Financing Strategies for an Overheated Device Market

At In3 West, a medical device conference held in Las Vegas recently, Windhover Information convened a panel of venture investors to ask them what's in store for device companies seeking investments in the near future, and to address one nagging question: whether or not the heady funding levels of 2007 are sustainable, or even desirable. Certainly exits have become more challenging; consolidation has removed certain would-be acquirers and the IPO market has become more demanding; no company will get out there without at least $30 to $40 million in revenues, several on the panel felt. Others were feeling the pressure of having to carry portfolio companies for even longer periods of time; more complex technologies, lag times at the FDA, and the need to get companies not only to the commercial stage but to a revenue ramp were pushing up the number of years to an exit and total investment dollars. Many were optimistic that early stage deals, exits by acquisition and other unusual phenomena would continue to happen; but selectivity was the theme of the day.

Three VCs and one venture debt principal share their views on the near future of medical device investing.

by Windhover’s Medical Device Team

In the world of medical device investing, the pendulum swings. Last year, a record-breaking sum was invested in medtech start-ups; 2007 saw more than $3 billion in venture deals for the device industry alone.

To a certain extent, in the time leading up to the banner year, the volume of dollars and deals going in medtech were inflated by the entry of new investors, including biopharma investors. The theory went that medical device investing presented less risk and, relative to the pharmaceutical industry, shorter-term returns, particularly in light of the recent dismal performance of biotech companies that had recently gone public. Private equity investors played an unusually large role, as did hedge funds. Whether driven by their unfamiliarity with the industry, a desire for quick returns or both, the flood of new dollars poured—40% of venture dollars committed last year—into later-stage companies, filling the coffers of companies raising Series D rounds or later. Early-stage rounds dropped, from $308 million in 2006 to $245 million in 2007.

At In3 West, a medical device conference held in Las Vegas recently, Windhover Information convened a panel of venture investors to ask them what’s in store for device companies seeking investments in the near future, and to address one nagging question: whether or not the heady funding levels of 2007 are sustainable, or even desirable. Certainly exits have become more challenging; consolidation has removed certain would-be acquirers and the IPO market has become more demanding; no company will get out there without at least $30 to $40 million in revenues, several on the panel felt. Others were feeling the pressure of having to carry portfolio companies for even longer periods of time; more complex technologies, lag times at the FDA, and the need to get companies not only to the commercial stage but to a revenue ramp were pushing up the number of years to an exit and total investment dollars.

Indeed, surprisingly, in many cases, medical device companies are receiving even larger investments and are remaining in the portfolios of venture capital firms even longer than early-stage biotechs. For although biotechs might be acquired on the strength of intellectual property and early proof-of-principle, medical device firms these days are not only required to be in the commercial stage, by those providing exit options, but also to demonstrate substantial revenues, and that means solving regulatory, reimbursement, and sales challenges with venture capital.

So, it seems one of the basic paradigms of life science investing is changing. Device companies have typically been regarded as less risky, more predictable alternatives to biopharma companies. Theoretically, lower dollar amounts could be invested early on to get the company to an FDA approval, the point where it might be acquired or find a way to the public markets. That’s no longer true. Dollars invested and development time lines are approaching those of the pharmaceutical industry, whereas exit options are at times limited by unfriendly public markets and, recently, a lack of large companies with an appetite for acquiring.

Device companies may need to create alternative financing strategies in this more challenging environment. To learn what VCs are doing to make their capital go farther these days, Windhover Information put together a panel consisting of Ellen Koskinas, a partner focusing on medical devices at InterWest Partners, which focuses its medtech investing on early-stage deals, Clarus Ventures and its managing director Kurt Wheeler, which, at the other end of the spectrum invests large sums in later-stage companies, Western Technology Investment a leading provider of venture debt to start-ups, represented by investment partner Maurice Werdegar, and Sam Wu, MD, PhD, speaking for SV Life Sciences, which does a combination of all three types of deals. Moderator David Cassak, managing partner at Windhover, queried the panel to learn what’s overheated, what’s not, where the market is headed, and whether, fundamentally, the traditional model along which investors have tried to make money from device start-ups is in fact outdated.

Q: David Cassak: We want to spend the next hour or so talking to you about some of the financing trends, some of the issues, some of the climate and environmental factors, and really drill down to what makes a company a successful and attractive investment opportunity these days, and what’s going on in the current climate. So by way of a longer set of introductions, I’d like to begin with everybody giving us a bit of perspective on their organization and where they come from. Kurt, let me start with you. Give us a brief overview of your fund, how big it is, what percentage of the fund goes to devices, whether or not that percentage is increasing, and any particular strategy or philosophy that characterizes or identifies your device investing.

Kurt Wheeler: Sure David. Clarus was formed in February of 2005 by a group of investors with a vision of bringing our operating experience to bear in terms of developing new companies. We recently raised our second fund, which is a $660 million fund, which brings our total under management to about $1.2 billion. We only do health care. Eighty percent of our investments are in biotech and specialty pharma, about 20% are in medical technology. But that really just depends upon the opportunities that we see. In our first fund probably closer to 30% of our investments were in medical technology. We generally invest in later-stage opportunities, even though we’re always tempted and we like to be involved in early-stage companies. Our main focus in the first fund as well as in this next fund will be in later-stage opportunities, companies that are ready to go commercial or launch a product, or are already commercial and on a ramp. Those are criteria that we look for in medical technology. My background is like that of a lot of you. I founded a medical device company. I took it public and I sold it.

[Editor’s note: Kurt Wheeler founded and was CEO of InControl, a company developing an implantable atrial defibrillator, and he sold it to Guidant for $135 million in 1998].

Wheeler: I love the process of starting companies, and one of the disadvantages of where I sit now is that we generally do the later-stage opportunities. All of the partners within Clarus have that kind of operating experience. They’ve either run companies or large divisions of companies before being on the venture side.

Q: Kurt, before we move on to Ellen let me ask you one question to clarify. Because Clarus focuses so much on late stage, if the dollar distribution is 80% in biotech, because you're later stage, would the portfolio mix be the same thing? Or because biopharma generally takes more dollars than late-stage device companies, does the ratio between biopharma and medtech differ when you're talking about the number of companies you invest in?

Wheeler: No, generally we’re investing larger dollars in medtech because we are investing in later stage. That doesn’t mean that a number of our early biotech companies won't take dollars, but the initial dollars that go into our investments are generally higher on the medtech side. We normally invest in an average company, across the portfolio, somewhere between $25 and $30 million. We don’t like to write checks for less than $15 million. To give you an example, we just made a major investment in Globus Medical. That was a $110 million financing. We took more than half of that financing. So we will write larger checks for companies that we are particularly interested in. In fact, our larger investments are in medical technology. [See "Globus Prepared for Trek with $110m from Clarus-led Group," START-UP, September 2007 (Also see "Globus Prepared for Trek with $110m from Clarus-led Group" - In Vivo, 1 Sep, 2007.).]

Q: Great. Ellen, tell us about InterWest.

