Medical Device Link.

Originally Published MX September/October 2002

COVER STORY

Play It Again

Serial entrepreneur James E. Nicholson, founder and chairman of Cortek Inc., offers lessons for up-and-coming medtech companies.

Interview by Steve Halasey

Sidebar: A Company with Backbone

The medical device industry thrives on innovation, but when it comes to business decisions, innovators can learn a lot by listening to those who have gone before.

One such seasoned entrepreneur is James E. Nicholson, whose industry credits since 1969 include inventing a number of world-standard medical products and founding several medical device companies. He guided two of his companies—Mitek Surgical and Innovasive Devices—through successful initial public offerings (IPOs). Both firms were later acquired by Johnson & Johnson's Ethicon division—Mitek in 1994 for $128 million, and Innovasive Devices in 1999 for $85 million.

"I end up speaking at a lot of conferences because I've been through the process a number of times," says Nicholson. His presentations focus on strategies for building small companies and making them successful—with emphasis on a group of key factors he has carefully distilled into his own "venture checklist."

The checklist is a tool that Nicholson makes use of for his own companies. "And because I'm on my sixth venture," he observes, "I can check off the seasoned CEO box."

Nicholson's current venture is Cortek Inc. (Dedham, MA), of which he is founder and chairman. The company develops advanced proprietary plastic and allograft technologies for spinal fusion and dynamic spacing to treat lumbar and cervical disc disorders. Now in its fourth year, Cortek has growing sales and is approaching profitability. "In the words of the venture guys," says Nicholson, "we're gaining traction."

In this excerpted interview with MX editor-in-chief Steve Halasey, Nicholson discusses how his career has progressed from venture to venture, the lessons he has learned along the way, and how the leaders of start-up medtech ventures can apply those lessons in today's business environment.

MX: You have an MS in aeronautical engineering from the Massachusetts Institute of Technology (MIT). How did you get from that specialty into the field of medical devices?

James E. Nicholson: Yes, I received my bachelor's degree in 1960 and a master's degree in 1963. That was an era when missile defense was a national priority. So, being an aeronautical engineer, I initially went to work for the Naval Supersonic Laboratory at MIT.

Shortly after that, a number of people left the supersonic lab to join a venture-backed company called Mithras, which was funded by the Rockefeller family. I joined them as a project engineer, and without realizing it, was watching the evolution of the venture.

It was an interesting transition, watching these guys write proposals, win contracts, execute the contracts, and then send the reports to various government agencies. And pretty quickly, I found myself as a program manager doing the same thing.

How long did you do that, and why did you decide to leave?

After doing that until 1968 or 1969, I began to wonder why I was doing government contract work and locking the final report in a safe where, basically, nobody would ever get to look at it.

So at that point I went to William Harris, MD, the chief of hip and implant surgery at Massachusetts General Hospital, and asked him what problems there might be that an aeronautical engineer might attack. The challenge he came up with was the problem of blood clots developing in the deep veins of the leg during total hip replacement surgery. He wanted to know if there was any way to prevent the formation of those clots during surgery using mechanical means.

The solution I came up with was the Venodyne system, an inflatable boot that squeezes the leg and stimulates blood return—and essentially takes over the functions that a patient would get from walking. The system shortly became the world standard for nonpharmacological prevention of deep-vein thrombosis.

Your strategy for developing that first product was to work closely with a physician to understand the problem that needed to be solved. Has that always been your practice?

Yes. One of the things I learned at MIT is that you have to define the problem first. And if you really define the problem well, the solution is usually quite evident.

The thing I was impressed with was that it was such a simple solution to a problem that had vexed the medical community. So I thought, "This is really easy. I can do something that physicians think is very elegant, but in fact is technically extremely easy." That appealed to me a great deal.

With that experience under your belt, what were your next challenges?

I was offered a job at Codman & Shurtleff Inc. (Boston), a subsidiary of Johnson & Johnson, and became a department manager in product development, making instruments for neurosurgery. That experience then led me into problems of the spine and problems in retracting vascular and neurological structures.

How was it that you left Codman?

I moved to Beaver Surgical Products Inc., which was a 50-year-old company run by John Beaver, son of the founder, Rudolph Beaver. He had all kinds of opportunities to make things that were sharp. So we made products for orthopedics, ophthalmology, and quite a few other specialties in the field of cutting.

I not only ran development, but I also had responsibility for the pilot operation, quality control, and regulatory affairs. So I was able to get my hands around a larger segment of the business.

That gave me the opportunity to go out and hire expertise for all of those areas. Ron Gatturna, who had worked with me at Codman and even a couple of companies before that, was my ace product designer. Together, Ron and I and several others eventually developed a traveling team that would go from company to company to solve product development issues.

How did your association with Beaver Surgical Products come to an end?

A company called Acufex Microsurgical—now a part of Smith & Nephew Endoscopy—offered me an opportunity to run its R&D, manufacturing, quality, and regulatory departments. I agreed to join the company, but only if management allowed Ron and me to start a little side company to develop breast localization probes and orthopedic attachment devices. I didn't really have an idea of what exactly we were going to develop, but I thought that with the technology we had, we would be able to get back into the orthopedic field.

