Business forum: For medtech, a new model is needed

  • Article by: PETE MCNERNEY
  • Updated: May 19, 2013 - 11:24 AM

The realities of the Affordable Care Act, longer FDA approval times and reimbursement challenges require new ways to finance medical technology start-ups.

I have been involved in early-stage medical technology investments for more than 25 years. Venture capital available for med-tech has been shrinking over the past five years, particularly for early-stage financings.

Nationwide, med-tech attracts less than 10 percent of all venture capital annually but in Minnesota this number has been approximately 50 percent, which is why we should pay special attention and be concerned.

Flows of venture capital into med-tech have slowed in the past, but, unlike the past, I do not believe that this flow will return to a healthier level on its own — especially for new, innovative medical devices. The time and capital requirements to bring a medical device to market that requires clinical trials have increased to the point where the existing venture capital model does not work. And these influences are not going away.

The FDA process has become less transparent, harder to predict and longer. But even with improvements to the approval process, the more sophisticated products will be even more difficult for FDA to evaluate. Examples include molecular diagnostics, personalized medicine, combination products and complex new materials.

Gaining reimbursement for new products that do not fit neatly into the existing coding schemes represents a challenge at least as formidable. Payers are challenged by the substantial administrative burdens posed by the Affordable Care Act and are bracing for the increased financial stress it will bring.

The world is changing for health care providers, including specialty physicians who are the primary customers of new medical technology. Consolidation is the order of the day. Steadily increasing numbers are being employed by hospital systems and mergers between hospital systems are at the highest level in 10 years and showing no signs of abating.

A primary driver of this consolidation is pressure on costs, which will only intensify as the government’s share of the health care bill grows from its present level of 50 percent to well over 60 percent under the Affordable Care Act. Standardization of product lines, a reduction in the number of vendors and the migration of the fee-for-service payment model to accountable care methodologies (bundled payments) are already underway. A lot of this change is good. But also underway are increased review times and additional data requirements for new products, which is concerning.

On the positive side, med-tech companies have significant financial resources and are hungry for innovative products due to the demands of an aging population, increased prevalence of chronic disease, advances in medical science and the growing wealth of developing countries, not to mention the demands of Wall Street.

As they grow, it is harder for them to innovate internally. Significant innovation will have to come from the outside, including the venture world. But for this to happen, the existing venture capital model needs to change and incorporate a new relationship among industry, venture capital and investors.

Each has important strengths. Industry players understand their own market and product needs, have access to capital and technology, and have a valuable market position. A good venture capitalist knows how to help build companies, structure investment syndicates and create the environment for a focused business with the proper incentives. Financial investors provide knowledgeable capital seeking a competitive returns.

Med-tech returns recently have not been competitive and they will not improve unless the time and capital requirements of the investment are decreased. To accomplish this investment and management teams must make more efficient use of their capital. That requires knowledge and experience.

More important, the investment timelines need to be reduced by building a closer relationship between industry and venture capital, something that is only beginning to happen.

Large med-tech companies should be a partner in the initial investment decision and, assuming good execution, be willing to acquire the company at a reasonable milepost, such as successful completion of a pilot study. This is certainly not necessary for all medical devices, but it is for those that offer true innovation and that require extensive clinical trials.

There are a number of forms this new model could take and the details are important. But it starts with an understanding that change is required. The health of the industry will benefit if this new model succeeds.

About the author: Pete McNerney is a founder and senior adviser of the venture capital firm Thomas, McNerney & Partners with offices in Minneapolis, Stamford, Conn., and La Jolla, Calif.

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