Ellen Koskinas: Sure. InterWest is a venture firm that’s been around for about 28 years. We’re currently investing out of our ninth fund. It’s a $600 million fund that is divided fairly evenly between IT and life sciences. Within life sciences, we do both biopharma and device investing. We tend to be pretty active and early investors. Our investing partnership is a mix of clinicians, scientists, entrepreneurs, and people with operating experience. My personal background is that right out of school I spent a couple years at Morgan Stanley working on health care companies in New York and London. After business school I went to work for McKinsey in a range of different operating and strategic projects across front-line health care delivery. I did lots of work in the pharmaceutical industry and some on the device side. After I finally extracted myself from McKinsey--which is a great training ground, but I wanted to be creating something long term--I started a brand new business for Guidant. I built it from a couple of R&D concepts in the lab, up to about a $15 million run rate, with direct responsibility for product development, marketing and sales, regulatory, clinical, etc. I literally went across the country with a team of engineers to figure out how to design the product to be the most successful in its category. That was the minimally invasive cardiac surgery business of Guidant. It was about $15 million when I left, and had made it to about $100 million when it got sold to Boston Scientific. So I’ve been through those first early stages of building a company and have found that to be very important in the work that I do with my portfolio companies today.

Coming back to InterWest, we are, as I said, active early-stage investors. We’re opportunistic in the late-stage deals, but we are primarily focused in the early stage. We take a very long-term perspective because most of the group around the table has been though some operating experiences. We understand that there are a lot of almost inevitable bumps in the road, and we’re comfortable and confident that we can work with our entrepreneurs to try and address those obstacles. In terms of general guidelines for us, some of them are the obvious and very general points around investing in companies that are addressing a large market, an unmet market need, a terrific management team, ideally that’s been involved in the category before. Obviously proprietary technology with protectable IP is very important. And I think regulatory path is becoming more and more important to us. We’re starting to book more 510(k) products when we can, just because of the incredible unpredictability, let me say, of the FDA these days. We are also very mindful of the reimbursement pathway as well. So generally we are involved in company formation, and we’re sort of pioneers in emerging categories. The one example I’d give on that is neuromodulation, where we are the largest venture investor. We were among the earliest investors and have done a whole range of devices. Neuromodulation is basically applying electrical energy to the nervous system, whether central or peripheral, to induce physiologic changes. We’re believers in that technology and technological approach, and have been really aggressive and early in our work there. So we try to find things that are ahead of the curve whenever possible.

Q: Can you give us a sense of some of the companies you’ve invested in at the early stages?

Koskinas: Actually, my first investment at InterWest was a company called Neuronetics. They're doing non-invasive neuromodulation, in this case for the treatment of depression. And interestingly enough, Maurice is a venture debt provider for the company as well. What we’re doing there is applying what’s called trans-cranial magnetic stimulation to the cortex of the brain. Without going into a lot of detail, we’re creating an electrical effect for what’s currently done chemically. We’re essentially depolarizing cortical neurons and enabling the release of neurotransmitters in a different mechanism for treating depression. Another company in our portfolio where we’ve been involved in the early stages is still in stealth mode. It’s an aesthetics company that I invested in about a year and a half ago. They are working on skin tightening with a fairly novel approach. We took some very experienced entrepreneurs to help start that.

Q: Now Maurice, this is the second time we’ve had you on a panel and invariably, either the companies or the VCs on the panel have worked with you on a venture debt deal. Give us a sense of what venture debt is, why someone would use it, and how it fits in the overall financing continuum, because you always seem to be in the mix with other financing strategies.

Maurice Werdegar: That’s right. One of the great things about venture debt is that we get to benefit from the knowledge of venture capitalists who’ve already invested in companies at early and late stages, in life science technology, biotech, and also IT. Very briefly, Western Technology Investment, where I’m a partner, is a 28-year-old firm. We’re structured in a way that’s very similar to a venture capital fund in the sense that we have limited partners and we do capital calls. We’re not a bank and we’re not a hedge fund, which in today’s environment is a very important distinguishing characteristic when it comes to the kind of money from the debt side a company might be taking. We provide what I would call a supplemental amount of capital. It comes in on top of a venture capital round to help companies get to the very next milestone with perhaps a little more cushion. It allows companies to have more time if there's an FDA issue, a slip in enrollment, or a development time frame that pushes out. It also allows companies that are very successful to hit the gas and accelerate their development programs and begin to acquire intellectual property, start that second product, open a new market, all within the context of not having to raise venture capital sooner than they originally wanted to.

Q: Are you an alternative to a reserve? Or are you an alternative to another round of financing?

Werdegar: I think we’re actually not necessarily an alternative to either. I think we are part of a proactive strategy to give a company additional time to look its very best before the next round. And that kind of money in life sciences makes a lot of sense, both in the early stages and the late stages because as everyone in the room knows, you really want to look good when you're out raising money for your next round. You want to have that FDA approval or whatever it might be that is the key milestone that was established with your original investors in the most recent round. So our company comes in with a line of capital. It can range from half a million up to $25 million. We are stage agnostic, so we’re not focused on a particular stage in a company’s development. We’re very comfortable coming in at the seed stage, series A stage, as well as the mezzanine or pre-IPO stage.

If I look back over the past two years, we’ve done about 300 transactions within our partnership. As opposed to the folks I’m on the panel with today, we do not take board seats because we’re a debt provider. So that enables us to really focus on being experts at one thing, which is providing a layer of capital that can help companies get further up-field. We don’t necessarily get into the weeds as a board member might. We don’t have that expertise either. So we’re very different than venture capitalists. And I would say the easiest way to think of us is debt that you can really use, there are no covenants associated with it. In that sense it’s very similar to equity because it’s money that can be used completely. But again, it’s debt, so there is a monthly payment associated with it, and it makes a lot of sense for that to be within a portion that’s appropriate for a company’s stage and the amount of capital it has raised.

Q: Was your return to your LP’s based on the repayment of the debt or convertible debt that then becomes equity?

Werdegar: We don’t convert our debt, so it’s typically a three-year note that gets paid down, similar to a home mortgage, over the course of three years. We make money in two ways. We earn interest on the money that we lend, and we also earn warrant coverage, which is always a very important topic around the venture capital table and in the board room. Warrant coverage is very similar to having options on a company. It’s an equity upside component, and we earn that as well.

Q: Great. There will be more on the subject of venture debt from Sam. Tell us a little bit about SVLS. How big a fund is it, and who’s in there?

Sam Wu: I’m with SV Life Sciences. I think I understand why I’m the cleanup hitter here. We invest both on the early side like InterWest, as well as on the late side like Clarus, and we also happen to be big proponents of venture debt in our companies to the extent that we can use it to extend our runways. We had our origins with Schroder Asset Management Firm out of London, as David mentioned earlier. Members of our group started investing in life sciences as early as the 1980s with our first dedicated fund in 1994. We closed our fourth fund at the beginning of last year, a $570 million fund, which is about half biotech, a quarter medical devices, and the balance is in health care services. Our group is a mix of operational, financial, and consulting types. We have a lot of deep operating experience from our venture partners as well. In general, we’re always playing very active roles in our companies. The earlier-stage deals that we do on the medical device side I would characterize as being seed and series A. Most of those we tend to do with one or two of our incubator relationships, the Innovation Factory down in Atlanta, as well as with Intersect Partners in Orange County. However, we also do seed-stage deals with experienced entrepreneurs or maybe even not so experienced entrepreneurs who have a great idea when we believe that the entrepreneur is someone we can build a company around. On the later side, we like to be as close to commercialization, if not already commercial, as possible. Though if you look at our portfolio I think you’ll find that the distribution also includes what you’d characterize as post–proof-of-concept, post–pilot-study companies going into an IDE trial.