So I signed a contract with Acufex. And on the side, Ron and I were able to run our business on a noninterference basis.

That's the company that eventually emerged as Mitek?

That's correct. Mitek developed the Mammalok, which has become the world standard for marking breast cancer lesions.

What came next for the company?

Working together with Jim O'Leary, a professor at Tufts University, Ron and I figured out that if we turned the Mammalok product around, we'd be able to make an anchor for attaching suture to bone.

So we developed the Mitek Anchor. After we were sure that the animal tests worked, we went to FDA and got an investigational device exemption (IDE) to test the first 12 anchors in humans. They worked quite nicely. In 90 days following the last implanted anchors, we had results that were comparable to the traditional method of reattaching ligaments and tendons in the shoulder using a Bankart procedure.

How did you finance the early years of Mitek?

Ron and I and a third partner had each put up $3000 to start Mitek. In the first year, we lost $23,000. In the second year, with the Mammalok product, we made $20,000. So, over the first two years, we had a net loss of $3000.

Considering what companies have to invest today, that seems like an amazingly small sum. Is it still possible to do that—to create successful medical devices with very little funding?

It is possible. I think it depends greatly on the product, the amount of capital investment, and the staff that's required.

But it was quite exceptional for Mitek to have turned profitable on such a small amount being raised. We raised a total $6.4 million and then took it public, and that brought the investors a return of 15.6 times, which, needless to say, made them very happy.

A Good Idea

Category	Item	Yes	No	Fixable
Idea	Enabling technology
	High-margin product
	Technically proven
Management	Seasoned CEO
	Experienced financial person
	Experienced marketing and sales people
	Innovative R&D
	Strong regulatory counsel
Market	Growth market segment
	Proprietary product
Legal Position	Patent counsel
	Corporate attorney
	Regulatory attorney
Performance	Meet or exceed plan
	Approaching profitability
	Capital availability
Exit	Clear exit strategy
Table I. Sample checklist of key elements for a medical device venture. Source: Cortek Inc.

In the venture checklist that you've developed, the first category suggests that company leaders need to have a good idea for a product (see Table I). What sources of ideas are worth exploring, and how would you weight the ideas of clinicians versus those of engineers?

I think the first step is to identify a need. Very rarely do I go after a problem based on the promise of a technology or a technical solution. I have had the good fortune of not falling in love with technology, and have therefore avoided the trap of building a solution and then struggling to find a market for it.

Failing to address a large enough problem—or attempting to address a large problem without a unique solution—really puts a company in an awkward position. Under those circumstances, it's difficult to make something powerful.

In relation to a company's key idea, how would you weight the value of preclinical and clinical testing for making sure that the company has a technically proven approach?

I think it's absolutely key. I've heard many a technical person, after doing a feasibility trial on one patient, saying, "I've got it." But when I say technically proven, what I mean is that here should be statistically valid evidence that the technology really works.

Having technical proof is huge for a variety of reasons, not the least of which is that it is next to impossible to get money from the venture capital community without a product that is technically proven.

Can you approach venture capitalists at the point of having bench tests and maybe some animal testing, or are there other prerequisites?

What I typically do is to work for a year with a small group and basically try to get to the point that you just described. At that point, I've got patents filed, an extensive search to make sure that the patents are unique, an opinion letter from a patent attorney, prototypes, tests in animals or human cadavers, and maybe even a first human use of the product—although that usually isn't required.

Then I raise money from angel capital. In the first round of funding for Cortek, I raised $1.7 million from angel investors to get the company going, and then we did our first case. During this initial stage, I coinvested with an angel group called the Winnipesaukee Investor Group. The venture capitalists, led by Prism Venture Partners (Westwood, MA), came in almost simultaneously to fund another $2.7 million, bringing the total to $4.4 million that was initially raised for the company.

Building a Management Team

Over the years, you've had a team with which you've worked on a lot of projects. Do you take that team from new company to new company? Have many of its members stayed with the company when it was sold off?

The teams really tend to split up, and individual team members may come and go depending upon what is best for their family.

There's a lot of risk in a start-up company. Among those that get started, 80% or more don't make it. And there may be a whole variety of reasons why they don't make it. Maybe the company just isn't right. Maybe it's not a great market. Maybe it can't raise the necessary venture capital. Maybe the patents won't issue. So I always urge people to take a very hard look at the venture before they jump into it.

Early-stage companies obviously can't add all of the management people that you've suggested in your checklist. What stage of company is this checklist designed for?

This is really a rolling checklist. When a company starts out, it would be lucky to be able to check off three of those boxes. But then, as it grows, it can check off more.

What is the typical pattern of hiring for the management team? What kind of talent should start-ups expect to be hiring?

A start-up company usually can't afford a serious financial person on day one. So the company works with a bookkeeper until it gets to the point where its finances get sophisticated.

The same is true for top operating executives. A company just can't afford someone who has run a $500 million division until it's up and running.

And you can continue down the list—through experienced marketing and sales people, regulatory counsel, and so on—in the same way. As the company evolves, it should keep improving and upgrading each of those areas until it finally has a solid team.

