By Jim Kasic, Boulder iQ
Say “start-up” in the medical device community and the conversation can move quickly to funding. Who will invest? How much? How long will it take?
A particularly tough challenge for medical device start-ups is that the executives tend to be the scientists and inventors of the device. When it comes to funding, you need to trade your inventor hats for business ones and learn to think like an investor. It’s not an easy task, and with most medical device start-up companies operating in a very competitive landscape, the need for speed in attaining this business acumen is critical.
How to do it? Here are five tips to help a medical device start-up be more interesting, more attractive, more investable – and less risky – to potential funders.
1. Define your market.
In other words, do your competitive homework. As wonderful as you believe your device is, make sure you have something new, something that performs a function at a lower cost than existing devices, or offers more for the same cost. If you can prove this, and communicate it clearly, you may have an attractive investment.
A market that is eager for a device to answer a clear unmet need is the optimal “defined market.” Investors want to see that your device fits clearly into a specific medical treatment area or diagnostic process and that it enhances or replaces current procedures. In the medical device start-up world, there is no place for “missionary” sales work, where you must convince a customer to believe in a new product concept – especially one that requires a change in current procedures. This process, which is incredibly difficult to carry out, also is long and involved – none of which works for an investor looking for timely returns.
- Create a device that will be used in procedures that are already being performed.
- Make sure the device will be used in a specific application.
- Define the physicians or other clinicians who know they need a new or improved way to perform the procedure.
- Calculate the market size. This could be based, for example, on the number of specific surgeries conducted each year that will use the device, or other relevant use factor.
- Know how to identify where the users are and how to reach them.
2. Make sure that your market will be willing to accept and pay for your device.
Investors want to make sure that buyers will be willing to accept and pay for your device. So, while medical device developers all want to create devices with clinical benefits, they must also have economic benefits.
Once ready for market, the reality is that a purchasing agent must deem your device necessary and affordable. Even if a physician requests it, the purchasing department has to make sure that the device satisfies the physician’s need at the lowest cost. One way to help assure this acceptability is to demonstrate that your device can be paid for within current reimbursement structures, specifically through Diagnosis-Related Group (DRG) reimbursement and Current Procedural Terminology (CPT) codes.
A DRG reimbursement is associated with a patient’s diagnosis, which typically is associated with a fixed dollar amount of reimbursement – i.e., a DRG reimbursement. The healthcare provider is expected to treat the diagnosis for this fixed amount. If your device can help them do that for less money, you may have an advantage in that provider’s system.
CPT code reimbursements are associated with a physician’s specific skills and their use of equipment and tools to perform a particular procedure. For example, physicians performing cardiac catheterization procedures require special training and qualification. The CPT code provides additional reimbursement for the special skills and equipment necessary to perform this treatment. Medical device entrepreneurs should understand that obtaining new CPT codes is a lengthy process typically requiring two or more years, along with several peer-reviewed publications attesting to a device’s advantages. However, if your device fits within existing CPT codes, you will have a clear economic advantage in investors’ eyes.
3. Set a price that supports high margins.
Investors are looking for a solid story of why you can expect high margins and how you will maintain those over a reasonable period of time.
Medical device values are based more on the importance they bring to a particular procedure than on manufacturing costs. Devices that offer a truly unique market advantage and provide excellent value to each of the “3 Ps” (the patient, the physician, and the payer) are in the best position to support high margins.
Gross margin is calculated as:
(Average sales price – Cost of goods sold) x 100
Average Sales Price
Gross margins above 70% are typically attractive to investors. A gross margin in the mid-80% range offers excellent returns. Investors also understand that these high gross margins are needed to support the overhead costs of working and innovating in a regulated industry.
Investors will want to see pricing that is commensurate with those margins. Think of it this way. In the early and mid-1900s, there was such a thing as “penny candy.” It was fun for kids to buy, but no matter how high the gross margin was on a piece of candy, the manufacturer was never able to make a significant amount of money on that product alone. The selling price was just too low.
In the medical device community, developers can look at the number of procedures performed each year that would employ their devices. Very few medical procedures are performed to the tune of millions per year, but it’s very possible that a device would be needed for hundreds or tens of thousands of cases per year. If so, there’s likely an opportunity to make a device that can be produced in a large enough volume to support high margins and command a price that will provide sufficient returns to investors (and the developer).
