Download Monetizing Medical Device Research

Monetizing Medical
Device Research
A Primer on the Life and Structure of
Successful Medical Device Ventures
November 2006
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The world is witnessing the big bang of scientific discovery in the medical device sector. While historians point to the impressive
advances made in the medical sciences during the twentieth century, experts project that the pace of discovery will quadruple in the
next twenty-one years.i This ocean of discovery comes at a time when NIH funding for life sciences research is at its highest level,
ever.ii It comes at a time when the baby-boomers will soon create previously unseen demand for health care services and for novel
treatment options. It comes at a time when the world has been flattened, so that companies that conduct research or provide services
to the medical device sector can be operated virtually anywhere in the world.iii The convergence of discovery, demand and resources
in this manner points to obvious opportunities for companies that have learned to leverage medical device research. Whether this
investment is structured as seed-stage capital for new ventures, growth capital for adolescent companies or capital for strategic
acquisitions, the ability to recognize the characteristics of a successful medical device venture is the key to success.
The Bayh-Dole Revolution
The political groundwork for the medical device boom was laid in 1980 when the Bayh-Dole Act was passed.iv Prior to the BayhDole Act, partnerships between academia and private medical device companies were severely constrained. Any new product
developed with government-funded research belonged to the government. For obvious reasons, the government was not in the
best position to exploit and commercialize new inventions. The Bayh-Dole Act represented a sea change in federal policy on the
private exploitation of government-funded research. The policy, restated, was simple: allowing commercial interests to exploit
devices funded with U.S. tax dollars was the best and the fastest way to achieve medical advancement and give the government
the highest return on its research investment.
The Bayh-Dole Act allows research institutions to patent and retain ownership of inventions they create using federal grant
monies, but there are strings. For starters, the academic institution must enter into a funding agreement with a federal agency.
The funding agreement requires the institution to disclose to the agency new inventions derived from the research paid for by a
particular grant. But the institution can elect to retain ownership of the invention by notifying the agency as well. In order to
retain ownership, the institution must give the United States a non-exclusive license to use the invention (although the United
States rarely makes use of these licenses). The institution is allowed to license the invention to a company owned by a variety of
private interests, including researchers, private equity firms and device manufacturers. The private company can exploit the
licensed technology for commercial gain but may not sit on the technology. If the company does not move forward with
reasonable diligence, the federal agency that made the research grant can exercise its “march-in rights” and reclaim ownership of
the technology. The Bayh-Dole Act also places restrictions on the manufacturing of products developed from federally funded
research, requiring them to be manufactured exclusively in the United States.
The Three Stages of a Successful Medical Device Venture
Assume that researchers at an institution have made a promising invention that has resulted in patentable technologies. The
institution and its researchers now license the technology to a newly formed medical device company. The period immediately
following the license is the venture phase. If the company can develop the relationships it needs to survive, it moves to the
second stage, the growth stage. If successful at testing its products, the company then moves to the third stage, the
commercialization stage. A mature medical device venture has the critical mass to fully commercialize a proven technology or
position itself to be acquired by a larger entity that could even more effectively commercialize the technology. A technology
licensed from a research institution only has value if it is fully commercialized, meaning that a venture’s success depends on
whether it can successfully reach maturity by navigating through the venture and growth stages. To get through these stages it is
essential to have a clear understanding of what the venture’s likely structure and business goals will be at each stage.
Phase 1—The Venture Stage
Medical device ventures that spin-out of research institutions all have the same goals at the venture stage: (1) obtain exclusive
license rights to commercialize promising, patented technologies; (2) structure proper relationships with research institutions,
investors, vendors and device manufacturers; and (3) develop a corporate structure that maximizes their intellectual property and
relationships to the greatest possible advantage.
THE IMPORTANCE OF INTELLECTUAL PROPERTY
Medical devices derive economic value from their uniqueness. If a venture-stage device company does not take steps to
safeguard its intellectual property, others may attempt to exploit the underlying technology. If others are using the technology,
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the technology loses its uniqueness, and the value of the technology is lost or diminished. Consequently, protecting patents is
critical for a company that seeks to develop and commercialize a new medical device.
