BB&T Contributing Editor

MINNEAPOLIS – The annual MedTech Investing Conference, held here for the 10th time in the latter part of May, was a veritable bonanza for entrepreneurs seeking either information or networking opportunities with potential investors.

The meeting, held at the Graves 601 Hotel, drew a sellout crowd of 375 attendees, and several of the panel discussions proved so popular that standing-room-only was the operative phrase for the hotel's ballroom. The conference is a joint project of International Business Forum (IBF; Massapequa, New York) and LifeScience Alley, a Minnesota-centered medical-products industry advocacy group. As evidence to its popularity, the gathering has drawn more than 2,500 attendees over its lifetime, many of whom come back year after year.

This year's topics included a look at the growing trend of medical innovation moving elsewhere than the U.S., a topic also touched on by the event's keynote speaker (see below); the availability (or unavailability, as is increasingly the case) of venture funding for start-ups; breaking into Asian markets; and whether to build to “flip“ technology to a corporate buyer or to build to be an operating company.

Innovation heads elsewhere

Medical innovation indeed is slowing in the U.S. and growing in other parts of the world. That's the crux of a report from PricewaterhouseCoopers (PwC) that led off the conference. Albert Malvehy, MD, global account director of PwC's Healthcare Group, handled the presentation, discussing the firm's Innovation Scorecard, which assessed the innovative capabilities of nine countries.

The nations involved in the scrutiny included traditional global leaders such as the U.S., Germany, Japan, France and the UK, along with device-development hotbed Israel and up-and-comer global markets China, India and Brazil.

The basic message of the study is that the traditional pillars of medical innovation in the U.S. are changing to more of a global focus, in part because of domestic financing and regulatory challenges, but also because of the efforts being put forth in other countries

While the countries that make up the largest European markets share a history of med-tech history with the U.S. and are benefitting from the growing trend by U.S. firms to do clinical trials in Europe and seek the CE mark as an initial commercialization strategy, Malvehy cited the “emerging growth market“ countries as places where innovation is making the largest relative strides. At the opposite end of the scale from the U.S., which he said is “experiencing the most rapid relative decline“ in medical innovation, he said China, India and Brazil are “accelerating relatively faster.“

Malvehy outlined what PwC calls the five traditional pillars of medical innovation in the U.S. – financial incentives, technical reasons for innovation, supportive regulatory system, price-insensitive patients, and supportive investment community.

The U.S. continues to lead by a sizable margin in the financial incentives area – in healthcare spending, some 19.3% of gross national product (GNP), compared to 17.9% in Germany, 16.7% in France, 16.7% in the UK and 9.9% in China. But the last figure is misleading, because the pace of healthcare spending in the latter country is growing by leaps and bounds. Malvehy said that by 2020, China will be No. 2 in percentage of GNP spent on healthcare – a remarkable growth rate by any measure.

In the area of innovation support, he said innovation networks are “going global,“ with leading U.S. and European research organizations and universities – he cited M.D. Anderson Cancer Center (Houston), Johns Hopkins (Baltimore) and the Mayo Clinic (Rochester, Minneosta), to name a few – now being involved in partnerships throughout the world.

Malvehy said the U.S. “will continue to lead in R&D spending, but China has passed Japan and is closing fast,“ now ranking second worldwide in both R&D and the resulting patents.

As for the third pillar, the regulatory framework, he said the U.S., long the leader in new medical technology, now ranks third in new-product approvals and a distant seventh in “ease of approval.“

Malvehy said that “as the rate of patent filings in developing countries increases, so presumably will their attention to intellectual property protection.“

He said that one of the key differences between the U.S. and Europe regulatory climate is that the U.S. experience is noteworthy for “the capriciousness and uncertainty in reviews,“ as well as elevated requirements for clinical data.

As for price-insensitivity, PwC says the U.S. spends five times as much on patients' hospital stays as even its relatively similar European industrialized counterparts. That's changing, Malvehy said, to a push to move patients out of the hospital earlier or not go in the hospital at all.

The final pillar, the investment community, also is changing significantly, he said, with emerging markets now becoming more and more entrepreneurial. At the same time in the U.S., med-tech has fallen from its usual status as No. 2 or No. 3 as a sector of interest to VCs to No. 4 on the list.

Paulsen slams policies holding med-tech back

Congressman Erik Paulsen of Minnesota is co-chair of the House Medical Technology Caucus and an unabashed supporter of the industry that employs thousands of persons in his home state. A member of the House and Ways Committee, which has jurisdiction over healthcare among its many fiats, Paulsen was the keynote speaker at the conference, clearly showing why he is known as an advocate for the device industry, the technologies it spawns and the jobs it provides in Minnesota and throughout the U.S.

