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Squadron Invests in Success of OEMs and Suppliers

In recognizing that small orthopaedic companies—not just startups—face funding constraints, Squadron Capital launched a firm focused on debt financing implants and instrument sets.

If one instrument set costs upward of $150,000 to produce, how can small companies afford to put ten sets in rotation to gain market share? This question continued to arise from David Pelizzon’s customers. Pelizzon is President of Squadron Capital, parent company to suppliers FMI Hansa and Structure Medical, as well as Squadron Medical Finance Solutions, which was founded in 2012 to answer that financial question for device companies.

Squadron Medical provides device companies with debt financing at an interest rate north of ten percent. The interest rate is lower if the company agrees to use Squadron’s suppliers. The advantage of this business model is that companies don’t hand over equity, and are introduced to supplier partners who specifically understand the challenges of orthopaedic device and instrument manufacturing.

Since 2012, Squadron Medical has provided four device companies with financing in amounts ranging from $250,000 to $30 million. One loan allowed a struggling foot and ankle company to move from 7 years of losses to profitability and then position itself to be acquired by a mid-tier player. A second investment allowed the only pediatric orthopaedic company to expand its product offering, develop an international business, and accelerate its growth rate. The company is preparing for a 2016 IPO.

Squadron Medical’s loan interest lies in companies that have achieved revenue of $5 million to $100 million.

How does Squadron Medical spot investment opportunities? What unique perspective does Pelizzon have from working on both the OEM and supplier sides of the industry? We asked him. Pelizzon retired from 30 years of active duty in the U.S. Army, then worked as Managing Director of Precision Edge Holdings and Colson Associates before starting Squadron Capital in 2008. He is an ORTHOWORLD® Member.

ORTHOKNOW: How do you spot opportunities?

Pelizzon: I look for four things. A company needs to have a great idea or a niche idea. What do they do that’s different from everybody else? They need to have good leadership and good management. They need to be well-capitalized, and they need to have good suppliers. They need a check in all four of those boxes.

If they have everything checked but the financing and manufacturing, we can support them with that—we can paint the picture whole. I think that we’re the only people who can provide capital in the form of debt and have a relationship with contract manufacturers. It’s a powerful mix.

ORTHOKNOW: Where do you see the greatest opportunity in the orthopaedic industry?

Pelizzon: Implant technology is really quite comparable among all of the manufacturers. I think folks that are providing individual sterile packages, even if the products are similar to each other, the delivery and the service is an opportunity. With sterile packs, reps take out what they need and then instruments are disposed. I believe that is going to transform how we do business.

ORTHOKNOW: You finance instrument sets. How will that impact your business model if more companies adopt sterile packaged instruments?

Pelizzon: Our contract manufacturing will have to think about getting involved in packaging, more so than we are now. Also, in terms of the financing business, I don’t think it will have any impact. I think it will make us more attractive.

ORTHOKNOW: How does the ability to work on both sides of the industry—with OEMs and suppliers—help you in making decisions?

Pelizzon: First of all, our contract manufacturers have rigid confidentiality standards; we don’t share what goes on between customers. I do see both sides. I sit on boards for several OEMs.

On one side I see OEMs pushing for reduction of cost. On the other side, I see the contract manufacturer struggle with pricing pressure. Also the increased cost of finding employees; we have escalating healthcare costs.

It’s helpful in understanding what is doable and not doable. For the OEM companies on whose boards I sit, I tell them that you’re going to create a race to the bottom with your suppliers. A good supplier isn’t going to stay with a customer like that.

ORTHOKNOW: In saying that, what has surprised you about the orthopaedic industry?

Pelizzon: I was surprised that for the most part it’s a purchase-order world. There’s little contracting. I think contracts would be great, because they would help the suppliers schedule manufacturing more efficiently. At the same time, it would force the customers to order more efficiently.

It’s incredible to me that I see purchasing practices appear to be more in line with the individual buyers—it may benefit the buyer, but it doesn’t ultimately benefit their company.

For example, I’ve approached customers and said, ‘You bought the same pair of clamps for X years, but you put in orders that are inefficient order sizes.’ Instead of ordering 25 at a time, they’ll piecemeal these orders. We would serve them better if we had a contractual relationship and knew that they would buy a certain quantity. Some of the buying practices are really inefficient.

ORTHOKNOW: How do you recommend that OEMs overcome these purchasing inefficiencies?

Pelizzon: Get out of this mindset that purchase orders are a good way to go. OEMs need to make sure that the way they incentivize their people is aligned with the financial objectives of the company. It seems ridiculous that they’re trying to cut costs, but they order sporadically.

ORTHKNOW: What is the greatest barrier to success in the orthopaedic industry today?

Pelizzon: For the smaller companies, it’s lack of capital. A lot of great ideas never make it because of capital constraints and the increasing cost of getting product to market.

The world is more complex than it was ten, even five years ago.