Startup Outlook 2013: The Medical Device Tax’s Impact on U.S. Innovation March 2013

Overview of the Startup Outlook 2013 Survey

The Startup Outlook report is based on an annual survey of private companies across the U.S. in the software, life science, hardware and cleantech sectors. Silicon Valley Bank — the bank for high growth tech startups across the United States — asks startups how things are going, whether they’re planning to hire, and how government policies are affecting their growth.

Medical Devices: The Situation

This year, we took a deep dive into a critically important segment of the U.S. innovation economy: the medical device sector.

For a variety of reasons, policymakers and ordinary Americans should care about the health of the device industry. Perhaps most importantly, new, innovative devices help improve patient outcomes and reduce costs. In addition, U.S. leadership in commercializing medical devices helps ensure that U.S. patients have early access to new tools for diagnosing and treating conditions. The device industry also creates high paying jobs and is a major exporter and an important contributor to the U.S. balance of trade.

Yet for nearly a decade, rising regulatory costs, delays, and uncertainty have made it significantly harder for device companies to succeed. This has reduced the amount of capital being invested in new device companies to an 11 year low. It has also caused a shift in investments away from capital intensive segments, impeding the discovery and commercialization of treatments for chronic, costly conditions such as diabetes, obesity, and vascular disease.

While Congress and the FDA are taking steps to turn this around, those efforts are still in the relatively early stages. And now a new challenge has emerged for growing companies: starting January 1, 2013, all device companies must pay a 2.3% tax on their total U.S. sales. This tax applies even to companies that are not making a profit. We wanted to hear firsthand how executives are dealing with the tax and how they think it will affect the device industry going forward.

Key Findings: 98 Device Executives Share Their Stories

 Eight in 10 respondents believe the device tax will affect their company’s long term growth

o  One in four will focus on expanding overseas instead of domestically o  Two or more in 10 will take one or more other steps in response to the tax, including reducing their workforce or

foregoing new hires, shifting resources away from growing their business, investing less in R&D for existing and new devices, or trying to raise more capital from investors

 The device tax compounds other challenges that threaten to affect U.S. leadership in medical device innovation

o  Device companies were much more likely than startups in other sectors to say they fell far short of their 2012 revenue targets (17% versus 9% for other segments)

o  Device executives were much less optimistic about business trends than their peers in other sectors o  Not surprisingly, this translates into less robust expectations for hiring than is true for other startups

 The survey captures the front row view of those leading small device startups – the kind of companies that create break-throughs in medical care but that are also the most vulnerable

o  70% of the companies had fewer than 25 employees. 98% had fewer than 100 employees o  61% aren’t yet earning revenues. Of those earning revenues, 56% earned less than $5 million in 2012, 95% earned

less than $25 million in 2012, and fewer than one in ten expected expect to be profitable in 2012 o  Most of the respondents were either the CEO (63%) or the CFO (28%)

Views on the Device Tax

Many Small Businesses are Still Trying to Figure it Out …

… and Deciding How to Cope

Eight in 10 Believe the Tax Will Affect their Long Term Growth

A Sector Already Under Stress

Device Companies Were Already Facing a Tougher Environment Than Other Startups

Device Companies Are Less Optimistic About the Coming Year

Device Companies Are Less Likely to Hire in 2013

  About half of the device respondents (46%) currently manufacture devices o  93% of these manufacture mostly in the U.S.

  Most of the remaining device companies (45%) plan to start manufacturing in the next 18 months

o  Of these, only 50% expect to manufacture mostly in the U.S.

  If we don’t reverse this trend, good middle class jobs will be lost o  More than half of the device manufacturing jobs require only a high school degree (28%)

or hire based on experience regardless of education (28%) o  Only 16% of these jobs require college or above

Device Headwinds Are Further Undermining US Manufacturing & Jobs

In Their Own Words: Device Executives’ Advice and Insights

“[T]he device user fees and Obamacare mandates will force our expenses to far exceed revenue and anticipated financing. Regulation seems to haunt the start ups.

The rising costs due to regulations such as Healthcare, US based manufacturing (2.3%), proposed reimbursement reductions etc are all major concerns.”

“If there has to be a tax, I would stage it and over 5 years. I would also not tax companies on revenues but on profits and would also not tax companies with less than $10M in revenues because those companies need more support so they can innovate

and create jobs and skills that will impact America longer term.”

“Our team wants nothing more than to change the world for our patients. In the process this creates well paying jobs and prosperity. It baffles me that the US government adds to the slope of the hill we have to climb with an unpredictable FDA process, uncertainty

with regard to investment tax rates and pre-profitability corporate taxes.”

“Please repeal Med Dev Tax for small companies (<$100M) to allow us to focus on growing our business with these funds.”

“Recognize that the US medical device industry contributes jobs to the US economy and contributes to the balance of payments. Reconsider and urge repeal of the

medical device tax.”

“We have now been selling our medical device product in Europe for over 1 year, providing safe and effective pain relief to suffering patients. It will be more than another

3 years at best before the product will be available to patients in the USA. With absolutely no additional benefit to patients.”

“Foster incentives, not taxes for medical devices - this is one industry where the U.S. used to lead the world and this position is eroding and at significant risk.”

In Their Own Words: Device Executives’ Advice and Insights (cont.)

Survey Methodology

Results for Silicon Valley Bank’s Startup Outlook Study were collected through an online survey conducted between December 4 and 20, 2012. The survey was completed among a national sample of 758 executives of innovation companies with less than $100 million in annual revenues and fewer than 500 employees. Over 60% of respondents are President/CEO, 18% CFOs and 19% all other executive titles. The industry distribution of respondents is 433 Software/Internet, 212 Healthcare, 50 Hardware and 63 Cleantech. 98 medical device respondents completed the survey. 63% of device respondents were President/CEOs, 23% were CFOs, and 14% were from other executives combined.

Find the Startup Outlook report at http://www.svb.com/startup-outlook-report/

About Silicon Valley Bank Silicon Valley Bank is the premier bank for technology, life science, cleantech, venture capital, private equity and premium wine businesses. SVB provides industry knowledge and connections, financing, treasury management, corporate investment and international banking services to its clients worldwide through 28 U.S. offices and six international operations. (Nasdaq: SIVB) www.svb.com. Silicon Valley Bank is the California bank subsidiary and the commercial banking operation of SVB Financial Group. Banking services are provided by Silicon Valley Bank, a member of the FDIC and the Federal Reserve System. SVB Financial Group is also a member of the Federal Reserve System.