Device Companies Look Far and Wide for New Capital

The global recession that struck last September drove many device investors into hiding. This left a barren financial landscape for device companies to subsist on. But some are finding the funds they need, and they're sharing their survival stories.

The global recession that struck with hurricane-like fury last September drove many device investors into hiding. This left a barren financial landscape for device companies to subsist on. But some are finding the capital they need, and they're sharing their survival stories

By Tom Salemi

Toss any old valuations and terms out the window; valuations, investor preference, and capital spending plans are all being rewritten.

Outside investors are taking months, not weeks, to perform due diligence; they're digging deeper and taking their time doing it.

VCs love company. They're more likely to step up when there's enough capital around the table to carry the company to commercialization and beyond.

Device companies need to expand their search for investors: pharmaceutical companies are kicking the tires of device companies and investors from the Middle East and Asia could provide significant capital.

The world didn't end for medical device investors and their companies last September, but it clearly changed. Company executives raising capital at the time felt a palpable shift in the tenor of the talks. Venture capitalists who had once promised capital and support in the warm summer months of 2008 turned decidedly cooler as the fall temperatures—and the global economic meltdown—settled in.

Venture cycles historically ebb and flow like the ocean tides, producing a gentle rise and fall of investor interest and capital commitments. But last September hit like a tidal wave, blowing apart any sense of stability. Device companies that were on the road raising capital were most vulnerable. Their cash reserves were almost on empty and the promise of pricing and terms that might reward their years of work was gone.

The financial collapse almost instantly reset everything. Valuations and terms negotiated in earlier rounds no longer served as sign posts guiding future deals. The appetite of venture firms changed from one day to the next. One device executive, who asked not to be named, recalls wrapping up financing terms on a Friday, requiring only the approval of the firm's general partnership at its Monday meeting. The executive waited all day Monday for the phone call that would confirm the investment, but it never came. The once willing venture investor passed on the deal entirely, choosing instead to conserve its capital for its current portfolio companies.

Companies requiring huge infusions of capital to move medical devices further into clinical trials or commercialization had to lower their fundraising goals, cut back on costs, and pursue alternative forms of financing. Others cast a wider net, raising significant rounds with capital coming from non-traditional investors based outside the US. Corporations with capital, including pharmaceutical companies, became even more attractive as many venture firms found themselves unable to raise new funds. Syndicates with deeper pockets dug deeper, with investors stretching their initial allocations to spare their companies (and themselves) the savaging from an outsider-led round. When insider and corporate rounds weren't possible or attractive, some companies bit the bullet and accepted the new terms that come with an outsider-led deal.

Deals Getting Done, Getting Smaller

But despite the turmoil, deals are getting done. According to Dow Jones VentureSource database, venture investors poured $1.3 billion into privately held medical device companies over the first six months of the year. The half-year total represented one-third fewer dollars than the $2 billion and $2.1 billion device companies collected over the first two quarters of 2008 and 2007, respectively. But it's important to note that this year's tally was higher than the half-year totals of 2005 and 2006. The total number of investments saw a similar drop with 122 deals reported in the first half of this year, compared with 159 and 150 over the two previous years, respectively. This year might be seen as a correction to two years of excessive investing in medical device start-ups and companies.

In addition to committing fewer dollars, investors also seem to be favoring smaller deals. According to Elsevier's Strategic Transactions, only 31% of the private financings raised over the first eight months of the year exceeded $20 million, a slight drop from 38% for 2008 and 37% in 2007. Those $20-million-plus financings accounted for 65% of the dollars invested in 2009. Again, this represents a slight drop from the two previous years when investments that hit or exceeded $20 million accounted for 71% and 69%, respectively, of the dollars committed.

The statistical shifts are too slight to arrive at general conclusions, but coupled with the anecdotal accounts it's becoming clear that venture capitalists are shying away from placing big bets. And when they do decide to invest, they're interested in spreading the risk. Venture investors always understood strategic acquisitions and initial public offerings of stock were never certainties, although they clearly had to work under the assumption that one or the other would take place. But the past 12 months have made it clear to them that raising a follow-on financing isn't a certainty for any venture-backed company. To mitigate the risk, venture investors are hoping to surround themselves with other investors who have the will and the means to carry companies toward commercialization and even profitability. "We like to make sure now that we've lined up a syndicate that can carry a company forward from the point we get into it," says Mark Brooks, managing director of Scale Venture Partners, which led a $42 million Series C round in macular degeneration company Oraya Therapeutics Inc. [See Deal] "In our case, all of the folks that participated in that syndicate are reserving strongly for the future. Oraya will not have to depend on another external round to get the company all the way to profitability." The impact on the industry remains to be seen. If well-funded investors will only syndicate with other well-funded investors and the number of well-funded investors shrinks, it's likely that fewer venture capital deals will get done.