If the patents are licensed from an academic institution that was the beneficiary of federal grant monies, the device venture should
take great pains to conduct due diligence to ensure that technology was appropriately patented by the institution before the
technology is licensed. Too often venture-stage device companies invest significant time and resources into a technology, only to
learn that the technology was not appropriately patented by the institution that is licensing it to them. Other times, the technology
that is the subject of the venture infringes on others’ patent claims. In either event, it is better to determine whether there is a
problem with the underlying intellectual property at the outset, rather than after the company has been set up and employees have
been hired. If this is not done at the outset, troubling intellectual property questions will almost certainly come to light when
investors bring in sophisticated due diligence teams to examine the venture’s intellectual property prior to making an investment.
STRUCTURING EFFECTIVE RELATIONSHIPS
Venture-stage medical device companies often emerge from research institutions that use federal research funds to spark
invention. The Bayh-Dole Act incentivizes the institution to attempt to develop new technologies and to share license fees with
the researchers/inventors who developed the technologies. The most common means of doing this is to license a new patented
technology to a venture-stage device company that is owned in part by the researchers/inventors. The research institution can
participate in the venture by taking an ownership stake in the company, a license fee for the technology or both. The institution
derives economic benefit from the license fees it receives from the venture, as well as the prestige associated with having its name
associated with cutting-edge research. The more recognition it receives for such research, the easier it will be to attract additional
private and public research funding for other projects.
Another critical part of a successful venture-stage device company is a group of researchers/inventors who are eager to take their
research out of the laboratory and into a commercial setting. Although many researcher/inventors will be eager to see the subject
of their work taken into a setting in which they could derive economic benefit from it, many companies fail at the venture stage
because they do not have the necessary mass of researchers. This most often occurs when there are multiple groups of
researchers/inventors at an institution whose work contributes to a new patented technology. One group may be eager to take the
technology into a translational setting, while others may be more comfortable remaining in the laboratory working on pre-clinical
research. In many cases, academic or personal rivalries act as barriers to full participation in the venture. In other cases,
researchers either lack the will or acumen to participate in a venture driven by profit motives rather than academic values. When
the start-up company begins to operate without one of the critical researchers or research group’s participation, difficulties will
arise when the company begins to leverage the research that the missing researchers contributed. When investing in a venturestage company, it is important not only to ensure that the technology is sound but also to ensure that all of the critical
researchers/inventors are committed to working with the venture to take the technology to the next stage.
After the venture-stage company has secured the appropriate intellectual property and the participation of the key
researchers/inventors, the company has the building blocks of a successful medical device company, but building blocks are not
enough. A January 2004 report issued by the Food and Drug Administration (FDA) and the Association of American Medical
Colleges estimated the cost of bringing a new drug or medical device to market to be $800 million.v As the venture-stage device
company grows, so will its need for funding. Private investors’ participation in the venture is required. This investment can
come from a variety of sources. In some cases, device manufacturers will invest directly in the venture, taking a direct ownership
position. More often, however, these companies shy away from venture-stage companies, preferring instead to participate in
more developed companies whose devices have been taken through FDA testing. Most venture-stage device companies will
receive funding from venture capital groups or angel investors. These groups will tend to cluster their investment in companies
that focus on specialized and discrete areas (e.g., nanotechnologies, orthopedics, stents).
Notwithstanding the increase in private funding of device companies, the amount of capital available to venture-stage companies
is becoming increasingly scarce.vi Venture-stage companies that emerge from prestigious research institutions are more likely
to receive funding, as are ventures that involve researchers/inventors who previously have developed and commercialized
successful fledgling medical devices.vii Devices aimed at treating diseases with broad commercial appeal (e.g., cardiac stents) are
much more likely to receive funding than those which are aimed at rare diseases (e.g., braces for patients suffering from
elephantitis). A corollary to this dynamic is that venture-stage companies that do not have the appropriate pedigree will likely
have less leverage in their negotiations with their investors. As a result, they typically will have to give their investors a greater
percentage of the company’s overall equity in exchange for the capital necessary to move the venture forward.
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The amount of funding required for a venture stage company will vary based on the strategic goals of the company. If the strategy is
to successfully demonstrate a device’s efficacy in clinical trials and then sell the rights to the device before the manufacturing begins,
the company will have less need for capital than a company whose goal it is to fully develop, commercialize, manufacture and
distribute the device. In general, investors who provide capital for venture-stage companies will only do so if there is a realistic time
frame for them to receive a return on their investment, generally three to five years from the date the investment is made. In most
cases this will dictate the strategic direction of the company, pushing it more toward a model where the device is developed only up
to a point and then sold to a larger company that is better positioned to take the device to market.
