While building a Canadian medtech company is tough these days, there are Canadian medtech success stories such as Novadaq and Cryocath. Novadaq, a past BDC Healthcare investment, which was 13 years in the making and recently passed the $1 billion market cap. Another example is Cryocath which sold to Medtronic for over $370 million 14 years after the first institutional round and well over $125 million of total invested capital. There are also a number of promising Canadian medtech stories such Monteris Medical and Profound Medical, both BDC Healthcare investments. These two companies are commercializing the next generation of image guided minimally invasive procedures for the treatment of various cancers. While there is always great excitement with every “start-up” and “exit”, we typically hear little of what happens in between and, in many cases, have little visibility into how much capital and time it takes to go from start-up to exit. What does it take, in terms of time and capital, to turn the “start-up” with all its promises into a company worth well-over $250 million? In particular, our interest is in medical device companies with an innovative durable medical equipment component to their business model. Do these medtech companies require more capital and time to reach an exit compared to other medical device companies and do they represent good investment opportunities?
To answer these questions, we selected companies using the following criteria:
(1) Product was a therapeutic, diagnostic or monitoring medical device,
(2) Product was considered innovative and had an impact on clinical outcomes or productivity,
(3) Product and revenue model had a durable medical equipment component,
(4) Exit valuation or market capitalization 2 years post IPO was in excess of $250M, and
(5) Target market was the acute care hospital market and required a capex decision on part of the buyer.
Our analysis captured years to exit, lifetime capital, exit valuation, return, regulatory pathway, and number of patients enrolled in clinical trials. We used Capital IQ and public information as a data source. For those companies that went public and remained public, we pegged exit valuation at the market cap two-year post IPO, the time when most venture investors should be free from any trading restrictions and would be expected to exit their position.
Our market search turned up 33 companies meeting our criteria which were divided into three groups.
Group 1 consisted of 12 companies that were acquired prior to listing on a stock exchange. The average exit valuation for this group was $352 million on $76 million of invested capital invested over a 9 year period. For the most part, the amount of invested capital ranged from a low of $50 million to a high of $136 million. One outlier raised only $20 million and provided investors an exit value of $250 million and nice return of 12X on invested capital. That was the exception to the rule. Very few companies made it to a meaningful exit without first raising >$70 million which seemed to be the amount required to prove out this type of business model and product.
Group 2 consisted of 10 companies that went public prior to being acquired. While the average exit valuation was slightly better than Group 1, the total invested capital was significantly higher. On average, these companies raised $112 million prior to being acquired 11 years after the initial institutional round of financing at an average exit value of $365 million. This is to be expected given that access to capital in the public market is better than the private or venture capital markets.
Group 3 consisted of 11 companies that went public but were not acquired at the time of the study completed in August of 2013. We locked in the market cap 2 to 3 years post IPO, around the time most venture capital investors would be free to sell their shares. We picked the most optimal market capitalization in the 2 to 3 years post IPO (maybe it skewed the return numbers to our favour but hey we all know VCs only sell at the top of market anyways). As with Group 2, this group also raised significant amounts of capital post IPO (on average these companies raised $49 million post IPO), which also skewed the IRR as most of the capital was raised in the 2 to 3 years prior to us picking an “exit” valuation.
What did the analysis of these 33 companies tell us?
(1) On average, it takes + 8 years from the first institutional investment and +$75 million (not including non-dilutive sources) to build a medtech company with a durable medical equipment component to the business model to the point of an exit in excess of $250 million. This is not to say that medtech companies with a similar business model can’t have a lower exit valuation, a quicker time exit and still provide a good return for their investors; we just didn’t review that part of the market with this study. It was clear that all exits in excess of $250 million required significant capital with very few exceptions to the rule. There were no companies in this group with a time to exit under 5 years.
(2) All the companies had exits greater than $250 million and it should be no surprise that all 33 companies generated a positive ROC with an average return of 3X to 4X for the entire group. Only three companies generated a ROC of >10. One third of the companies provided a low IRR of less than 20%. Overall, the majority of these investments provide a reasonable return to their investors.
(3) In general, these companies required more capital and time to reach an exit than medtech companies with different business models (i.e. no durable capital equipment component). The added component of making a capex sale into the hospital market appears to require more resources and time to reach commercialization.
(4) Over 90% of the companies in the analysis followed the 510k regulatory path. Very few were required to go down the FDA PMA regulatory path at that time but that was yesterday and not so likely in the current environment.
(5) Even with a 510(k) regulatory pathway, almost all companies still recruited over 300 patients in various clinical trials prior to an exit. The target market is data driven. Clinical evidence was essential in not only demonstrating safety to the regulators but, more critical, to proving the business model and gaining adoption and utilization with customers. Achieving regulatory approval was the starting point for the long path of driving customer adoption.
(6) Product revenue or some demonstration of customer traction was necessary, profitability appeared to be absent and sales multiples were irrelevant as they ranged from anywhere between low single digits to over 100X. Not surprising some had no sales at the time of exit, meaning sales trajectories, market validation, market size and pipeline quality were of greater importance.
Overall, we can conclude that medtech companies with a durable capital equipment component focused business model require more capital and time to reach a meaningful exit as compared to other medtech business models. Fortunately, the sector also provides an appropriate return to those investors willing to dedicate the capital and time. While we are seeing very capital efficient models emerge in the IT and pharma sectors, we have yet to see this trend carry over to the medtech sector with any meaningful success. With the current regulatory, reimbursement and focus with value-based decision making in the acute care hospital market, it is likely that the medtech will continue to require a high level of capital and time to reach a material exit valuation. It will be imperative that the Canadian medtech sector find ways to accelerate commercialization in order for it to remain a viable and continue to generate more Canadian success stories. How best to achieve this goal is the topic of a future blog.
(2) Special thanks to Haitao You for assisting in the analysis.