Medical Device Link.

Originally Published MX November/December 2005

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

Entrepreneurial medtech companies can make steady headway if company leaders pay early attention to key considerations.

Fred Dotzler

Starting a medical device company offers many rewards. The personal ones include working with a team of hand-selected people, achieving recognition, enjoying freedom from bureaucracy, and creating wealth. A larger satisfaction comes from the opportunity to improve the health and well-being of patients.

There are costs, too, including the 24/7 time commitment, the responsibility of providing for the start-up team, the concentrated risk, and the stress of meeting deadlines. But entrepreneurs determined to start a medical device company will be more likely to see rewards if they guide their enterprise by adhering to a handful of proven start-up principles.

First Things First

Certain issues should be addressed before resources are committed, to determine whether the product idea and business strategy are ideal. Medtech entrepreneurs can send their start-ups down the right track and avoid later pitfalls by making these actions and decisions a priority.

Determination of Interest. A product idea should be vetted by potential clinical users before launch of the company. It is valuable to obtain opinions from both academic- thought leaders and healthcare practitioners. Start-up founders should listen carefully to the feedback, both positive and negative, and should ask how a device they are planning to develop might be improved for the intended use. They should try to gauge the size of the targeted market.

In addition, founders should engage venture capitalists and other entrepreneurs, seeking their informal feedback on the business model. An entrepreneur who does not receive some positive feedback at this point might delay launching the company, or might begin searching for another idea.

Patents, Reimbursement, Regulatory Affairs. Performing a patent search early is essential. That will give the entrepreneur assurance of freedom to operate and certify that an opportunity to secure a proprietary position exists. Next, the entrepreneur should determine whether reimbursement codes for the product and related procedure are in place. Another consideration is whether the product is to be approved by FDA under a premarket approval (PMA) application or via the premarket notification (510(k)) route. The former takes more time and capital, but it also serves as a barrier to entry by potential competitors.

Legal Assistance. An entrepreneur should enlist the services of a corporate attorney to incorporate the new company and to advise on allocation of stock, vesting, confidentiality agreements, in-licensing technology, and other matters that need a solid legal footing. Law firms can also be helpful with introductions to prospective investors.

Market Focus. Entrepreneurial companies do well to enter a niche market where they can demonstrate that their product performs significantly better than any alternative. They may not have sufficient resources to address the entire market, where large competitors will try to stifle their progress.

Even if the start-up is pioneering in a market that lacks directly competing products, it will usually not have sufficient resources to sell to every known prospective buyer. Success in the targeted market segment is the first priority. After that is assured, the entrepreneurial enterprise can raise expansion capital and launch an assault on a broader market with an enhanced product line.

It is helpful for entrepreneurs to focus their efforts in a clinical area in which they have had experience. They will know the thought leaders and thoroughly understand their needs. Also, they will be better able to identify appropriate prospective team members.

Money

Financial considerations are fundamental to any entrepreneurial plan for success.

Fund-Raising. Start-up company founders should allow up to six months to raise their first financing. Before raising capital, they should develop a detailed spending plan and identify important milestones. It is valuable to build prototypes and identify key management team members.

If the founders plan to raise venture capital, they should poll their advisory network to help decide which potential investors to approach. If they plan to raise $3 million, they should meet with enough investors to raise $6 million on the assumption that not all will invest. Periodic solicitation of feedback is advised. If some of the venture investors seem unlikely to invest, then the number of them to whom the entrepreneurs present their plan should be increased.

Disclosing the risks and challenges of a venture to prospective investors enables them to make an informed judgment regarding the probability of its success. It will also enhance the credibility of start-up executives. But if prospective investors are not heard from within seven days of proposal, they are probably not interested.

Entrepreneurs usually cannot dictate the price per share or financing terms, so they should be prepared to negotiate. They will be partners with their investors for several years. Consequently, checking the investors' references is prudent.

Start-ups should plan to raise the next round of financing after completing steps that add demonstrable value to the company, such as the filing of initial patents, completion of product development, performance testing in animals, and conclusion of pilot human clinical trials.

Uses of Capital. Once they have raised the money, entrepreneurs should pay careful attention to their rate of spending and their cash balances. They should be frugal with regard to facilities, furniture, and other items not critical to developing and testing their product.

People

The success of a start-up company will depend on the strength of the team the entrepreneur assembles.

First-String Team. A company founder should hire top-quality people for every position. Networking can help to identify the best candidates, who must be convinced to join the company. It is better to wait for an ideal person than to settle for someone merely good enough, even if that means delaying the beginning of a development project. Friends may join the team, but they should be hired only if they are the best available candidates.

Quality should also be a prime consideration in selecting reputable outside support, including corporate legal counsel, investors, scientific advisers, administrative consultants, product designers, consultants, and vendors. The entrepreneur should recruit reputable people as outside directors and as members of scientific and clinical advisory boards—individuals who will fill needs that have been identified. It is often useful to solicit advice from entrepreneurs who have built successful noncompeting companies.

