BB&T Contributing Editor

While reimbursement used to be little more than an afterthought in the overall question of moving an emerging med-tech company's product toward commercialization, it now plays a much greater role as those companies and their investors develop their action plans to get to the Holy Grail of profitability.

A panel on “The New Regulatory Paths & Reimbursement“ during the MidAmerica Healthcare Venture Forum at the Monona Terrace Conference Center in Madison, Wisconsin, drew a sizable crowd of attendees intent on delving into both of those elements.

In introducing the panel, John Neis, managing partner of Venture Investors (Madison, Wisconsin), reflected on the traditional reality by noting, “It used to be that, as a VC, you didn't even care about reimbursement.“

It now gets far greater attention, but one of the biggest areas of concern for those VCs and the companies they back remains the regulatory pathway, in particular the 510(k) approach to product clearance, which the FDA seems intent on making significantly more difficult.

Increasingly the path that companies in the medical device space have elected to follow in seeking product approval, the 510(k) program is, in the words of panelist Mark DuVal, president of DuVal & Associates (Minneapolis), a well-known consultant in the regulatory area, “a political football.“

He cited a New York Times series on “The Evidence Gap,“ noting the strong criticism directed toward the 510(k) program, criticism shared by the federal government's General Accounting Office, with allegations of corruption at the FDA. “I have worked with the agency a lot,“ DuVal said, “and have not seen this corruption that is alleged.“

Nonetheless, agency leadership has strongly indicated that change is in the air. “The level of risk aversion at FDA is the highest I have ever seen,“ he said, “and it affects their daily work.“

Asked by an attendee if he sees 510(k)s “going away,“ DuVal said, “I don't think they're going away – the FDA just wants to cover new questions of safety and efficacy.“

He said companies “will need new data, especially confirmatory clinical data as a starting point, much as with PMAs.“

Put simply, DuVal said, “[FDA] reviewers are asking for what they want, not what they need.“ He said agency leadership is “letting their reviewing staff run wild“ in the matter of determining clinical value.

While FDA is “trying to grab more control over more areas,“ DuVal said, “they aren't staffed to handle this.“

Fellow panelist Dan Mans, vice president of research & technology at American Medical Systems (AMS; Minnetonka, Minnesota), said, “It has definitely had a real impact on us. We're concerned about the impact of 510(k) changes.“

He noted that AMS and other med-tech companies whose continuing success is based on bringing new products to market are spending more and more dollars on regulatory and clinical affairs. “We'll spend more dollars on clinical studies even if they're not presently required by the FDA.“

Neis asked Mans how important changes to the process are to AMS and its traditionally aggressive stance on making acquisitions.

“We're trying to be much more diligent about the whole package,“ Mans said, “such as if these matters have been thought through“ by companies AMS might be interested in acquiring. “We're taking a more disciplined approach to the technology in question – will it have a favorable value proposition?“

As for approaching the whole regulatory pathway, DuVal said, “You have to have the end in mind – think in terms of a sales rep's presentation and work back from that.“

Carla Monacelli, managing partner with Argenta Advisors (Woodbury, Minnesota), touched on the new attention on reimbursement. She showed a slide illustrating the differences between the FDA on the product approval side and the Centers for Medicare & Medicaid Services (CMS) on the reimbursement side. The slide had a brick wall running between the two columns because, Monacelli said, “those two agencies do not talk to each other.“ But they “will need to work more together.“

Her key take-home message for both investors and companies in the audience: “Integrate work on the reimbursement pathway early. It's a complex system – you need to start early. I like to see companies on the reimbursement bus early and stay on it late.“

From a VC's perspective, Neis said, “We encourage the CEOs of the companies in our portfolios to get into this regulatory environment earlier. It's important that these companies understand their disease state,“ starting with finding out if there is an FDA comparative effectiveness report available for it.

Relationship-building a key in dealmaking

Absent an active initial public offering (IPO) market today, the exit route for venture-backed healthcare companies is essentially focused on strategic investments and acquisitions by the sector's larger players.

While one participant in a panel discussion on “Corporate Strategic Investing & Acquisitions“ during the conference expressed some guarded optimism that the IPO market will awaken from its slumber in 2010, the reliance of the smaller firms on partnerships/acquisition by the industry behemoths is likely to continue.

Mina Patel Sooch, managing partner with both Triathlon Medical Ventures (Cincinnati) and Apjohn Ventures (Kalamazoo, Michigan), shared moderating duties for the panel and said of what she termed “the exit scene“ that she sees “glimmers of hope: for IPOs in 2010. “These things are cyclical,“ she said, “and 2009 was at the bottom of the cycle.“ As for the M&A exit route, Sooch said she thinks the companies that have been most active as acquirers – Abbott and Medtronic chief among them – will continue to be active.