Q: Would you give us a couple of your portfolio companies as a sample?

Wu: We were investors in Insulet, which is a disposable patch pump for delivering insulin. Many of you are probably familiar with this story. The IPO was last year. We were still holders of that; we expected that there was still some upside in that stock. On the very early side, I guess the best examples to point to would be the series of companies we’ve done with the Innovation Factory. The ones that are probably better known would be Liposonix, which is working on an ultrasound lipolysis device for body sculpting or the removal of fat. And then the other one I would point to would be a company called AcuFocus, which is developing a presbyopia implant.

Q: And isn’t Neuronetics, mentioned above, an Innovation Factory company? Although they did independent financing outside of the incubator.

Koskinas: That’s right. It did start with Innovation Factory as well.

Wu: Yes. Our relationship with incubators is such that when they show us an idea, if we like, it we do it. Obviously we’re very favorably inclined to doing their deals, but we don’t do all of them.

Q: Now, let’s look back two or three years. Medical device investing got hot after being very cold during much of the 1990s and early 2000s. I wonder, in each of your minds, do you think that’s still true? Why do you think device investing got so hot, and what is the appeal within your portfolios? Sam, let me tee up with you. Compare and contrast the biotech performance, or the performance of the biotech companies in the SVLS portfolio, with device companies over the course of the last years. Are we getting better returns from device companies these days than we are from biotech? Or is that a hopeful wish on the part of the device guys?

Wu: Let me get to that question. In my view, I think people look to medical devices as a faster path to market. I think they tend to think of them as offering shorter development time lines, and therefore, hopefully, faster exits. What’s interesting is that when we look, in our own portfolio, at how many years we’ve been in our medical device companies versus our biotech companies, we find that we tend to be in medical device companies longer. This is partly because although the approval paths may be shorter, the exits come later. In biotech, we are often selling post–Phase II proof-of-concept, certainly before approval in many cases, and in the last couple years, even before Phase II data. Whereas on the medical device side, much more often we’re seeing that we stay in companies until they can generate a revenue rate that leads to a buyout, say, a $30 million dollar run rate. In order to get there, of course, you have to take into account not just a commercial round but reimbursement, if it’s an issue.

Q: Ellen, Kurt, how are your device portfolios doing? When you go to partner meetings on Monday mornings, do the device guys get to the doughnuts first? Or do they have to wait in line?

Koskinas: We always get to the doughnuts first! I would say we continue to take a pretty balanced approach. I think in the last several years, and as you guys have probably read in the lay press, there have been a significant number of very meaningfully sized biotech exits. That’s really a function of the weakness, let me say, in the pipeline of Big Pharma. We’ve seen a lot of very large deals and a couple of them are ours, thankfully. We had MyoGen, which was purchased by Gilead. It settled for $2.5 billion. It’s very difficult to get medical device exits in that range. I would say we’re still very bullish on both, and I think it’s a particularly interesting time right now in devices.

We’ve obviously seen a significant increase in dollars going into devices. I think the increase in 2007 over 2006 was approaching 40%. But I think remarkably, last year’s second quarter was the first time when more than a billion dollars went into medical devices in a single quarter, which I’m fairly certain is a historical record. I haven't looked back beyond 10 years. But in any event, I think there is a crush of capital right now in the category, and what that’s really telling us is there are a lot of new entrants into the category as well, and people who have not spent a lot of time doing device investing. We are, I would say, being very selective in deals we do. We’re very price disciplined, and we think that this wall of capital that’s come in is going to diminish over time. I think we’re already starting to see the hints of some high-priced deals that are kind of late stage in their development coming back to us as recaps on the device side.

So I think we’re at that inflection point where we may start to see things come down a little bit as reality strikes. Particularly in the context of significant stock market volatility and economic uncertainty that’s driving a lot of cautiousness across the board.

Q: Kurt, do you have a perspective on that? Ellen raises an interesting point, which was that the rationale for the greater investment in devices was that people were hedging their bets. They were tired of serendipity and the unpredictability and the poor performance in the biotech sector. But when you get a winner in biotech, it’s on a much larger scale than it is on the device side. What’s the rationale for device investing today?

Wheeler: We believe that in terms of how we structure our fund, that biotech is primarily going to drive the major returns. So when we’re looking for a 5X or a 10X type of return, it’s probably going to come from the biotech side of the portfolio. When we’re looking for a 3X, plus or minus an X, then we’re looking to the medtech portfolio. The way that we would like to see the portfolio balanced is that medtech companies roughly mature in three years, more or less, and biotech companies mature in five to seven. If we look historically at all of our early-stage investing, which we did prior to Clarus in medical technology, we also find that medtech companies take longer than biotech to exit, and that’s probably not acceptable in terms of the risk/reward profile that we’d like to see. Hence we’ve migrated to a much later-stage activity in medical technology.

Now that doesn’t mean that the early-stage stuff isn't getting funded, because it is. If you look at 2007, there were probably close to 400 financings in the medtech sector, and most of them were early-stage start-up–type companies. Then if you go back just even two more years to say 2004 or 2005, you’ll see that that number was probably 200 to 250. So we’ve seen almost a doubling in the number of medical technology companies, primarily early stage, that were funded in 2007. I think we saw that crest a bit in the fourth quarter, and some of those numbers aren’t out yet, but I think when they do come out we will see that there's probably a reduction in medical technology funding for early-stage companies. We’re not finding huge valuation changes between the early rounds and the later rounds, so our strategy is to invest in the later rounds when these things are more mature and some of the technology risk and the FDA risk have been taken out. If I look back I think the FDA has added at least two years to about half the early-stage portfolio in medical devices that we’ve been investing in over the last six or seven years. And that’s absolutely a killer in terms of the returns and the cycles and the amount of capital that has to go into these companies.

Q: Let me follow-up on a comment that both Ellen and Kurt made. Last year was a record for the device space—something like $3 billion was invested, which was about $1 billion more than the previous year. Both of you seem to suggest that may have crested, and we may have begun to see the end. Many of us sitting in this room have been around long enough to remember the late 1990s when it was almost impossible to get a device company funded. Is a retrenchment a positive correction because it shows more rationality in the marketplace? Or is it going to get more difficult to finance device companies going forward because we've gone past this crest? Does anybody have a perspective on that?

Wheeler: I’ll take a stab at that. Probably Sam and Ellen have the best perspective, and we work with both of their firms and we have a lot of respect for what they do. But I actually believe that there will be more consolidation over the next two years in the medtech sector, particularly among the early-stage companies. It is going to be more difficult to raise capital than it has been over the previous two years.