EFFECTIVE LICENSING STRATEGIES
The license agreement between the research institution and the venture-stage company must be structured in a way that is a winwin for both parties. The research institution must ensure that the venture-stage company acts in a manner that is consistent with
the institution’s obligations under its funding agreements with federal grant-making entities. The research institution also will
want to maintain the right to publish the results of its research at a time that does not interfere with the commercial value of
products derived from the research. The research institution also may ask that the venture-stage company indemnify it for any
intellectual property infringement claims that are brought after the license is effective, as well as any professional negligence
related to the use or testing of any devices that are developed using the licensed technology.
The scope of the license also is essential, and is something that the parties may spend a great deal of time negotiating. The
research institution may desire to enter into exclusive licenses with more than one start-up company if the uses that each start-up
company hopes to make of the technology are different. Problems sometimes arise when the scope of the licenses are unclear and
potentially overlap. For example, one start-up company may hold an exclusive license to develop and commercialize a
shockwave technology for the treatment of certain illness caused by diabetes. A second company may hold an exclusive license
to develop and commercialize the same shockwave technology for the treatment of diseases of the skin. If the second company
develops a shockwave device that is designed to treat diabetic ulcers of the skin, the first company may object, leaving the
research institution caught in the middle. From the venture-stage company’s perspective, the best license is a broad license that
covers a wide-variety of potential uses. The venture-stage company must carefully negotiate the scope of the appropriate license
with the technology transfer office of the research institution and must be assured that the license it is being given truly is
exclusive and will not overlap with other licenses the research institution gives to competing ventures.
If the research institution is a tax-exempt entity (as they often are), the license fee paid by the venture-stage company for the
technology must be at a fair market value rate. License fees can be tricky, since a cash-strapped venture-stage company typically
does not have the ability to pay significant ongoing license fees, particularly when the company has no source of recurring
revenue. Luckily, the fair market value of a license for an unproven technology is relatively low, and license fees can be deferred.
One common way to do this is to structure a license fee that is payable upon reaching critical milestones in the commercialization
of the technology. For example, upon passage of critical FDA trials, a license fee might be due. If the venture-stage company is
sold, a separate lump sum license fee would be due. It also is common for the research institution to receive a small percentage of
the net revenues derived from sales of products developed utilizing the technology licensed by the research institution. The
staging of license fees in this manner ensures that the research institution receives fair market value for its technology, but at a
time when the venture-stage company can afford to pay it.
A good license agreement will do more than just define the scope of the licensed technology. It also will address many of the
operational matters that must be addressed if the start-up venture is to succeed. For example, a license agreement also should
allocate the responsibility and costs for maintaining the patent portfolio that is subject to the license. It also may describe in detail
the resources that the research institution will make available to the venture-stage company and the cost that the venture must bear
for these resources. Because a start-up company may be relying on space, equipment or services owned by the research
institution, it is essential that the research institution contractually commit to continue to make these items available to the venture
for as long as the venture will continue to need the items to grow and expand.viii
LEGAL STRUCTURES THAT MAXIMIZE POTENTIAL
Apart from the license agreement, the corporate structure of the venture-stage company also is an important consideration in
leveraging the relationships among the constituent parts of the venture. If a venture-stage company does not plan on pursuing
more than one application for a given technology, a straight-forward and simple corporate structure makes the most sense. The
research institution typically will license technologies directly to a company that is owned by a group of researchers, private
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investment groups and, in some cases, the research institution itself. This company then directly develops, tests and
commercializes products with a goal of either going public or positioning itself for sale.
If the venture-stage company is intended to be a repository for intellectual property that will be used to commercialize a variety of
applications, a holding company structure works best. The research institution licenses patented technologies to a holding
company. The holding company then attempts to secure other licenses from public and private parties that will assist with the
development and commercialization of products. Once the holding company has the necessary bank of intellectual property, it
can sublicense the portfolio to a number of different venture-stage companies. Each company receives an exclusive license to
develop and commercialize products in a discrete area. Each company has a separate existence and is usually comprised of
different researchers and different private investors. The holding company structure offers economies of scale since a single
entity can expend the resources necessary to procure the requisite intellectual property for the development of technologies that
have more than one potential therapeutic or commercial application. It also helps to protect intellectual property because any
testing or clinical trials of potential products are conducted by the separate legal entity that holds a sublicense of the technology
for a particular application. Liabilities arising out of such tests normally would remain with the testing company and would not
bleed through to the holding company.