Touting the value of working diligently to develop a relationship with possible acquirers, Kevin Conroy, now president/CEO of Exact Sciences (Fitchburg, Wisconsin), recounted his experience in the same positions at Madison's Third Wave Technologies, which he led to its mid-2008 acquisition by Hologic (Bedford, Massachusetts). “It was valuable to have relationships that led to high-level talks,“ Conroy said. “That eventually led to us getting a sale done in 45 days.“

Building on the relationships theme, fellow panelist Christopher King, senior director of corporate development at industry colossus Medtronic (Minneapolis), said, “We like to build relationships [with potential acquisition/partnership targets] early.“

Michael Johnson, director of corporate business development for Eli Lilly & Co. (Indianapolis), agreed, saying “early is better. We would like to know you as early as possible.“ He said Lilly “will follow companies and molecules for a long time.“

King cited some of the rationale that company applies to its M&A activity. He said that fundamentally, each of its businesses has a core, and in pursuing recent acquisitions, “we saw opportunities to create technically differentiated positions in those spaces.“

For the near term, King said, Medtronic's task will be to define whether to do “tuck-in“ acquisitions that fit existing businesses, or to identify possible new areas of business activity and look for acquisitions that might provide entry. “We will continue to look at opportunities in what might be a 'white space' for us at present“ he said, citing obesity and hypertension as chronic disease spaces where the company does not currently have a franchise.

In short, he said, Medtronic wants “to look at device opportunities across the board to leverage our existing technologies.“

Johnson said Eli Lilly does look “beyond our core pharmaceutical business“ when considering strategic investments and acquisitions. He cited vaccines as an example of an area where “a big acquisition“ would be the necessary starting point if Lilly wanted to gain a significant foothold.

Jan Garfinkle, managing director of Arboretum Ventures (Ann Arbor, Michigan), asked whether Eli Lilly might be considering getting back into diagnostics or medical devices – two areas which it has shed over the past two decades – Johnson said that, for instance, the company does look at diagnostics partnerships or acquisitions that tie in with therapeutic areas within which it already has strengths.

He said key areas for growth include oncology, diabetes and autoimmune diseases. “We don't pass on white space opportunities,“ he said, “but look at 100 to 200 molecules a year“ as possible investment/acquisition opportunities, so not every potential deal gets carried through to fruition.

Conroy said of his Third Wave experience: “When I joined Third Wave [in December 2005], we were in really bad shape. Nobody wanted us.“ So, he said, “we set out on a course of action of engaging all possible companies that might be a fit for us.“ That process led eventually to gathering a list of nine companies “that wanted to hear more“ about Third Wave, he said, adding that smaller companies need to “make the M&A process a part of your overall business processes.“

Asked whether he had pursued corporate partnerships rather than an outright sale of Third Wave, Conroy said, “With partnerships, you have to hand over what really is your company's entire value and depend on that partner to deliver. I felt that if we were going to do that, why not just sell the company?“ As for bringing a company through to an acquisition-based exit, he said, “you need to be sure that you have a plan. Do not get distracted – make sure everyone knows what your goals are. At the end of the day, you make decisions quickly,“ but at that point in time, “you want as much information as you can get, and get it as quickly as possible.“

Asked by Sooch what might trigger an acquiring company's interest in an acquisition target, King said, “All of our acquisitions are at the pre-FDA approval stage, but they all are very far along in the product development process.“

He said Medtronic looks at the entire regulatory/reimbursement pathway. “The bar for FDA approval and for commercialization of a technology can be very different, so we look, for instance, at what the post-marketing clinical data requirements might be, as well as reimbursement issues.“

From Johnson's perspective, target companies should be open in letting the potential acquirer know where things stand on regulatory matters. “We will tell you what we need in terms of clinical data in order to pull the trigger on a deal.“

Asked whether the holding of a large stake in a potential acquisition target by one company precludes interest by other possible acquirers, he said, “It does give them a huge advantage, but if you have other assets in the pipeline beyond the molecule that is tied up with another company, you'll still attract interest from other possible buyers.“ He added that when Lilly announces a deal, “It typically is based on a known clinical endpoint; we want to know what the end-game is.“

King noted that such a situation is more likely to be found on the biopharma side of things. “On the device side, a possible deal is more likely to be based on a single therapy than on a broader pipeline of compounds or products.“

Ideas more important than geographies

Fittingly enough given the locale of the conference, the East and West Coast-based members of a panel on “Coast-to-Coast Healthcare Venture Capital Investing“ showed an interest in steering some of their investment dollars to Midwestern start-ups. The session brought the requisite acknowledgements that VC investing in healthcare and virtually every other sector is at low ebb right now, but signs of optimism were commonplace.

