A REV.1 Engineering White Paper
Launching a medical device company has never been easy, and it certainly hasn’t become any easier in recent years. Getting it right, right out of the gate, has never been more important. In this White Paper, we’re going to explore some of the implications, risks and potential fallout of seemingly reasonable delays during the development of a Class II Medical Device. Let’s begin!
With thirty-four years in the industry, the last twenty-two of which being almost exclusively with investor-driven startups, the wheat begins to fall away from the chaff. Over time, truisms begin to emerge - commonalities shared across seemingly disparate startups. One example of this is momentum.
Startups that successfully cross the finish line (meaning a positive exit) come out of the gate fast and never seam to lose momentum. In fact, these successful companies often gain momentum as they move through the formal commercialization process. Others, unfortunately, don’t.
One of the most insipid risks to a startup is drag; often seemingly minor events or management decisions that slow the development of your device. Once introduced, drag has a sneaky way of accumulating. Let’s explore the often veiled, economic impact that emerges from what often seam like indiscriminate, small decisions, long before the planned-for launch.
Early, Iterative Design
There is only one stage in the development process where I recommend taking one’s time. Early in the process of discovery, long before you’re pursuing investors, taking one’s time to explore and refine the device, perhaps to a point of proof of concept, is time well spent. Startups that have taken the time to push their concept into a representative reality, before they seek investors, are often well served. This is the first phase of de-risking your device.
Please don’t mistake this for needing to have a working prototype in hand in order to secure investors. That’s simply not the case. I’ve landed many, many investors long before we had a working prototype in hand and witnessed the same with other startups as well.
This is, however, where devices that emerge out of institutional settings (e.g., teaching hospitals, grant-based research) often have an advantage. The early, bench exploratory work has been done, and done under subsidy I might add. There’s also a bit of cache associated with leading institutions that can put a bit of shine on your device as you’re pitching your prospective investors. Access to facilities, fellow clinicians, and the institution’s guidance and professional network are also significant advantages that can contribute to speed out of the gate. There are, of course, licensing fees and royalty payments associated with institutional technologies, but the early advantages often outweigh these eventual expenses.
A critical factor you can control, and one that can slow down a device coming out of an institutional setting, is the institutional culture accompanying it. While perfect for exploration and discovery, institutional culture is not well suited for a commercial startup. This can be addressed by bringing in leadership team members from industry. In fact, the Stanford Startup Genome project identified that startups with a technical lead (e.g., clinician, research scientist) and a business lead, working together, were much more likely to secure funding and make it to market launch than lone entrepreneurs of either stripe.
Conversely, startups that emerge from the inventor’s proverbial garage, will confront a variety of challenges, early on, that the institutional startup will never encounter. Resource constraints (in the form of grants, facilities, grad students, etc.) are the primary, dragging factor for the independent entrepreneur, pre-money.
Regardless of the environment of origin, taking one’s time prior to securing investors is time well spent.
Once you’ve secured your initial equity financing, you’re no longer on your own. You’re now in business with your investors, and the clock is ticking. Investors are like any other business, only their inventory is capital. The faster they can turn their inventory, like in any business, the more profitable they will be. Always keep in mind, investors get in to get out…as quickly as possible being their preference.
Here’s where the entrepreneur is well served to recognize they’ve crossed a threshold. The thinking and approach that got them to this point of funding will not necessarily get them to where they need to go next. We often hear that entrepreneurs have to wear a lot of hats. What’s rarely discusses, however, is what hat they should be wearing, and when they should be wearing a particular hat.
Here’s what I mean. Bootstrapping develop steps may have made enormous sense, pre-money. Now that the company is properly funded (more on that shortly), taking short cuts or trying to do things on the cheap, can have negative effects, downstream. Time to take off the fund-raiser hat and put on your vice president of engineering and development hat. The manner in which you approached an engineering task, pre-money, may very well be the antithesis of how you should address the exact same task, now that your funded.
I mentioned earlier I’d touch on the concept of “proper funding”. Proper funding is the amount of capital your startup will require to reach your next key milestone. What is a key milestone? An event that triggers your next funding round.
For example, a relatively simple, Class II device, following a 510(k) regulatory path, might experience the following funding sequence:
Friends and Family funding - Pays for initial legal expenses, patents, licenses, early engineering, etc. Provides sufficient validation to justify your Seed Round.
