High-end customers, mission-critical applications and operative pitfalls

VC expectations of medical technology deals, and how founders can utilize them for success


Let's be clear: Medical technology is not "biotech light", and is not for Web 2.0 investors who want to get a taste of a little more technology. Medical technology is complex on a number of levels; the customers are extremely demanding, applications are often matters of life or death, and the market is highly professional, in an environment of very conservative private and public contractors.

From the VC point of view, however, not all medical technology is the same. The dimensions that play a role in the evaluation of an investment case are:

1. technological complexity/depth,
2. mission-critical grade of the application,
3. footprint in the medical workflow/obstacles to a paradigm shift among users,
4. investment volume/business model,
5. existing market allocation, incremental/disruptive innovation.

The "in" technologies for VCs, for example, include drug delivery implants, active bandages, deep brain stimulation, devices that support minimally invasive procedures, miniaturized diagnostic devices, radiation detectors and combined and expanded imaging procedures (see VentureSource: First-round financings US, Il, EU since 2007).

It is critical for the assumptions of the investment case to be a thoroughly researched piece of work for the VC - but first and foremost it is the excellent practical execution of the investment case's go-to-market strategy that is sufficient for success.

Operative challenges underestimated
Often due to a lack of practical experience, founders tend to underestimate the operative challenges of product development and market launch, which are not linear but rather iterative. If the iterations then are not short and quick, the financing often disappears and/or the market disintegrates. Since many stakeholders have an influence on company development, the sources of the iterations are inherent in the medical technology business itself: Pilot users, study participants, admission authorities, and finally, market sentiment regarding one's own product initiate expensive changes. The sales rep who storms into the office of the CEO and founder late on a Friday, distraught because an important potential reference customer just jumped ship ("The competition now does 50 Watts, we can only do 30 Watts!") is a case in point. One decisive issue is the unpredictability of the feedback that must be taken into consideration by the participants. That makes the excellence of one's own processes an absolute precondition. Further specific examples are described below.

The product development manager case
Founders are often the visionaries, business developers, and/or architectural geniuses behind the technology. But they are not the development managers who are responsible for organizing the details of the development work. A competent development manager is, however, urgently needed to efficiently implement project plans, because otherwise the delays and (really, unnecessary) surprises in technical detail mount up. But be careful: The development manager shouldn't hail from the dinosaurs of the industry because they are more attuned to product maintenance, and generally cannot keep pace with the founder team.

The second source case
The product depends on a highly innovative component that is sourced from a supplier. The "second source principle" (always have one) is well known, but it is to be applied later, during ramp-up to serial production. With the first reference customers there are failures that can be attributed to these specific components. This is where things start to get bogged down: Everything is done to help the supplier to get the problem under control. A number of other suppliers are feverishly sought so that their products can be tested. But one thing is not done – the components are not directly taken control of, for example, through reverse engineering. Licensing issues would have to be considered in such a case, but there are at least ways of getting around them.

The working capital case
The classic: Complex med tech devices are a specialty business. Subcontracted components are produced in small series and have long delivery times. Expensive semi-finished parts are on stock, the financing for which the founders are loath to shell out using equity financing because it would dilute their company holdings or it simply can't be found. Banks, however, have clear restrictions as to when working capital loans can be extended. An early agreement is therefore imperative.

The first mover case
Let's say that two start-ups have competing products. Start-up 1 develops the 150% solution and Start-up 2 the 80% solution. Start-up 2 gets to market faster; it's not all perfect, but they are the first and therefore the only ones there. Start-up 1 gets to market somewhat later, but because the product development was much more involved, not everything works properly. The market, however, no longer tolerates these imperfections, especially since Start-up 2 has managed to improve its product in the intervening period – a death sentence.

The financing case
In general, it is unadvisable to live from hand to mouth, especially not as a medical technology start-up. Financing should be secured for the long term. The basic rule should apply that to concentrate on the business better, it is preferable for more shares to be released rather than entering into a new "casino round" every year, thus pushing the "virtual" share value upward. These stakes quickly lose their value because the company loses sight of its own business.

