From The Editor | August 5, 2014

7 Unconventional Ways To Fund A Medtech Startup

By Jim Pomager
Follow me on Twitter @jpomager

Gears and dollars

Bringing innovative new medical technology to market today is as challenging, complex, and competitive an endeavor as it’s ever been for entrepreneurs and startups. Making matters worse, venture capital — the fuel that fledgling companies once depended on to drive product development — has dwindled in recent years.

According to an annual report by PricewaterhouseCoopers (PwC) and the National Venture Capital Association (NVCA), venture capitalists (VCs) invested a mere $2.1 billion in medical device and equipment companies in 2013. That may sound like a lot on the surface, but it’s the lowest annual figure for the industry in the last nine years, down 17 percent from $2.5 billion in 2012, and down a whopping 43 percent from the $3.7-billion high-water mark of 2007.

Not only is funding scarce, but VCs have become incredibly risk averse, waiting until much later in the product development cycle to get involved. There was a time not so long ago when new entrants to the medtech sector could obtain funding with little more than a great idea and a solid business plan, or so it seemed. Today, however, investors are withholding their support until a device accumulates significant safety and efficacy evidence, and often until regulatory and reimbursement approval have been secured. This leads to an unfortunate catch-22 — startups need substantial funding to get their technology into clinical trials, but VCs often want to see clinical trial data before committing.

Faced with this conundrum, medtech entrepreneurs have to get creative, and the broader healthcare industry is rallying to help support them. Experts from Cleveland Clinic, UnitedHealthcare, and other organizations discussed this trend during a lively panel session on this topic called How Healthcare Will Support Startups: In Dollars And Beyond, during the recent MedCity Converge conference in Philadelphia. While the panel focused primarily on digital health startups, they did identify 7 nontraditional sources of funding that might fit the bill for your medical technology company.

1. Divergent Corporate Venturing
Seeking capital from established corporations may not sound like a novel idea. In fact, it has become commonplace for large medical device companies to loan small, private companies millions in return for an option to purchase them at a later date. (See Boston Scientific’s $15 million deal with MValve Technologies last month or St. Jude’s acquisition of CardioMEMS in June.) These arrangements have their benefits — medtech corporations offer startups critical market knowledge and tend to be more patient than private VC firms.

However, more interesting strategic partnerships are beginning to form across traditional industry lines. Not only can large corporations outside the medical device space offer medtech startups new investment streams, they can also provide important technological solutions and a fresh perspective on design. “We are typically looking not just for cash, but for other technologies that our startups can embed in theirs to make a better mousetrap,” said Gary Fingerhut, executive director of Cleveland Clinic Innovations.

Fingerhut’s group, whose goal is to translate the ideas of physicians, scientists, and caregivers to the market, manages approximately 450 royalty-bearing licenses a year from a traditional tech transfer perspective, and also has 67 spinoff companies operating underneath it. Among the many cross-industry corporate partnerships it has helped form for its startups in recent years are joint initiatives with Parker Hannifin, IBM, Verizon, and Lubrizol.

“We very much believe that it can bring a lot of resources to the table — not just capital, but resources in other industries that they've been in and have not ventured into healthcare,” Fingerhut added. “We bring the domain expertise. They bring their technologies, their experience, their go-to-market capabilities, and their capital. It’s a win-win.”

2. Aggressive Grant Funding
Another twist on a familiar fundraising tactic was identified by Tom Vanderheyden, VP of business development and commercialization for health insurance carrier UnitedHealthcare (UHC). He said that really focused startups can sometimes substitute significant grant funding in lieu of early VC support.

“Something that I've seen a few times recently is companies taking the angel rounds of a couple hundred thousand dollars to get started, and then putting a lot of energy into grant funding,” he said. “They go for the non-dilutive $1 million to $3 million. We've seen that be very successful, and then you come out of that grant funding phase and you've got meaningful enterprise that's got lots of IP juice behind it.”

Daphne Zohar, founder of PureTech Ventures — a venture creation company that proactively creates new companies to solve unmet healthcare problems (including one developing a noninvasive neuromodulation device for the treatment of neuropsychiatric disorders) — said that her company pursues a great deal of grants for its startups. “We actually have a person full-time on the team who just applies for grants,” she explained. “They have gotten millions in grants, which is terrific, because the funds are non-dilutive and move things forward.”

Cleveland Clinic’s Fingerhut agreed, saying his group has brought in over $150 million of state money through programs like Ohio’s Third Frontier. Many other states offer similar programs to support startups. (For instance, I wrote about Pennsylvania’s Ben Franklin Technology Partners in a previous story.) The federal government is also a good source of grant money, through the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs at the National Institutes of Health (NIH) and National Science Foundation (NSF).

3. Accelerators & Incubators
Having founded a medtech startup himself, Joseph Mayer, M.D., extolled the virtues of accelerators and incubators. The CEO of Cureatr, a mobile care coordinator, went through the New York Digital Health Accelerator when his company was starting out.

“For us, it was a good opportunity,” he said. “We had two people when we started, with one customer, and we came out of it with two more customers. At the end of the day, that's what matters. You have to ask yourself, ‘What would I pay for two customers in terms of salespeople, etc.?’”

Compared to some other sources of funding, the amount of money you can get from an accelerator or incubator is relatively small, typically in the tens or hundreds of thousands. UHC’s Vanderheyden said that Rock Health, a healthcare accelerator that his group supports, characterizes its financial support as “grants and Ramen (the infamous and inexpensive instant noodles) money.” But what these entities lack in funds they more than make up for in value-added services.