“It's a tough environment for you right now,“ he said, “but I really think that med-tech is an American success story and a Minnesota success story for sure, and I want to continue to see that happen. As well as being the land of 10,000 lakes, Minnesota is the land of technology. It's also the home of 400 medical device companies and 35,000 jobs – it's a big deal in this state.“

Paulsen said that such companies “are exciting places to work, working on techniques that will make a difference in healthcare in the future. That is why I am so proud to champion this industry and be a passionate advocate for it. All of you are a part of bringing the wonders of these technologies to bear, and fortunately you are succeeding in a really tough environment that is getting even tougher.“

In turning to the knotty issue of dealing with the FDA, he said, “I could go on and on about how the FDA approval process is unpredictable and it takes you longer to get an approval here in the U.S., two years longer on average than it does in Europe. But you know all those stories all too well.“ Paulsen said the fundamental challenge is, “How do we change the culture at the FDA? How can we make it more amendable to getting these lifesaving technologies to market without needless delays?“

He said hearings on the FDA already are taking place. “The question is, is there a better way? Well, there is better way, and as co-chair of the caucus I have an opportunity to put a human face on some of the FDA's foot-dragging.“ Paulsen said he's hoping those hearings “will bring to light some of the problems companies are having in their dealings with the FDA. If you look at Europe, not only do devices get to market much faster than they do here, they don't cost as much as they do here in the U.S.“

Saying that he hears regularly from investors about the risk involved in working with the FDA and how it makes its decisions. “This regulatory uncertainty absolutely affects access to capital. It's absolutely disconcerting to me when I hear an investor say today [earlier in the conference] that now they will only invest in companies who are staring their clinical trials in Europe, so innovation is starting to move offshore.“

Paulsen added that the FDA isn't the only hurdle. “Another one that is on the horizon is the device tax. I have heard companies say they'll be cutting R&D to pay that tax, [but] that's where innovation comes from. I want to make sure that congress and the administration understand what the real effects of such a tax are. We'd like to see adjustments or changes in any way possible.“

Funding gap a continuing problem

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 heightened regulatory hurdles, VC firms have a tendency to steer away from deals where the company involved seems likely to have to follow a tortuous regulatory path.

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, who is a partner in Morgenthaler Ventures and heads up noted device incubator The Foundry (both Menlo Park, California), hailed “big ideas,“ saying his 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 U.S. is more popular these days.“

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.“

Citing “structural changes in our industry,“ Harrington said the pace of fund formation has been “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.“

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?“ 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.“

Asian markets draw interest

Asia, and especially China, was on the minds of conference attendees as they listened to a group of panelists discuss “Breaking Into Asian Markets.“ A wide-ranging discussion on market opportunities in the region, as well as on how regulatory and reimbursement processes differ from the U.S. and elsewhere, included panelists J.P. Peltier, managing director at Piper Jaffray & Co. (Minneapolis); Barry Wilson, former president of Medtronic (Minneapolis); and Chen Yu, MD, a partner in Vivo Ventures (Palo Alto, California).

Citing China's ranking as the world's second-largest economy, Peltier emphasized that there has been “a lot of growth of its healthcare system,“ especially in rural areas. He noted that the growth is a reflection of the need to improve healthcare under China's universal system of care, which covers some 90% of the population.

Peltier also hailed what he said is a “significantly improved“ intellectual property structure, with “much better IP law“ and a new mindset of “moving from copying to inventing.“ Wilson said that IP enforcement “isn't what it needs to be, but the environment is getting better there – they're getting after the abuse systematically.“

Yu isn't quite as convinced, saying, “The situation is improving, but for U.S. companies going into China, my advice is, 'Watch your back.'“

Peltier said U.S. firms need to develop products “that are cost-effective, not only for China, but also India, Eastern Europe and other emerging economies.“

Citing a reality that in many ways pervaded the conference, Yu said his firm “began feeling back around 2005 that U.S. growth was slowing, so we opened a China office then.“ Whereas Vivo Ventures at the time was the only life sciences venture capital firm operating in China, it today is facing competition from a variety of sources, including international venture funds, general funds now turning to a life sciences focus, and local funds. “This has created a lot of entrepreneurial opportunities,“ he said. “The Chinese are starting to realize that these are huge opportunities for them.“

Yu added that “The domestic market is growing so quickly that it is starting to look like the U.S.“ He said, for example, that China now has an active mergers-and-acquisitions market, and that “a lot of large local companies are now becoming acquirers.“

Peltier said that growth means that “the big question now for multinationals is, where do they go?“ Citing the reality of China being an extremely price-sensitive market, he said, “It's a high bar for the multinationals to be comfortable here; we have seen many [potential] deals fall apart.“

Wilson said that despite the well-documented worries about IP protection, the biggest problem with doing business in China may be rampant corruption. He also cited the “massive distribution problems“ that firms face in doing business in China. “There are 110 cities with more than 1 million people, [and] 20,000 hospitals. You have to have local distributors.“ And if a product hasn't already been approved in the U.S., he said “you have to do full clinical in China.“

Building to flip vs. building a company

Two panel discussions during the conference fit together so well that it's a wonder they weren't scheduled one following the other, rather than having a couple of unrelated topics take the attendees in different directions, at least for a while.