The strategy case
Many start-up founders dream of having independent companies with many hundreds of employees. But is that realistic? The development of a company always takes place in stages. Three to five years elapse before a technology in the medical technology field makes its first market launch and gains its first reference customers. The build-up of a global sales and service force comes later, with a new risk profile and new, considerably increased capital requirements. Forming large companies out of start-ups is still very difficult to do in Germany because there are so few investors. Here it is worth checking out alternatives early on and, for example, being sold to a major incumbent fairly soon after market launch, which helps reducing expansion risks.

Conclusion
Medical technology investments are much more complex than other software and hardware investment fields. The markets are much less forgiving and start-ups have to pull off the nearly impossible: to be as quick as the small players, and as precise and excellent as the big ones. Only a few VCs can help them in this endeavor.



* Dr. Bernd Geiger is a physicist who worked for five years at the German Cancer Research Center, a further five years at university spin-off Heidelberg Instruments (now Leica Microsystems), and subsequently spent two years with Zeiss. Triangle is currently the only VC in Germany to invest only in spin-offs originating in universities and research institutes.

Public launch financing or professional investors?

Or why it's important to make the right choice from the start

The good news is, the start-up scene is gaining momentum again, and a spirit of optimism prevails. The bad news is, even high-potential start-ups are doomed after one or two years, even though they could have generated one to two million in sales, just because they get involved with the wrong financing structure! What lies in store for start-ups, and what should they consider?

Case study: In early 2007 a financing search team introduced its company to a well-known early-phase venture capital company – the idea, from the realm of computer games, was revolutionary and promised to turn a profit very quickly. There was nascent competition in the USA, but it could not fulfill key quality criteria. Upon closer examination, however, it looked as if the lead could not be maintained forever, and that "execution" was key, that is, targeted and pragmatic product development and a quick market launch, otherwise other technologies would establish themselves in this market. The venture capitalist recognized the opportunity, and after a first phase due diligence within a few weeks prepared a termsheet that would enable the company to concentrate fully on the market introduction and development until break-even, and consequently, until the next growth phase.

The founder, however, reckoned otherwise, going with public funding that yielded only ¼ of the capital that the private VC would have contributed and at a high price, but at least the valuation would increase from the outset. Yet a half a year later, the financing round with the public investor still had not been concluded, and the employee search was proving difficult because it was hard to attract the necessary highly qualified programmers – they didn't want to venture on an undertaking with a financing period of only six months. Today the CEO (that had been required by the public investor in the meantime) has also bowed out, and the start-up is back at square one, except that a year and a half and a wealth of motivation have been wasted.


How would things have been different with a private venture capitalist?

- The biggest difference is that a start-up is financed completely until break-even is reached,* allowing the founder to concentrate on business right away, and giving both employees and customers a reliable outlook.

- Optimal assembly of the management team: When the founder team has no previous start-up or industry experience, the venture capital investor can help round out the team so that the company runs smoothly and efficiently right from the start.

- Use of "industry best practices" from the beginning: You don't have to try everything out for yourself to identify the best processes – others have already done that for you.

- Co-entrepreneurs are ideal for team players; each party contributes what they do best – you the technology and the energy to market it, the venture capital investor the experience gained from many successful and less successful start-up investments. "Hands-on" venture capitalists are your biggest supporters.

- Warning: With venture capital investors there is no "trial phase" or "light" version of a start-up during which process and focused action can be disregarded. Extra (financing) rounds cost money and stakes – why not do it right the first time?


Everything in life, of course, has a flip side, and you probably do not need venture capital financing if you think:

- you earned ample money with your last start-up,
- you won't learn very much more,
- we all need to stop and smell the roses,
- the state knows exactly how to set up start-ups, that's what the taxpayers' money is for, after all,
- that venture capital investors are "locusts" that destroy jobs,
- that 100% of a small success is better than 50% of a great success.


If you are interested in VC financing nevertheless, or wonder if you should be, send me an e-mail: b.geiger@triangle-venture.com.