How Much Is Too Much?

But venture investors must weigh security against over-capitalization. An abundance of capital might be good for the development of the company, but investors obviously are mindful of the returns on their capital. They should be. While the average size of investment in each medical device company rose, the non-existent IPO market and generally weak merger and acquisition environment have put a lot of capital at risk. (See "Have Device VCs Bet Too Big?," IN VIVO, September 2009 (Also see "Have Device VCs Bet Too Big?" - In Vivo, 1 Sep, 2009.).) Steven Weinstein, the managing director who oversees device investing at Novartis Venture Funds, says capital intensity "has always been a large issue. But I think it's been ignored." Venture investors are caught between external forces. Only a handful of device companies draw the $400 to $500 million that make VCs salivate, so a small percentage of companies raising $50 million, $100 million, or more will not bring in anything close to venture-style returns. At the same time, venture capitalists recognize they need to carry their companies further, taking these start-ups to clinical trials and even commercialization. Add on to that the increased demands from the Food & Drug Administration for more extensive clinical trials.

It's difficult to draw an arbitrary line in the sand for all medical device companies since each has its own specific capital needs. But investors interviewed do seem to have their own particular comfort levels. "When you start to get over $100 million it starts to get a little scary," says Jeani Delagardelle, managing director at New Leaf Ventures, which this year led the $30 million Series D in Neuronetics Inc., which has started to sell a neuromodulating device as a treatment for drug-resistant depression. [See Deal] Neuronetics' new round put its total capital raise at $96 million, but as an outside investor New Leaf was able to secure terms that mitigated some of the risk associated with over-capitalization. Weinstein, meanwhile, says, "I like it to be sub $75 million." He adds, "Sub $50 million would be great, but again certain efforts are just capital intensive. You can't always get what you want. If you get north of $100 million, it's problematic." But he stretched his own comfort level just a bit earlier this spring. Novartis Venture Fund led a $40 million Series E investment in Visiogen Inc., giving the intraocular lens maker more than $70 million (with another $10 million in reserve). [See Deal] The gamble paid off almost instantly when Abbott Laboratories Inc. agreed to pay up to $410 million for Visiogen, adding it to its growing eye care business. [See Deal]

The other risk tied to capital-intensive projects comes from venture investors themselves. "If you're going to need to raise $100 million you're going to raise it in multiple rounds," Weinstein says. "And every time you raise that type of money you run the risk of a down round." That's not the risk these days, that's just the norm. The macabre mantras of a flat round being the new up (and down round being the new flat) resonate because they're true. Company executives and existing investors have written off any hope of maintaining their post-money valuation from earlier rounds. Investors in early rounds, meanwhile, must be ready to give up or rewrite some of the terms—such as liquidation preferences—granted from earlier rounds. Venture investors with cash see this market as an opportunity to rewrite those terms to spread the benefit to later-stage investors and to set aside sufficient capital for the management team to keep it motivated.

This is the overview of today's fundraising landscape. To better illustrate the market, we've selected a handful of companies that have raised significant rounds of capital--$30 million or more—under very different circumstances: insider rounds; corporate-led financings, even two companies that drew heavily from non-US firms. Our hope is that these stories will provide some lessons to device company executives mulling over their chances at raising follow-on capital.

