Welsh Carson Sits in K2M Driver's Seat

With the backing of the private equity powerhouse Welsh Carson, K2M will look to grow beyond its historical niche in complex spinal cases, though it will have to do so without any financial ties to the surgeons who once owned part of the company.

With the backing of the private equity powerhouse, K2M will look to grow beyond its historical niche in complex spinal cases, though it will have to do so without any financial ties to the surgeons who once owned part of the company.

By Tom Salemi

Founded in 2004, K2M set out to employ Surgeon-Driven Design to establish a leadership position in treating spinal trauma and deformities.

In doing so, the company followed a then-novel model of surgeon ownership, finding at least a portion of the company's original investors among leading spine surgeons who were also expected to supply the company with ideas for new spinal devices.

Private equity firm Welsh Carson recently bought out the surgeons and other outside investors, severing what once had been an important – but now is viewed as legally questionable – tie to its founding surgeons.

Now K2M, which is looking to expand its degenerative disc line, is ready to show it can innovate and grow without surgeons holding an equity stake.

Seven years ago, K2M Group Holdings Inc. president and CEO Eric Major had just separated himself from American OsteoMedix Corp., a minimally invasive spine company he'd led until its acquisition by Interpore Cross International (which would later be acquired by Biomet Inc.). [See Deal] [See Deal] His pursuit of his next opportunity led him to renew acquaintances with John Kostuik, MD, who then was chief of spine surgery at the Johns Hopkins University School of Medicine. Major sought guidance on what shape his next venture should take, and Kostuik, who'd served as president of the Scoliosis Research Society, pointed him toward an opportunity to create a company that would devote itself to developing tools to treat the most difficult pathologies of the spine: deformities, trauma and tumor removal.

Kostuik went further, suggesting that in its pursuit of tools for treating complex spine procedures, the new company adopt the surgeon-led strategy of spinal pioneers like AcroMed (acquired by what's now Johnson & Johnson's DePuy Synthes Spine Inc. in 1998) and Danek (now Medtronic Sofamor Danek USA Inc., part of Medtronic PLC's Medtronic Spine Inc. division after merging with Sofamor in 1993). [See Deal] "In those early days, there were surgeon-leaders like Dr. Kostuik at those other companies who were really spearheading real-world expertise of the theater of what they needed to treat these patients," Major says. Kostuik, who serves as chairman and chief medical officer, not only brought his own insights but tapped the minds of many of the 100-plus fellows worldwide he'd trained throughout his career. Through this network of frontline surgeons, K2M crafted a strategy to target the most difficult spinal pathologies.

As is the case with many spinal start-ups, K2M's plan included having many of those same surgeons own a piece of the company. Clearly, surgeons often have consulted – and owned stock in – device companies of all sizes and industries. But K2M embraced that strategy more robustly than most spine start-ups – where most surgeons get stock options or warrants commensurate with the value of their consulting work on the start-ups' designs, K2M, along with a handful of other start-ups at the time, would experiment with what was widely described in the industry as "surgeon ownership." In exchange for providing initial device designs and continued development work, surgeons would make up a significant – if still minority – part of the equity ownership of the company. K2M even coined a phrase to describe its philosophy or approach – Surgeon-Driven Design – and acquired a trademark on the term that would be featured prominently in its marketing materials and press releases. ( See "K2M Inc.," START-UP , September 2006 (Also see "K2M Inc." - Medtech Insight, 1 Sep, 2006.).)

As noted, all surgical device companies sell products that are, to one degree or another, "surgeon-designed"; what K2M and a handful of similar companies hoped to do was to reward surgeons more fully for their design contributions and give the company greater credibility by creating a special relationship, defined by equity ownership, in the company. Critics of the arrangement centered less on the design aspect of the relationship and more on the potential of surgeon-driven sales, questioning whether a surgeon-owned company owed its sales success to business from its owners. Whatever the pros and cons, that relationship is now over. Last month, private equity powerhouse Welsh, Carson, Anderson & Stowe acquired a majority stake in the six-year-old spinal company for an undisclosed sum. [See Deal] According to principals involved in the deal, Welsh Carson pursued K2M for more than a year, waiting out the company's pursuit of other acquirers or equity investors who could provide the capital necessary for the company's planned rollout of a series of new spinal implants and devices.