Setting sales prices encompasses far more than the cost of making them and obtaining required regulatory and quality certifications. Medical device developers may overlook the real costs of marketing and selling as they analyze margins and pricing. Consider that there is substantial cost in communicating to potential buyers and convincing those buyers – usually physicians and payors – to purchase the device. You must balance the cost of obtaining a customer with your gross margin and number of devices a customer is going to buy.
For example, you want to make sure that the margins on the device can cover the sales and marketing costs. Imagine a device is sold for $2,000 with an 80% margin – meaning the company would make $1,600 on the sale. But that’s before overhead costs that include sales and marketing. If those costs are $5,000 – not unrealistic – then the company will not make any profit, and in fact, will lose money on the deal.
However, if a customer buys four devices, the company would be making a total gross margin of $6,400. Subtract that $5,000 cost for sales and marketing, and now you are covering the cost of converting the prospect into a customer as well as starting to create a positive cash flow.
Conversely, let’s say you have a less expensive device that sells for $1,000. At that price, you’ll need to sell twice as many to cover the cost of converting a prospect into a customer. The bottom line is that start-up device developers must do the math, be realistic, and understand the importance of pricing to investors.
4. Confirm your FDA pathway.
Regulatory hurdles can present some of the greatest risks for investors interested in start-up medical device businesses. Sadly, horror stories abound about companies that were convinced they had a clear FDA pathway and later found otherwise. Hopeful investors and investment dollars went by the wayside.
For example, a client of ours was developing a drug delivery device, which it considered a simple pumping or transfer mechanism. Far along in the product development cycle, they learned that the FDA classified the device as a “combination product” and required proof that the drug container provided long-term stability for its contents. As a result, instead of looking to obtain a 510(k), the company faced lengthy, expensive drug storage testing to confirm that the device had no adverse effect on the drugs it would deliver.
Other examples include devices that try to combine predicates in a 510(k) application, when the devices actually have separate indications of use. Instead of a 510(k), a lengthier and more involved de novo application might be required.
Medical device start-ups should also be aware they may be required to conduct clinical trials to help establish a device’s safety and efficacy. They would then need to submit a Clinical Evaluation Report (CER) with appropriate statistical evaluation of the results with their 510(k) application. Some 510(k) devices are cleared without clinical data requirements, but not all. To assume that no clinical data will be required can lead to a grossly underestimated timeline and budget, which translates to poor investor returns. The best advice is to check it out in advance, consulting with industry experts or the FDA if needed.
The bottom line is to never assume a simple path to regulatory clearance. While some cases may be straightforward, it is almost always advisable to take the time to get an opinion from a regulatory affairs professional or ask the FDA to classify your device by submitting a 513(g) application.
5. Show solid intellectual property protection.
While a key to achieving high margins and prices is unique advantage, keep in mind that uniqueness is temporary. Others will try to copy these devices unless it is unlawful to do so, such as when a patent or other intellectual property protection exists. The United States, as well as many other countries, grants inventors a monopoly to profit from their invention for 20 years from the initial patent filing date. After that time, the patent information becomes usable by all, and others can freely copy any and all aspects of the device.
The reason patents are so sought after is that they represent the most common and recognized ways to maintain uniqueness and avoid the problem of devices becoming commodity products. Other ways to retain uniqueness – such as maintaining trade secrets on how a device is produced – are much harder to confirm, defend, and value. Investors prefer patents because they can be analyzed and assessed for monetary value in a particular market area.
Investors also are interested in ongoing innovation. Smart device developers will present a strategy that demonstrates innovation and invention that will enable an overlapping string of patents and a future portfolio of new products.
Investors want to put money into ventures that have a high likelihood of success, with as many of the risk factors as possible already mitigated. Medical device start-up companies are inherently risky, with much to do to reach steady and growing revenues. Thinking critically about the potential benefits of investing from the investor’s perspectives, and how you can reduce risks, will make your start-up company that much more attractive and investable.
About the Author:
Jim Kasic is the founder and chairman of Boulder iQ. With more than 30 years of experience in the Class I, II, and III medical device industry, he holds more than 40 U.S. and international patients. His career includes experience with companies ranging from large multinational corporations to start-ups with a national and international scope. Kasic has served as president and CEO of Sophono, Inc., a multinational manufacturer and distributor of implantable hearing devices, which was acquired by Medtronic. He also was the president of OrthoWin, acquired by Zimmer-BioMed. He received a B.S. in physics, an M.S. in chemical/biological engineering from the University of Colorado, and an M.B.A. from the University of Phoenix. He can be reached at firstname.lastname@example.org or on LinkedIn.