Seed Round - Your seed round should pay for your design, development, V&V, regulatory, quality and early manufacturing (pre-commercial, for testing). The objective is to get the company to 510(k) with this round of funding. Doing so delivers a salable device and this is your next milestone.
Series A - Ideally, this round should get you into the market. Exit or additional funding round(s) to scale will follow. More complex or novel devices may require substantial, clinical studies, which will require follow-on rounds of funding (a successful study would be another milestone).
Now that you’re funded, your next task is to efficiently guide your device through design, development and V&V. Your milestone gate is submitting the device’s 510(k) filing with FDA. With clearance, you have a salable device and your entire world will change (for the better!).
Quick word to the wise…choose your regulatory strategy early. With this in hand, I highly recommend conducting your FDA Pre-Sub meeting as early as possible, too. This guidance will be priceless in helping you move efficiently forward through development and will increase your likelihood of a successful submission on the first pass.
The most risky thing you can do is run out of cash prior to having a salable device. This space is darkly referred to as “No Man’s Land” (in reference to the land between enemy trenches in WWI…with startups, this is the space where fledgling companies go to die a slow death). If you’re fortunate enough to raise bridge financing, it will be very, very expensive and there’s a fair chance you’ll lose control of your company at that time.
The best way to hedge this risk is to thoroughly educate yourself as to the requisite inputs necessary to get your device from concept to commercial-ready. If you’re unfamiliar with what is required, secure expertise from outside vendors. Help is available and it’s quite often very much worth the money.
Calculating the True Cost of Developmental Delays
We’ve discussed a variety of factors that may introduce delays to your development process, now let’s take a look at the potential economic fallout of developmental delays.
In this model (based on an historical project), the market launch is projected to occur at month 18, post-money. In other words, the project plan for this device projects it will be ready and cleared for market launch a year and a half after securing “proper funding”.
The targeted exit is at sixty months, post-money. That’s our baseline, our constant to which we will measure the potential economic impact of delays. Projected EBITDA, at Month 60, is $63.4 million. Using a conservative multiple, the projected company valuation at exit is $63.4 million x 8 ≈ $498.4 million.
Now, let’s consider the impact of a three month delay to launch. This delay pushes out sales and resulting cash flow by three months…but keep in mind, you’re not forgoing the cash flow from months one, two and three. Your forgoing the cash flow from months fifty-eight, fifty-nine, and sixty.
This results in a lower EBITDA at exit (remember, sixty months is our target and constant) of $62.3 million. Using the same multiple, $62.3 million x 8 ≈ $498.4 million valuation at exit. The three month delay cost the company $8.8 million at exit.
A six month delay pushes out cash flow even further, lowing EBITDA at exit to $60.2 million. So, $60.2 million x 8 ≈ $481.6 million, a drop of nearly $26 million in company valuation at exit from the original projections.
A nine month delay lowers EBITDA to $47.8 million at exit. So, $47.8 million x 8 ≈ $382.4 million, a drop of more than $125 million in company valuation at exit, versus the original projections without delays.
Missing your launch date by twelve months will lower EBITDA to $42.2 million at exit. So, $42.2 million x 8 ≈ $337.6 million, a drop of more than $170 million for the original projections.
Once you’re formally underway, trying to cut corners to save money, or choosing to do something internally you’re not well suited to do, can have a significant impact on your company and your investors. Delays can be a slippery slope, As developers, we’ve witnessed more than once, entrepreneurs pausing development for what was intended to be a short timeframe all of a sudden finding themselves six or nine months behind their original targets. This is especially true today, with the added risk of uncertain supply chains.
Other than safety, no other imperative is more critical to your success than speed to market. We didn’t even touch on the competitive drivers, of not knowing who may be coming up behind you, quickly, as another critical factor for getting to market sooner rather than later. It turns out the old adage, time is money, is quite true.
We have seen on more than one occasion, entrepreneurs attempting to preserve cash trade time to market for cash preservation, “Let’s just slow down for while…” Conversely, we’ve also witnessed entrepreneurs trying to cut a corner here or there, again, in an attempt to preserve capital. These actions rarely pay off as intended and are the most common source of delays.
In conclusion, if this is your first time going down this road, seek outside expertise. Much in the same way you seek out legal expertise or regulatory expertise, please recognize device development follows a sophisticated path that requires a very specific set of skills and experiences to navigate successfully.
® 2022, REV.1 Engineering.
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