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INVENTION TO STARTUPSOURCES OF FUNDINGTrevor Moody – Frazier Healthcare VenturesJens U. Quistgaard – LipoSonix, Inc.
Overview
Observations on the current financial climate
Sources of funding Exercise – potential sources and their attributes Quick case study: SonoSite, Inc. Quick case study: LipoSonix, Inc.
Venture funding in depth What is a venture capitalist? Venture capital funding criteria What has changed recently?
World Market Conditions
“Fear” is high Global credit
crunch/recession Uncertainty about
size and extent of problem
Companies most affected have: Operational leverage to GDP or
Balance sheet debt
VSX Volatility Index Sept 2000- Sept 2008
Data courtesy of SV Life Sciences LLP
Effect on Private Companies
Relatively limited impact on healthcare companies
Reduced access to public markets for exit or financing
Reduced availability of credit and increased financing costs
Potentially longer time period to exit and lower exit valuations
Performance of Healthcare Indices Health sector is driven by non-discretionary
spending and therefore traditionally a safe haven at times of economic turmoil
U.S. healthcare indices have all outperformed the S&P500 over the last 12 months
S&P 500 down 30% Medical device (DJUSMC) down 11% and
biotech (NBI) down 10% Healthcare services (IHI) down 17% due to
HMOs’ reduced rates of growth, credit contraction and fears about reimbursement
Performance of Healthcare Indices
65%
70%
75%
80%
85%
90%
95%
100%
105%
110%
05/10/2007 05/11/2007 05/12/2007 05/01/2008 05/02/2008 05/03/2008 05/04/2008 05/05/2008 05/06/2008 05/07/2008 05/08/2008 05/09/2008
Re
lati
ve
12
mo
nth
pe
rfo
rma
nc
e
Healthcare Services Med tech Biotech S&P500
12 month performance of US Healthcare indices to 5 October 2008
Data courtesy of SV Life Sciences LLP
Healthcare Fundamentals Strong Recession resistant
characteristics: Rapidly ageing population ~10% of world population is
over 65 Rising incidence of chronic
disease Rising healthcare costs US healthcare spending $2.3
trillion in 2007, $7000 per person
Healthcare spending outpaces overall economic growth and inflation
Regulation creates high barriers to entry
Globalization and new markets Innovation creates new markets
0 20 40 60 80
Cancers
Mental disorders
Diabetes
Heart disease
Hypertension
Pulmonaryconditions
Stroke
% rise in disease
Forecast rise in chronic disease 2003-2023
Predicted population growth 19%
Data courtesy of SV Life Sciences LLP
Healthcare Investing (USA)
Equity into US VC-backed healthcare companies
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 H1-08
Am
ou
nt
inv
es
ted
($
mill
ion
)
Biopharmaceuticals Healthcare ServicesMedical Devices/Equipment Medical Software & IS
Pro
-form
a
Data courtesy of SV Life Sciences LLP
So…
Financial markets are a mess Healthcare is a great place to be in these
times Funding is still available, but…
Bar is raised for new investments Valuations are down Each type of funding is affected differently
Sources of Funding
What are they? Self Friends & Family Debt Grants, contracts – NIH, SBA, DARPA, etc. Angels Venture funds Crossover funds Strategic (other companies) Public markets
Sources of Funding
What are they? Self Friends & Family Debt Grants, contracts – NIH, SBA, DARPA,
etc. Angels Venture funds Crossover funds Strategic (other companies) Public markets
Quick Case – SonoSite, Inc.
ATL Ultrasound – parent Digital ultrasound pioneer Core competence in ASIC implementation
The hand-carried ultrasound vision The internal funding reality DARPA dual-use program
ATL Ultrasound University of Washington VLSI Technology Harris Semiconductor
SonoSite – Getting Off the Ground Basic development 1996-1997
$12.6MM DARPA matching grant Handheld Systems Business Group 1997 Spin-out as SonoSite, Inc. - April 1998
$17MM cash (+$13MM later) Technology license NASDAQ listed – distributed to ATL
shareholders First working prototype – September 1998 First follow-on financing – April 1999
($33.8MM)
SonoSite – Lessons Learned
Government grants are a wonderful thing But…
You need an impressive consortium to get large $
There are some complications Government technology rights Consortium member’s technology rights Reporting requirements Etc…
Being a pre-revenue public company, in my humble opinion, is not a wonderful thing
Quick Case – LipoSonix, Inc.