Now, that being said, there's been a tremendous amount of money raised, and that money will get invested. So there are opportunities to raise money for good ideas that meet significant unmet clinical needs, and there are a lot of significant unmet clinical needs. I don’t think we will see $3.7 billion or almost $4 billion going to medical device investing in 2008. I just don’t see that as sustainable. On the other hand, there are large funds like ours being raised, and that money will be put into work. So it’s not going to go away; but it’s just going to moderate. That’s my view.

Q: There are some folks who’ve said that part of the phenomenon was due to a lot of the biopharma investors directing more of their portfolio to medical devices to hedge their bets. They poured a lot of money in because these guys are used to doing big deals. That raised some of the valuations. Is that a myth, or do you guys agree? Is what we’ve seen in the device space a kind of overvaluation or aggressive valuation as a result of biopharma guys who are used to spending a lot, getting into this sector? Sam, do you want to give us a perspective?

Wu: I certainly would agree that there’s been a lot more money pouring in and newer investors coming into the medical device sector. I don’t know whether I’d necessarily pin that all on the biopharma guys, and frankly I don’t know the numbers well enough to be able to say. But certainly our view is, yeah, the valuations have gotten pushed up, not so much for seed and early-stage rounds, but for those subsequent rounds and later-stage rounds, the valuations have definitely been pushed up. That’s one of the reasons that we continue to do the seed and series A rounds because we view those as the opportunity to still get a reasonable valuation for a company, even though you do have to take higher risk. But if we can pick the right companies, then we can manage our way around that risk.

Koskinas: I would very much echo that thought. I think we’re clearly seeing things move up significantly in the B and C round stages. As Sam said, I think we definitely agree that seed and early-stage companies are still very actively being funded. And I think as you start to see those B and C round valuations going up, and the post-money valuations floating up closer to 100 or into the triple digits, it really becomes challenging. As Kurt mentioned, we’re seeing longer time lines, and prolongation at the FDA, frankly, in getting some of these approvals through. We’re starting to see multiple compression in our business that is very visible. Consequently, we’re looking for new deals that can be much more cash efficient. When I mentioned earlier that we’re trying to find interesting 510(k) opportunities or more expedited regulatory paths, that’s part of the reason why. It’s to try and figure out how to get a company to a point of a meaningful exit with a more moderate amount of cash than has gone in. So it’s kind of amazing; I mean, it used to be the case that we were talking about $30 or $40 million to get a medical device company public or to some kind of sizeable exit. These days, because the technologies are getting more sophisticated, in many cases that’s really approaching $100 million. Insulet, which Sam mentioned earlier, I think raised $120 million prior to the IPO. We’re seeing more and more deals like that. So I think it’s a real issue for our industry, and one that we need to be very thoughtful about in terms of entering into new deals.

Q: Maurice, is a frothy environment good for a venture debt company? Does that expand your role with these organizations? Or limit it?

Werdegar: Both. We like to say that venture debt is a lot like a drug, where if used according to the label it can be very helpful. But if overused or abused it can actually kill a company. We’re big believers that debt needs to be used in moderation at the appropriate time for a specific purpose that relates to a core strategy of getting a company from one financing to the next or to an exit. We are also concerned about rising valuations because if you think of the perspective of a debt provider, the one thing we are not looking forward to is a recapitalization of a company. Often that means our phone is ringing with respect to what we’re going to do to help a company get through a recapitalization. We do think rising valuations are a risk factor, and within our own portfolio, which is a very broad portfolio of over 500 companies, I’ll tell you that the M&A data are not exciting in terms of exit valuations and the number of exits over the past two years. By way of context, we do invest in technology companies as well, life sciences, medical devices, and health care services are probably a third of what we do. But across the board we’ve had 40 exits in the last two years. And three of them have been for more than $150 million. None of those, by the way, were life science companies.

We have had some life science companies raise money at very good private valuations, but in terms of getting liquid, I think that what you're hearing today is true. The bar is being raised, and you have somewhat of a dis-economy where valuations are rising privately; yet it’s taking more money to get companies to an exit point, and it’s becoming a more difficult and longer process to get there, and valuations are not rising on the exits.

Q: The theme that’s emerging is that things are going to get more selective. Let’s talk about how you guys go about selecting your investments, to give guidance to folks in the audience. Maurice, let me start with you. Who’s not a candidate for venture debt? What kind of company walks in, thinking that you guys are going to be its savior by getting it over the hump, but to whom you have to say, "Sorry, you're the wrong kind of risk for us?"

Werdegar: That’s an excellent question. It might surprise people that we turn down a lot of deals. Venture debt by definition is more of a portfolio approach to investing than a specific equity investor might have. The company that comes to us for what we call "the wrong reasons" is typically a company that has a broken syndicate of investors, is running very low on cash, and is really looking more for bridge financing, which we think is more of an equity problem. We won’t get involved in those companies, either because we think we’d be delaying the inevitable, or in many cases actually adding to the problem by putting debt onto a company that is going to have problems raising equity. So our focus at every stage is to work with great management teams, very good investors, like all the folks at this table, with whom our firm has worked and has a lot of regard for.

Getting back to Ellen’s comment about the bumps in the road, as a lender we know that 98.5% of our companies are going to miss their plan, miss their milestones, and in essence not do exactly what they said they were going to do. We know we’re signing up for that when we get involved. The question is does the management team and the board have what it takes to get through that? That’s really how we look at things. The glass for us is always half empty, and after we meet with a company, we know they're going to miss their plan; the question is how are they going to react when they do, and what's the situation going to look like a year down the road?

Wheeler: WTI is great to work with, because we’ve been in a number of positions where we’ve wanted to take venture debt just for the reasons that Maurice said. Not as part of early-stage development, whether it’s a company’s financing plan, whether it’s biotech or medical technology. But it’s very useful if you can use it to get to another point that’s an inflection in value that’ll allow you to raise equity capital. And the thing about debt is you’ve gotta pay it back. So whenever you start venturing into that area, then you have to be very careful about when you access that type of capital because if you get into a recap situation, you’ve got venture debt involved. Then the new investor coming in says, "My money’s going to go back to pay for the debt." When you do that, then you’ve got an additional amount that you have to finance that’s not going to build value if you get into that kind of situation.

WTI’s very good about it. They’ll say, "Look, that’s not for us, we’re not going to do that," and several other venture debt guys also take the same perspective. But historically over the last two years what we’ve seen on the venture debt side is that if you want venture debt you can have it, and if you don’t think that’s enough, we’ll give you more. And that’s a very dangerous position to be in for early-stage companies.

Q: Does that mean, then that early-stage companies and PMA companies are not good candidates?

Wheeler: Not at all. An early-stage company that says, "OK, I’m going to get to an IDE and show proof-of-concept" or "Can I get to a 30-patient trial so we can raise capital?" is a very good candidate, because it allows them to extend the runway by six months. But if they think they’re going extend the runway by a year, then that’s pretty risky, because a lot of things happen to our companies in that time frame. Sometimes the trials don’t go exactly right; the enrollment is always slow. You don’t hit some of the milestones that you want to hit. In that case, taking on debt is going to be a negative in terms of getting your company financed. A modest amount of debt to get you to a near-term milestone that makes the company look better is very appropriate. But other than that, it’s not. Because it could be a major hindrance in terms of financing the company going forward with that debt in place.

