “We hope to have our companies get well over the [regulatory] bar, whatever the bar is.”

Asked by Harrington how his firm accommodates the “shifting goalposts” of FDA clinical requirements, Carusi said, “That’s a big problem, and it’s why doing trials outside the U.S. is more popular these days.”

Harrington observed that doing trials in Europe amounts to doing a “mini” version of what will be expected of them in the U.S., adding that having such clinical data “helps attract late-stage investors.”

Like his fellow panelists, Casper de Clercq, a partner in Norwest Venture Partners (Palo Alto, California), also laid blame at the feet of the FDA, saying, “Developing companies need clinical data, so they go to Europe to get some data as well as some early revenues.”

Saying that development-stage firms “tend to be cash flow-negative for a long time,” de Clercq warned that “we need to fill that gap,” although he anticipates the decline in availability of capital lasting “three or four more years.”

Harrington cited “structural changes in our industry,” with the pace of fund formation being “much slower in recent years.”

Carusi said that has made the task of forming syndicates of venture investors to gather the necessary funds all the more important. “We want to invest alongside a syndicate that has staying power,” he said. “If you have a stronger syndicate, you have more options.”

Saying that “we’re seeing early-stage investors losing direction,” Plain added “but there is money to be made in late-stage investing. The survivors are going to do very well.”

May said, “we are offshoring innovation. There is opportunity, but how to get there is the question.”

Harrington said he sees a trend toward smaller deals, calling it “small ball” investment.

But Carusi’s stance on that is that “I can’t bring myself to do it. What I struggle with is, what happens to those companies when they need more money to reach the finish line?”

Harrington nodded agreement, saying that “in a large fund, it’s hard to justify a small investment.”

de Clercq chimed in with, “Make sure you have enough dollars to get to the end.”

Plain touted angel investing, saying that such funding “can get you moving toward solving some issues and perhaps toward a quick exit.”

On the topic of strategic investors or buyers, Plain said, “demand for innovation is up, but supply is down.” The tendency, Plain said, is for the larger companies to buy something before it is FDA-approved.

Carusi said the space is seeing much more investment activity by strategic partners. “They bring a lot of value and knowledge, although their presence as an investor can make the eventual M&A process a little trickier.”