What factors should fund-seeking entrepreneurs and thoughtful medtech investors really care about? Joe Mandato, MD of DeNovo Ventures, offers his thoughts
Given the funding challenges facing young entrepreneurs, it’s important you not only identify the most appropriate investors for your medical device – and there are choices, from angels to medtech venture capital – but that you also demonstrate you know what you’re doing and that the opportunity to invest in your project is one investors should take seriously. So what factors should both potential investors and entrepreneurs focus on?
Well, firstly consider how good a business opportunity your medical device offers? Is it a science project? Is it incrementally better than what is currently used? Or is it a disruptive product – one that fundamentally changes the way things are done, one that could turn an industry upside down? Examples of disruptive healthcare products include the Invisalign invisible bracing system developed by Align Technology and the Da Vinci robot from Intuitive Surgical. Both were clearly disruptive in very conservative, slow-to-change categories, but they were also really challenging, costly projects. Yet, for investors, whether crowdfunders or those involved in medtech venture capital, disruptive products can be very exciting and potentially worth the considerable risk to develop.
In addition to the medical device itself, investors care about its stage of development. Judging from the chart below, they are very much shying away from seed-stage investments at the moment. That’s simply because the risk to early-stage investors from subsequent financing rounds is too high. If we pay $5 per share today, depending on the progress or lack thereof, the next round might be priced at $1, thereby causing significant dilution to early-stage investors.
For me, the management and team is the single most important indicator of probable enterprise success. As an investor, I need to be confident that the individual or team presenting to me has the ability, drive and work ethic to achieve their goal. I need to see a leader with the appropriate experience and attitude to form an effective team, lead it and succeed. If that leader isn’t yet present, the team needs to recognise that a leadership gap needs to be filled to increase the probability of success. Or, if the entrepreneur is a trainee who requires a significant commitment of investor time and energy, I need to review if I am willing to make that commitment?
It’s also important to consider if a need for the product been identified, or if a market needs to be created? What about market receptivity? Do potential customers have what they need or, at the least, are they curious and perhaps willing to try out new technology? For example, take Invisalign and the Da Vinci robot. Orthodontists were perfectly satisfied with traditional metal braces, and surgeons never claimed they needed a surgical robot when skilled hands and a cheap scalpel might do. In healthcare, change happens very slowly – and investors need to understand this and, as an entrepreneur, your strategy to create and/or penetrate the market segment you’ve targeted must be clear and believable.
The life science world is a litigious one. Having a firm foundation built around a clear intellectual property (IP) strategy is essential for entrepreneurs as well as potential investors. It’s important to have at the least a provisional patent filed. In doing an IP search, it’s vital that there’s opportunity to own a meaningful piece of the relevant field of intended practice. Also consider IP as real estate to surround with a ‘picket fence’, which will include anticipated improvements to the product and what competitors might do. In other words, think strategically, and hire a highly experienced IP counsel. A proven expert is worth the fees charged; and some of the more experienced might defer fees in anticipation of the likelihood of funding.
Understanding the regulatory challenge in front of you is key to successful financing. In the United States, there are several categories of regulatory approval, the 510(k) being a shorter, less rigorous review cycle and, in the case of many investors, the preferred route. A PMA (premarket approval) requires a much more time-intensive and rigorous review, clinical trial and patient follow-up process. As for reimbursement, understanding the likelihood of successfully achieving insurance reimbursement and the process you have to go through is crucial to funding. Actually having started the process is a critical indicator of the seriousness with which the entrepreneur is dealing with this challenge.
Investors, whether angels or those involved in medtech venture capital, need to understand how they will generate a substantial return on their investment (ROI). A successful investment outcome is based on the reality and understanding of anticipated revenues, when they will begin, how the sales function will be staffed, the degree of sophistication and understanding of projections, and what the projected five-year growth plan looks like. Other variables used to determine potential ROI include: projected capital requirements, and time to liquidate and likely exit options, that is, an IPO (initial public offering) or via a merger with a strategic buyer.
Finally, investors are looking for a solid, realistic deal – one that allows a good return for all parties. As entrepreneurs, you need to understand and appreciate what the technology is really worth at the time of financing and have the data to support such a value. Here are some key questions you should be asking:
So, as an entrepreneur embarking on the long and winding road to raising money, understand that the investing environment has changed. For one, there are fewer healthcare venture capitalists. Many firms have abandoned medtech in favor of software technology and the internet, others have reduced their exposure, and several healthcare-only funds have abandoned the business altogether and wound down their funds. Exit timelines have been extended from three to five years to seven to ten. As a result, for those still in the business, the investment bar has been raised, as firms must preserve capital for existing investments and look for clear and substantial successes that have been ‘de-risked’ as much as is practical. And, as mentioned above, seed or A rounds are suffering as the risk to early investors has increased substantially. As entrepreneurs, you may be forced then to carefully define the most appropriate investor environment, which might include money from friends and family or pre-qualified angel investors, and look for institutional funds later in the innovation process.
But above all, whatever difficulties and challenges you may experience in seeking funding, never, ever give up your dream of changing the world.
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