With a projected $100 million in revenue, K2M has established itself within the niche complex spine surgery field by supplying implants and tools used to treat spinal deformities, trauma and tumor removal. (Sales of implants for these procedures account for roughly 50% of the company's projected $100 million in annual sales; the other 50% come from degenerative spine products.) The company now is poised to expand in the degenerative disc space, which accounts for most of the estimated $8 billion spinal market, with a flurry of product releases planned for next month's North American Spine Society Annual Meeting in Orlando, FL. It's also reporting early success with its Serengeti minimally invasive surgical system, which would put it in position to compete for a broader piece of the spinal market. The question is: even with Welsh Carson's deep-pocketed backing, can K2M realize its full potential now that its surgeon-ownership model is a thing of the past?

Surgeons Sitting In The Owners Box

The idea of so-called surgeon-owned certainly has some inherent appeal – if the success of spine companies was directly related to the innovativeness of their device designs, why not reward those surgeons who came up with the new designs? But concerns of conflict of interest and questions of legality and propriety arose about the model soon after the launch of companies such as Globus Medical Inc. and K2M. Is it right for surgeons – or any physicians – to have a financial incentive to use a specific product or to take into account any factor other than the patient's best interest in deciding what implants or drugs to use? The conflict-of-interest debate, which has roiled the medical device and pharmaceutical industries for the better part of this decade, came to a head when whistleblower-fed investigations by the Department of Justice and a subsequent $311 million settlement with the so-called big five orthopedic implant companies forced the industry to revisit its financial relationships with surgeons in the innovating of new medical devices and implants. ( See "Orthopedics Settlement: Puts the Issue to Bed – Or Does It?," IN VIVO, November 2007 (Also see "Orthopedics Settlement: Puts the Issue to Bed--Or Does It? " - In Vivo, 1 Nov, 2007.).)

Moreover, despite the inherent logic of having surgeons rewarded for their own device designs, the surgeon-ownership model itself soon revealed limitations of its own. For one thing, questions arose whether other surgeons, those without equity in the company, would be as quick to embrace the company's technology, perhaps out of some kind of competitive instinct with the surgeon-owners or a concern with the whole idea of surgeon ownership of a company. More critically, innovative device designs are only part of the playbook in developing a sustainable medical device company – just as important, if not more so, is the capital to build the company.

Three years ago, Globus Medical raised $110 million in private equity money from Clarus Ventures and AIG SunAmerica. [See Deal] The financing diluted the position of the surgeons and salespeople who held 25% of the company before the deal. ( See "Globus Prepared for Trek with $110m from Clarus-led Group," IN VIVO, September 2007 (Also see "Globus Prepared for Trek with $110m from Clarus-led Group" - In Vivo, 1 Sep, 2007.).) In the K2M acquisition, Welsh Carson bought out all the surgeons and individual investors who had contributed to the company's early fundraising. Venture firm Ferrer Freeman & Co., which led K2M's second round in 2006, also sold some of its stake to Welsh Carson. [See Deal]

Whether through dilution – as in the case of a venture investment – or outright buyout, the infusion of capital in surgeon-owned companies clearly removes the implicit value of surgeon ownership that was so much a part of the original model. Welsh Carson's bet: that the original vision of K2M, that of a company built on designs provided by leading surgeons, will itself prove a sustainable model, capable of building on the impressive revenue stream K2M has already achieved.

Raising Capital To Grow

The investment reflects Welsh Carson's new commitment to finding opportunities in the medical device industry. In 2008, the firm brought on device industry veteran Daniel A. Pelak, a medical device executive who had most recently served as CEO of InnerPulse Inc. He previously had been CEO of Closure Medical Corp., a biomaterials company acquired by Johnson & Johnson in 2005, and he had worked for two decades at Medtronic Inc. [See Deal] Welsh Carson's focus on health care had largely been in the health care services sector, including outpatient surgery centers like United Surgical Partners Inc. Welsh Carson has enjoyed some success in devices recently. AGA Medical Holdings Inc., which Welsh Carson acquired in 2005, went public last year. [See Deal] Shares in the cardiovascular occlusion device company have held their IPO value at approximately $14 since the public offering.