[Editor’s note: For more on that issue, see "Venture Debt: Device Financing Lifeline or Anchor?," IN VIVO, March 2008 (Also see "Venture Debt: Device Financing Lifeline or Anchor?" - In Vivo, 1 Mar, 2008.).]

Wu: Let me just add to that. Certainly we do plenty of early-stage companies, and when we’re financing them, we are financing them to that point with enough equity plus runway, you know, plus with a six-month window ideally, so they can raise the next round. Then we talk about layering on venture debt on top of that, really as an insurance policy. So the equity we raised should be enough to get the company where they want to go on their plan with extra room to spare, but since we all know, as Maurice was saying, that 98% of these things cost more and take longer, we like to layer on venture debt as the insurance policy.

Q: Let me turn this back to our venture capitalists. You're going to see hundreds of business plans; you're going to do a handful of deals—three, four, five--in the course of a year. Can you give folks in the audience some guidance as to how you make those cuts? And let’s assume that market size and unmet clinical need are givens. What differentiates the handful that gets funded? Is it management team? Is it stage of company? Is it the technology space? Ellen, why don’t you start?

Koskinas: For InterWest, it’s really pioneering new categories, where we’re looking for things that are really more of a breakthrough type of technology. I think there are occasional cases where there's a particularly creative approach in a follow-on category, but I guess we’re kind of like GE. We’re looking to be the number one or two in any category, and we want to break into new markets, not so much because we want to fund the market development cost, which is part of that process, but I think we feel that to get the kind of attractive exits, whether it’s in the public markets or through acquisition, they need to be technologies that are opening up a meaningful new market. So something that’s targeting at least a half billion if not a billion dollar market plus, in terms of what the potential may be ahead of it. Looking at emerging categories is one of our key areas.

As I mentioned earlier, I think regulatory and reimbursement factors have come into play a lot more significantly than they have in the past, so we’re looking at more consumer-facing technologies. We’ve been fairly early in the venture community in terms of that approach, and we’re looking proactively at some different categories that have not been invested in before, where consumers are the payors, because I think we’re all well aware of the challenges that we’re facing in terms of overall health care costs. At this point we feel that there's going to be more cost shifting rather than reimbursement of new technologies. We’re consequently looking for alternative payors, namely consumers, who can pay directly for either interesting hybrid procedures, for example, a glaucoma device that might lend itself to a supplemental payment from the patient or consumer, on top of whatever the Medicare or the private payor reimbursement might be. So those are some of the things that we’re trying to do to find differentiated new companies.

Q: Sam and Kurt, let me phrase that question to you in this way: among the many, many businesses that you see, is there anything that companies do that can distinguish and differentiate themselves positively or negatively when they finally get an opportunity to talk to you? Is there advice that you would give to folks when they want to pitch either SVLS or Clarus about what's going to make them more attractive or less attractive to you during that initial conversation? Sam?

Wu: Sure. I think, as a lot of VC’s will say, that management team means a lot. By that, I mean a team that we believe can do what they say they want to do, a team that’s taken the time to think about how their investors are going to get out of this deal, what the exit’s going to look like, where they have to be and how they get there. Part of that is having talked to people who know the industry quite well, and having gotten the feeling that there will be a buyer for the company downstream, and understanding what they have to show in order to attract that buyer to the table, whether it’s revenue, reimbursement, clinical data, adoption, whatever all those factors are.

Q: Kurt, do you have any perspective?

Wheeler: Well, first of all let me just say that venture capitalists are not all the same. Every one of us is different. And every one of us brings a different perspective. So, David said to assume that we’re looking for a big unmet clinical need or a large market. But we all view unmet clinical needs and market sizes differently. Those are the two major factors. Of course you’ve got to have a solid management team to build around it. But if you go to 10 different venture investors you will find that there is quite a bit of variation in terms of how we perceive all that. Just because Clarus says that’s not the right stage for us, that’s more of a portfolio investment decision on our part, and not necessarily a reflection of what your company is or how it can be financed. You may be solving an unmet need in a large clinical market, but maybe it doesn’t fit with InterWest or SVLS. It might fit with half a dozen other groups in terms of where they want to be investing. It has to do with their experience level and where they feel like they can get an exit. So you can’t categorize us as all the same and say that investors always look for this.

And I guarantee that we would have different perspectives on later-stage deals than some of the other guys will have, and they will have different perspectives on early-stage and potential exits and timing of exits than we will. So I would encourage you as entrepreneurs and founders of companies not to think that just because you’ve talked to three venture guys that you understand the venture community. That is absolutely not correct. We all look for different things and have different appeals at different stages of development of the company.

Q: That’s a good point. Similarly from your perspective, just because a company’s been turned down by a dozen firms does not necessarily mean that you're not interested in looking at them. Or is it a tainted fish kind of thing?

Wheeler: No. There's a fine line between success and failure all the time. And if you can see your way based upon your own experiences that this is an opportunity that can be successful, we will go it alone. But we generally like to have a syndicate that’s kind of agreeing with us. So it is possible that we would take that approach, depending on what the opportunity was, and whether we could get comfortable in our own due diligence with the issues where the company’s obviously not passed in front of other investors. But we’re all different and so I would just encourage you not to give up because you’ve been to three or four VCs and you're not getting the responses that you would like.

Koskinas: I think a great example of that is Kyphon. Karen Talmadge always tells the story of starting Kyphon. I can't remember exactly how many VC’s, but she tried a number that approaches triple digits, I think, before she found some groups that actually saw her vision. And obviously it’s certainly a really successful example in the venture community.

[Editor’s note: Kyphon pioneered a minimally invasive spine procedure for vertebral compression fractures. The company went public in 2002, raising $95 million. [See Deal] In July 2007, Medtronic bought Kyphon for $3.9 billion. [See Deal]]

Koskinas: I also wanted to pick up on something Kurt said about persistence because I agree with it, and I wanted to put a slightly different angle on it. A lot of deals that we do we’ve actually looked at multiple times. So it might come in, it’s a little early; we say, "Hey, if you could do this animal work, this proof-of-concept data that we’d like to see, come back and see us." We take a pretty long-term perspective about building relationships with entrepreneurs and like to meet with groups early. But I think persistence is really important, and it’s not just at the level of getting the company financed but also in terms of how you approach the business.

I also think that you need to bring an understanding of the various steps in the process. That’s not to say that if you're a company with a concept on a cocktail napkin at this point that you need to have figured out exactly what the coding and coverage decision’s going to be--but some reflection of the fact that you’ve thought about all of those phases coming up ahead. That is really important to us in terms of understanding how you as entrepreneurs are thinking about the opportunity ahead, what are some of the likely obstacles, what kinds of contingencies you have planned for that, what's your plan for building your team, and at what point key capabilities come into play. We can certainly help and work with you on that. But I think the more thinking you can do about that up front, before coming in for a meeting, the better. It’s impressive to us when groups have thought through a lot of the key issues at the outset, and aren’t caught by surprise when we’re asking some questions for the next phases of work.

