Soapbox

4 Red Flags Investors Look For When Vetting Your Medical Device Company

By Nick Tippmann
November 22, 2021


• Categories: 02-MedTech Economics, 04-Product Design & Development, 05-Quality/Regulatory, Soapbox

Raising capital for your medical device can be intimidating. If it’s your first time going through this process, you may be wondering if your inexperience will hurt your chances of receiving an investment. If this is a concern of yours, you’re not alone. That’s why we sat down with four investors to learn what red flags they look out for when deciding who to invest in.

Red Flag #1: You don’t understand the complexity of the path ahead

James Eadie, managing director at Santé Ventures, says he always comes back to one question: “Do you understand, realistically, the milestones and value-creation episodes that are in front of you and how you’ll reach those? If you’re a preclinical stage company and pointing towards FDA approval, that’s going to require significant clinical studies. What are the interim steps before you? Five years and $40 million down the road, what steps will help prove the technology?”

“It’s imperative to engage with the medical device startup community, singling out entrepreneurs who have gone through the same process,” says John Kim, managing director at Aphelion Capital. “Startups need to understand what are the pitfalls and other unexpected hazards down the road that they haven’t planned for?”

Caitriona Kelleher, fund manager for the SOSV Ireland Fund, agrees. She says she often meets with companies that need help imagining how complex the path will be. To address the issue, Kelleher says she counsels startups to follow the journeys others in adjacent spaces have followed: Which firm(s) invested in the first round? How many rounds have they done? How have they raised capital? At what point in their journey did they raise capital? Kelleher says her firm helps portfolio companies unpack these details, “You’re trying to reverse engineer the process and get them thinking about concepts such as ‘Why do you think X company invested in that startup at that stage?’”

Red Flag #2: You don’t think like an investor so you’re not realistic about the investment opportunity

Eadie says startups need to inhabit the minds of potential investors to understand their biggest concerns. The most common shortcomings he sees is “a lack of understanding about the market that you’re entering and not being realistic about what the likely exit opportunity will be.” He goes on to explain, “Recently, the public markets have welcomed really innovative medical device technology, which is wonderful. I hope that that will remain. But the vast majority of medical device technology is, and the entrepreneurs are focused on a M&A exit.”

With that in mind, startups must understand what’s going to drive an M&A, says Eadie; what kind of data collection will be required, who the buyers will be, and what comps indicate? “When you’re speaking to the investors,” he says. “They will absolutely understand all of these things and have an opinion about them.”

Eadie advises that startups also be clear-headed about what will motivate an investor to buy-in. Startups should “suspend disbelief” and imagine their product works in a best-case scenario. How will competitors and late-stage investors view the product?

Red Flag #3: You lack an in-depth understanding about regulatory pathways

“One of the two big due diligence questions will be in and around, ‘What’s your regulatory pathway?’” says Kelleher. “Is there a way to expedite that? Are you being too optimistic? People who are in the space know a lot more about the space, and so the startups need to show that they’ve tried to educate themselves and learn from the people who they’re interacting with.”

Kyle “Skip” Boudreaux, managing director at Acadian Capital Ventures, agrees, “You might have an engineer or a doctor who developed the product, but if they don’t understand the regulatory process and how grueling it can be… It’s going to be very difficult.”

The best route for founders who lack this knowledge is to bring in experts who have that specific skill set and can shepherd the process.

“Vetting these experts is critical,” says Kwame Ulmer, principal and Ulmer Ventures. “Our industry at this stage is highly referral-based, and there’s good and bad that comes along with that. Some companies don’t know what ‘excellent’ looks like, so they’ll accept good.”

Red Flag #4: You leave too little runway

“A lot of times startups don’t leave enough time,” says John Kim. “They think that the process is going to be relatively quick. Depending on the market, sometimes these processes can drag on for months — including trying to get the term sheet signed and then finding the right syndicate. And [startups] don’t leave enough runway to process all this.”

Kim tells his startups to think about fundraising and start the process earlier than anticipated to leave room to maneuver. “Otherwise the process may drag out, you may be running out of capital, and then you’ll be taking valuations that may not be to your liking,” explains Kim.

Kim also points out that a short runway can corner entrepreneurs into accepting sub-optimal terms. “Without adequate runway, they trap themselves,” says Kim. A well-prepared founder/CEO will analyze and review all of this well before they are ready to make a deal.

Being aware of these pitfalls can make a big difference when it comes to time and money related to your medical device. The common mistakes and misunderstandings founders make as they try to attract investors can be a challenge to navigate through.