This is a deal Pelak wanted. Though some venture investors have cooled recently on spine companies – particularly compared with the frothy times of the mid 2000s, which saw hundreds of spine start-ups raise venture capital, Pelak says he long ago had identified spine as "fertile ground for somebody who has capital to invest to be able to provide growth capital." Asked why he identified K2M as his first WCAS target, Pelak pointed to the breadth of the product pipeline and the experience of its management. In his opinion, the company didn't need fixing, just capital to pay for growth initiatives such as building up product inventories and broadening its distribution channels, primarily outside the US. Welsh Carson and K2M executives initiated talks in spring of 2009 after an introduction by investment bank Piper Jaffray & Co., which had been retained by the company to help arrange an investment or acquisition. Pelak says the initial conversations went well, but "sort of petered out" as the company sought other options.

Speculation on Wall Street centered around a possible purchase by Smith & Nephew PLC, which would have used K2M as a platform to enter the spinal market. One industry source says the two parties came close to signing a deal before Smith & Nephew walked away from the deal, possibly spooked by the some of the troubling signs of a slowdown in sales in the spinal industry. In what may or may not be a coincidence, Smith & Nephew and K2M this spring dissolved a distribution agreement the two parties had signed last fall. Eric Major says K2M had considered every possible route – IPO, acquisition, growth equity – since its inception, though he wouldn't address the specific rumors of a purchase by Smith & Nephew or any large strategic, except to say that such discussions are common. "It's a small industry," he says. "A lot of the CEOs know each other as do a lot of the board members. But I can't really speak to any specific conversations along the way." As for the distribution agreement with Smith & Nephew, he says K2M executives simply decided the company would be better off selling directly in Germany as it does in the UK, an apparent sudden change of direction.

As K2M explored its options, Daniel Pelak waited. Whatever talks took place, they didn't deter Pelak, who says he kept in personal contact with Major throughout the year. The contact took on more formal tones this spring when K2M realized that Welsh Carson's acquisition offer was ultimately the best deal on the table. For Welsh Carson, K2M was the best entry into a market Pelak has long liked. "The bottom line is as we age, our backs continue to give us problems. You add that all together and the dynamics are perfect for an innovative company such as K2M, if in fact it can get good distribution, to do extraordinarily well."

Finding A Place For Surgeons

Company officials created a corporate structure that has enabled the company to capitalize on those surgeon-designed products and bring them to market quickly and efficiently. The company is structured into "silos" that concentrate dedicated resources to each specific problem. Each silo is treated almost as a separate company, according to Major. It's staffed with product managers who are responsible for knowing the competitive landscape, engineers who can address what's technically possible, and consulting surgeons – paid through salary – to confirm what tools surgeons have and don't have. "Those three come together and they will brainstorm, and they'll go through and say 'OK, we need to find the best way to actuate the rod into the screw head, and control each vertebral body for segmental control,'" Major says. "It's really how we've been very successful." In its product conception and research, K2M doesn't go to many surgeons, only a few who are put on the silo teams. These surgeons enter into a contract with K2M and are paid hourly for their time. These relationships will be very important going forward.

Since its start, industry perception of the company – fairly or not – has placed a great deal of importance on the first class of surgeon investors who contributed to the company's first round in 2004. Even the mantra, Surgeon-Driven Design, puts a great deal of weight on the participation of those founding surgeons in guiding the company's direction and aiding in its product development. Six years ago, such a relationship had been worth boasting about for any medical device company. Similar claims were made to bolster the company's standing with patients, customers and, of course, investors by underlining the company's connections to the very people who used the products being sold. But the DOJ investigations and subsequent settlement with the US Attorney's Office, while centering on consulting agreements between surgeons and the large, multinational orthopedics companies, changed that positive inference and more clearly defined what kinds of relationships with surgeons would be allowed in the future. The settlement also put new oversight measures in place and encouraged companies to implement new guidelines – some modeled on the AdvaMed code for such relationships – in an effort to make sure that past abuses aren't repeated.

