Investors Talk Technology, People and Funding Fundamentals

At a recent BioEnterprise event, a panel of members from four private equity firms discussed trends in funding, all related to themes we’ve heard repeatedly in the orthopaedic industry: value, outcomes data and cost pressures, and the effects of those trends on investor decisions.

During the presentation, Private Equity Roundtable: Emerging Trends in Biomedical Growth Capital, panelists agreed that there is a high availability of growth capital seeking a home, but the post-ACA environment continues to leave investors with questions on how those companies are creating value for hospitals, ensuring that technologies will be reimbursed and improving outcomes.

This led to discussion on the attractiveness of the healthcare IT market, and the opportunities to utilize technology to generate better outcomes and patient satisfaction. The topic matches the message we heard from the investment community at the Musculoskeletal New Ventures Conference in 2014 and at AdvaMed in 2015, and has been borne out in the product launches we’ve reported in the last 18 months. Many of the orthopaedic device companies with revenue over $300 million are complementing their traditional product portfolios, especially in joint replacement and spine, with diagnostics, navigation, computer-assisted and post-surgical tracking tools. These portfolio enhancements are coming via internal development or partnerships with small, specialized companies. Investors believe that there is room for orthopaedic and non-medical players of all sizes to focus on these technologies.

“Healthcare is unpenetrated from a technology standpoint,” said Chris Adams, Partner at Francisco Partners, a technology-focused private equity firm.

After the BioEnterprise panel, I spoke with Mark Tomaino, Senior Industry Executive at Welsh, Carson, Anderson & Stowe, a private equity firm that invested in K2M. Tomaino is a board member of ViiMed, a telemedicine platform that allows orthopaedic surgeons to follow up with patients remotely after surgery. He noted that technologies such as this can improve patient satisfaction and address rising costs in the healthcare system.

“[It will] enable orthopaedic practices to be more efficient because [surgeons] can do a follow-up message and deliver it to the patient at home,” he said. “When convenient for them, the patient can listen to it. If the doctor is looking for the patient to show range of movement, they have the ability to video that and send it back to the doctor. Effectively, it’s a workflow automation tool that significantly increases administrative efficiency. More importantly, it creates greater scale, so it will help reduce costs.”

The web-based platform just secured Series A financing and is beginning to acquire clients—Hospital for Special Surgery is one, according to Tomaino.

I also spoke with William Trainor, co-founder of Mutual Capital Partners, a venture capital fund; he too mentioned room for technology that is intended to enhance surgeon performance, as well as improve outcomes. His company has invested in OrthAlign, a manufacturer of alignment technology for total hip and knee arthroplasty, and in OrthoHelix, which was purchased by Tornier in 2012.

“OrthAlign’s handheld navigation tool is an example of something that can improve the procedure by helping surgeons control alignment, and it’s not too bulky or expensive,” he said. “The implants are established, so whether it’s the knee or the hip, you can put it in and the implant is going to work. In knee, if the implants are all the same, how do you ensure the best patient outcomes? If your knee is $5,000 and [a competing] knee is $4,500, but your knee is bundled with an alignment tool, you win.”

Another trend discussed at BioEnterprise focused on R&D initiatives and innovation within medical device companies. The panel agreed that big medical device companies are strategically acquiring or partnering with startups that have new technologies as a more cost-effective approach to growth.

“R&D within medical device companies is unproductive; it’s more cost-effective to buy large technologies,” said Guido Neels, Operating Partner at Essex Woodlands, an equity and venture capital firm that invested in Bioventus and United Orthopedic Group.

Neels also stated that “the orthopaedic industry has been great at commercialization but poor at innovation.”

The reality is that of the nearly 20 funding announcements that ORTHOWORLD reported during 1H16, a handful were backed by orthopaedic device or distribution companies. The remainder of the funding mainly arose from venture capital and government sources. It’s important to note continuance of a trend in recent years in which funding is achieved by more established companies with products that have passed through the regulatory phase.

Also, funding announcements reported in 1H16 were to support the commercialization of already-cleared products, as well as the development of traditional orthopaedic products and not healthcare IT solutions. This isn’t to say that funding for IT healthcare isn’t out there or that those investments aren’t being made. But by ORTHOWORLD’s reporting, traditional orthopaedic companies are not receiving this funding. (A list of 1H16 funding can be found here, and 1H16 M&A can be found here.)

For companies in search of funding, the panelists further emphasized the importance of having a good management team and alignment both within companies and in the relationships between investors and companies.

As William Trainor explained, “You have to have a shared vision. Putting money in just to put money in without an idea of where you want to take the business isn’t going to get you far. If the entrepreneur, the board and the investors’ exit expectations aren’t all aligned, the entrepreneur could be perfectly happy with a $10 million exit or could want a $1 billion exit. The investors could be perfectly happy with a $100 million exit, or a $500 million exit, or a $50 million exit. The board is usually somewhere in between. If the entrepreneur in particular isn’t seeing the exit scenario, that can lead to disaster.”

The recipe for success, according to Trainor, is good people, good technology and good overall market opportunity.

“We see a lot of great technology in the orthopaedic space, but not a lot of things that are great technologies with great people that are financeable opportunities,” he said. “They want a future valuation today even though they haven’t done the necessary clinical work. They may have an FDA 510(k) clearance, but it doesn’t mean that they’ve been able to prove efficacy, or they’re piggybacking off of the CMS code, you name it. They want what’s theoretically going to happen in the future, today, and that makes it very challenging to invest. You have to hunker down and work with your champions and collect data. Data is everything.”

Tomaino agrees, and called out addressable market size, specifically.

“Every dollar of capital that goes on the balance sheet needs to at least earn a certain return, so when you investigate whether the public markets or even the private markets will value a business, these key metrics will be scrutinized: revenue growth, margin and capital,” he said. “Ultimately, it’s going to be a function of  the size of that addressable market. Then you can project future performance of the business. At the end of the day, when you value your business, you’re valuing a stream of cash flow. The further out in the future that the cash is generated, the smaller the value is going to be. The greater the stream of cash flow, the higher the business.”

For start-up companies, Trainor warned about the dangers of mismanaging investments at the very early stages. He sees a lot of start-ups that raise money at valuations that are too high.

“They raise money at 25x revenue and think that they’re going to be self-funding at that point, and they’re just not,” he said. “If you raise a couple million in angel money at that level, all you’ve done is set yourself up to fail.”