Q: I think that’s important. I don’t think you can overstate how important persistence is. And it’s not that there aren’t some companies that will never get funded, but Kyphon is a great success story. When they finally got investors, they got some savvy investors: Vertical Group and Warburg Pincus, who couldn’t understand why others weren't jumping on this. But Karen was turned down by dozens, if not hundreds of VC’s. Now let me open the floor up to questions from the audience.

Stephen Levin: Let me pursue what was raised earlier about the amount of money going into devices perhaps cresting. Over the last couple of years we’ve seen a lot of new investors, whether it’s venture firms that weren't previously interested in devices, or private equity type investors, hedge funds particularly. Also for you, Maurice. You’ve seen newer money coming into the venture debt side. What signs are you seeing, perhaps, that this interest is waning? Are you seeing the more recent entrants starting to drift off? Or can you enlighten us a little bit about any signs you're seeing that maybe this is cresting?

Werdegar: I’ll go first. In venture debt the new money has been hedge funds, and in some cases investment banks such as Merrill Lynch doing the last wedge of capital in advance of an IPO. I think in both cases, hedge funds and investment banks, we’re seeing that money go away, and I think it’s because those shops have their own issues to take care of right now. Credit policies are changing. Venture debt looks like a really sexy, great, exciting business when you're making money. It just so happens that it’s not as much fun when the returns aren’t there. So we’re seeing sort of a return to normal. I think that the new entrants over the past three or four years--and there are many funds that are backed by hedge funds as well as hedge funds doing direct investments in the category of venture debt—are exiting. It’s because they're realigning their own portfolios. Perhaps they have redemptions or they're losing money, so they’re trying to figure out what asset classes they believe in and which ones they don’t understand. That’s probably what’s going on there. Venture debt is sort of an arcane black art, and probably hasn’t done great for a lot of the folks who have come in recently. We are seeing a change. I think you're ultimately going to see the landscape dominated by banks--like Silicon Valley Bank-- who really do the best job of financing early-stage companies, as well as the funds like ours, and there are several others like Lighthouse, Pinnacle, and a few others that we think are the traditional, good long-term players. We’re already seeing that. We’ve seen our deal flow accelerate to the point of being a fire hose, so we’re being more selective now. It was always strong; I think it’s stronger now, and it’s because a lot of the alternatives out there just aren’t answering the phone anymore.

Wheeler: And I think you can really split it into two different categories: those who’ve come lately and those who have a longer-term commitment. We’re seeing in a number of firms a number of new partners that are specifically addressing medical devices. I can probably pick out a half a dozen firms where that’s the case, where they became partners specifically for medical devices. That’s not going to go away.

Q: You mean within hedge funds?

Wheeler: No, within venture funds. The hedge funds are always going to be transitory. These are funds that wake up every morning and decide what they want to hold in their portfolio. And when you make an investment in a private company expecting it to be public, and the public markets aren’t there, then the guys who are operating the hedge funds say, "You know, we’re not doing that anymore." If the public markets are with you and the wind is blowing at your back, then you will see hedge funds come in. But as soon as the public markets have dried up--and right now they are absolutely shut as tight as I’ve ever seen them in any two- or three-month period since I’ve been involved in the business--then they're gone. They're in and they're out, they're in for a 20 or 30% gain; they're not long-term investors; and so that part of it is dissipating very, very quickly.

Now in the venture community, we lag almost every perspective of what's going on in the public market. And part of that is because we take a long-term view. What’s happening today in the public markets isn't going to be indicative of what’s going to be there in two to three years when we expect some of these things to mature. The problem is that we have some of these companies maturing that need to access the public markets today. And some of the funds are short. They don’t have enough capital to support them through that lag, and so you start looking for other alternative investment guys to come in. So you may try to access more venture debt than you really should; you may try to get a hedge fund, but they're going to be gone just exactly when you need them. That part of the market is very, very soft right now, and some of the higher valuation, later-stage companies that are more mature I think will struggle unless the public market turns around for us. That’s a long winded answer to a very short question, but I think that there are really two different things. Part of it is not going away; part of it is gone.

Q: Has the sub-prime crisis begun to trickle down? Will it trickle down or will it ultimately prove irrelevant to your investing strategies?

Wheeler: Well, clearly it’s already affecting us in terms of taking companies public right now. There are two types of investors in the public market--well, there are more than that, but I will just lump them together—there are those who are dedicated life science investors, and there are momentum players. In order for there to be a good public market, you have to have the momentum guys in, the guys who are not specialists in terms of life science. They’re out of the market right now. And so the life science guys are being hit by their allocations within their specific funds. They’re trying to consolidate and pick the very highest quality within their portfolios, and they're trying to eliminate names, not add names to the portfolio. That’s why we’re seeing a shutdown right now.

Question: Given that last comment, what percentage of your fund is going toward feeding your portfolio companies?

Wu: I don’t think that has changed too much up to now. When we say we’re going to invest 25% of our portfolio in medical devices, we tend to reserve that amount when we make the initial investment in each company. So unless something drastic happens to the company such that those reserves are inadequate, we’re usually not going above those caps, and that kind of balance is not changed.

Koskinas: Same for us. We’re still going to be active new investors throughout this period, and I think to Sam’s point, I think we always do try to set aside reserves and we incorporate that as we think about how much of the fund has been spent down effectively. Even as we plan toward raising a new fund, we’ve incorporated that thinking, and continue to review it. So I think you won’t see a slowdown at all in terms of new investments.

Wu: Yeah, I might also add that by the time you’re running out of the money that you had reserved for a company, that fund is no longer making new investments anyway. We’ve already moved on to the next fund, and we’re making new investments out of another fund.

Wheeler: Let me just echo that. The problem is that when that starts to happen, we don’t have the reserves because we need to take some of these companies longer. I don’t think that’s going to impact the number of companies that are invested in per year. I think that’s really kind of a base set. But the problem is when the public markets aren’t open to us, and we don’t have the reserves because we thought that they were going to be covered. As a general rule, we venture guys are not very good at predicting the cycles. In fact, I don’t think anybody’s very good at it. It will happen if this is an extended period of time over the next six to 12 months. There will be some recaps in terms of the later stage. Now, it may reverse quickly, and we’ve got some very good bankers in the audience here who are absolutely counting on that come the third quarter. We hope so.

Q: A couple things that we’ve heard this morning is that a lot of money has been crushed into medical devices, and we need to be selective going forward. I wonder whether any of you are concerned that over the course of the last couple of years some particular spaces might have gotten too frothy or too crowded. Kurt, let me begin with you. You just put a ton of money into Globus at a time when a lot of VCs were saying that spine is overheated, we really don’t want to be in this space anymore, and we’re worried how our company’s going to get sorted out among all the other companies. Talk to us little bit about the Globus deal. And obviously you have great expectations for that at a time when a lot of other folks are saying spine’s too risky and too crowded.

