Demystifying medical technology venture funding : Kapil Khandelwal, EquNev Capital,


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Kapil Khandelwal
EquNev Capital

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Demystifying medical technology venture funding : Kapil Khandelwal, EquNev Capital,

  1. 1. Vol. 4 No.3 March - April 2011 <125/Annual Subscription <750 Me~irnl Equipment AutomationIndia's Premium magazine on the diagnostic, medical equipment industry and technology Product Watch Medical Imaging Taps New Levels of Graphics Display and Processing Technologies Sonography: A Blessing or a Curse Demystifying Medical Technology Venture Funding: Strategy and Options for the Entrepreneurs Scientech Medicare's Caddo 11B- Porlable Ultrasound Machine In Product News >Schiller India launches MEOILOG HOLTER RANGE with Advanced Oetection Modes >FONT: Fiber Optic Neonatal Transilluminator MAGLUMI: ChemiLuminescence Immunoassay AnalYler
  2. 2. 76 Mar-Apr 2011 Medical Equipment & Automation Funding Strategy My earlier article titled “Medical Devices Innovation – Funding, Partnering and Consolidation Activity in India” published in the May-June 2010 issue of this magazine evoked many responses from budding entrepreneurs, promoters and technologists in the health sciences and biomedical and many aligned sectors. I, Kapil Khandelwal would like to thank the readers for reaching out to me and providing me with some frank and candid feedback on some of their issues which they have been facing in scaling their ventures. The medical technology industry in India will reach around 30,000 crores by 2015. Demystifying Medical Technology Venture Funding: Strategy and 0ptions for the Entrepreneurs Demystifying Medical Technology Venture Funding_modi.indd 76Demystifying Medical Technology Venture Funding_modi.indd 76 5/4/2011 5:37:41 PM5/4/2011 5:37:41 PM
  3. 3. Funding Strategy 77Medical Equipment & Automation Mar-Apr 2011 C urrently, a large majority of innovation in medical technology in India is very low end disruptive innovation. However, as the industry in India grows and matures, the high- end innovation and disruptive innovations in medical technology will follow. To succeed, funding becomesonecriticalsuccessfactor. I, estimate that for the industry to succeed and grow, funding to the tune of Rs 100,000 crores will be required by the industry to reach a critical mass and scale. The four main purposes for which funding may be required are generally in medical technology ventures: • To start and grow a new venture; • To develop/takeover an existing venture/medical technology intellectual property (IP) developed; • To change the shareholding structure of an existing venture or buy back equity stake; and • To rescue a venture. There are different types of funding mechanisms available to the promoters (see diagram below). The next few sections of the article address some of the issues around funding strategy for the promoters. What makes a disruptive innovation in medical technology fundable? Information technology and medical technology start ups have something in common. They often begin the same way - with a great idea and venture bootstrap funding. Innovation in medical technologies has been growing in our country. Having reviewed business plans in the medical technology space practically every week and provided my preliminary advice on what works and what does not with Venture Capitalists (VCs), Private Equity (PEs) and other investors is demonstrating the financial and clinical impact on our health care system. Besides, solutions that have demonstrated ability to reduce overall costs of our health care system and improve quality of life and outcomes is preferred. Medical technologies venture funding comes at a time after the business model and regulatory risks have largely been eliminated. However, I suggest an initial approach that centers on how the medical technology fits with the fundamental economic drivers of our health care system. If the disruptive innovation passes one or more of the questions below, then it has passed the acid test that would be fundable as a venture: • First, does the product improve clinical quality-or at least deliver equivalent outcomes in a less costly and better way? • Second, does the product more than offset its cost through reduced overall health care expense to the system, such as reducing costly side effects or replacing or eliminating other expensive procedures? • Third, does the product offer clinical and/or financial advantages for patients, insurance, and providers alike? Some examples of Indian companies that have demonstrated successful innovation are given herein. What is the Mantra for Putting the Right Funding Proposal? Every entrepreneur’s dilemma is getting the business model right and articulating it properly in the funding proposal or the information memorandum (IM). Having defined the value proposition correctly as outlined above, the corresponding delivery proposition and the financial proposition has to be spelt out clearly. These would become the inputs to putting the formal funding proposal that clearly articulates the purpose of seeking the funding (Money), clarity in