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.