Wheeler: This is a different play than betting on a new motion-preserving opportunity in spine. It’s a different play than saying we were going to be in nucleus replacement or an artificial disc or a dynamic stabilization. This is more of a sales and marketing play in terms of having a full product line to go forward. So in 2006 the company did $86 million in sales with $20 million in EBITDA. And this year they grew by 40%, hit $123 million in sales with $35 million in EBITDA. That’s a different play in spine than the traditional, new concept. Globus has programs in artificial discs, they have programs in dynamic stabilization, they have programs in minimally invasive technologies, in fact, they probably have more programs than the sales force can actually absorb. And at the same time we added 50 new sales reps last year. We’re going to add another 50 sales reps this year. That’s different from being involved in a motion-preserving spine company, which I think is overdone.

But you know, whenever it’s overdone in a space, then there are opportunities. Just as everybody wanted to make an investment in the spine area two years ago, everybody’s really being skeptical right now, and that’s probably the time to do some pretty interesting stuff, probably for those of you who are early-stage spine companies. It’s probably going to be a little more difficult, but there are still appetites there.

Koskinas: Our philosophy tends to be if we’re gaining liquidity in a certain sector to avoid that sector going forward because it’s kind of been played, so to speak. And spine is a good example for us. We were investors in Spinal Dynamics, which got sold to Medtronic, [for $270 million in 2002 [See Deal]]. We subsequently saw this incredible rash of deals following the multiple artificial disc deals that got done at very nice valuations on the order of $270 to $400 million exits and then a lot of second-generation discs when we really didn’t know what the issues were with the first-generation discs. We have tended to be very cautions in areas after there's been a lot of liquidity there. That said, we are selective, and one of our companies, Applied Spine Technologies, is a dynamic stabilization deal. A flurry of deals have come up behind it, but the reason that we did that one was that we think they have the leading technology because they're really scientifically driven, we have some scientific evidence, and a founder who was really the biomechanics spine guru in the US. That was a critical element of our investment thesis behind that particular deal.

I think generally there are a number of overheated areas right now. I think there are some areas that are softer, too. I think in cardiovascular we’re really not seeing that many new and innovative deals, and frankly, we’re very cautious about that, even though two out of three of us who primarily focus on device investing came out of the cardiovascular space. We’re very bearish on it right now. We’ve made a number of plays in the category, and we think that it’s largely been pretty saturated in terms of the appropriate or interesting investment opportunities from our standpoint.

Q: You're cautious because you're concerned that the next-generation technologies that you're seeing may not be as innovative? Or you're cautious because the general climate isn't favoring an exit in cardiovascular devices?

Koskinas: I think we just don’t see the return potential there. It’s really incredible the amount of capital and the length of time that it’s taking in a lot of these PMA studies today, and that’s almost a given in the cardiovascular and in the spine spaces. Spine is a two-year follow-up period following your actual pivotal trial, so it’s a really significant amount of time. And as Kurt was pointing out earlier, it directly affects our ability to generate financial returns for our investors. So I’d say we’re very much trying to avoid areas that are frothy and find new ground, as I mentioned earlier, consumer facing technologies, etc.

Q: Well, not to put you on the spot, let me continue with you for a second. The flip side to overheated spaces are spaces that are really hot, but that haven't yet proven themselves. One difference with Globus is that it’s got a solid revenue stream and the technology is well established. You have investments in neurostimulation and it is a hot space. After the Advanced Bionics deal, a lot of people got interested in neurostim. But we just saw the devastating clinical trials from Northstar that have basically sunk the company. [See "Neuro Device Start-Ups Continue to Cause Headaches," IN VIVO, February 2008 (Also see "Neuro Device Start-Ups Continue to Cause Headaches" - Medtech Insight, 1 Feb, 2008.).] Anybody want to argue that early-stage technology deals like that are simply too risky to do in this space?

Koskinas: We were out on the road working with investors for a road show on Interim Medics, one of our companies. It’s a neuromodulation company with a treatment for obesity. We were literally out on the road, and basically the Northstar kind of signal came through that something went wrong, that they were delaying their planned data submission, etc., and that had an impact, I can tell you, on the pricing of our IPO in that case. Yes, that is a significant challenge that is now out there: the single pure play neuromodulation company had a major miss in its pivotal trial despite having very interesting prior results. That said, given that there are several large acquirers that are extremely interested in and experienced in electrical stimulation technologies, I think that there still is a significant opportunity, both from an investment and acquisition standpoint. And I think again, it’s going to come down to the clinical data, so we’re certainly not shying away from any of our neuromodulation companies. We’ve generated some very interesting data in a number of companies. One is CVRx. It’s a company that’s treating hypertension, which has never been treated by a device before, and we’re generating some very interesting clinical results, which we think will be pretty impactful on treatment in that particular clinical category. [See "CVRx: Can Devices Succeed Where Drugs Fail for High Blood Pressure?," IN VIVO, September 2007 (Also see "CVRx: Can Devices Succeed Where Drugs Fail for High Blood Pressure?" - In Vivo, 1 Sep, 2007.).] So I think that is an interesting example, but I don’t think anyone’s going to be rushing out to take any pre-revenue neuromodulation companies public right now. And frankly, any pre-revenue companies at all.

Q: You raised the next logical question. When you look at something like Northstar, and Kurt, you said before that you felt the IPO market has already begun to be affected, does that mean the end to pre-commercialization IPO’s? When we saw the IPO market hit its nadir in 2003 when there were none, the argument was if you don’t have revenues and you don’t have profitability, you just can’t get investors to come on. We saw a bunch of companies go out pre-revenue. Northstar was a great example. It had a very promising story. Has this killed pre-commercial IPO’s?

Wheeler: A number of them went out--Dexcom, Insulet, Hansen Medical, and Northstar—all with very attractive valuations and pre-commercial IPO’s. I think Northstar and Dexcom have put a real dent into that opportunity. People are saying, "OK, reimbursement is a big issue, clinical trial risk is a big issue." I think they're probably dead right now. In fact, I don’t even think there’s a growing revenue story right now. And by the way, there was clearly a barbell effect here; those companies in the middle with $30 million plus or minus revenue, they got very, very unattractive valuations in the public sector. And those with over $50 got very, very attractive valuations. And those that had pre-revenue were very, very attractive. And so it was really almost a barbell effect in terms of what happened in 2006 and 2007 in terms of the IPO market. But right now it’s all dead. There’s nothing. Nothing is getting out.

Q: Well, I know some venture capitalists, one in particular who told me that he thought that Dexcom alone could do for this current group of IPO wannabes in the device world what the class of 95–96 did for those in late 1990s. It basically shut the market for them. Is that an extreme view, do you think? Is the current IPO market, which has been relatively strong over the course of the last four years, sustainable? Or are we headed for a period of very difficult public offerings for device companies?

Koskinas: I think we’re going to see most companies going out with meaningful revenues. CardioNet just got done at $73 million in revenues trailing. [See "The Best of The IN VIVO Blog," IN VIVO, April 2008 (Also see "Best of Blog: Start-Up March 2008" - Scrip, 1 Apr, 2008.).] So I think there is going to be an opportunity, and I think all these things cycle, as we know. I think the market will open back up for pre-revenue companies. I think that right now just the stock market volatility and the general uncertainty in the economy are creating a climate that’s very risk averse in most of the core health care investors.