*Not in biotech, where other laws apply.

Spin off with Venture Capital

How private investors can contribute to successful technology transfer
In a study conducted with Worms University of Applied Sciences*, it was shown that technology transfer institutions clearly prefer spin-offs to licensing, but that the number of spin-offs falls far short of expectations. The oft-lamented, lacking “entrepreneurial spirit” is a long-term challenge, which can only be improved with the dismantling of the provider state, something that the politicians and the media demanding it in Germany cannot yet seem to manage. Those that have the guts to enter into the risk of a start-up, however, should be able to find conditions that help them stand on their own two feet quickly, even in an environment that is hostile to entrepreneurs. Ultimately, spin-offs are the most successful type of technology transfer even though, in contrast to licensing, many requirements must be met in the process. What are the “best conditions” in this context, and how can VCs be particularly helpful?

Don’t just bank on government programs!
The conditions are optimal whenever the learner’s learning curve is particularly steep or is determined only by the learner. It is expensive if the learning speed is held back by environmental conditions, because development is slower, and some mistakes are costly both in time and cold, hard cash. Why is this relevant to the entrepreneur? Because the success of the spin-off depends on a long chain of decisions, many of which are irreversible. And the clock is ticking. That is why it makes sense at least to create a solid foundation of information upon which to base these decisions. In reality, the spin-off process looks much different. Very few tech transfer centers maintain regular contact with VCs and actively involve them in spin-offs. Instead of choosing venture capital, commonly known as the best financing alternative for the “high potentials” among the spin-offs, governmental financing programs are recommended across the board. But how can the high-potential spin-offs be identified? Together with venture capital companies as experts, it is best to identify them early, for example, by staging technology showcases or idea competitions. The earlier potential entrepreneurs receive feedback on possible marketing and implementation opportunities, the more creatively they can respond, and keep themselves out of the traditional divide where the top technologies are developed in Germany, but the Americans have the successful marketing ideas. But what is it that venture capital investors in particular can contribute in an early encounter?

“I have a technology – but what is the product?”
Out there in the globalized economy, customer needs lie more or less dormant, just waiting for money to be paid for a new technological approach to meeting them. To meet them, an understanding of the macro- and microeconomic drivers and the rules of the game for the specific segment is required. Because venture capital companies typically review around 1,000 new projects a year, and usually have their own research teams, they are practically predestined to plumbing marketing possibilities by brainstorming with tech transfer facilities and researchers.

“I have an idea – but no team”
The decisive success factor for entrepreneurial success is execution – good people doing what they do best to be effective and efficient. Therefore, for a successful spin-off, a team needs to be put together comprising more than technology specialists. In response to recurrent requests to build teams, VCs generally have access to a large pool of internationally focused entrepreneurs that would fit nicely into start-up teams – candidates that usually cannot be found by headhunters.

Finally: “The entrepreneurial environment”
Being an entrepreneur changes one’s life – does everyone want that? Does everyone have the right personality for it? How does it feel when things come to the crunch, or really take off? In an environment in which most of one’s personal contacts are employees, it is most likely difficult to get a clear picture of how things will be. There is probably no one who can give you as much in-depth information about that than venture capitalists, who are constantly working with start-up entrepreneurs with varied backgrounds, levels of development and economic success.

A better starting point
Of course, not every VC firm will jump in and invest at the level of “functional model from the university”, but the most attractive spin-offs can obtain this professional financing right from the start, and develop optimally. The potential spin-offs that do not receive VC financing can nonetheless still benefit from early interaction with venture capital by achieving a much better starting point from which to better utilize state financial assistance or spin off with the help of “family, friends and fools.”

Conclusion:
The greatest challenges for a spin-off are to identify the best product strategy for commercializing the technology in the right target markets, and to put together a team made up not only of scientists but also experts with industry experience. Government programs that administrate founders’ “self-discovery phases” are usually less helpful. The key is to banter about the ideas with venture capital investors that are marked by entrepreneurship, to do so early in the conception phase, and to develop the best projects into spin-offs together.