Moving the Market

The next section of your checklist deals with the market. Tell me about the two categories listed here. First, is it a growth market?

To give you an example of what I mean by a growth market, consider the field of orthopedics. There are a lot of market areas within that specialty. The market areas that involve the spine—and in particular, interbody fusion, which is Cortek's area—are growing at a very nice clip—faster than pretty much anything else in orthopedics.

So the company has to narrow its understanding down to its own niche, its own key point of success. That's the level at which the determination of whether the company has a growth market segment has to be made.

Capital investment tends to go in cycles. How do you weigh those sorts of trends when you're trying to determine whether you've got the right market segment?

We've recently come through just such a period, when many venture capital firms dropped all of their medical device investment in favor of the booming dot-com stocks. Then all of a sudden the dot-bomb dropped, and suddenly medical devices and biologics were back in vogue.

So these have been extremely tricky times for companies that need additional capital to survive.

Do you work closely with venture capitalists to make sure that they understand your niche?

As closely as we can. At every board meeting, we're always trying to explain what we're doing and why we're doing it. And I think the better ones listen hard.

It is important for companies to tell VCs what they're doing and how they're attacking the issues in their field. If the company is making progress, they'll believe you. If it isn't making progress, they'll get skeptical pretty quickly.

In your checklist, the other market-related element is the proprietary product. Is that consideration directly related to competitive intelligence, or are there more elements that go into making sure that a company has secured its niche?

Having the right product is very complicated. A small change can make a product either very attractive or very unattractive. I like products for which you can charge a premium because they provide a distinct advantage.

It's very difficult to build a major company on the basis of a product that is easily reproduced by somebody and doesn't have any particularly proprietary aspects to it. I'm not aware of any company that has taken something ordinary like that and built a successful product without capturing a proprietary niche.

Legal Positioning

The next section of your venture checklist deals with a company's legal position. How closely should companies be watching their patent situation? And what's their first step if they find that they've got some risks?

Having diligent counsel that thoroughly checks out what a company is doing relative to what's in the public domain and other patent literature is key. When a company's product comes very close to somebody else's technology, it's easy to fall into gray areas. The more distinct the company's idea is, and the clearer it is that the company's technology is different from that of other companies, the less likely it is that litigation will arise.

How important is it for a start-up company to have a corporate attorney?

Companies need a corporate attorney very early, so that they can become incorporated and set themselves up for investment by the venture capital community and others. In this regard, there are certain structures that work and others that don't. So it's really important to deal with corporate attorneys who work with the venture community on a regular basis. They really need to be talking the same language.

You can't pay too much for a good attorney. The services of a good regulatory attorney may cost a lot of dollars per hour, but the objective is to use the fewest number of hours and get the best result.

At what point, if ever, would you find it necessary to bring regulatory counsel in-house?

I have never brought it in-house. I've always tried to find the best people and use them as part-time expertise.

If a company is spending $100,000 a year on a regulatory attorney, it's spending a lot of money. Of course, that depends entirely on whether the company is undertaking a lot of regulatory submissions activity, such as IDEs and PMAs.

Star Performance

Can you put the importance of company performance in context with other elements in your checklist?

Having a company that's performing to plan and approaching profitability is a huge part of the criteria for getting venture funding. Companies that are a long way away from profitability are just having a terrible time raising money.

Here at Cortek, fortunately, we are on the cusp of being profitable, and we believe that we have sufficient capital to get there. So that has put us in very good shape.

At what point in its development should a company begin to figure out its exit strategy?

Frankly, figuring out how to get out is one of the first things that a company should think about. A venture-backed company is a lot like a marriage: it's relatively cheap and easy to get into, but getting out can be difficult, messy, and expensive. So I think company leaders need to have a pretty good idea of exactly where their exit is going to be, well in advance.

And, by the way, an IPO should not be considered a legitimate exit. Generally speaking, the only legitimate exit is acquisition by a larger company. And that's truer today than it ever has been.

Does the absence of an IPO market increase the number of fund-starved companies willing and eager to be acquired by larger companies?

Well, there certainly have been some acquisitions. For instance, Stryker bought Surgical Dynamics (Norwalk, CT) from Tyco for about $132 million. And then Medtronic bought Spinal Dynamics Corp. (Seattle), a company that has developed an artificial cervical disk, and paid something like $270 million. That company has implanted its device in about 800 patients overseas, but it only recently received approval of its IDE for clinical studies in the United States.

So there are acquisition opportunities, at least in the spine market, but they're few and far between.

Considering that Cortek's exit strategy is to be acquired, the fact that there exists even a small acquisition market would seem to bode well for Cortek going forward. So what is the current status of Cortek and its products?

The company is approaching profitability. We are approaching 1000 implants in the United States, and our clinical results have been excellent. Our sales are growing at a very nice clip every month. In the words of the venture guys, we're gaining traction.

At the same time, we're getting a lot of attention. We're taking sales and market share from large companies, and that has put us on their radar screens. So we're in exactly the position I like to be in. I would say we're in the sweet spot right now.

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