If there is significant additional research and development that must be completed before products can be developed, there may be
some advantages to establishing a separate, offshore research and development company. The offshore company develops new
derivative technologies, taking advantage of the favorable foreign tax laws applicable to research and development activities. The
research and development company then licenses the derivative technologies to the operating company for the development and
testing of new products.
CONTROL OVER THE VENTURE STAGE COMPANY
The culture clash between academia and the business world has been long documented, but nowhere does it raise its head more
prominently than in the medical device industry. The clash is most obvious when a venture-stage company begins to discuss how the
venture will be governed and managed. On the one hand, the researchers who have developed a technology will usually seek complete
control over the scientific aspects of the venture. On the other hand, investors will look skeptically on the ability of academic researchers
to govern a fledgling company and drive it in a direction that will result, as quickly as possible, in a product that can be commercialized.
They will likely want governance control at the corporate level as well as management control at an operational level.
At the governance level a balance can sometimes be set by allowing the private investment group to maintain governance control
of the venture, except with respect to several critical actions that cannot be executed without the approval of the researchers. The
“reserved powers” can include approval of actions involving the sale or merger of the company as well as the approval of capital
and operating budgets, for example. On the operational side, the private equity group likely has more experience and talent at
running the business aspects of the venture (e.g., creating draft budgets, maintaining accounting controls, the creation of financial
statements), but all scientific decision-making would be made only with the approval of the venture’s scientific advisory
committee. This committee typically is comprised of members selected by the researchers.
Stage 2—The Growth Stage
OUT OF THE NEST
A venture-stage company that has established a corporate and capital structure, negotiated a license for a promising technology
and received some initial funding to further develop the technology has survived the birthing process and has entered the growth
stage. The company is no longer speculative in that all the proper relationships among the players (e.g., research institutions,
researches, private investors) have been established, and there is no risk that the venture will crater as a result of a failure to strike
a balance among these conflicting interests. There no longer is a risk that the venture will fail to attract investment to fund its
immediate capital needs. The company begins to outgrow the laboratory space it was leasing from the research institution.
Technical employees will often leave the employ of a research institution and go to work directly for the growth-stage company.
The company moves into new office and laboratory space, and work begins in earnest on the clinical development of devices.
As a device venture moves from the venture stage to the growth stage, the venture’s reliance on the research institution
progressively weakens. At the outset, a new venture may lease laboratory and office space, employees, equipment and services
from the research institution. Because the research institution typically is a tax-exempt entity, it cannot provide goods or services
to a private device venture for less than a fair market value return. Although the device venture gets no break on the cost of
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equipment, space and services, it at least has the security that these critical things will be provided. As the venture grows and
hires more employees, it will require less personnel support from the research institution. As it outgrows its laboratory, it will
move into its own space and no longer lease space or equipment from the research institution. As it begins to develop an array of
relationships with technology and bioinformatics vendors, it will require less services from the research institution.
If a venture is well capitalized and has the critical mass necessary to begin testing new devices directly, it usually will move into
office and laboratory space that it will build to suit its specific needs. It will hire a full-time staff and enter into contracts with
service providers to support its operations. When companies are less well capitalized, they may not have the resources
to immediately lease their own space, hire a full-time staff and otherwise incur the overhead associated with running a business.
In many cases, these companies are too big to continue to lease space from their sponsoring research institution, but too small
to go it on their own. Many of these companies will turn toward incubators (a.k.a., accelerators) as an answer.
EXAMINING THE INCUBATOR
Often times, new medical device ventures do not have the capital to build out their own laboratory space. The founding researchers may
have never run a business before. The company may need outside service providers to assist them in conducting clinical research but
may not have developed relationships or contracts with these outside vendors. They may not have the regulatory approvals to operate
some of the equipment they must use to conduct their research. They may not have developed the sophisticated information technology
infrastructure that they will require to operate successfully. In this case, the company may need to look to an incubator for assistance.
