In the last issue of The Pulse, I noted that 2006 was an excellent year for venture capital investing in the United States, and that one of the primary drivers of the robust activity was medical device companies. As noted in the last issue, medical device companies accounted for the most venture capital (VC) deals during the three months ended September 30, 2006 (pharmaceutical companies accounted for the greatest amount of funding). Data from the fourth quarter confirmed the record year for venture investing in medical device companies. According to data from Thomson Financial, the life sciences sector covering biotechnology and medical devices was the pacesetter in 2006, receiving $7.2 billion in investing in 731 transactions, both records for the sector.
In light of the robust market, what can be learned from 2006 to project venture capital medical device investing in 2007? Based on a review of certain transactions and continued discussions with local area venture capitalists who focus on the medical device sector, we continue to project that 2007 will be a strong year and see positive VC investing trends. As recently noted by PricewaterhouseCoopers and the National Venture Capital Association, increases in investment were focused on the right areas and produced a well-balanced mix of investing in early-stage companies, first-time financings, expansion, and later-stage investments. It is noted that one of the keys to the medical device area is the room for scale and growth that can be achieved. Another very important note is that quarterly investment levels appear to be steady and reasonably prudent and, as such, there is not a sense of overfunding in the marketplace. As a result, we expect funding levels to continue to increase at steady levels.
From a staging standpoint, the trends for early-stage, expansion, and later stage are all pointing in positive directions. In 2006, funding for startup and early-stage companies increased both in terms of number of deals and dollars, 16 percent and 11 percent respectively. Expansion stage companies saw a significant increase in deals and dollars, accounting for 44 percent of all the VC deals completed in 2006.
As noted in the previous issue, we project that medical device companies should expect to see several layers of VC investing. A typical investment for 2007 may include an initial A round of $3 million to $7 million, from which the company can achieve certain milestones. If the milestones are achieved, the investors are likely to build a syndicate and increase the funding in the B round, likely to be in the $10 million to $30 million range. Ultimately, medical device companies should anticipate or seek a five-year funding commitment. As for other specific terms, we currently anticipate that, depending on the nature of the company in which funds are being invested, that the initial round will “cost” the founder approximately 30 to 35 percent of the equity of the business, that the investors will receive a dividend preference and weighted-average anti-dilution rights, and will have a liquidation preference that will allow the investors to receive back their investment plus dividends, and then a right to “participate” in the remaining proceeds, which participation will be capped at some level. For example, an early-stage medical device company raising an initial $5 million round that gets a $8 million “pre-money” valuation, should expect that the investors preferred stock will have the right upon liquidation to receive its $5 million investment back, any unpaid or undeclared dividends, and then to participate on an “as-converted” basis, pro-rata with all of the common stock; provided, however, that the participation may be capped (perhaps at three times the original investment amount) if the company has enough leverage to negotiate a cap.
Based on the foregoing and our experience the first two months of 2007, we continue to be extremely confident that the strong medical device investment trends will continue in 2007.
This article is a part of the April 2007 edition of The Pulse, a newsletter for leaders in the Medical Device Industry.