2006 has been a very strong year for venture capital investing in the United States. As of the end of the second quarter of the year, the venture capital industry was gaining momentum and ratcheting up investment levels. A primary driver of the robust activity has been the life sciences sector (biotechnology and medical devices). This momentum continued in the third quarter of the year, and total venture capital funding raised by life sciences companies during the third quarter of 2006 increased by close to 30 percent, compared to the third quarter of 2005. Medical device companies accounted for the most deals during the three months ended September 30, 2006 (pharmaceutical companies accounted for the greatest amount of funding).
In light of the robust market, what can be learned from 2006 to project venture capital medical device investing in 2007? Based upon a review of certain transactions and discussions with local area venture capitalists, it appears that medical devices should continue to see strong venture capital investing trends in 2007 for several reasons.
First, medical devices are real, tangible items. Investors like medical device companies because they have specific, well-defined markets. Venture capitalists not only can test the products, they also can get a sense of market size. For example, for a medical device company that is developing a back-pain alleviation device, a prospective investor can get his or her hands around the device and see how it actually works, and he or she can develop a solid sense of the market for such a device by looking at those who suffer from back pain. Another important factor to venture capital firms investing in medical device companies is that generally speaking, medical device companies are able to establish strong management teams. There is an exceptional pool of talented, experienced entrepreneurs, directors, and advisors interested in medical device companies. In part, this is a result of the fact that these individuals are more interested in getting involved with privately held enterprises that will likely seek an merger and acquisition (M&A) exit than being part of a publicly held company or enterprise that is seeking to complete an initial public offering (IPO).
Venture capital firms are very interested in funding management teams that have expertise in the field and have come from successful endeavors. Further, the ecosystem for medical devices is very healthy because large national companies are building their portfolios actively, have available cash and alternative access to financing to acquire medical device companies, and have been very acquisitive. We expect this trend to continue into 2007 and project that large national companies will continue to be focused on acquisitions in 2007.
As a result of the active M&A market, venture capitalists can project a legitimate exit with solid valuations. In addition, it appears that the technology and the products being created by medical device companies are continuing to improve and have meaningful purposes. Imaging technology, diagnostic technology, and the like are responsive to the desire for greater, clearer information from an aging population, and are garnering significant interest from investors.
Of course, certain pitfalls continue to exist for medical device companies that are seeking venture capital investing. In particular, the medical device field has not been the best place for blockbuster IPOs. In addition, medical device companies' capital needs are large, and are subject to numerous entrepreneurial risks, including the length of time it takes to bring medical products to market (although it is significantly shorter than that required by biotechnology companies), proving product safety and efficacy, securing patent protection, securing a good distribution channel, and facing entrenched competition.
Medical device companies should expect to see several layers of venture capital investing. A typical investment for 2007 may include an initial A round of $2 million to $3 million, from which the company can achieve certain milestones. If the milestones are achieved, the investors are likely to build a syndicate and increase the funding in the B round, likely to be in the $10 million to $15 million range. Ultimately, medical device companies should anticipate or seek a five-year funding commitment. In all, medical device companies should expect a continued strong investing market in 2007.
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