describing the opportunity we are addressing through the medical technology (Markets) and the ability of the team to ensure the results (Management). I call them the 3Ms. Markets How large is the market for the medical technology, and how compelling is the need? How fast will the market grow? Generally, potential market size must be at Company Product Key Drivers MediVed Pacemakers Reduced healthcare expense: Pacemakers cost is Rs. 20,000 to 25,000 below the comparable pacemakers produced by international companies. Bigtec Labs MicroPCR Improve clinical outcomes: A bed-side miniaturised, no-frills and portable version of the bulky PCR (polymerase chain reaction) machine where the samples have to be sent for testing Reduced healthcare capex: Costs Rs. 1 lakh compared to a conventional PCR’s price tag of Rs. 15 lakh. Perfint Healthcare PIGA-CT Improve clinical outcomes: Uses robotics to make image- guided, soft-tissue biopsies simpler, safer and more accurate Reduced healthcare capex: At Rs. 15 lakh a machine, it is less expensive than other imported alternatives - such as fluoroscopes - which are double the cost. Skanray X-ray imaging systems Improve clinical outcomes: High-frequency digital X-rays with radiation leakage control. Reduced healthcare capex: Cost is a fraction of the imported equipment. Demystifying Medical Technology Venture Funding_modi.indd 77Demystifying Medical Technology Venture Funding_modi.indd 77 5/4/2011 5:37:45 PM5/4/2011 5:37:45 PM
  4. 4. 78 Mar-Apr 2011 Medical Equipment & Automation Funding Strategy least Rs 350 to Rs 500 crores per year at least - to justify the returns investors are seeking. Do many competitors with similar products or solutions already exist? Can the start-up be clearly differentiated? Does the start-up have an effective distribution strategy for its targeted customer group? Management What is the experience and track record of key management team members? Because it reduces risk, investors are especially attracted to ateamthathasindividualswhohave already “been there and done that” successfully in their specific roles at a previous company. Is the team complete? Early-stage companies needn’t have all positions filled, but VCs, PEs or angel investors like to see that the company can recruit strong candidates as the business progresses. Investors are especially interested in entrepreneurs who have a special advantage in a particular market sector because of their skill set or experience. Money How does the company plan to make money? Is the pricing and reimbursement strategy realistic? Are the margins high enough to support the research and development, clinical trials, and distribution costs associated with the device industry and still make an attractive return within an intermediate time frame? How will the company manufacture and distribute the product and support customers? How will the start-up compete with companies that have more resources? Stacking up this means that the venture has the potential to grow @ 25% CAGR per annum – meaning it can double in size at a minimum every 5 years. This level of potential is required in the funding proposal (IM) or the business plan that must be targeted at the minimum. Anything less would mean the money is sub-optimally invested if the business plan is not achieved. When to Raise money and from Whom? This is a billion dollar question. The promoters must determine how much money to raise, and when to raise it. Promoters typically start out raising a small amount of money to prove the feasibility of the product idea, and then raise more over time. How much money to raise and when to raise it, is an issue that needs to be mapped to major milestones over the life of the venture. What Strategies to Follow at what stage of Funding? Just as each stage in the business life cycle of the medical technology venture brings about different issues and opportunities and hence each stage is unique from the other in terms of risks, problems, rewards and outcomes that accompany it. The strategies that can be followed need to be carefully considered by the promoters before seeking the funding from different funding sources. The effect on the business cannot be considered in isolation but has also to be viewed in the light of the changes that will occur as a consequence of the funding. The above mentioned table summarizes the strategies for funding at different stages. VCs and PE Funding: A Few Caveats VCs and PEs may be positive about the venture. However, the structure of the investment must fit their fund profile. VCs and PEs have specific criteria for their investments: some invest mostly at the early stage of a company’s life, whereas others specialize in later- stage investing. Additional criteria can include the following: • The type of product-whether the focus is devices, biopharma, diagnostics, etc; • The amount of equity diluted; • The “premoney” valuation of the company; • The stage of company development-initial invention, working prototype, animal and human clinical trials, market launch, and ultimately, growth equity. • The projected timing of the company’s eventual liquidity and other financial issues. How does VCs and PEs Funding Process Work out? The typical process followed by VCs and PEs which are active in the medical technology space is set out below: • Determination by the potential promoters that cash is required in the venture for growth, buy back existing investors, or buying out IP, etc. • Preparation of business plan Money In a Box: Sources of Money 1 Your own money 2 Grants and soft loans 3 Revenue from the business 4 A mentor 5 A friend 6 Bankers 7 Revenue with the enticement of future equity 8 Business angels 9 VCs/PEs 10 Money lenders Demystifying Medical Technology Venture Funding_modi.indd 78Demystifying Medical Technology Venture Funding_modi.indd 78 5/4/2011 5:37:45 PM5/4/2011 5:37:45 PM
