New Funding Models Key to Keep Innovation Churning

During this year’s American Academy of Orthopaedic Surgeons annual meeting in Chicago, Ill., Orthopedic Design & Technology caught up with Christopher Velis, president and CEO of MedCap Advisors, a Cambridge, Mass.-based firm that provides merger advisory, consulting and valuation services to medical technology companies. Velis has spent more than 20 years as an investment banker, consultant and venture investor in medical technology. He shared insight about the current state of investment in medical technology, what’s needed to spur continued funding for new product development and how, if government isn’t careful, the United States could lose its spot as a market leader in medical device innovation.

The following are excerpts from our AAOS conversation:

Orthopedic Design & Technology: How has investment in new orthopedic technology changed?
Chris Velis: Some companies have found themselves really contained because of the state of the capital markets, particularly the state of the venture capital community, which is not flush with cash. As a result, many of the companies that would have been “layups” for venture capital five years ago are finding themselves very constrained. That’s a problem because it certainly hinders innovation. It also hurts valuation. That’s clearly not a positive trend. That said, when there is a lack of capital, other sources step in to fill the void. Traditional venture financings are getting back-filled by angel investors who are emerging en masse and providing lots of capital for developing technology. Wealthy families are stepping in to make investments, and sovereign funds from around the globe also are stepping in.

More importantly, larger orthopedic companies are looking at deals a little bit differently than they were a few years ago. They are increasingly willing to make investments or strike partnerships that align the interests of newer technologies with their need for a developing pipeline. This is a really important factor, and it is motivated by their mutual interest. A little company needs funding, needs partners. Big companies have distribution channels, but most of them aren’t particularly good at developing new technology. They’re much better at sales, distribution and marketing. Many companies are operating in the old funding paradigm. If you’re able to step out of the old venture paradigm and look for new sources of capital and new structures, you’ll see exciting possibilities. I don’t see the traditional venture capital markets for orthopedics coming back any time soon.

ODT: What kind of companies will be most successful in this new reality?
Velis: Companies that can validate the market by generating some sales on their own prior to trying to develop an exit are always looked upon favorably. Because their concept is proven, they have their regulatory approvals, and nobody has stepped out to try and copy them. So that becomes a bit of a no-brainer. The second category is technology that’s disruptive, that has the potential to destroy existing markets. Those are more risky because they’re not validated by the market, but they are much more exciting.

ODT: How should companies retool their thinking? Is there a message lawmakers are missing?
Velis: You take an uncertain regulatory process and add the capital gains and medical device taxes, and you’ve got a major problem brewing with desire to invest in medical technology. That’s something that the federal government and that our senators and representatives in Washington [D.C.] should pay very close attention to because it puts us in a situation of losing our edge in medical technology to other parts of the world. That said, investors are going to have so start thinking very globally. There’s going to be price pressure on anything used in healthcare. Demographics are going to outweigh that. You look at an aging United States, a growing China, and most of all a huge population surge in India, and there’s absolutely no question that the number of patients on the planet is going to double and triple. There will be a huge need for medical devices, but a need for inexpensive and efficacious technology. We need to stop thinking about 90 percent margin implants and start thinking about three things: Does it save the hospital money? Does it prevent suffering? Does it save lives? If entrepreneurs are thinking about those three things with a global perspective and thinking innovatively about sources of capital and partnerships, they’ll succeed. Short of that, it’s a really hard path.

[The medical device tax] should be repealed; it shouldn’t have been implemented in the first place. The United States has the best scientific minds in the world. Our firm is located smack in the middle of Harvard University. We have some of the best minds in the world right here in the Boston area. And that goes for many other parts of the United States—the best scientific minds and best resources. But we’re not demanding that the [U.S. Food and Drug Administration] be really clear about what it takes to get approval around innovative classes of products. Increasing capital gains tax on medical device investment when our goal is to drop the cost of healthcare makes no sense to me. This kind of investment should be privileged, not taxed at a higher rate if you’re going to risk your capital in this technology. And If you’re going to lower the cost of healthcare, why are you going to tax the devices used to treat patients? That really makes no sense. It will raise costs. It’s going to defer investment from what is one of our national treasures—our knowledge around medical science and healthcare.