There's some debate whether smaller spine and orthopedics companies can and should follow the new approaches taken by the top ortho companies. Those smaller companies may face a bigger risk from the Stark Law and anti-kickback measures that question the ethics of having a surgeon potentially benefiting financially from medical decisions and procedures. The Stark Law was enacted a decade ago to prohibit surgeons from referring Medicare and Medicaid patients to facilities in which they hold a stake, but the law also applies to medical device companies as well, creating a potential problem for medical device start-ups.

Venture capitalists increasingly are steering clear of companies that count surgeons as shareholders, even a small minority. Their concerns are twofold. First, it's difficult to tell whether these equity relationships are, in fact, driving sales – even as they presumably encourage equity owners to use more product, some worry that they may drive other surgeons away. Second, investors worry that strategic buyers may avoid these companies so as not to acquire a potential legal liability that might bite them in the back at a future date. Keith Longson, general partner at Ferrer Freeman & Co., says his firm didn't see surgeon ownership as a problem when it led the company's Series A investment in 2006. "We viewed it as a means to have the early investors participate in product development, and that was the intent," Longson explains. "However, the perception of that relationship changed over five years, and it became a bigger issue from outside looking in, compared with actually how it worked." Longson says the size of ownership was well within compliance of industry standards, although he and Major declined to say how much of the company the surgeons owned. (Speculation is that it was close to the 25% previously owned by Globus' individual investors.)

Asked about the "surgeon-owned" tag worn by K2M and others, Major says it's a misconception he's had to "address for years." Major said K2M never fostered the perception, suggesting, in fact, that it might have been a perception conceived by the company's competitors."We have talked about surgeon-driven design. And surgeon-driven design really meant having surgeons involved in the development of product. Not associated with their use of product. But it was the concept that they're the ones who have a conception of their needs in the operating theater." Major said its surgeon investors accounted for "not only a minority, but a small minority" of total sales. One estimate suggests that one-fifth of the company's revenue came from those investing physicians. It's quite possible – perhaps even likely – that those surgeons will stick with K2M products, but at the very least the sale of ownership introduces a higher level of uncertainty about what their future purchasing decisions will be.

Still, as companies like K2M matured, it became increasingly clear that the original surgeon-ownership model that seemed like such a great idea half a decade ago would be unsustainable. The conflict-of-interest debates and the dilution that would naturally come as companies like K2M raised the capital they'd need to grow would together place less of a premium on the inherent value of surgeon ownership – both optically and in fact. Both Longson and Major say the changing outside perception didn't force K2M's hand. The company didn't make the deal to divest themselves of surgeon investors. The deal simply allowed all shareholders to gain liquidity, including Ferrer Freeman. "This was a means for everyone to benefit" particularly since K2M's investors had come to believe that an exit via IPO was increasingly unlikely in the short term, Longson says. "We did have a lot of strategic interest in the company, but the management team was compelled to keep going. The Welsh Carson transaction really allowed a variety of different parties to get what they wanted: management to keep going, current shareholders to gain some liquidity, and Welsh Carson to put the kind of dollars to work that would make the company grow."