  5. 5. Funding Strategy 79Medical Equipment & Automation Mar-Apr 2011 and funding proposal (IM). • Initial presentation to the VC or PE firms. • Preliminary analysis by VCs/ PEs followed by meetings & visits and Preliminary offer letter (term sheet). • Discussions of the terms by the promoters and their consultants. • Acceptance of the indicative offer given by VCs or PEs. • Due diligence by the VCs and PEs team and their advisors. • Study of results of due diligence and indicative offer confirmed or modified term sheet. • Investment committee proposal by the VCs or PEs and indicative terms approved, modified or rejected. • Issue of full offer letter (subject to legal stages) by the investee. • Legal stages are, first meeting betweentheVCsorPEsandtheir lawyers to draft shareholders and legal agreements, then meetings between the venture and their lawyers to consider its reply and finally a series of meetings between what is offered and what will be accepted and agreed. • Signing and completion of the contracts between the VCs or PEs, their lawyers and the promoters and their lawyers. • New investor joins the company and their board (in most cases). • New governance processes. To Appoint or Not to appoint Professional advisors I always recommend that promoters appoint professional advisors for their technical inputs in preparing the business plan and the funding proposal that you would like to present to the VCs and PEs. However, it is prudent to restrict their scope of work. Outside lawyers and accountants have their contribution in the funding process, however they should be employed at the right time. Some considerations are: • Costs burden will increase on the venture at the start up phase (certainly) • Time taken to complete will extend (probably) • Harmony between the management team will unravel (possibly) It is best to have the professional advisors’ skin in the game to ensure success in aligning the needs of the promoters and the venture. Finally, The Indian medical technology industry is poised for growth and would incubate new venture. Opportunity exists for innovative and committed promoters who wish to start their own venture. Once potential start- ups have developed a compelling business plan, funding proposal, investors would be available for those promoters who follow the right steps to secure funding. As many industry professionals have discussed with me and found, starting and growing a venture is a time consuming and painful process, but it can be tremendously gratifying in both personal satisfaction and financial rewards. Stage Potential Investors Timing Running the Business Post Funding Knowing how to get Out - Potential Exit Seed Stage Own money, Grants and soft loans, loans from friends and family When a firm idea/ concept has been proven Promoter and associates develop the concept Concept fails to meet all the three acid tests mentioned above. IP is patentable and a larger partner is willing to back it up Start Up Stage Own money, incubation funds (universities, governments, etc.), angel investors and VCs Soon after you have protected your IP and filed the patents Building complementary skills through the angels and VCs Dilutions in the next rounds with investors Expansion Stage Own money, PEs, bank debt Prior to going profitable/ cash flow positive Board-level additions, newer management talent to grow the business IPO, stake sale/merger, buy out by promoters Shareholder Change PEs, bank debt, strategic partners Stake acquisition or exit by a set of promoters Consolidation and management of the venture IPO, stake sale/merger, buy out by promoters Kapil Khandelwal, runs his own investment banking and advisory services company, EquNev Capital. He earned recognition as an expert in health sciences, education, agri and information communications and technology (ICT). He serves several company boards and industry advisory committees in these sectors. His expertise positions him as one of the thought leaders in India, Asia Pacific and Emerging Markets. He holds the unique distinction of being among the elite club of Chief Information Security Officers (CISOs) in the early-phase drug discovery in the world. His particular area of focus is investment banking and business advisory and driving business results through mentoring leaders and connecting to people in this region. Kapil Khandelwal Demystifying Medical Technology Venture Funding_modi.indd 79Demystifying Medical Technology Venture Funding_modi.indd 79 5/4/2011 5:37:47 PM5/4/2011 5:37:47 PM