Historically, incubators were run by state or municipal governments in collaboration with research institutions. Increasingly,
companies like LaunchCyte LLC and a variety of private equity companies are acting as incubators for medical device and
biotech ventures.ix An incubator is an entity that spreads its investment in fledgling device companies by providing critical
operational assistance to help the company mature. In exchange for an equity stake in the device venture or a portion of the sales
generated from products the company eventually develops (or both), the incubator provides a growth-stage device venture with a
variety of services that can include:
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Laboratory space
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Cold rooms
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Office space
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Animal testing centers
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IT infrastructure
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Business planning
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Legal assistance
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Grant-writing assistance
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Use of costly equipment
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Skilled personnel
Apart from these critical services, the incubator also offers a device venture other intangible benefits. Often times the incubator
has relationships with investors who are looking for opportunities to invest in medical device ventures. The incubator also
introduces the founders of the device venture to other researchers, and allows them to develop relationships with technical service
providers that can assist them in conducting their work.
However, the incubator is not intended as a long-term fix. Incubators have a financial incentive to churn as many promising device
ventures though the incubator as possible. The average length of stay in an incubator is between one and three years. The incubator
provides incentives to move the company through as quickly as possible. In many cases, the rent paid by the device company for office
space increases the longer the company remains at the incubator. If the company does not attract sufficient capital to move into its own
facilities and set up its own operations after several years, the company will be expelled so that new companies can use its space.
THE NEED FOR A COMPLIANCE INFRASTRUCTURE
When a device venture moves out of a research institution, it leaves behind a compliance infrastructure that must be completely
rebuilt. A research institution, unlike a fledgling medical device venture, is accustomed to operating in a heavily regulated
environment. It has developed sophisticated policies and procedures that define the manner in which it conducts scientific
research, protects patient data and makes required regulatory reports and filings. The medical device venture that moves out of
the research institution is a separate legal entity. It cannot rely upon or adopt by association the compliance policies of the
research institution out of which it emerged. Even though the venture is a small business, it is held to many of the same scientific
and legal strictures as the research institution. It must develop the same complex web of relationships that a large research
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institution develops when it conducts research. These relationships exist in a heavily regulated industry, where it easy to misstep
and where the consequences for misstepping can be costly. The medical device venture has no choice but to develop its own
compliance infrastructure that is equal or close to the level of sophistication of the research institutions.
Because a device venture’s success is judged in large part by whether it can produce a medical device that tests successfully, the venture
cannot be successful if the scientific research that supports the testing is tarnished. The first part of an effective compliance
infrastructure is the development of conflict-of-interest and scientific misconduct policies. If the venture will be sponsoring clinical trials
or conducting clinical testing, it must closely scrutinize each of its many financial relationships and take great pains to ensure that the
financial interests are not influencing the outcome of its research. In June 2005, the Public Health Service issued rules addressing
research misconduct.10 The rules, which set new standards that a research institution should follow in investigating allegations of
research misconduct, underscore the growing scrutiny that scientific research is receiving from regulators. To comply with these new
standards, research institutions will require detailed certifications from their researchers. Device manufacturers also are required by the
FDA to disclose certain financial relationships.11 To meet these reporting obligations, these companies will impose their own reporting
obligations on researchers and medical device ventures. The only way to meet these reporting obligations and to produce scientific data
that is untarnished is to implement policies and procedures designed to ferret out and manage conflicts of interest, investigate allegations
of misconduct, and meet industry-standard reporting obligations.
A second critical element of an effective compliance program is developing compliant policies and procedures. The Health
Insurance Portability and Accountability Act of 1996 (HIPAA) prescribes the manner in which patient identifiable data may
stored, disseminated and used.12 If a medical device venture will be sponsoring or conducting clinical trials on patients, the
venture must assure that its information technology infrastructure can track and generate an accounting of each person who
viewed a patient’s medical information. HIPAA also tightly restricts the parties to whom the patient-specific information can be
disseminated, allowing dissemination only in limited circumstances where appropriate safeguards have been put into place. Most
importantly, HIPAA does not allow protected health information to be used for purposes of conducting research unless the patient
signs an authorization form. The scope of these authorizations must be crafted carefully and narrowly enough to comply with
applicable law, but broadly enough to allow the data produced from the clinical trial to be used again for secondary research.
After detailed policies and procedures have been drafted, the next step is to conduct compliance training for the venture’s
employees and contractors. This training aims to educate employees and contractors on the legal framework in which they
operate, train them on the policies and procedures that are designed to help the company meet its regulatory and scientific
obligations, and instill a culture of compliance.