Rod Altman, senior partner at CMEA Ventures (San Francisco), said that the cost structure for companies operating in the Midwest – as in the Southeast and South Central region – is less, “so opportunities exist there“ for increased VC investment.

John Fletcher, founding partner of Fletcher Spaght Ventures (Boston), said that data gathered by his company identified Michigan and Ohio in particular as regions showing promise for healthcare investing, “so we want to look more enthusiastically there – it has good potential.“ He added, “We like meeting people who have good ideas.“

David Lowe, a partner in Skyline Ventures (Palo Alto, California), said his firm is “agnostic to geography,“ adding that “it is a question of people and ideas.“

Moderator John Neis of hometown firm Venture Investors noted that recent data on VC investing have not been kind. Neis, who heads his firm's healthcare practice, observed that the psychology being followed by VCs generally “appears to be that they are hoarding their cash for deals they already are in. There are companies out there getting financed,“ he said, “but they need to be hitting the ball out of the park“ insofar as product development and clinical results are concerned.

His observation about portfolio companies ruling the roost when it comes to receiving financing generated a range of responses.

Lowe said, “The deal flow actually is very good for us – it probably has never been better.“ But he added that getting deals together “seems harder, most likely because uncertainty is higher.“ He said the percentage of healthcare deals his firm is getting involved in is skewing more toward device companies than in the past, now amounting to more than 50% of all deals, “because with devices, you can see a way through to taking it to market.“

Altman said his firm is doing “a couple fewer deals,“ and acknowledged that in the current economic environment, “sure, we're putting more money into existing deals.“ He said that because of both economic and political uncertainties, such as the don't-yet-know status of healthcare reform, “there's more work to do at the board of directors level with these portfolio companies.“

Ashley Friedman, senior associate with Investor Growth Capital (New York), said his firm has been “a bit surprised“ at the difficulty in getting deals done, sometimes even in quoting on possible deals. “You'd think it would be easier to do deals in this environment,“ he said, “but it isn't. “We have seen deals tip over at the altar because the terms or something else wasn't right.“

Fletcher explained the general trend to shy away from new deals in favor of existing pieces of a portfolio: “You need to have enough money to take a company all the way through to a deal,“ likely an exit via acquisition. “We do in fact tend to put money into a company longer“ than might have previously been the case.

Altman noted that VC investors are “looking more closely at what stage [a company] might be at“ in relation to what the final cycle might be.

Referencing a specific deal, but one that serves as an illustration of the market in general, Lowe said that from a practical sense, there really was only one way to turn. “Absent an IPO market and with the uncertainty in the economy, combining venture capital with a corporate strategic investment was the right deal.“

Friedman said his firm's competitors today “now are not so much other VC firms, but rather, corporate investing.“

As to whether there are more limited paths open to VCs in these troubled economic times, Altman said, “In this market, it's all about survival – the main goal is to get a company financed.“

Citing what he termed “the differential in VC return rate,“ Fletcher said that “in the absence of a public-market option, you have to put a cap on your investment and clearly see a company's public value.“

All of the panelists cited the importance of being involved with other investors in syndicating a financing deal. It's a matter of making a given company valuable to potential public investors and eventually to possible corporate acquirers. “We have to provide the incentive to get others investors in,“ Altman said.

Fletcher added, “In syndicates, each participant is putting in less, but it's still a way to spread out the risk.“

So, when is the right time to sell a company? Altman, said that “different investors have different perspectives, but my view is that investors sometimes hold on too long.“ What is the “right time,“ he said, “depends on the individual deal.“

Fletcher said, “You're looking for an exit with a favorable return, even if it's lower“ than it might be if an investor were to continue funding a company for a few more years. “You have to realize that [the value of a company] may never get better“ than it is right now, he said.

For Friedman, the decision is one of having “the opportunity of liquidity today versus the possibility of hitting a home run tomorrow.“

Lowe was decidedly succinct: “Anytime you have the opportunity [to get out], you need to take it.“

As for the keys to survival for start-up firms, and thus for those who finance them, Lowe said, “you need to try to judge the strategic outcome.“ It's also important, he said, to have a Plan B, since “strange things can happen.“

He said the key questions to ask are, “Does it work?“ and if it works, “Does anybody care?“ Add to that “How are you going to get paid for it?“ and you have the framework of the dilemma both investors and companies face moving forward. But, said Lowe, “there is always going to be a need for innovative medicine.“

Of the VC industry as a whole, Altman said, “a lot of firms are going to disappear. But in the end, he said, “things will still get funded because there will still be ideas that need to get out.“

Fletcher said, “If there are fewer funds at some point and fewer dollars per fund, that puts tremendous pressure on entrepreneurs to get their idea incubated and moved along – that bar is rising.“

Innovation aplenty

The “innovation“ question was brought very much to life at the conference. Mixed in among the various panel discussions were presentations by nearly 50 small, early-stage companies. In rapid-fire, 10-minute bursts, early-stage companies looking for investors presented their cases, outlining product development goals, potential markets and monetary needs to investors who continue looking for good ideas to back.