Company Name: Endosense SA

Location: Geneva, Switzerland

Founded: 2003

New Round: $36 million (25 million Euro) Series B

Previous Capital Raised: $19.8 million Series A

New Investors: Edmond de Rothschild Investment Partners, Ysios Capital Partners, GIMV, VI Partners, Sectoral Asset Management, Initiative Capital Romandie

Previous Investors: NeoMed, 3i Group (did not participate)

Time Spent Fundraising: 12 months

Initial Target: $36 million Series B

Valuation: Not a down round

Next Financing: 2011

Product: TactiCath ablation catheter

Stage: European commercialization (it gained the CE mark four months ago) and a US PMA study of its TactiCath ablation catheter

Perhaps the biggest hurdle Endosense SA faced in raising its $36 million (25 million Euro) Series B round wasn't the business, but its investors. [See Deal] Edmond de Rothschild Investment Partners, the lead investor in the company's new round, saw clear opportunity in the company's TactiCath ablation catheter used to treat atrial fibrillation. But the Paris-based firm, like most investors these days, needed assurances that the other investors in the company saw the same potential and were willing to provide the necessary capital for the company to execute.

The uncertainty centered around the fate of the shares owned by Series A investor 3i Group. The global investment house had paired with NeoMed Asset Management in 2005 to provide $19.8 million (CHF26 million) to EndoSense. [See Deal] But it has since pulled the plug on its venture capital activities. The move created a huge portfolio of orphan companies that were bound to find new homes through a sale to a secondary firm.

Neither Endosense nor Rothschild executives really wanted to be part of a bundled basket of start-ups left at the door step of a then-unknown acquirer that likely would have few strategic interests in the company. (3i announced last month it would sell its European portfolio to the trio of firms Coller Capital, HarbourVest Partners, and DFJ Esprit.) Olivier Litzka, partner at Rothschild, repeats a feeling shared by many venture capitalists in this questionable economy: "We wanted to know who will be sitting around the table with us."

The uncertainty led to negotiations between Endosense, Rothschild, and 3i over the firm's stake in the company. The talks led to 3i selling its shares in Endosense to Rothschild and other Series B investors as part of the financing. Litzka knew 3i. He'd been with the firm for four years, leaving in 2006 to join Rothschild because he wanted to continue making venture-style investments. He didn't manage the Endosense investment while he was at 3i, but he certainly knew the company. "I was impressed by where they were in development," Litzka says. "They did a very good job of doing what they wanted to do and bringing innovation to an established procedure." But the fundraising climate was markedly different than in 2005 when 3i first invested. Litzka declined to say what Rothschild paid for 3i's shares, saying the three parties were all "happy" but also shared in a "little bit of pain, which seems to me a fair characteristic of a good deal."

EndoSense started fundraising last September. The financial storm already had begun to hit European and US venture capital markets, but the company needed capital to push forward with European commercialization. The company anticipated receiving a CE mark for its ablation tool and did so in May 2009. Endosense also needed capital to fund its planned clinical trials for the Food & Drug Administration. CEO Eric Le Royer declined to say how much capital the company had left when it started raising the round, but he admits, "We're glad we got the money when we did."

EndoSense concentrated on European investors. Le Royer estimates that the firm talked with more than 20 venture firms, but only one quarter—maybe half—of those had the means to lead a deal. Rothschild was one, and the two paired up pretty quickly. "I knew [Litzka] from his time with 3i," Le Royer recalls. "We engaged in a dialogue early on. That's not to say everything went smoothly and easily from day one to the closing, but I think it worked." Looking back, Le Royer thinks EndoSense executives timed the fundraising well because the company hit a series of milestones during the fundraising, with the biggest being obtaining a CE mark for the catheter. Le Royer believes potential investors enjoyed seeing such clear evidence of a company's progress, and they felt "part of our story as we were moving forward."

Company Name: Neuronetics Inc.

Location: Malvern, PA

Founded: 2003

New Round: $30 million Series D

Previous Capital Raised: $66 million

New Investors: New Leaf Ventures

Previous Investors: Investor Growth Capital, Quaker BioVentures, Three Arch Partners, Onset Ventures, InterWest Partners, KBL Healthcare Ventures

Time Spent Fundraising: Four months

Initial Target: $30 million

Valuation: Down round

Next Financing: None planned

Product: NeuroStar TMS Therapy system

Stage: Commercialized after receiving 510(k) approval in November

New Leaf Ventures managing director Jeani Delagardelle liked many parts of the Neuronetics story three years ago when she first had the opportunity to invest. "I found it compelling in terms of the new technology they were using, the size of the market they were addressing, and the management team was really top notch," Delagardelle says. However, a few elements of the neuromodulation company's pitch concerned her. First, the company's NeuroStar TMS Therapy system failed to hit some of the end points in a clinical trial at the time. Second, the company's grapple with Food & Drug Administration promised to be a long, arduous one. Third, she wondered whether the company could actually establish a new sales channel to sell this device to psychiatrists, who don't typically buy devices--even one that had promise to treat people with depression who have failed to benefit from drug treatments. At the end of the day, the concerns outweighed the potential upside and New Leaf passed on the opportunity to invest.