Diving In A Draining Pool

Only time will tell if the buyout of the early supporting surgeons changes the nature of the company, or in any way diminishes the company's prospects. But there's another factor that could weigh on K2M's future. When K2M launched with its novel approach of surgeon ownership, the spine market was booming, and the company's ownership structure was designed to give it an edge in a fast-growing space. Welsh Carson is entering the spinal industry at a somewhat uncertain time. With a few exceptions, spinal device suppliers are reporting slowdowns in revenue over the past six months. Company executives are identifying two pressure points. As the spine industry matures, hospitals, keen on keeping costs down, are now negotiating more over prices for spinal surgery tools, adopting the tactics previously employed in their negotiations on pricing for knee and hip implants. Meanwhile, insurers are beginning to balk at paying for spinal surgeries, at least until all non-surgical treatments for back pain – physical therapy, steroid injections, etc. – are exhausted, which could lead to fewer – or at least delayed – surgeries. Just recently, a raging debate arose over the clinical efficacy of vertebral compression surgeries such as kyphoplasty and vertebroplasty, brought at least partly by two studies published in the New England Journal of Medicine. ( See "Despite Surgeon Support, NEJM Vertebroplasty Articles Spark Slowdown, Reimbursement Review," IN VIVO , December 2009 (Also see "Despite Surgeon Support, NEJM Vertebroplasty Articles Spark Slowdown, Reimbursement Review" - In Vivo, 1 Dec, 2009.).)

Welsh Carson's hope is that while major players with measurable market shares have felt the downturn in spine, smaller players with innovative product pipelines and niche approaches like K2M are still making progress, and are less likely to feel the broader pricing and discounting pressures that larger companies are feeling on more mature product lines, even if they're going against regulatory and economic headwinds affecting the whole industry. Medtronic Sofamor Danek reported first quarter spinal revenue of $829 million, a 9% decline, while Biomet, in announcing its quarterly sales recently, posted a 1% increase and Stryker Corp. recorded a 3% drop. In contrast, publicly traded NuVasive Inc. reported a 35% increase in year-to-year quarterly sales at the close of its second quarter. NuVasive chairman, president, and CEO Alexis Lukianov told analysts the company is able to outpace the spine market's overall 8% growth through a focus on innovation that creates and delivers less invasive products to win business and increase procedural volume. Even Stephen MacMillan, chairman, president, and chief executive of Stryker, told analysts, "I hate to say it. I think [large companies] are seeing some slightly slower growth than some of the smaller ones."

Welsh Carson's Daniel Pelak obviously is betting on K2M's ability to compete for a bigger piece of a slower growing market, but he's still high on the spine sector. "There's an awful lot of people getting spine surgery and doing very, very well afterwards," Pelak says. "And we'll continue to see that to some level into the future. And as long as we have the most innovative products, we don't have really too much concern about that piece of it." Pelak also points out that K2M, with a small share of the spinal market (at $100 million, its share appears to be just over 1%), has little to lose and much to gain. Even if insurers succeed in driving down procedures and hospitals continue to erode pricing, K2M still is in a position to grow.

Treating A Complex Spine

One reason K2M has been able to avoid the pricing and procedure pressure of the bigger spinal players lies in the niche market/technology strategy that has been a hallmark of the company from the very beginning. K2M's clearly leading with a two-pronged approach, pushing aggressively for adoption of its Range and Denali systems to treat deformity as well as its new minimally invasive system called Serengeti . All together, the company counts five active areas of interest: lumbar, deformity, interbody, cervical and minimally invasive. But K2M expects its ultimate success in competing in the spine industry will come from its ability to develop more broad-based degenerative disc products from its expertise in treating complex spinal procedures such as deformities.

At the very start, Major and Kostuik identified the complex spinal market as one largely underserved by major players, so they set out to create a line of products that would make the complicated tasks of straightening and repairing broken spines much easier. K2M's offers an array of screws, rod connectors, and a device – unofficially called "the Cricket" – to correct spinal deformities. "Those Crickets have become the cornerstone and big differentiator for our system," Major says. Surgeons affix the Cricket – a two pronged device – to screws that have been placed at each level of the spine. The prongs straddle a rod, which runs parallel to the spine but in the straight pattern that the spine should follow. ( See Exhibit 2.) Surgeons then tighten a screw on the Cricket, lowering the piston that connects the prongs that are attached to the screw. As the piston pushes against the rod it pulls the vertebrae in place. "It's segmental de-rotation. You provide the surgeon complete control at every level of the spine to individually move that level so that the whole spine, which is one unit, lines up," Major says. The vertebrae twist and turn, almost as if they're part of a puzzle. Eventually, the vertebrae are aligned, with the rod left in to stabilize the spine.

