Medsider: Learn from Medtech and Healthtech Founders and CEOs - How to Fund Your Medical Device Startup

Episode Date: December 9, 2020

This interview brings us to the end of a throwback mini-series that I’ve been releasing over the past few months with some of my favorite Medsider guests of all time.On this particular episode, I chatted with Rich Ferrari, Managing Director of De Novo Ventures, and one of the most well-known VCs in the Medtech space. Here are some of the points we covered:Novel ways to fund early-stage medical device companies.The metrics that are most important when it comes to early-stage versus late-stage medtech investing.Why does the FDA “runway” seem to get longer and longer over time?How Rich identifies and validates whether an idea is truly disruptive.Download the transcript here.

Welcome to MedSider, where you can learn from a mix of experienced medical device and medtech experts. These proven mentors will show you how to master the med tech space on your own terms without going to school. Now, here's your host, Scott Nelson. We will not invest in your company because it's clear you'll need a PMA. That's the stance that some MedTech venture capitalists are currently taking. Why? Because costs continue to rise for early stage. medical device companies at a significant clip. While the approximate cost to obtain a PMA approaches

$100 million, 80% of MedTech exits over the last several years have been less than $250 million. Do the math. Those numbers are less than impressive. In this interview with Rich Ferrari, managing director of DeNovo Ventures, we'll learn more about the state of MedTech venture capital and the corresponding impact on medical device startups. Here's some of the points we're going to cover. novel ways to fund early-stage medical device companies. Two, early-stage versus late-stage med-tech investing. What metrics are most important? Third, why does the FDA runway seem to get longer and longer over time?

Four, how does Rich identify and validate an idea that is truly disruptive? Of course, we'll cover even more interesting insights in this interview. But before we dig in, you need to listen to these brief messages from our sponsors. And by the way, if you're interested in becoming a Medsider sponsor, go to Medsider.com forward slash sponsor. Again, that's Medsider.com forward slash sponsor. Now listen up. The simple reality is that a conference is a huge opportunity to build relationships with extraordinary people. People who might have a significant impact on your professional or personal success.

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forward slash news. Again, that's medsider.com forward slash news. As a reminder, MedSider is on iTunes. Just do a search on iTunes for Medsider and you can subscribe to the podcast for free. That way, all the new interviews will automatically download to your iTunes account. It's super easy. Also, if you like the podcast, don't forget to rate it. That really helped us out. Okay. For you ambitious MedTech and Medical Device Doers, here's your program. Hello, hello, everyone. It's Scott Nelson. Welcome to a edition of MedSider, the place where you can learn from med tech and medical device experts on your own terms without going to school.

And on today's episode, we have Rich Ferrari, who is the co-founder and managing director of De Novo Ventures. So thanks for taking some time out of your day today, Rich. I appreciate you coming on. No problem. Pleasure to do it. All right. So let's start out with a quote or a statement, I should say, that I recently read in

mass device, I believe. if I remember correctly, but it was from Jody Hatcher, who's the CEO of Novation. And his quote was something along the lines of hospitals have a burning platform to reduce costs. So when you first read a statement like that as a storied MedTech B.C. yourself, what's your gut reaction tell you about a statement like that? Well, I think he's fundamentally right in that hospitals are constantly looking to reduce costs. Now, whether or not that relates specifically to medical devices or relates to, let's call it, inefficiencies of the delivery system, you know, overall, I'm not sure what he's referring to. But be that as it may, there's always pressure using costs and devices, at least on the device side.

And, you know, things that are commodity-related, commodity-oriented devices, things that don't really offer some. significant benefit, you've got to ask yourself, why wouldn't those be really scrutinized if they put under tremendous pressure to, if they all look alike and they all do the same thing, it should be a way to lower the cost of them. Right. So, yeah, I mean, I think the margins for the hospital business is not all like great, and a lot of it's, you know, due to inefficiencies, and some of it has to do with, you know, the devices they're buying and why they're buying and how they're used.

Great. And I definitely want to get into some of those aspects when you look at early stage med tech companies and some of the different ways to fund some of those companies that are actually producing interesting devices, but we're obviously in an era where exit valuations aren't as high as we've seen a significant rise of the cost to fund some of these early stage companies. But before we jump to that, when you see, I mean, some of your VC tech brother in kind of the social space, if you will, VCs that have funded Instagram, OMG Pop, Buddy Media, etc. When you look at some of those acquisitions, does it make you jealous when you compare that to kind of where we're at within MedTech today? Of course. I mean, I would love to be in a deal that look like Instagram, right?