Fast forward three years. Neuronetics did in fact run into a speed bump at the FDA. An advisory committee initially advised against the agency giving the company 510(k) approval for the device, suggesting insufficient efficacy. But the company persisted and drilled down the data to present a clearer case of efficacy as a treatment for patients suffering from depression. A year ago, Neuronetics got the nod. (See "Neuronetics' FDA Nod Opens Doors to New CNS Market," START-UP, November 2008 (Also see "Neuronetics' FDA Nod Opens Doors to New CNS Market " - Medtech Insight, 1 Nov, 2008.).) Following the approval, Delagardelle says she received a call from Wilf Jaeger, general partner at Three Arch Partners, an early investor in the company. "He said, 'I remember your concerns the last time,'" Delagardelle recalls. With the FDA approval in hand, Delagardelle says Jaeger assured her the company was ramping up revenue and blowing away sales projections.

So New Leaf took another look. Delagardelle says Neuronetics had made considerable progress over the two years, answering every question she had save one—reimbursement. Chief executive Bruce Shook says the company currently holds a tracking CPT3 from the American Medical Association that records the numbers of procedures done. Neuronetics is currently trying to pursue a CPT1 code that would open the door for insurers and payors to pay for the procedure. The firm agreed to lead the round and supply half of the $30 million Series D. Not only did the company provide a safer bet than two years ago, but New Leaf paid a lower price, one more in line with the current marketplace. "We don't talk about valuations," Shook says. "But it was certainly a softer market than the last time we raised money in 2006. We did take a bit of a haircut but it was all fair and reasonable."

Neuronetics began fundraising in April and had money in the bank in the beginning of August. Shook says the company had enough cash on hand to last until the end of this year prior to raising the round. Now it has enough capital to fund a full commercial launch of NeuroStar. The device includes a chair, console, head rest, and emitter that fires magnetic pulses into the brain stimulating function in selected regions. The 40-minute outpatient procedure requires no anesthesia or sedation and is performed by a psychiatrist. Treatment is administered daily for four to six weeks for a total of 20 to 30 visits. Neuronetics currently has 16 sales representatives, selling directly to private practices and larger institutions. Walter Reed Army Medical Center was one of the first customers. (See "Transcranial Magnetic Stimulation Device Gets Drafted by Army," The Gray Sheet, March 9, 2009 (Also see "Transcranial Magnetic Stimulation Device Gets Drafted By Army" - Medtech Insight, 9 Mar, 2009.).)

Company Name: Oraya Therapeutics Inc.

Location: Newark, CA

Founded: 2007

Round Raised: $42 million Series C

Previous Capital Raised: $22 million

New Investors: Scale Venture Partners, Domain Associates

Previous Investors: Essex Woodlands Health Ventures, Synergy Life Partners

Time Spent Fundraising: Six months

Initial Target: $40 million

Valuation: Flat or down

Next Financing: Unknown

Product: IRay external beam radiation system

Stage: Expanding clinical trials

Oraya Therapeutics' raising of a $42 million Series C round demonstrates that venture investors are still willing to bet—and bet big—on an early-stage idea. The two-year-old Oraya secured the substantial funding—as well as $22 million in earlier capital—without any significant clinical data on its IRay external beam radiation system, which delivers radiation to the eye as a potential treatment for age-related macular degeneration.

Guido Neels, managing director at Essex Woodlands Health Ventures, which seeded the company, says the company's road show was fairly straightforward. "We approached the people we know and the people we knew had money," Neels says. Scale Venture Partners and Domain Associates both recently raised funds. "Luckily the people who had money were also the people we like to work with," he says. Deep pockets were important as Oraya executives wanted to build a syndicate that had the means to carry the company through commercialization.

