9 Key Investor Milestones Every Med Device Developer Should Know
Let’s face it. Designing, developing, and bringing a medical device to market takes money — lots of it. While true of any product in any industry, medical devices can be tougher than most. The requirements of a tightly regulated industry and potential liability issues inherent in the field present time and financial hurdles companies in other industries may not face.
Since few startup companies can bootstrap complete device development, they typically look to investor funding. As daunting and overwhelming as the funding process can be, there are definite guidelines and stages of investor de-risking that can make the design and development process much more on target and successful when it comes to raising capital.
The basic rule of thumb is that the further along in the design and development process, the less risk an investor takes on. And, at all times, a device developer must be aware of de-risking points. But the risk curve is not a gradual one. In fact, investors perceive quite sizable jumps in risk reduction at various points in the process. If the device company understands the process and these milestones from the investor’s point of view, it will stand a much better chance not only of securing funding, but of how much to seek at what point.
Base Criteria For Investment
Before a company can even think about investor funding, it must meet several criteria with its device:
A reasonable device idea with a sizable market. “Sizable” will depend on the device, but in general, potential investors consider a total available market of at least $1 billion “reasonable.”
A logical regulatory route to market. The idea for a device could be terrific, but without a practical regulatory path — generally one with reimbursement codes already in place — it will be of less interest to investors.
A device that has true value. The device must offer the same therapeutic value as competing devices for a lower price, or it must do more than competing ones to command a higher price.
High price and gross margins. Because of the extraordinarily high testing, regulatory, sales, and marketing costs, a device must be able to command a high price and support high margins. Looking at two devices that both support an 80% gross margin, it will usually be better to work with the device that commands a high sales price (e.g., more than $500) than one with a low price (e.g., $10 or $20). Given the amount of effort it takes to convince customers to buy any device, the reality is that you would need to sell substantially more of the lower-priced device to realize significant sales.
Once a device has met these basic assumptions, you can plan technical activity to align with key investor milestones.
Patent. You must protect your idea. Before you get to the next milestone (pitch deck), you should have a patent application filed (patent pending) or better yet, issued.
Pitch deck/investor deck. This is the opportunity to tell your story. Most design and development professionals can tell a passionate, involved, technical story. That’s not enough. The pitch deck and way you present your story must be business-focused, geared to the investor audience, and professional. It’s worth it to pay communications specialists to hone that focus, use language appropriate for a non-technical audience, correct grammatical and style errors, and work with you to create the most professional presentations possible. At this stage, it’s often possible to raise money — typically from friends and family but it won’t be much, and it won’t be at a high valuation.
Proof of concept. This point, simply put, proves that the device will work. Proof of concept usually happens in a lab, under perfect conditions. It may be “built” with a 3D printer, and it demonstrates that the physics of the device work but are not robust enough to manufacture at scale. At this stage, it’s tempting for developers to get over-excited. Be aware that many ideas which work on paper prove unbuildable. As a result, some investors may have interest at this stage but will still see the device as high on the risk scale.
Design and development. The FDA and European Union (EU)-mandated design control process is a long, arduous one that, if successful, results in design freeze. It involves taking a proof-of-concept device to the point where you are able to file for regulatory clearance (generally a 510(k)) or perform human clinical trials.
Clinical data. In an investor’s eyes, strong, solid clinical data is a must. Again, it depends on the device, but companies frequently start with good animal data and then move to human clinical data, showing how their device works in a person. More investors may start to take more interest at this stage, especially if the developer can show genuine enthusiasm among physician users, but will maintain a keen eye on the next milestone: regulatory clearance.
Regulatory clearance. The point at which you receive the 510(k) — or other appropriate regulatory clearance — is a major investment point. Simply stated, regulatory clearance ups a company’s valuation, as it will be much more difficult for a potential competitor to enter the game. And, if a company has been able to complete a clinical trial with humans, it will find investor interest increasing fairly dramatically, as it’s a significant de-risking point. In working with several hundred devices and developers over three decades, I’ve found that a rule of 1,000 applies in the testing and trial phase leading to regulatory clearance. That means a developer needs to have either 1,000 devices implanted or a record of 1,000 patient years (e.g., devices used by 1,000 patients for one year or devices used by 500 patients for two years). This substantially de-risks the investment.
Sales. Making the device is good. Getting it on the market is great. But will your target market buy it? Showing an investor that you have sales is a major milestone that will significantly increase funding interest.
Breakeven point. Next on the scale comes breakeven point. Investors (and you) want to make, not lose, money. While every device and company is different, breakeven commonly occurs around the point of $3 million to $5 million in sales.
Sales multiples. Again, the number will differ by device, but generally, an investor sees that there is a bona fide market when sales of a device reach somewhere between $3 million and $10 million. The device may not yet be profitable, since even with good gross margins and operations management, so much money goes into sales and marketing. Yet investors see this point as a “sweet spot” where it’s possible to get to profitability with a relatively minimal infusion of capital. For businesses looking to be acquired, keep in mind that investors almost always buy device companies based on multiples of sales, not EBITDA (earnings before interest, taxes, depreciation, and amortization). Why? Building a market for a device is very expensive, and acquiring companies typically have established infrastructure to envelop new products into their marketing plans and programs. Whereas sales and marketing costs average 22% for large device companies, they can easily amount to 50%–60% of revenue for a startup. A potential acquiring company knows how and where it can integrate a new product into its system, so in evaluating devices, it’s all about sales.
When To Seek Investment
This is, quite literally, the million-dollar question. It’s very tricky to find the exact milestone where investors will want to invest in your device. Depending on the technology, industry, use, market, economy, and personal preference, some investors seek out early-stage companies. Some will only be interested after a device has obtained regulatory clearance, a set level of sales, or breakeven.
Getting to know your potential investors is critical. It’s not realistic to expect an investment after a single meeting. Most investment firms will want to see real, tangible progress over a period of six to 12 months — or more — before writing a check. People invest in people, too. So as the investor gets to know you and your company, and sees the progress, they’ll champion you within their investment firm and among other investment firms.
Beyond getting to know your investor market, a few rules of thumb prevail. Typically, a startup device company must get to the proof-of-concept stage to successfully raise significant capital. In that first round of funding, they’ll commonly experience dilution of 25%–35%. (Dilution is the process of a startup's founders surrendering ownership of the company in return for the capital they receive.)
If a developer can then get to regulatory clearance — a huge hurdle — the device’s worth and company’s valuation increase significantly, and investor risk decreases significantly. It becomes much easier to go out and raise money.
As technically brilliant as an idea, a proof of concept, or a manufacturable device may be, it still may not be investable. At every stage, a device developer needs to know not only its next steps to take in the lab, but what it will cost to get to the next investor milestone. Only then can it calculate realistic valuations and determine if and when to seek outside investment. Device development firms that focus on investable development can lend invaluable help in this area.
The road to invest may be as long as the proverbial road to Tipperary. Going in with eyes wide open, knowing what investors are looking for at which stages, will allow a startup developer to walk the fine line between technical device development and investor needs and stand the best chance of receiving an investment.