While policies and procedures give a medical device venture a clear operating framework and training helps to implement it,
compliance officers also have an important role. Compliance officers (e.g., research compliance officers, HIPAA compliance
officers) monitor compliance and make suggestions for compliance improvements. When misconduct arises, the compliance
officer helps to minimize the damage by managing the incidents and assuring that appropriate reporting is made, as needed.
Stage III—The Commercialization Stage
When the medical device venture has successfully taken a technology through clinical trials and has one or more products capable
of being commercialized, marketed and distributed, it has reached the commercialization stage. Companies that reach this plateau
pursue one of two paths. They either sell the venture to buyers who have the resources to manufacture and distribute the product,
or they seek the funding necessary to do so themselves.
PUTTING IT ON THE BLOCK
Ninety percent of mature medical device ventures choose sale as their strategic path.13 Sale has many advantages. It allows the
researchers and investors to cash out, thereby giving them the capital necessary to start and build other ventures. It also allows
researchers whose primary interest is scientific discovery to turn over responsibility for managing the business to the buyer. These
management responsibilities would increase if the venture decided to manufacture and distribute products itself. Private equity firms
that have invested in the medical device venture will likely push very hard to sell a mature device company. The sale gives the
private equity company an immediate return on its investment, eliminates future risk and, most importantly, forecloses the possibility
of the firm having to raise and contribute additional capital that would be necessary to take the company to the next stage.
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If a company has developed and tested several marketable products, it may attempt to sell non-core technologies and manufacture
and distribute its core products itself. The proceeds derived from the sale of the non-core technologies can be used to fuel the
expansion efforts needed to take the core products to the next level.
Another common strategy is to partner with large device manufacturers to joint venture the development of the technologies. In
this scenario, the small device company sets up a joint venture holding company and then transfers ownership of its technology to
the new company. The larger device manufacturer will then purchase a significant equity stake in the new company, leaving the
smaller company with a minority equity position. The original researchers and investors are able to cash out; however, they also
have the benefits of a continuing equity stake in a venture that now has more resources to commercialize the technology that
underlies the joint venture.
If a medical device company does decide to sell, it can expect to receive an initial purchase price for the company (which may be
payable in cash or in the stock of the acquirer, or both). If the researchers who were part of the venture are expected to continue to assist
with the roll-out of the product, it also is common for the sale agreement to pay a portion of the overall purchase price in the form of
“earn-out payments.” Earn-out payments are made based on a sliding scale, rewarding the seller for meeting agreed upon performance
or sale benchmarks, and penalizing the seller for failing to meet these targets. If there are additional regulatory or business hurdles that
must be overcome before a product can be taken to market, the sale agreement may defer a portion (in some cases, a significant portion)
of the purchase price until these approvals are obtained. These “milestone payments” pay out an increasing portion of the purchase price
each time one of the milestones is reached and the company comes closer to a marketable product.
THE PATH LESS TRAVELED
The small percentage of companies that do decide to go it alone fall into two categories: specialty companies and platform
companies. Specialty companies tend to have a limited product portfolio or a broader portfolio with limited application.
Specialty companies typically outlicense their technologies and products to other companies (platform companies, large device
companies, etc.). The revenues of a specialty company are in large part derived from the license fees it receives for its
technologies. A new trend among these companies is to securitize the revenue streams derived from their license fees, thereby
allowing them to realize current value for technologies that are designed to pay off over time. Because the specialty company has
no need to mass-market a product publicly, its operating costs are also lower than a platform company’s costs.
Platform companies have a broader product portfolio with greater marketing potential. Platform companies that seek to fully
commercialize a product all have one thing in common. They need to raise capital—a lot of capital.14 Although there are private
equity companies that specialize in mature device ventures and that have the resources to take a platform company’s products to
market, this capital is relatively scarce. If the venture has developed a revenue stream or has a product with obvious mass appeal,
it can go public. The initial public offering or “IPO” is the most common way to go public. In the IPO, an investment banking
firm underwrites a syndication of the company’s securities in the public markets. The IPO gives the company an immediate
source of capital and also allows the company the ability to make strategic acquisitions using its own stock as currency. Still,
device IPO prices have deflated in recent years, and many have raised less capital than anticipated.15 The cost of an IPO also is
very high, and once the company has gone public, its costs of operation also will increase.
