Christopher J.P. Velis
Christopher J.P. Velis, chairman & CEO of MedCap Advisors has spent more than 20 years as an investment banker, consultant, and venture investor in medical technology. Prior to founding MedCap Advisors, he was a partner, board member, and managing director in charge of investment banking at HealthpointCapital. He was previously head of medical technology investment banking at Brown Brothers Harriman, a partner at Mirus Capital advisor. With such deep roots in the global medtech industry, Mr. Velis provides clients with a unique level of access to strategic buyers and capital sources, shepherding deals to successful conclusions. Having represented more than 150 medical device mergers and venture investments, he has brokered a wide array of transactions including licensing agreements, joint venture partnerships and mergers and acquisitions, and exit strategies. In this Q&A, he talks with Medical Design about the investment challenges facing the medical device industry and examines what he says are the three key factors affecting the prosperity of US medtech entrepreneurs.
What are the issues facing medtech in getting funded today?
In so many ways, it is a very special industry. It is the one industry that directly cares for Americans and globally cares for the health and well-being of all the people around the world. There’s no other industry, except perhaps tangentially the food industry that is so directly related to people’s health and well-being. And so the health of our industry and its growth and medical technology innovation and healthcare economics are critically important because none of us really survive and live prosperous lives without it.
Underlying and overlying everything we talk about today is the fact that this industry is so critically important to our well-being. And it’s almost 20% our GDP in the United States, so economically it is important to our well-being also. So as we get into sequestration and what’s going on in the economy and taxation and what drives M&A, there is this massive overlying issue that I think sometimes people lose focus on—which is just how important this industry is to all of us.
There are three key factors affecting the economics of the healthcare industry—especially the device segment—and its prosperity. First, there is the regulatory environment, the fact that FDA increasingly unclear about the regulatory process for the products and technology, especially in sectors like combination products. The second factor is the device tax, and the third is reimbursement.
How does the regulatory environment impact funding?
The uncertainty surrounding the regulatory process is inhibiting investment. So there is a government-regulated issue that is having a massive impact on investment in healthcare. It’s really dangerous to device development and design because investors become less likely to put money to work in device development if they don’t know the regulatory path to market—how long it’s going to take, what are the hurdles, what am I going to have to provide the FDA? As those things are unclear, it makes both time-to-market and cost of development unclear. When they’re unclear, it becomes very difficult to get money to design and develop new technologies and new products.
So FDA is a major regulatory hurdle to investment. It really doesn’t matter whether the regulatory process is more or less complicated or they’re requesting more or less information. [Instead,] what needs to happen is that what is needed to get approval needs to be very crystal clear and much less encumbered than it currently is. By way of comparison, if you look at the CE mark, it is so much easier to get a medical technology into the hands of a well-trained physician in Europe--and there’s the irony. Where our FDA is supposed to be a protective regulatory body—and they do a good job of that—what is curious is that so many sectors of healthcare is less expensive and just as efficacious in Europe under a CE mark, which has a substantially lower and less expensive hurdle to design and develop a product.
What we’re setting up is the potential for our innovative technologies and technology development to emerge elsewhere in the world. We are frittering away our competitive advantage by having unclear regulatory process and that is a problem. There’s a lot of talk about resolving it, but it’s clearly not. We’re working with early and late-stage companies all the time and it has late-stage companies shying away from development, putting the burden on early-stage companies and then standing back and looking for which early-stage companies come out of the end of the pipeline and are able to get funding. The dynamic that’s developing is that everyone wants to stay away from the risk.
Where do you see the biggest effect of the device tax on medtech funding?
The device tax is a real irony to me. On one hand, our government talks about lowering healthcare costs, and on the other hand, we put a tax, which seems to be a rather arbitrary tax, on the very devices that are central to the delivery of care. And it does nothing but raise the cost of healthcare. And to make it worse, it raises the cost of building new technology companies. And what I’m seeing with respect to the device tax is that it is hurting the mid-size companies that are launching products the most. Early-stage companies are spending a lot of time on design and development and then they get approved and start going to market. And it’s when they get toward profitability that this tax—at whatever rate—is impactful because it literally strips away profit for those companies that are just operating on the verge of profitability. It’s difficult to understand in light of what we espouse as our goal of lowering healthcare delivery costs.
What role does reimbursement play in investment?
Another significant issue is reimbursement. It takes years for an early-stage company to get codes for its technology. Many new technologies actually save costs. Here’s an example. We work with an imaging technology company. The imaging technology doesn’t require an injectable reagent, but you get the same image as the old technology. So I can provide an image of someone’s’ vasculature without having to inject a $1,200 reagent. It eliminates the $1,200 reagent. It eliminates the time it takes for that reagent to work. I eliminate the shelf space. That device without the imaging reagent does not get reimbursed. It has no code because it’s the reagent that has the code. But the diagnostic result is the same. Why should our company be encumbered with a difficult two- to three-year reimbursement process? It should be issued a code immediately—and without question. That, to me, is a very good example of where inhibiting technology actually raises the cost of healthcare.
So you’ve got these three factors that are government-regulated, government-controlled issues that are not working in the favor of medical technology development and healthcare in general. I think it’s about thoughtfulness more than anything. It’s not a criticism of bureaucracy or government so much as it is a willingness to stand back from issues an look at them as a whole and ask what are we doing as a nation to have competitive advantage in healthcare? The US should be a global leader, but our willingness to accept a policy to lose some of that leadership to places that have more advantageous processes. The measure at the end of the day is efficacy, and to the extent that they have the same or superior efficiacy at a lower cost says that we’re not optimizing.
Where can innovative young companies find funding?