As an example of how K2M's complex-spine focus drove innovation in other areas, the company created its Serengeti minimally invasive retractor system partly as a means to be able to perform the scoliosis procedure through a minimally invasive approach. Now the same procedure can be done through the company's minimally invasive Serengeti system. "Today the majority of cases are done wide open, so you end up with a scar all the way down your back," Major says. "Now what we're doing is doing this through very small punch incisions the size of a dime," Major says. One of the obvious benefits is lack of a scar, but the more important benefit is the faster recovery time as less soft tissue is damaged. "Sometimes people lose sight of the fact of how muscle and ligaments play a big role in the integrity and the strength of your spine," Major says. "By leaving the ligaments and the muscle intact, the recovery is faster, and you don't have all the scar tissue."

Major says K2M's minimally invasive line includes both tools to access the spine with minimal cutting as well as the implants necessary to repair and readjust the spine, and it is selling well both inside and outside the US. The Serengeti line is directed toward posterior thoracolumbar surgeries. Major calls Serengeti a departure from other minimally invasive technologies because it eschews the two-dimensional tube that most other companies require surgeons to use as a point through which rods, screws and other implants are passed, using instead a flexible, open polymer retractor, an approach Major calls "a breakthrough" in minimally invasive spine surgery. ( See Exhibit 3.) The Serengeti retractor system consists of two open halves of a tube that are affixed to the spine with a single screw. The two halves of the retractor can be spread wider than a tube to create a "mini-open," according to Major. "The incision size is about the same as other systems, if not smaller. It's about the size of a dime, but because you're not going down through a tube, you're actually splitting and opening that tube in a flexible way." Major says surgeons can actually stick their fingers through the opening to feel the spine. Furthermore, the tops of the cannulas can be cut off and thrown away during the procedure to give the surgeon unobstructed access. At the end of the procedure, the two cannulas simply pop off from the screw. "This has allowed us to put very long rods in since you don't have to go down and make the turn around that 90-degree curve through a cannula," Major explains. "By splitting open the top of it, surgeons can, from a geometric perspective, get back and feed a long rod all the way up the spine." Whereas K2M's deformity series pits the company against all major suppliers of fusion technologies, K2M's Serengeti puts it in direct competition with NuVasive's eXtreme Lateral Interbody Fusion ( XLIF) system and TranS1 Inc.'s Axial Lumbar Interbody Fusion ( AxiaLIF) . Major says the financial support of Welsh Carson will give K2M the capital to compete with all comers.

Getting Less Complex

As is often true of start-ups, K2M's early niche strategy has served the company well. But Welsh Carson's investment is predicated, to a large degree, on the company's ability to tap into larger, more mainstream markets in spine, most notably degenerative disc disease, and Major argues that leading off with complex spine procedures positions K2M for product development that is suitable for the larger degenerative spine market, which he estimates to be $7 billion out of the total $8 billion spinal market. With Welsh Carson's support, K2M will begin releasing a string of new products in complex and degenerative spine starting this fall. The company likely will begin to address two areas of the spine it's largely ignored: biomaterials and motion preservation. K2M did in-license a polymer technology from Promethean Surgical Devices Inc. in 2008, but Major says the project is still "well under development. It's going to take a while to bring it to market." [See Deal] In the nearer term, K2M is in the process of bringing a structural allograft into the market. Then the company will look at filling out the biomaterials portfolio. As for motion preservation, Major acknowledges that K2M is probably the largest spinal company without a motion preservation product. "It's not that we don't believe that motion preservation will have a role in the continuum of care of patients," Major says. But K2M wanted to focus its limited resources. "We've looked at motion preservation over the years," Major says. "It is something that we want to look to for the future. But again, we as a company have consistently and methodically bitten a piece off and then, I think, capitalized on it successfully before moving on to the next strategic piece." Before the Welsh Carson buy out, K2M had raised less than $50 million from investors, and management was careful not to overreach. Now with Welsh Carson's backing, K2M will presumably have access to capital to support the strategic moves necessary to tackle the opportunity in degenerative disc disease.