Originally pitched to investors by two individuals Not successful
Picked up by a medical technology “incubator”
LipoSonix, Inc. founded in late 1999 Initial venture funding, January 2001 (1.4MM)
IP licensing Exploratory work
Series-B, tranche #1, November 2001 ($4MM) More exploratory work
LipoSonix – The Bothell Story First full-time employee and dedicated
facility, August – October 2002 Series-B, tranche #2, September 2002
($5.9MM) First human study, July 2003 The joy of venture debt Series-C, July 2004 ($27.0MM) More debt… Initial customer shipment More debt… Acquired by Medicis Pharmaceutical Corp.,
July 2008
LipoSonix – Lessons Learned Top-drawer investors really help! Be aware of capital structure issues
associated with incubators Be aware of capital structure and terms
issues associated with venture financing Multiples requirements Liquidation preferences (!) Etc…
Venture debt is a wonderful thing If you can get it, and use it appropriately
Different money sources are likely to be involved as the company grows
Funding Source Prototype Pre-Clinicals Clinical Proof
IDE Approval Pivotal Trial FDA Approval
Commercialization
Angels, Grants etc.
Venture Capitalists
Corporate
Public Markets (IPO)
ConfidentialConfidential
5%
25%
45%
15%
60%
100%
10%
Funding needs increase significantly as the start-up moves towards commercialization
Typical Funding Requirements Through a Company Lifecycle
Sources of Funding – Venture Capital
> What is a Venture Capitalist?
> What criteria do VCs use to decide what to invest in?
> What has changed recently?
What is a Venture Capitalist?
Follow the Money
The General PartnerAnd the Fund
Sources of Capital Investments in US HealthcarePortfolio Companies
• Retirement funds
• University endowments
• Families / high net worth individuals
• General partners
0
1000
2000
3000
4000
5000
6000
7000
Inve
stm
ent (
$MM
)
1996 1997 1998 1999 2000
Update!
> Typically small partnerships made up of a few General Partners (2-10) and other staff
> General partners collect a percentage of the profits
> Payouts over several years
> Lucrative but high risk
> Manage one or more funds raised sequentially over several years
> Fund sizes range from <$5MM to >$2B
> Some firms have been around for >50 years but vast majority have emerged in the last 15 years
What is a Venture Capitalist?
Medical Device VCs are looking for the most exciting new technologies
> Opportunities of great interest to medical device companies
> Innovations that will be rapidly adopted by physicians
> Incremental improvements
> “Products, not companies”
A typical large healthcare VC may see 1000-2000 plans per year and invest in only 10
The Medical Device Investor’s checklist
Management / Founder Teams
Big Markets / Rapid Adoption
Regulatory/Reimbursement pathway
Early Clinical Proof-of-Principle
Patents
Management/Founder teams
> Most startups won’t have a CEO who has taken 3 companies public
> Experience in other successful ventures
> Have recruited top-tier mentors, board members and advisors
> Open to adding other great executives to the team
> Deep understanding of the target market and technology
> Just want money, don’t want a partner
> Unrealistic expectations of how hard it will be
> Looking for a quick win
Big markets/Rapid adoption
> Physician specialty has demonstrated that they will rapidly adopt new technologies
> $1B + potential market
> Targeting procedurally oriented specialties e.g. cardiologists, orthopedic surgeons, etc
> Challenging physician referral patterns
> Requirement for large upfront capital outlays
> A very large existing or potential market is critical for generating investor interest
Regulatory/Reimbursement
> Clear FDA approval requirements
> Compelling economic argument to key decision makers e.g. physicians, hospitals
> Physician community excited enough about technology to lobby for reimbursement
> Trials requiring long follow-up
> Great macro-economic argument but no-one incented to adopt
> FDA and CMS challenges are often underestimated by founders
Early Clinical Proof-of-Principle
> Rapid, ethical path to early clinical feasibility testing
> Early clinical data that is highly suggestive of likely success of the pivotal trial
> Need to run large, lengthy clinical trial to see if it works
> Mediocre efficacy results
> A rapid path to clinical proof-of-principle greatly increases the fundability of a company
Patents
> Very strong protection around key innovation
> Building a “patent thicket” to cover other related inventions
> Broad early patents (an added bonus)
> Sloppy patent strategy / disclosures that have limited patentability
> Freedom to operate concerns
> Strong patent protection is essential in a technology-driven venture
What is the impact of the economic crisis on venture capital?
> Limited impact in the short term – in 95% of cases, funds will continue> Quality VCs raise money from quality, long-term Limited Partners
(LPs)> VCs have not typically used debt … fortunately
> Potentially dramatic impact in the long term> Exits – Definitely delayed significantly
> LP appetite for VC investments will decline over time
> VC investment criteria will be more conservative> Early-stage VCs will still invest in early-stage companies but hurdles
will increase> More sensitive on capital needs, time to market etc.
Wrap-Up
> Healthcare - Perhaps no better place to be driving innovation
> Buyers less affected by acute economic turmoil
> Insatiable demand
> Demographics
> Lot’s of money still out there … the bar is much higher but great opportunities and great teams will get funded
> Take a strategic approach to fund raising. Target the best sources of money given your opportunity and stage of development
> Expect to spend a lot of time raising money