The venture community is really in dire straits and predominantly because the market crashed in September 2008; pension funds are out of alignment, and venture funds raising money from pension funds are struggling. It’s very difficult to raise a venture fund, especially in healthcare. It’s likely that the medical technology and device investment will be among the last to recover from the standpoint of venture investment—and that means there’s a need to find alternatives sources of capital. And, they’re emerging—angels, family offices, sovereign funds from other countries, major strategics—they’re all making investments in this space. But funding is not coming from conventional sources. I’m a little skeptical about crowdfunding only in that I see, from the financial standpoint, that there is likely to be some major regulatory scrutiny around that type of funding.
Of these source—angels, family offices, crowdfunding, and sovereign funding outside the US—the last, and most important, is major strategics. They are very aware of the capital void and they are very aware of the need for innovation. And so innovation is really the only way for them to combat pricing pressures, by producing a more efficacious product. And so they are going to face a lot of global pricing pressure and the only way it will protect them is to produce devices that works more effectively.
How can early-stage companies partner with established medtech firms?
Large device companies are looking at the major white spaces they have, the areas where they lack product and that are the most promising, and trying to pick up technology in those areas by developing relationships with early-stage companies and funding them. Those come in all forms, and we’re structuring them in a variety of interesting ways. Frequently they will come with an upfront investment and milestones that lead to an acquisition. Sometimes they come in the form of an outright acquisition, but where payments are staged based on development of the underlying technology. An example would be a device for meniscal repair that puts a suture through a meniscus, helping the surgeon to pass a suture in a semicircle and then retrieve it from the same side of the meniscal tear. A major orthopedics company might acquire a company that’s at a prototype stage for an upfront payment. Then [the orthopedics company] would make a final payment when that product has the regulatory approval and the first product is sold.
What do those partnerships look like?
We’re seeing more transactions that complete acquisitions. You see a milestone based on a development, an animal study, a regulatory approval, and then on sales. That is the single best way to advance medical technology right now if you’re an entrepreneur. I think this is the best mode—that doesn’t mean I think it’s going to be the most common. The angels are going to be the most common. They’re plentiful, and entrepreneurs seem to have an endless ability to ask mom and pop to fund their ventures. But angel money frequently lacks industry insight and synergy. If you strike a deal with a major company like Johnson & Johnson, what you’re accessing is a distribution channel that calls on the doctors, surgeons, nurses, and hospitals that have access to patients.
Imagine a company that develops a technology and doesn’t have access to that distribution channel. It starts hiring salespeople and with a single product starts calling on specific surgeons. It’s got a high cost to do that. If you were to do the same thing with a strategic, they will have 20 products going to that same surgeon. And the issue is, “If I spend the money to build that distribution channel on my own, is the strategic going to value the investment that I’ve made in building the channel when it ultimately acquires me?” And the answer is, no. These companies have those call points already, so they’re not going to value it. You’re arbitrarily being diluted by something that isn’t valued by big companies.
Any medical device and technology company that has an approva,l or is close to receiving an approval, should not build a major distribution channel without first testing the market to be acquired or strike a partnership with a company that has those call points existing already. The money spent is duplicative to what the big company already has. The recommendation is that if you get to a point where you can see what your regulatory approval is, you have clinical data, it is best to see what the big companies think and whether there is a deal to be struck.
How has the funding landscape changed?
It’s been a slow shift, but it’s a shift. Ten years ago, I would have expected far more companies thinking about building the distribution channel than today. You could see a single-product company like Kyphon, which was sold to Medtronic, thinking about building that channel 12 years ago and actually succeeding with an interesting call point. Now that those channels are more in place than ever before, it’s much less of a question as to whether you should build or leverage them. More and more, big companies are looking for consolidation of their suppliers, and the hospitals are looking of reconsolidation of the device suppliers.
There is enormous opportunity, and it’s all a matter of how you develop competitive advantage. The first thing to think about is that despite all of these problems, global demographics are going to carry the day. Populations are booming, and those people are getting older. And if you look at the demographics, it’s really India that we should be looking at in terms of absolute demand. If trends continue, it will be the most populous continent.
The second thing to look at is prices in a care setting being cost-effective. The weakness that big companies now have is that they’ve grown up in an environment where margins grow very fast. Those margins are going to consolidate. Products are going to commoditize. That creates an opportunity for entrepreneurs to deliver cheaper products that are more efficacious, and in company cultures that don’t have a bunch of overhead. They are not running at 60%-80% gross margins on products. Big companies have to cut fat. New companies can think efficiently about their use of capital and their infrastructure from day one.
Do new companies think that way as they are putting together their product development plan?
Some do, dome don’t. If the entrepreneurs, engineers, and scientists don’t, it’s the new sources of capital that do. Venture funds were unique in that they were paid not only on the upside return, but they were paid to deploy money. The more they deployed, the more their management fee was. In the new world, the major investment sources—whether they are sovereign funds or family offices—they’re not concerned with accumulating management fees. They’re concerned about only return on investment. There’s no other way for them to make money and accumulate wealth. So they are only investing in companies that think in a capital-efficient way.
At the end of the day, innovative entrepreneurship has always overcome economic obstacles and challenges. Absence of capital from conventional sources will pose a brief obstacle. In reality, the underlying economics of healthcare make it one of the best areas globally to be investing in. It’s a changing dynamic.
So where does that leave the industry?
Reimbursement, the device tax, and the FDA regulatory process—we need to stand back and look at all of them and how they affect each other and make an overall effective system. That’s a call to action to our legislators: create an environment that fosters our competitive advantage in healthcare. We have to lower delivery costs, and we absolutely cannot lose our competitive advantage in the medical technology and device industry.