Medical Device Link.

These general trends for VC investment have also been reflected in the healthcare sector. The fourth quarter of 2000 showed VC investment at $1.4 billion in 116 rounds, down from $1.7 billion in 129 rounds in the third quarter. But the total amount invested in healthcare in 2000 was $6.1 billion, up 74% from the $3.5 billion invested in 1999.

According to VentureOne (San Francisco), a leading VC research firm, 60% of all VC investment is in the technology sector, followed by 30% in telecommunications, and 9% in healthcare. Although VC funding is consolidating, the numbers indicate that there is more VC money for healthcare than ever.

How to Score VC Cash

The following discussion therefore offers several guiding principles that medical technology manufacturers can use to better their chances of getting funded by a VC firm.

Stage Valuations Appropriately. One company, having an Internet component, was red-hot in February 2000. The biggest voice on the company's board pushed for a very aggressive premoney valuation for the next round of financing, which was approximately six times the previous round. Today, the company is preparing to accept a decrease from the last round.

The lesson to be learned here is that sectors of investment markets move in and out of favor. Aggressive valuation tactics urged by a company's executives can scare off many appropriate VC coinvestors. In short, given execution to plan, executives should generally be happy with a double or triple valuation for round-to-round markups within a year.

The danger in pricing a subsequent round too high is that, as the investment scenario for the company returns to normal levels, a subsequent round may be a down round, which disappoints investors. While not unforgivable, such a decrease can create a strained relationship with investors.

Seek the Right Size of Financing. Far too often, VCs are met with good deals seeking less than $5 million in financing. The reality is that most top VC firms are at the $100 million­$250 million size. They typically don't wish to place less than $3 million­$5 million per round and nearly always desire the syndication and backup of two to four other VC firms. Doing the math, this puts the optimal round size at a minimum of between $8 million and $12 million.

Negotiate Directly. Another company was represented by an experienced attorney at one of the premier technology law firms who didn't understand valuations for the company's stage of development. The attorney insisted upon an $8 million premoney valuation, which ended up being $1 million after he was out of the picture. Valuable time and money were wasted at the expense of both sides of the proposed transaction.

This lesson often also applies to companies using investment bankers as intermediaries. Typically, these outsiders aren't fully attuned to the set of circumstances surrounding medtech entrepreneurs. Also, there is no substitute for being able to look someone in the eye and hash out the particulars of a deal. If legal clarification seems necessary in this process, then defer to an attorney.

The Scientific Advisory Board. Scientific advisory boards for emerging growth companies, especially in the medical technology industry, are now more important than ever to VCs. Their input is invaluable when it comes to eventual product and services usage among their constituency, and their charismatic public relations attributes can help garner initial orders and fine-tune the product and service offering.

The All-Important CEO. The CEO of a start-up company is responsible for strategic planning, fundraising, building a first-rate management team, lining up strategic partners, instilling a corporate culture, and interacting with the board of directors. Backing the right CEO is therefore of ultimate importance. Since the average start-up goes through 2.1 CEOs in its first five years of operations, the comfort level and time-saving gained by getting the right person from the very beginning are truly invaluable.

For example, one company's CEO was qualified in many ways as an inspirational leader and recruiter. He was also experienced in the company's field of endeavor and successfully raised a first round of several million dollars from top VC firms. But because he had never managed a high-growth-rate operation, he was unable to execute at the speed necessary to satisfy investors.

Another company's CEO had the proper experience. The VCs funding this company were not so quick to question the CEO's management team selections, business-plan updates, or business strategy in general. Thus, far less of the VCs' time, which is an extremely valuable commodity in the investment world, needed to be devoted to the latter company, as compared with the first company.

Why VCs Say No

What is the probability that a VC will agree to fund a deal? Less than 1% of business plans received by VC firms are actually funded. Medical technology entrepreneurs should therefore consider the following when completing their presentation or business plan.

Veracity. VCs, above all else, are not hesitant to walk away from a deal early on. Once an entrepreneur starts making significant omissions and telling half-truths or outright misrepresentations, even to a minor degree, most VCs will walk out on the deal. VCs who are too patient end up wasting far too much time and money.

Single-Product Deals. Many VCs invest only in medical device deals that include something of a platform technology. As early-stage investors, VCs prefer to have a number of options regarding eventual distribution channels, variations on technical outcomes, FDA timelines, and exit strategies.

Take, for example, CardioNet (San Diego), a medical technology company with a wireless solution for real-time cardiac patient monitoring. If CardioNet doesn't meet its expectations for product development, 510(k) approval for its cardiac patient monitors, or reimbursement, its management team can still develop the company's technology for remote monitoring of other disease states—and that makes for a good investment.

Acquisition versus IPO Exit Strategy. The past several years have not been favorable for medtech companies seeking a public-market exit. While some VCs feel that this situation may improve, most agree that acquisition should be the exit strategy of choice for medtech companies. The biggest, most important future acquirers of successful medtech start-ups are likely to be companies such as Medtronic (Minneapolis), Guidant (Indianapolis), and Johnson & Johnson (New Brunswick, NJ).

The lesson is to be receptive to and mindful of how large companies such as these perceive your company's strategy and operating plan. Intellectual-property protection, quality VC backing, and a well-thought-out rationale for valuation are key ingredients for a successful exit. The outcome of successful acquisition by a larger public company may be even more palatable to entrepreneurs and investors than an IPO, as it often comes in the form of a stock exchange rather than an immediately taxable transaction.

How to Approach VCs

Entrepreneurs often express frustration about their ability to make presentations to VCs. The presentation should address the following issues.

• Show why the company and its products are different from and better than those of existing companies and their products.
• Understand the competition and address their strengths and weaknesses.
• Make sure that financial projections are reasonable, documented, and justified.
• Disclose pitfalls and shortcomings of the company as well as strengths.
• Don't make exaggerated claims about the product or company management.

In short, a catchy, well-prepared executive summary is generally what VCs want to see initially. If referred through a source that they know and trust from past experience, it will get special attention. In addition, it is important to take care not to broadly shop your deal. The Internet is a terrific tool for scanning prospective target VC Web sites and to see if the firm you're interested in doing business with has funded deals such as yours in the past. Web sites also offer a look at the caliber of the VC's experience in your field of endeavor.

Daniel C. Wood is cogeneral partner of IngleWood Ventures (San Diego), an early-stage life sciences venture capital fund.