As the route to a successful exit in med tech has grown longer, and the pathway riskier and more expensive, many VCs have shifted attention to other sectors such as tech, biotech, and health IT. S2N’s emerging med tech clients wrestle daily with this new reality, turning over every rock to find money, tapping foreign investors, family offices, and physician-believers in the technology for cash. Pitches have taken on a more biotech-y or tech-y tone in pursuit of broader appeal and higher valuations, with Theranos as a prominent and lucrative example (until the bottom fell out). One of the many curious / suspicious things about Theranos was always the lack of any traditional med tech investors around the star-studded BOD table. Turns out that a number of veteran health care VCs were pitched Theranos and didn’t like what they saw. Smart.
To define the elusive concept of "smart money" in our industry, we approached two dedicated early stage med tech investors, Aaron Sandoski, Co-Founder and Managing Director of Norwich Ventures and Joshua Phillips, Managing Partner of Catalyst Health Ventures. Norwich and Catalyst are both relatively small funds, closing one or two deals a year from among the heaps of pitch decks they receive. Having stuck it out through the rollercoaster ride of the last decade, Josh and Aaron have accumulated wisdom that informs their investment decisions and interactions with entrepreneurs. So what makes these focused, experienced med tech VCs different from other sources of capital for emerging med tech companies?
Both Josh and Aaron started off with the diligence process – a critical function of any venture investor and a good way to know if you are dealing with smart money. For Josh, it boils down to the clinical value proposition, which has to be “clear and tangible, not a me-too or a just a little different.” Josh sees many cool, futuristic technologies that don’t really change outcomes (a particular issue for diagnostics); less savvy investors can be dazzled and lose sight of this critical success factor. Aaron goes right to the big picture math: “The main question is whether the company can get to the finish line in the right amount of time with a reasonable amount of capital.” In med tech, defining that finish line is where smart money again can distinguish itself. Unsophisticated investors look to FDA approval as the end-game, but for Aaron “FDA is very far down the list.” Aaron pointed out that <20% of 510(k) devices are acquired before commercialization; while that figure goes up to 60% for PMA technologies, once development costs and time are factored in, “timelines to exit and returns are not any better for 510(k) vs. PMA.” That’s smart med tech money talking.
On the other side of the diligence gauntlet, if you are lucky enough to get funded, is the thought-partnership a smart investor can bring to their portfolio companies on complex topics, such as what evidence will generate the most incremental value (e.g. animal vs. human). “You don’t necessarily have to get this kind of expertise from an investor, but you need it from somewhere; the entrepreneur who doesn’t believe this doesn’t understand what all is involved in med tech development,” cautions Aaron. Smart money investors also understand that med tech development is iterative by nature, and they are less likely to get spooked and run when problems arise. Josh summed it up: “When things don't go right, it’s very easy for investors to give up and leave; it might be easier to get money from a family office your uncle knows, and their valuations might be better than ours, but when things aren’t going well and you need someone to talk to, good luck.”
Experienced med tech investors also have the benefit of seeing many technologies spanning multiple market segments, so they can “go broad” to source innovative ideas and solutions while the entrepreneurs “go deep” and focus on execution. By Aaron’s rule book, “an entrepreneur should know 10X more than me about the companies and technologies in their specific field, but having been in the industry for a decade and seen 1,900 companies, I should know a lot more about companies outside their field.” This panoramic view enables smart money investors to propose different ways to frame challenges and expand the solution set. Aaron cites the example of intellectual property strategy: “You can approach IP in many ways, and we know lots of tricks other med tech companies have used successfully.” Josh has gained important insight along the way about managing burn rates by outsourcing many functions, and has built up a network of contractors with capabilities in different aspects of med tech development (manufacturing, quality systems, etc…) that can be leveraged.
Going in, I thought these investors might tout their ability to open doors with potential acquirers, but both Josh and Aaron downplayed this factor as benefit of working with them. If the company is pursuing something valuable, it’s not that difficult to make connections with the big device companies who constantly scout for new technologies. Josh is more concerned about his entrepreneurs becoming de-focused in “trying to make Medtronic happy.” Aaron thinks the involvement of smart money in a deal “might give strategics some comfort” and lend an edge to early interactions, but “a good product and entrepreneur will get there anyway – there is no magic Rolodex.”
Wherever emerging med techs go hunting for money, Josh and Aaron recommend conducting diligence of their own on potential investors, for example by asking other entrepreneurs who have worked with that investor about them and their relationship. “You should do reference checks on investors the same as anyone else getting involved in your business,” explains Aaron. “Would you hire a VP and not call references? Think about how long the average employee is with your company—3 years? The average investor will have more control and will be involved much longer than even your key hires.” So, med tech entrepreneurs, before you take one more dime from an investor, consider what value they bring beyond the cash, and think about going after some smart money.