The founder should keep the entire team apprised of the company's progress and challenges. This will enhance everyone's ability to contribute and will foster an open, creative, and cooperative work environment.

The Founder. A start-up founder often has an evolving role in the company. The founder should take stock of personal strengths and weaknesses and not assume that he or she will be CEO of the company forever. Many medical device start-ups are founded by entrepreneurs who have not had broad general management experience, or who do not want to deal with the problems of running a rapidly growing company. Their principal objective should be to maximize the value of their stock holding by having their company succeed. Founders should take comfort in knowing that most qualified CEOs are not capable of inventing and developing the products on which companies are built.

Unequal Equity. The question of how to apportion equity in a start-up company should receive careful consideration. It is usually not wise to divide ownership equally among the initial team members, because some individuals will likely contribute more than others. All members of the team, including the founders, should have their ownership positions vested over time. It is unwise to allow full ownership up front. Anyone who leaves the company should accrue equity only for the time during which that person contributed to the company's success. This will ensure that shares are available for hiring replacements for those who leave.

Venture capitalists will insist on vesting over four years as a condition of their investment.

Patents

An entrepreneurial company needs to secure a very strong patent position that gives it freedom to operate and the ability to exclude others from copying its device and marketing a knockoff. Founders should engage a reputable patent attorney as soon as possible, preferably the strongest attorney possessing experience and expertise in the start-up's product or technology domain. The patent firm employed must be acceptable, but the individual attorney who will be writing and filing the company's foundational patents should be the very best that can be found.

The new company needs to develop an overall patent strategy that encompasses the technologies to protect, the countries in which patents will be filed, and other essential intellectual property (IP) considerations. It may be necessary for the strategy to include licensing patents to extend and enhance the company's IP protection.

The entrepreneur should not view patent filing as a one-time event, but should instead continually manage the company's patent portfolio. The start-up should establish a patent committee, and someone in the company should be charged with managing the patent portfolio. Sufficient resources should be budgeted for filing and prosecuting the patents needed to protect the inventions that the company will disclose as it proceeds with product development.

Broad patents will dissuade competitors from developing products similar to those of the start-up. When an entrepreneurial company is being sold or prepared for a public offering, the strength of its patent protection will be weighed heavily.

Product Development

With the team, the money, and the patent structure in place, the start-up enterprise needs to get into the market. That means developing workable, salable products as quickly as possible.

Rapid Iteration. Entrepreneurs should learn ways to accelerate the product design and testing cycle, including the use of design and simulation software, rapid prototyping, and other tools that facilitate rapid development and improvement of a product. Speed and agility are the start-up company's big equalizing advantages over large companies that will have more resources.

Start-ups should invest in tools of their own that will accelerate product development—computer-aided design programs, a machine shop, prototype molding capability, a chemistry lab, and whatever else is essential to enable the company to control its development cycle. An early-stage company does not want to rely on vendor schedules for its critical components.

Keep Only the Good. An entrepreneur's goal is to create value, not to prove that an initial product idea was correct. The innovator should keep the elements of the design that prove to work and willingly discard those that do not. There is no use in being wedded to ideas that should be dropped.

Plan for the Glitches. The product development plan should be aggressive but realistic, with buffers in place to accommodate missteps. The company should be prepared, when it encounters glitches and setbacks, to think creatively and find ways to catch up.

Feedback. As device development proceeds, the start-up should show prototypes to prospective customers and solicit feedback from them often. The devices should be used in animals as soon as possible so that what works and what does not can be observed. Continually improving the product by these means will maximize the probability that it will work successfully in human trials.

Test. Prior to market launch, the device should be tested thoroughly to ensure that it works reliably. Any remaining design and manufacturing problems can be corrected at this stage. Pilot trials are useful and even necessary for some devices. An entrepreneur often has only one shot at a successful market introduction, so it is essential to be certain that the device works as intended before finalizing the design.

Conclusion

Now is a great time to start a medical device company. Venture capitalists are raising significant amounts of money to invest in companies developing unique products that address potentially large markets. The amount of capital required to hire a team, develop products, establish manufacturing operations, and begin selling is in the vicinity of $25 million. An additional $10 million should enable the entrepreneurial company to increase sales and establish a position in its chosen market.

Many large medical device companies continue to acquire early-stage companies that show promise. The acquisition price for a typical device company with momentum can be $200 million or more. Entering the public market via an initial public offering (IPO) is another option for companies with the potential to continue growing.

Whatever the exit route, the return to the founders, the management team, and the venture investors in a successful medical device start-up company can be significant. The key start-up considerations outlined here, if pursued, can enhance an entrepreneurial company's chances for success.

Fred Dotzler is managing director of De Novo Ventures (Menlo Park, CA), a venture capital partnership that invests in early-stage medical device and bio/pharmaceutical companies.

Copyright ©2005 MX