Oraya clearly benefited from the general appetite for new treatments for debilitating eye disorders like age-related macular degeneration, a condition that causes blindness brought on by leaky vessels in the back of the eye. At this point, the new treatments for AMD have come from the pharmaceutical industry with Genentech's ranibizumab (Lucentis), the current gold standard. Device companies such as Oraya and NeoVista Inc. are positioning their devices as complements, not replacements, to Lucentis. Their hope is that patients being treated by both the device and the drug will need fewer doses of the latter, which is significant since Lucentis is administered with an injection to the eye.

Neels says the safety data on the device were "excellent" and the promises of efficacy were "very good." Mark Brooks, managing director of round leader Scale Venture Partners, says his firm watched the company from the start and waited until the data clearly were promising enough to invest. The capital will be used to fund clinical trials in the US and Europe on more than 500 patients. If successful, Oraya's IRay would represent a huge advance for eye treatment because unlike Neovista's treatment, which requires the surgical insertion of a small device in the eye, the radiation would be delivered with an external device, an experience akin to having x-rays taken of teeth at the dentist's office.

Brooks says the financing had to be big, even if the technology was relatively early stage. Scale Venture Partners, when investing in devices, looks to line up syndicates that have committed the capital and set aside the reserves to carry a company to commercialization. "In this case, all of the folks that are part of that syndicate are reserving strongly for the future," Brooks says. "We will not be dependent on another external round to get the company all the way to profitability."

Company Name: Small Bone Innovations Inc.

Location: Morrisville, PA

Founded: 2004

New Round: $144 million Series C and D

Previous Capital Raised: $42 million

New Investors: Goldman, Sachs & Co.

Khazanah Nasional Berhad, Malaysian Technology Development Corporation (MTDC), The Family Office of Bahrain

Previous Investors: Trevi Health Ventures, NGN Capital, 3i Group, TGap Ventures

Time Spent Fundraising: 12 months

Initial Target: NA

Valuation: NA

Next Financing: Undetermined

Product: Orthopedic implants, tools for small bones

Stage: Commercial

Company Name: ConforMIS Inc.

Location: Burlington, MA

Founded: 2004

New Round: $50 million Series D

Previous Capital Raised: $30 million

New Investors: BioOne Capital, Kuwait Pension Fund

Previous Investors: Aeris Capital, SBG, Thorner Ventures

Time in Market: 12–18 months

Initial Target: $50 million

Valuation: Up round

Product: Patient-specific Partial Knee Resurfacing System. Patient-specific Total Knee System to be Launched in 2010.

Extremities player Small Bone Innovations Inc. and ConforMIS Inc., a maker of knee implants, were the only two orthopedics companies to raise more than $30 million this year. SBI closed on a staggering $144 million, whereas ConforMIS secured an even $50 million. [See Deal] [See Deal] The two companies share more than healthy bank accounts. Both companies, in fact, drew heavily from investors from Europe and the Middle East, as well as Southeast Asia. In addition to drawing from different geographies, the two companies also tapped investors from unusual asset classes.

Small Bone Innovations, which actually closed a $36 million Series C round and a $108 million Series D, counted among its investors Khazanah Nasional Berhad, the investment firm of the Government of Malaysia; Malaysian Technology Development Corporation (MTDC), a Malaysian-based venture capital company; and The Family Office of Bahrain. BioOne Capital and the Kuwait Pension Fund were among the investors. Zurich-based Aeris Capital led the round.

ConforMIS and SBI aren't the first US-based medical device companies to draw capital from outside the US. Typically, those investments come through US-based venture funds or venture units established in this country by foreign entities. Often when foreign entities invest directly, they're rounding out massive, late-stage rounds. The companies get capital from investors who care less about valuation and more about gaining insights into the life sciences industry. But Small Bone and ConforMIS executives say their non-US investors don't want insight; they want business. They want to help these companies grow large enough to warrant plants or offices being opened in the sponsor countries. ConforMIS CEO Philipp Lang, MD, says his company's plans to expand into other countries aren't defined, but they exist. So ConforMIS set out with "the objective of having global investors." The equity investments provide ConforMIS, which already sells several lines of knee implants, with the opportunities to expand into foreign markets. One of the company's investors is based in Singapore, and "there are some very interesting manufacturing opportunities in Asia," Lang says.