No Doctors In The House

Indeed, with more cash available, K2M officials say they now have the ability to branch out and fill in any gaps in the company's portfolio. Major and Pelak say the company could do so through acquisitions, buying up the less fortunate members of the class of spinal start-ups launched over the past half decade. But Major and Pelak also argue that K2M will continue to develop innovative technology through its internal development efforts, and that's where some questions emerge. Will K2M suffer a slowdown in new product creation if consulting physicians aren't incented by stock ownership? Major says no. "We do believe that the engagement and the interest in the organization have been such that we have a lot of doctors along the way that have been continuously bringing us new technologies, wanting to innovate with us, who were never part of the original ones who had an opportunity to invest in 2004," Major says. The original group of surgeon-owners were, he says, "just a small group."

For most of the spine companies grouped under the umbrella "surgeon-owned," surgeons were, in fact, never majority shareholders and the percentage of equity that they owned seems to have been closer to 25% than full ownership. Indeed, it's unlikely that either K2M or Globus would have achieved the success each has had if they'd had to rely substantially on surgeons with equity stakes to drive sales.

Still, the label "surgeon ownership" seemed to be both defining and differentiating for these companies, particularly from the perspective of perception among patients, other surgeons, and competitors, and thus even a percentage as low as 25% raised the conflict-of-interest and dilution issues these companies have faced over the past couple of years. Just as importantly, as they look to the future, and with buyouts of those original surgeon-investors behind them, companies like K2M face a different question revolving around surgeon ownership: with its original group of surgeons no longer part of the ownership structure – and thus in theory no longer having a vested interest in the long-term success of the company – will K2M be able to deliver the kinds of innovative products that have been part of its vision all along?

Even as he downplays the size of the original equity stake of the surgeons, Dan Pelak acknowledges the validity of the question, saying Major and K2M management will work hard to ensure innovation isn't derailed. But he warns that K2M isn't the only spine company facing challenges in developing innovative technology. "This is going to be an industry-wide issue broader than K2M or Welsh Carson: how do we make sure that we continue to [attract] the very people who can come forward with innovative ways of solving unmet medical needs, without having, at the same time, to provide them any kind of ownership interest," he says. "We're going to work very, very hard at that. We continue to want our surgeons to be integrated with us. Clearly we have every right to compensate them for any patent ideas they have, and we will do that. But this issue isn't just K2M's. I think K2M will lose, and more broadly, I think industry and patients will lose if, in fact, we don't find a way to keep surgeons integrated."

SIDEBAR: Surgeon Societies On Ownership: Disclose, Disclose, Disclose

Neither the North American Spine Society nor the American Academy of Orthopaedic Surgeons has issued any guidelines restricting surgeon ownership of equity, but both organizations encourage its members to disclose all ties.

According to John J. Callaghan, MD, president of the American Academy of Orthopedic Surgeons, surgeon-ownership stakes aren't really an issue among surgeons. "I think 99% of physicians believe that there is a place for this relationship," Callaghan says. "They believe that it has helped us develop the implants that are the best in the world and has produced the best results for the patients in the world, and that it has to be done ethically and professionally."

Such a stake might give a surgeon a "sense of credibility" for having started a company and having a hand in designing an implant, Callaghan says, acknowledging that this relationship might sometimes lead to "jealousies" between surgeons. But generally the surgeon ownership of a device company doesn't influence other surgeons or impact their behavior, he says.

Callaghan says the problems emerge when surgeon-owners act unethically in the testing, promotion, or use of a product. "We need to promote the fact that there are very few problems out there," he says. "Most of the people doing this work are very ethical and professional, and they're actually helping patients."

Callaghan specializes in adult reconstruction, specifically hip and knee replacements, and serves as a professor in both the department of orthopedics as well as the department of bioengineering at the University of Iowa College of Medicine. He also is on the orthopedic staff at the Iowa City Veterans Affairs Medical Center.