In one, slotted in the early part of the schedule, panelists discussed “Build to Flip: Developing Products vs. Companies,“ while in the other, which closed a packed-to-the-rafters morning session, company business development folks delved into “The Corporate Philosophy on Structuring Deals.“

Panelist Michael Glennon, chairman and co-founder of Pavilion Medical Innovations (Norwell, Massachusetts), set the tone for the “Build to Flip“ discussion by noting that “every idea is different . . . you have to have a vision on which way you want to go.“ He added that “to me, building a company or building a product is the same vortex.“

Sami Hamade, a partner in Aberdare Ventures (San Francisco), who once headed up corporate dealmaking efforts for Guidant, chaired the “Build to Flip“ panel. He said that the big corporate acquirers maintain that if you're building your company for eventual sale to one of them, you should develop technology that fits existing product lines for those potential acquirers, and asked panel member Eric Simso, until recently the vice president of strategic alliances for Boston Scientific (Natick, Massachusetts), for a response as if he still was wearing his Boston Sci hat.

“If you choose to build a product,“ Simso said, “you need to look at the technical and clinical risks and how a strategic [buyer] could use it.“ Most importantly, he added, “you need to look at it in terms of having meaningful clinical data.“

Another panelist, Jan Garfinkle, managing director of Arboretum Ventures (Ann Arbor, Michigan) and a former senior manager for two different start-up companies that ended up being acquired by Guidant, said that a particular challenge is that with the changes taking place at the FDA, resulting in tighter regulation, “it's going to take a lot more capital to flip a company than it did three or four years ago. We're interested in putting $5 million into a company, but it may take $20 million to get to a flip.“

Hamade said the one thing that's a certainty “is that there will be buyers.“ He said that fact may be emphasized by recent or pending changes at the top management levels of several of the big players. Those newly named or yet-to-be-named CEOs “will bring their own areas of interest to these new jobs.“

Panelist Russ Sampson, president/CEO of Sierra Surgical Technologies (Palo Alto, California), said that in his view, “It's difficult to build to flip; you really need to be in it for the long haul.“ Saying that there are “a lot of dead or dying ideas out there,“ Sampson added, “I think the corporates are starting to understand these companies a little better, [so] it is doable. There are some nuggets out there where companies can be re-started.“

In the corporate buyers panel discussion, which was moderated by Bruce Machmeier, partner in the law firm of Oppenheimer, Wolff & Donnelly (Minneapolis), panelist Susan Morano, vice president of new business development at Johnson & Johnson (New Brunswick, New Jersey), said that the list of possible deals is relatively limitless. “I average 30 to 40 calls a month“ on deal-related inquiries, she said.

To the question of how J&J sets its acquisition strategy, she said that “a lot of work happens within our own franchises.“ In many possible deals, Morano said, the thrust is to “make our existing businesses stronger.“

Chad Cornell, VP of corporate development at Medtronic (Minneapolis), said that “the merits of the technology matter. If it's a business we're not already in, you have to show us why we should be in it.“

Bulend Corbacioglu, vice president, business development and licensing for Covidien Ventures (Boulder, Colorado), said of corporate partnering and M&A activity at Covidien (Mansfield, Massachusetts), one of the most active acquirers both historically and especially in the past year or so, “Ideally we have a list of opportunities to pursue, and then we rank them against one another.“

Asked by Machmeier whether the presence of a competitor as a corporate investor in a potential acquisition target is a plus or a minus to a would-be buyer, Morano said, “We wouldn't back away because of that. It can make a small company a more attractive acquisition candidate.“

Corbacioglu said corporate strategic investors “help point a smaller company in the right direction, but it's also true that they know more about the company than you do.“

And, Cornell said, “If they invested in it but didn't buy it, that raises questions.“

Machmeier initiated a discussion on what stage a company needed to be at to attract the attention of corporate buyers. Saying that the “What stage?“ question is changing because of more stringent regulatory requirements, Cornell added that “companies are trying to sell earlier because of regulatory costs,“ and said that for its part, Medtronic is “willing to do that, especially in areas where we think we can add value.“ He said that an overall constraint that even the largest acquirers face is, “How many [clinical] trials do you have to run at any one time?“

As for what corporate buyers are looking for, Morano said J&J “likes to have a strong management team in place; that gives you more confidence in the company.“ Corbacioglu agreed in part, but said that “if it's a space where there are a lot of companies operating, we're less concerned about the management.“

Asked by Machmeier if they were looking for companies that have the CE mark or are doing clinical trials in Europe, Cornell said, “It's more common than previously; having the ability to generate meaningful clinical data is very valuable“ for companies that might be acquisition targets. In fact, he said, “if they're doing trials in Europe, that can be even more valuable [to an acquirer] than the commercial part, [because] that potentially can jump-start you with the FDA.“ Morano agreed, saying, “It's really valuable to have clinical data; the CE mark not so much, but trial data is.“