14 people, you know, a billion-dollar return on not that much capital being put in. I guess the closest thing that we have is something like that, you know, it might be like Ardion. Sure. Right? Really not, when you look at Ardion, not as much money went into Ardion, although it took a bit longer than Instagram, but the outcome for it was exciting. but those, as you know, are few, very few and far between. And in reality, they're really few and far between, even in the tech space.

Sure. For the most part, although they seem to resonate really well in the news, you know, Instagram and what 10 interests might get sold for and these other things. But, yeah, I mean, there's no doubt that the business and medical devices and the have been, with no IPO market, we've only got one market. That's the M&A side.

of it. And with every startup company that's been funded over the last, you know, six to eight years looking to try and get an exit, you know, the BB guys have an awful lot of material we'll be looking at and can certainly, there's no rush to them to really buy anything. Sure. In a certain respect. So, yeah, I'd love to see, quote, the 10x returns in venture capital. They're few and far between. Right. It's definitely a nice topic of conversation, right? The Instagrams, the buddy medias, the OMG pops to the world. But I think you said it great.

You know, on our side, Ardion was certainly celebrated as one of those big wins. But to your point, they are few and far between. And it's easy to talk about them, but they certainly don't happen very often. No, it's like everything. You know, it comes down to comps. And the comps in the tech area seem to be. you know, out of orbit in ridiculous, but they're there, that's real cops. And the cops in the medical device arena are much more bounded.

I mean, we've got a long history of collection of data, and that data points to the fact that, you know, 80% of the transactions are 250 million below. Wow. And 55, 58% of them are 100 million below. So that's just, that's the state. of affairs. Yeah. Did you say, so 80%,

just to review it, 80% are 250 million or below, 80% of the exits? Absolutely. Absolutely. Yeah. You track the exits for the last decade.

80% are under 250 million. And about 58% right at about 60 or so, right at, certainly in the 50s are 100 million below. Gotcha. So you won't exceed.

There's only a small number greater than 250. Wow. That's a really interesting stat considering. I think Josh McHour wrote a piece recently where he stated that the average cost of a PMA approaches $100 million these days. And when you look at the stat that you just mentioned 80%. Well, it does depending upon the technology area. But no question, if you're in a space in which a PMA is required, generally speaking, by the time you get through, that PMA, that clinical trial, the follow-up period, all the overhead costs and all the development costs that

when getting there, he's right. It's between 70 and 100 million. If you're in a neurostimulator or a new wireless pacer or something else, which, what I would call very high technological demands, you're going to be closer

to the 100 million. Right. versus something that might be closer to the $70 million, but nonetheless, it's a big number. Sure. Yeah, no doubt. I think I interviewed Rudy Mazzaki not too long ago, and he actually mentioned that some of his counterparts in the VC world won't even fund a device that's going to require a PMA. Do you find that to be true, that statement? Well, yeah, I think that, again, I think that generally speaking, the prevailing thought process there. Most BCs would say, I don't want to get involved in a PMA. It's just too costly,

too long, the follow-up, I don't want to go there. So I think that's probably true. But I have to tell you, I mean, I've seen some 510Ks that are beginning to look like PMAs. I mean, we just got done with one in an orthopedics company. They did a 300-patient randomized controlled trial. Wow. That was a 510K. Hmm. And so the lines between a 15K and a PMA are starting to blur. It depends, again, on the area they can become awful blurred. Right. Right. So again, everything's relative. So you can't have a blanket statement so that wouldn't fund a PMA.

Because you had a PMA in which it only was 120 patients. And maybe one-year follow-up might not look so bad. Sure. Yep. Right. So. Gotcha. No, great points. And so let's jump to some of it. Let's use that as kind of a springboard to jump into the next topic. That would be if an early stage company, whether they're in the orthopedic space, the cardiovascular space, you know, you mentioned neuromodulation just a little bit ago, whatever disease state they're looking at, what are some of the novel ways that early stage companies are using to drive capital in order to get to that point where they can de-risk an investment, you know, for a potential M&A acquisition. Well, you know, again, there's no, as you know, there's no perfect pathway to this, but there are a number of folks, entrepreneurs I've dealt with, that have gone the path of Super Angels to start, you know, trying to get Angel dollars in early, and then look for government grants.