Khazanah Nasional Berhad, in fact, issued its own press release announcing its $25 million investment in Small Bone, the company founded in 2004 by Viscogliosi Brothers LLC, the orthopedics-oriented merchant bank and venture firm. In the release, Khazanah announced that Small Bone will set up its Asia Pacific hub in Kuala Lumpur, the largest city and capital of Malaysia. The hub could include product development, manufacturing, research and development, and a surgical training site. "SBI's presence in Malaysia is expected to create additional skilled knowledge workers in the areas of new technology and product development," the release states. "Malaysia's nascent medical devices industry will be enriched by the introduction of SBI. The human capital development of the local orthopedics ecology in particular, will benefit from potential collaborations between SBI and the local researchers, entrepreneurs, and surgeons."

Anthony Viscogliosi, co-founder of Viscogliosi Brothers and president and CEO of Small Bone, says the company's expansion plans will include the establishment of global hubs in Europe, the Middle East, and Asia. "I explicitly sought out investors who could help me build a business," Viscogliosi says, noting that he achieved his goal of securing investments from investors based in each region. "Our intention and the actuality of the business model is we are a global business and want to have powerful partners in the key geographies who have the ability to help us locally." Viscogliosi says the global hubs will house sales and marketing, logistics, some research and development, and training sites where surgeons can learn to use SBI's devices.

Calling Malaysia "the Switzerland of Asia Pacific," he says Small Bone sought out a site in that country because he sees in it a vantage point for reaching into the larger Asian markets such as China and India, and also into Australia. Khazanah Nasional Berhad is backed by the Malaysian government. "When you have a powerful partner like that it opens a lot of doors," he says. "We are very grateful to the government and the sovereign wealth fund." Viscogliosi also says his new investors have a stake in health care services and hospitals within their own countries. He expects they'll help Small Bone establish commercial relationships with potential customers.

Clearly this level of financing isn't available to everyone, particularly in these financial times. Small Bone initially had designs on closing on the fundraising last fall, when the financial market collapsed. The delays continued after the terrorist attacks in Mumbai caused investors to pause. But Small Bone and ConforMIS both benefited from their stage of development and their health care focus. "Everybody has suffered under the current economic conditions," Lang says. "But the health care market is one that benefits everyone and investors saw it as a good, long-term play that will continue to be a decent business opportunity and less dependent on the overall economic climate." Neither company is a start-up. Both are selling products into the market, which assured investors. A world of capital may be available to companies that meet those criteria and are willing to travel. "I literally knocked on doors that I've never knocked on before," says Viscogliosi.

Company Name: Transcend Medical Inc.

Location: Menlo Park, CA

Founded: 2005

New Round: $41 million Series B

Previous Capital Raised: $7 million

New Investors: HLM Venture Partners, Canaan Partners, Technology Partners, Latterell Venture Partners, Kaiser Permanente Ventures, Finistere Ventures

Previous Investors: Morgenthaler Ventures, Split Rock Partners

Time Spent Fundraising: Eight months

Initial Target: $35 million

Valuation: Down or flat

Next Financing: N/A

Product: Minimally invasive stent Cypass to reduce intra-ocular pressure from glaucoma

Stage: Company is building out pivotal trials and ramping up commercialization in Europe.

Executives at Transcend Medical Inc. hit the fundraising trail on September 29, a few weeks into last year's fiscal calamity. CEO Brian Walsh had been on the job a little over a month. He had spent that time getting his arms around the business, recreating the company's five-year plan, and pulling together a presentation to draw Series B investors. But on the day Walsh made his first pitch, the US stock market dropped 42%. Even worse, "the firm we pitched to, one of their limiteds apparently failed that day," he recalls. "It was an interesting scenario."

Not a good start, but Transcend pushed forward, meeting with firms through the rest of the year. None of the meetings matched the conditions of the first, but Walsh was getting a clear message. As interested as the venture capital investors might have been, limited partners were asking firms to hold back on making any new investments. "A lot of firms were kicking the tires and dragging it out a bit," but no one was really buying. Transcend executives and investors discussed their options and decided to take one more swing at the January JP Morgan conference. If things didn't free up, they'd look to do an insider round. Walsh, meanwhile, cut back on spending and scrapped the company's plans to move out of Foresight incubator space until it could close on some capital.