Here's a thumbnail look at some of the companies that presented:

• Advanced Diamond Technologies (ADT; Romeoville, Illinois) President Neal Kane described the company's existing work in thin diamond technologies for use in industrial coatings and its hope of creating a spin-off to further develop biomedical products. ADT already is working with famed cardiologist/inventor Robert Jarvik on potential diamond coatings for implantable devices such as the Jarvik heart pump, and sees many other potential applications in a market that sees some 100,000-plus devices implanted annually. It has identified other applications such as biosensors and retinal implants as having solid potential.

• Jim Burns, president/CEO of AssureRX (Maineville, Ohio), said his personalized/predictive medicine company “is at the intersection of medical technology and informatics.“ Its initial product, GeneSightRx, was introduced at the beginning of the fourth quarter and is targeted to behavioral health hospitals and clinics. The software-based product can help doctors understand the way a psychiatric patient's genetic makeup affects his or her ability to tolerate or respond to psychotherapeutic drugs – a substantial difference from the trial-and-error approach that represents the current standard of care.

• Axenic Dental (Kalamazoo, Michigan) is developing disposable dental handpieces designed to replace the traditional metal models in use today. President/CEO Mac Waldorf said the product replaces the “costly, time-consuming cleaning and sterilization of a reusable instrument“ with a disposable dental drill, the Axenic DHP, that has “all the performance of metal“ but offers maintenance-free convenience that eliminates the staff time now devoted to cleaning and sterilization. The drill has been FDA-cleared and Waldorf said commercial introduction into a market where some 250 million to 260 million procedures involving handpieces are done each year was less than a year away.

• CEO Shawn Guse of Compact Particle Acceleration Corp. (Madison, Wisconsin) described the company's efforts to commercialize its dielectric-wall accelerator (DWA), terming it a particle accelerator for which “cost and size won't be issues.“ That's as opposed to existing particle accelerators used in the developing cancer treatment area known as proton therapy. Currently, only a few thousand of the millions of patients receiving radiotherapy treatments worldwide each year receive proton therapy, due largely to the cost and size of such units. Guse said the first patient treatment with DWA will come in 2012.

• Irene Hrusovsky, president/CEO/chairman of EraGen BioSciences (Madison, Wisconsin), described her commercial-stage company's efforts in vitro molecular diagnostics, with 13 products already released and several more in its near-term pipeline. Those products are based on EraGen's MultiCode chemistry platform, and are aimed at ease of use and rapid diagnosis of critical diseases. “Diagnostics is a pretty hot market,“ Hrusovsky said. “It's an exciting space to be in.“

• Incept BioSystems (Ann Arbor, Michigan) CEO Chris Bleck said his company “has the opportunity to develop an entirely new medical device category.“ The technology under development by the company, the SMART Culture System, is aimed at providing non-invasive handling of embryos during in vitro fertilization. The goal that is being addressed in development of the SMART (System for Microfluidic Assisted Reproductive Technology) is to increase embryo implantation and the live birth rate for patients.

• John Seaberg, chairman/CEO of NeoChord (Minneapolis), described his company's efforts in developing a beating-heart, sterna-sparing treatment for mitral valve repair of the heart. The technology allows minimally invasive implantation of artificial chords, replacing the ruptured or elongated chords that are the primary cause of mitral leaflet prolapse. The company began its first-in-man trial with treatment of the first patient in Denmark in October 2009.

• Nerites (Madison, Wisconsin), which is developing an adhesive mesh for hernia repair that will eliminate the need for surgical tacks and sutures, draws its inspiration from marine mussels and the substance they secrete to adhere to underwater surfaces. CEO Shaun Lonergan noted that the company's scientists are creating synthetic mimics of those proteins and using them to build adhesive polymers.

• Ratio (Monona, Wisconsin) is developing what it terms “elegant drug delivery“ technology. Director Ben Moga described the company's platform technology, a microneedle pump worn like a patch. Its first application is a flu vaccine delivery system being developed through a partnership with vaccine maker FluGen, another presenter at the conference. Moga said Ratio's technology has the advantages of low cost, no reformulation needed for drugs, painless delivery, delivery to immune-rich skin and high adapability.

The 7th MidAmerica Healthcare Venture Forum was sponsored by the Mid-America Healthcare Investors Network and conference organizing firm International Business Forum (Massapequa, New York).