A second way of going public is to engage in a reverse merger. In a reverse merger, the device company is merged into a
previously formed, public “shell” company. The owners of the shell company retain between 5 and 20 percent of the equity
interests of the merged entity. In some cases, multiple device companies with complementary technologies can be merged into
the same shell, thereby creating a larger and potentially more marketable public company. Although the cost of engaging in a
reverse merger is generally lower than in an IPO, there may be less of a market for the company’s stock, and therefore, the stock
will not be as liquid as it would be if the company had gone through an IPO.
The Pot of Gold at the End of the Rainbow
In 2005, 16 percent of the U.S. economy was spent on health care.16 In a decade, the percentage is expected to grow to 20
percent.17 By 2015, the nation’s total health care bill will rise to more than $4 trillion.18 The annual budget for the National
Institutes of Health, a major source of federal research grants, has doubled over the last five years.19 The baby boomers are aging,
and science is progressing at a whirlwind rate. The prospects for device ventures have never been better. Those who can pilot a
device venture through the stages of its life will continue to have unprecedented opportunities to contribute to the advancement of
the life sciences while monetizing medical device research.
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About the Author
John Callahan is a partner in the law firm of McDermott Will & Emery LLP based in the Firm’s Chicago office. As a member of
the Health Department, John’s practice focuses on mergers and acquisitions, outsourcing transactions, complex contracts and
corporate governance.
John has developed a national reputation for representing medical device companies, life sciences companies, private equity
firms, technology companies, and other health care entities in the acquisition and divestiture of businesses and business lines. His
unique focus on both corporate law and on health regulatory law has given him an unusual and important knowledge that is
critical to the successful negotiation of medical device transactions. In his capacity as deal counsel, John has handled some of the
most high-profile capital markets transactions within the health sector to date, as well as a variety of smaller transactions designed
to address the strategic needs of venture-stage entities. John can be reached at 312.984.7553 or [email protected].
i
Fantastic Voyage, Ray Kurzweil and Terry Grossman, M.D. (Holtzbrinck 2004), at 3.
Report of an Invitational Conference Organized by the Association of American Medical Colleges and the Food and Drug Administration
Center for Drug Development Science at the University of California, San Francisco, January 13-14, 2004.
iii
Thomas L. Friedman, The World is Flat: A Brief History of the 21st Century
iv
The Bayh-Dole Act , U.S. Code, Title 35, Section II, Chapter 18, §201, et. seq.
v
Report of an Invitational Conference Organized by the Association of American Medical Colleges and the Food and Drug Administration
Center for Drug Development Science at the University of California, San Francisco, January 13-14, 2004.
vi
The percentage of overall private investment dollars that fund start-up companies is relatively small. See, e.g.,, James, Carol: Making Life
Sciences Companies Go and Grow: Time, Money and Community Support Critical Success (reprinted with the permission of the National
Business Incubation Association at www.biostart.org/news/grow.html), where it is was estimated that only 6 percent of the venture capital funds
in the states like Ohio are invested in seed-stage companies.
vii
The prejudice for certain research institutions is grounded as much on financial footing as it is on the intangible prestige associated with
developing a device that emerged from a pre-eminent institution. The more respected the institution, the more likely it was to have received
federal funding for the pre-clinical development of the device. The more money that has gone into pre-clinical development, the less money that
will need to be spent by the venture-stage company on additional research and development.
viii
As discussed below, the space, equipment and services provided by a tax-exempt research institution must be compensated by a venture-stage
company at fair market value.
ix
Private investment in incubators waned when the dot com crash occurred, in part because investors viewed the dot com incubator failures as a
warning against investment in these types of entities in the all industries (including the life sciences industry). Given the marked difference
between life sciences incubators and incubators in other industries, however, private equity investment in these entities is now reemerging.
10
42 C.F.R., Parts 50 and 93.
11
See, e.g., 21 C.F.R. 54.1, et. seq.
12
45 C.F.R. Parts 160 and 164.
13
“Twenty-five Years of Biotech Trends,” Genetic Engineering News (October 14, 2005).
14
Steven Holtzman, CEO of Infinity Pharmaceuticals, estimated the cost at between $250-350 million in his presentation Biotech is Dead, Long
Live Biotech at the 2002 Atlas Ventures Life Sciences Conference in Cannes.
15
[CITE]
16
U.S. Health costs on Unyielding Rise, Associated Press, Washington (February 22, 2006).
17
Id.
18
Id.
19
See supra, note 5, at p.1.
ii
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