MEDICAL DEVICES

Medical device companies rarely go public through an IPO. They are instead groomed for acquisition. Acquisitions of device companies tend to be in the range of $50M - $70M, though a few have been much higher. Medical devices typically require 4-6 years to develop, making it feasible to start and sell a company in that timeframe. Whereas early-stage investors focused on drug development often swing for home runs, medical device investors expect to steadily making base hits.

If VCs want to make 10x their money by selling a company for $50M in 5 years, they must invest at very low valuations, often $1-2M pre-money, with slightly larger follow-on rounds if necessary. Investing at such low valuations also limits how much capital the VC can deploy at a time, forcing medical device funds to stay small (<$200M). That's not to say that medical device companies don't raise larger rounds. In fact, three Seattle device companies Vertis, Calypso, and Spiration each raised between $22M and $37M in 2002. These numbers, however, are not the norm.

Typical medical device products may have gross margins from 55%-70%, compared to 80%-85% for branded pharmaceuticals. Also, devices are usually marketed directly to surgeons that use them; television ads are uncommon and patient demand does not drive sales as it does for pharmaceuticals.

Medical devices tend to be "low tech" and these companies rarely fail because of technical difficulties. Poor execution by management is more commonly to blame. However, unlike the biotech sector, the medical device field has been around long enough that there are a fair number of experienced managers available to work with startups.

Device investors often bet on management's ability to successfully develop one product, not a portfolio of products, and to sell the company to giants such as Medtronic, Boston Scientific, and Guidant. The neuro/spinal field is most active with 10-12 acquirers, cardiovascular has 4-5, and other fields may have 2-3. The device giants in the medical device sector are relatively risk averse compared to large pharmaceutical companies. They will wait until a small company has reached a late stage of validation, possibly filed for FDA approval, before stepping in to partner with or acquire the company.

Small device companies cannot expect to successfully market their own products when faced with competition from the entrenched giants. Surgeons primarily trust the products sold by the established manufacturers and are much faster to adopt a device with a J&J label than one marketed by an unknown company, all else being equal. Therefore, the marketing efficiency of the big players creates a significant barrier to entry, and device companies are forced to either sell out to the larger players or at least partner with them.