“We are very active with accelerators in terms of venturing,” said Vanderheyden. “Some entrepreneurs we have found in this space are focused on the clinical benefit, the physician engagement, etc. They haven't quite figured out yet the economics of the business. That's something we feel we can shine some light on.” In addition to business advice, some of the perks provided by these programs can include inexpensive office and lab space, medical expertise and guidance, targeted educational programming, and more.

And some accelerators are now offering funding packages that are “getting closer to real money,” as Vanderheyden put it. You can obtain a total of $300,000 from New York Digital Health, he said. Verizon Foundation gives approximately $800,000, according to Cleveland Clinic’s Fingerhut. And there’s nothing prohibiting startups from going through multiple accelerator programs.

4. Partnering With Not-For-Profits
Everyone knows that patient advocacy and other not-for-profit organizations play a major role in financially (and otherwise) backing fundamental research. But what you may not know is that these groups are starting to become much more involved in helping technologies related to their treatment areas of interest reach commercialization.

Zohar described an initiative that PureTech Ventures launched called the Valley of Life, which brings together investors and not-for-profits to achieve common financial and mission-driven goals. The program aims to assist select startups bridge the so-called biomedical “valley of death” between angel and VC funding.

The Valley of Life’s first pilot program is in the juvenile diabetes space and involves the Juvenile Diabetes Research Foundation and the Joslin Diabetes Center (an affiliate of Harvard Medical School). “The idea is basically a $10 million fund that's funded primarily from patient groups that have been up until now funding basic research, and are now really interested in the translational aspect,” Zohar explained.

5. Customer Investment
The next approach, while admittedly much more straightforward for digital health companies than for pure-play device makers, is still worth noting. Cureatr’s Mayer was the first to point out that customers can be an excellent source of funding for new companies: “You build a strong relationship with a customer, a large health system, the big for-profits in the national market — they're starting to do more and more, not just biotech but healthcare IT investment.”

In some cases, these current or future customers may be willing to pay an advance on future services. “Another thing I have seen, but I won’t say we’ve done, is what I like to call the prepaid revenue model,” said UHC’s Vanderheyden. “I have seen corporates take some risk and say, ‘I think over the next 12 or 24 months, we plan on spending $600,000 in total for your services, so we'll give you half of that up front to get the party started. Now you can get some hiring done and expand your infrastructure — whatever you need to do.”

6. Hybrid VC Approaches
Although securing venture capital funding is no picnic these days, there are signs that the situation is improving. According to the latest quarterly report from PwC and NVCA, VC dollars invested in the medical devices and equipment sector rose for the second straight month, reaching $649 million in 73 deals. Narrowing the focus to the capital of the global medical device market, Minnesota saw medical device investing more than double between Q2 2013 and Q2 2014, per a recent report from Life Science Alley.

PureTech’s Zohar shared a potential strategy for working with VC investors — engage a mixture of life science and technology investors, and cater to each group’s specific needs. “I think one thing that's interesting is the metrics that life science investors use versus the metrics that technology investors use. There really are not many investors that are focused on digital health and can really look at all sides of the spectrum,” she said. “Tech investors tend to look at the customers and whether you have revenue or are likely to have revenue, whereas life science investors will look at the technology IP and the specific application. The kinds of things that we're doing are really a hybrid, so we have to cultivate a group of investors that have that creativity.”

Regardless of whether you use a traditional approach or a hybrid one, Mayer of Cureatr shared some general advice on engaging the right VC investor. Make sure you pick one that truly understands the healthcare sales cycle, that believes in you and your team, and that you think you will enjoy working with, he suggested.

7. Crowdfunding
The use of crowdfunding was an almost unavoidable topic of discussion. After all, not a week goes by without news of a medtech startup (particularly in the wearable segment) launching a new Kickstarter or Indiegogo campaign. However, I saved it until last because the panel expressed a great deal of concern about the use of crowdfunding, and offered some sound advice as to why.

Vanderheyden shared a cautionary tale, based on an anecdote he heard during a recent investor conference in Minneapolis. “[One of the speakers] said he took over for a company that had crowdfunded. They had 450 non-credited investors, and he said it was a disaster. One of the investors had originally sent in $5,400, and 90 days later he calls the CEO asking for his money back,” Vanderheyden explained. “Think about it as the CEO of an early-stage startup. Now you have dozens and dozens —or conceptually hundreds — of equity stakeholders, non-accredited, that you now have to manage.”

As an inherently public exercise, crowdfunding also exposes startups to potentially negative publicity. Zohar likened it to using an online dating site, where people won’t be willing to engage you until you have built up sufficient credibility and validation on the site. “There’s a bit of a risk in putting yourself out there and saying, ‘Hey, I'm looking for money,’” she said of crowdfunding. “What if you can't raise the money? What does that say [to potential investors]? Does that say your idea isn’t good?

“During the very early stages, when we actually could use that funding, we would rather find the funding from other sources that exist, and not put ourselves out there as looking like as if we need the money,” she added.

If you are hell-bent on exploring crowdfunding for your startup, the panelists agreed that you should check out AngelList, which is effectively a crowdfunding site for accredited investors. “AngelList is probably the best example of institutionalized crowdfunding,” Mayer said, “where you can get 20 people into a round.”

While finding and obtaining investment for new medtech companies is certainly a challenge in the current economic environment, it is far from impossible, as the examples above attest. I am curious to hear your opinion on these strategies — or other unconventional methods you have either used or learned about. Please contact me with your ideas or feedback at editor@meddeviceonline.com, or post your your thoughts in the Comments section below.