I can say, at least from taking a company public, that it’s really dependent on some kind of key thought leaders who are health care specific, and who really know those categories to drive an offering effectively. I think those groups are always going to be looking for new technologies that have substantial opportunities ahead of them. We’re just going through a cyclical phase here. But I do think for the near term and maybe for the intermediate term that only companies with a bare minimum of $40 million in revenues have any chance of getting out.

Q: The one thing that rescued the device industry in the late 1990s was the presence of a lot of large medical device companies which, even though there was no public market for companies, needed to acquire companies to feed their product pipelines. I wonder if you could just briefly give me a sense, each of you, of what you think the current climate for M&A is. Because even if the public market goes away, as long as there are some big companies ready to acquire, it’s still good news. But Guidant doesn’t exist anymore, and Boston Scientific has gone into a very publicly stated quiet phase. Are you guys confident that the M&A exit is still going to be robust for device companies? Anybody have a perspective on it?

Koskinas: I think it’s a great question because you're right, there’s been a tremendous amount of consolidation and I think we expect to see continuing consolidation in a lot of the major categories: spine and cardiovascular. We’re still relatively optimistic about the M&A climate. I think we’re going to start to see an emergence of more middle market buyers, like the Inverness Medicals of the world, that are more active in some of these acquisitions. But the fact of the matter is that in order to continue to generate double-digit top and bottom line growth, these companies can't do it based on organic growth alone because the absolute numbers are just too great. I think that’s going to continue to drive a fairly healthy M&A climate. But there will be certainly some pauses along the way. I think Boston is a particularly noteworthy example where far too much integration and debt reduction needs to go on before they’ll be ready to reenter.

Wu: I’ll add to that. I certainly agree with Ellen in terms of what’s going on with the market there. Obviously when we’re doing early-stage deals, it’s always hard to predict where these things will be five years from now, when we’re actually thinking about an exit. But I think it does tend to at least steer us toward companies that we think can get to a point where they can at least be self-sustaining. So if we’re stuck waiting out the markets, whether the M&A or IPO markets, at least we’re not pouring out more capital to keep these things going. And, back to reimbursement and the time line to get to a break-even point, you know, all that becomes doubly more important when we’re in an uncertain environment. The other interesting thing to point out, and this may be a bit off-topic, but since I work on the biotech side as well, we are very much looking at this on the biotech side. I think over the last couple years we've seen a lot of large, multi-hundred million dollar exits by pharma companies. But we’re very concerned that the pipelines aren’t there to sustain this kind of buyout frenzy in the long run, and we’re really starting to look very heavily at middle market buyers, just as on the device side, as being the new acquirers for a lot of our portfolio companies in the future.

Wheeler: I’m very bearish on M&A for medtech for the next three years. And I just see tremendous consolidation in terms of the big uglies: Abbott, Boston Scientific, Medtronic. The one acquisition Medtronic made was in neurostim obesity, and it blew up on them; they totally wrote off $250 million. And they have been absent. They keep saying they want to be back in, but we just don’t see them. For early-stage acquisitions like we used to see in the 1999, 2000, 2001 time frame, I think those are gone, and I think they're gone for at least the next three years. For companies that have significant revenue and a growth ramp like Kyphon, yes, there’s an acquisition. But we used to think that we could get to proof-of-concept, or we could get to FDA approval, and then we could sell the company. I just think that scenario is gone. There will always be exceptions to the rule. But before, we used to be able to count on most of these things being acquired at a fairly early stage with fairly low capital. I just don’t see that happening right now.

Q: Well, we’re right up against time, but that does tee up my last question. You’re bearish, and folks who generally are even more bullish are still worried about deal valuations, exit strategies, and the cost of things like clinical trials and reimbursement restrictions. The model that has sustained the device industry for the last 10 years was to get to proof-of-concept quickly, find a ready buyer, and do this with great capital efficiency. Is that model broken in the device world right now? Or does it still sustain with the occasional bumps and bruises?

Koskinas: I think that acquirers are looking for a much more significant proof point where you have real revenue traction and a very attractive growth rate. And similarly, I think that’s almost definitional, as we were saying earlier, in the IPO market for the foreseeable future. So I do think it’s a model that probably may have its time again, but I think these days we’re really looking farther ahead and really incorporating into our analysis and assessment of a company just the overall capital that it’s going to take to get it to that meaningful point of revenues, which is $30 to$40 million, and proximity to profitability at least for the public markets, and for M&A it can vary dramatically.

Wu: David, I might argue with you whether that model ever really existed.

Wheeler: I can testify it did.

Wu: I guess we’ve always looked at the device market as if there were two different markets. There were devices in those areas where there were established consolidators that would buy companies when they’d enrolled an IDE trial, before they had revenue. But then there was the rest of medical device space, which was probably the bulk of it, where you didn’t have consolidation. There was no one you could point to who would be a likely buyer, and you did have to plan to get to that revenue point. And so our investments, I would say, in certain traditional areas like spine, cardiovascular, and orthopedics where you could see early exits, the expectation when we made the investments was, yeah, we would get those early exits. But in other areas, we were always planning for that revenue-stage company in order to get to an exit.

Q: Maurice, I’m going to turn to you before I get the last word from Kurt. In this environment, does venture debt become a riskier strategy, or again a more helpful strategy?

Werdegar: Both. I think it is risky, though. I think that companies need to be very mindful of taking on debt in light of what you're hearing about valuation pressure and exit opportunities. Therefore, I think debt really needs to be used for specific, value-creating opportunities to get a company from one milestone to the next, particularly in a private financing scenario. Or to profitability in some cases. We’ve heard a lot about companies needing to get to a certain amount of revenue in order to become attractive. Quite often a company might be $5 million short in their cash plan to get there. Perhaps that's a good opportunity to think about financing a company to profitability. But I think overall when you see illiquidity in both the public sector and sort of a broken scenario on the M&A side, which we also see, by the way, we ourselves are quite concerned with any company that comes to us with a large debt request saying, "Well, it’s just going to get us to our next $40 million series B financing." I think you need to be quite mindful of why you're taking it on, what the purpose is, and like everyone here has said, there is a payment associated with it. You begin the paying back. It increases your burn rate and might make you less attractive to an X round investor. So I think being thoughtful about that’s really important.

Q: Kurt, a final word?

Well, I’ve been a negatron up here, but at the same time I’m very bullish long term. What we’re doing is really meaningful to a whole bunch of people, and Americans and the rest of the world deserve the kinds of technologies that we can bring to bear on health care problems. We all want to be 25 years old with the wisdom of those of us who are in our 50s. We want to run, walk, be active, and we want great health. Medical devices can supply a lot of that. So we’ll have short-term aberrations, and we’ll go through cycles, but over the long term, this is a really great place to be, and it’s a really good thing to do. So don’t let my short-term negativity get in the way of what is a long-term bull opportunity to be investors as well as entrepreneurs.