That's not involved with the company right now. That's actually done quite well on the government grant side, a million dollars. and for a small early-stage startup, you couple that with, you know, some angel dollars maybe at a million. That's $2 million. And depending on how they've structured, $2 million for an early-state transaction should be enough to have you prove out the method of action,

get all the quality work done, all the GLP work done, actually file, in this particular case, let's call it a $510K, and actually have human clinicals on $2 million. That's pretty good. If you've got half of it from grants, that's a pretty good deal, right? Now, those, I must say, are not, you know, you don't see those very often. You see those few and far between. So more often what you see is some sort of combination of angels in the beginning,

and then those sees sees who like to play in the early stage. generally raising a more modest amount of money, let's call it, in the one and a half to two and a half million dollar range, so that you reduce risk, you get through those early risk reduction components, and then you go out and try to raise the bigger round. Right. So with that said, and I think it's, and I'm not sure exactly where you guys are at de novo, but it seems like most MedTech VCs, when you look at their portfolio, I guess in today's economic environment, they much prefer late-stage deals versus early-stage deals. Do you see angels become, you know, as the main bridge from, you know, from early stage to later stage when, you know, when folks like yourself can make a significant investment? Yes. Well, yeah, generally speaking, and there is some other models, you know, out there.

There are, quote, you know, the incubator sort of models. There is a model, believe it or not, I'll put a plug-in for myself. that I had just put together with a group out of Switzerland and a group that I put together here to kind of bridge that exact phenomenon, which is if you've got an entrepreneur or a doctor who's got a really great idea and has done actually some work on it that's having trouble, getting the money, this particular structure I put together is if that technology passes the due diligence process, the funding is taken care of for it. up to first in man.

And the engineering is all done in Switzerland. Okay. So that's an alternative to having to go out and trying to get angel dollars, setting a valuation. This doesn't even set a valuation. It just parses out ownership pieces to the entrepreneur and to my group and to the group in Switzerland that's actually quite economical. and it's all funded to first and man, and then you go out and raise dollars.

So there are different approaches to try to do this. And I think you're right. Most VCs today would prefer to do a later stage de-risk transaction. But you've got to remember why. And the reason they want to do that is they need a return. They need to score a goal. Otherwise, the likelihood of them raising another fund is very difficult. So the prevailing thinking today is I don't want to take on any risk.

I just don't want risk. Gotcha. And that... You've got to find those guys who are still interested in taking on a little bit of the risk, you know? Yep. Yep. And those, are those venture capital, those VC companies, are those few and far between that are willing to take on risk these days?

I mean, is De Novel considered one? of those first? Well, we were when we were making new investments and now, well, we're at a stage with our third fund where we have reserved the cash and capital for the current portfolio, which, by the way, is where a vast majority of all these firms are. So if a firm hasn't raised money, let's say in the last two years or three, two years, let's pick that, they're most likely going to be reserving their capital for the current portfolio they've established.

So the number of early stage guys clearly has dwindled down. Got it. Okay. And that different model that you just referenced a few minutes ago, I'd like to dig into that a little bit. Do you refer to it as a certain model? And help me understand how it's different than the incubation model that we've off. Yeah, people on this call are familiar with. Yeah, it's a good question.

It's really not an incubator. We call it a medical device generator. And the reason we call it that is because, like, for the first one that we're running through this program, these are technologies that have already been developed to a certain level. For example, you know, someone coming out of a Stanford Bio Design program, where they have developed and run through a series of tests all under the program specifics. right so they would have done they would have done animals they would have done all the method of action how it works but as they graduate they don't have a they don't have a way to fund it

many of the graduates are postdocs they go on and doing their surgical residency what do they do with that technology or this could be a doctor who developed it developed the technology far enough along in his garage you know many of them do or wherever but they can't get the funding done. This model is where we look at it and say, okay, we like the space, we like the clinical rationale behind it, we'll now take it all the way to first demand for you,

and you maintain a nice position of the company. So really, it's not an incubate. We're not incubating it. We're taking it and finishing it, generating it, all of the different steps. through a very methodical process and the funding's there for it. So it's all encompassing, so to speak.

Right. I see. And so is that, our novel sort of models like the medical device generator model that your model that you just mentioned, is that what we're going to have to get to in order to see some of these disruptive technologies actually get to a point where a large strategic would actually acquire them?

Well, again, I don't know if it'll be what will create the vehicle for a large strategic to acquire it, right? Because the large strategics, I think the large strategics will always have to require disruptive or new innovative products. Because their structure prevents them in a way from doing this kind of stuff internally. Right. So the startup world and the acquisition world are really a structural component. Because, you know, the big guys, what are they spending their money on? They're spending their money on those franchises that are carrying the bulk of the revenue. So they put their top guys on those programs, and they're constantly innovating around,

like the perk valve business, right? But the perk valve guys really aren't developing the insulary products. that the profile of business needs like symbolic protection. Sure. How do you close the hole in your way? They think he's fresh. Hey there, it's Scott, and thanks for listening in so far.

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