Walsh says Transcend got a good reception at the San Francisco conference. The company is developing a minimally invasive stent that could be used to treat glaucoma, a hugely interesting space for venture capitalists who are hungry for new vision-oriented deals. Still, despite the good meetings, Walsh sensed trepidation even in the new year. "All the firms were looking at the other firms to see who was really interested and who would make a move," he says. "Everyone across the board wanted to reduce financing risk so they wanted to know who would be sitting around the table and how their pockets were if another round were needed in the future."

HLM Venture Partners, which led the new round, was one of the firms that met with Transcend, and it moved quicker than most. Al Wiegman, partner at HLM, says the firm had been in the market for an ophthalmologic-oriented company and "certainly knew of Transcend and a number of other companies in this space." Wiegman says the timing of the financing enabled the company to get terms that "we found attractive relative to other deals done historically in this space." But HLM was even more impressed with the company's approach of marketing a device for the treatment of glaucoma. Glaucoma treatments require patients to administer a series of eye drops at specific intervals, which can be complicated. "This device, if the data hold up, can get 75% of those patients off all drugs," Wiegman says. "It's a benefit to the patient, a benefit to the provider, and a benefit to the payor."

But the huge potential raised as many questions as it answered. Clearly, investors want to own part of a company that could introduce a whole new type of treatment. But the risks associated with obtaining FDA approval through the pre-market application process are daunting. "We had to feel very good about the data, the trial design, and the particular branch at the FDA, and part and parcel with that we had to feel good about the amount of capital the company was raising," Wiegman says. In a way, those concerns—coupled with the potential—helped Transcend exceed its $35 million target. The company secured $41 million with Kaiser Permanente Ventures and Finistere Ventures rounding out the syndicate. [See Deal] Investors wanted the company to have the means to withstand a long review by the FDA without needing another round. "In a better market this financing would have been half this size," he says. "We funded this company to get it to FDA approval."

Company Name: Pathway Medical Technologies Inc.

Location: Redmond, WA

Founded: 1998

New Round: $42.5 million Series D

Previous Capital Raised: $65

New Investors: Limited partner of Forbion Capital Partners, WRF Capital

Previous Investors: Accelerated Technologies, Forbion Capital Partners (leader), Giza Venture Capital, HLM Venture Partners, Latterell Venture Partners, Oxford Bioscience Partners

Time Spent Fundraising: Five months

Initial Target: $55–$60 million

Valuation: Down

Next Financing: Undecided

Product: Jetstream G2

Stage: Commercialized; received 510(k) for two devices over the past year

Pathway Medical Technologies Inc. seems never to have an easy time of things. Founded in 1998, the company nearly shut down in 2004 when its partner, European cardiovascular company Jomed, went out of business. Pathway slipped onto life support until device accelerator ATI Inc. invested with the condition that the company direct its atherectomy devices toward peripheral vascular, rather than coronary, disease. Company executives naturally obliged, putting the company on the tail of FoxHollow, now part of ev3 Inc. (See "Pathway Medical: Pursuing the Hawk," IN VIVO, May 2006 (Also see "Pathway Medical: Pursuing the Hawk" - In Vivo, 1 May, 2006.).) The company went to raise $65 million in additional rounds from both earlier and new venture investors. It added to that total with a $42.5 million Series D round earlier this year. [See Deal]

Over the past year, Pathway received 510(k) approval from the FDA for its two JetStream peripheral atherectomy catheters. CEO Paul Buckman says business is growing. "We're approaching it a little differently than we might have four or five years ago," he says. "Clearly the emphasis for investors has changed. The current thinking is to make your cash last as long as possible and get to profitability as quickly as possible." Pathway eliminated 30% of its work force, cutting evenly across research, development, marketing, and other departments. "We're trying to grow our revenue but it's not a strategy of growing at any cost. I would say it's going quite well. The technology is being well received by the medical community, and its demonstrated clinical versatility is growing the atherectomy market segment."

Pathway Medical considered several multiple capital sources for its Series D. "We weren't just talking to traditional venture capitalists," Buckman explains, listing corporations, venture debt, hedge funds, royalty debt, and even reverse mergers as some of the options Pathway explored. "We just wanted to make sure that we weren't missing any potential avenue for funding." Ultimately, the company didn't pursue those other avenues, choosing to stick with venture investors. But company executives quickly determined that any new investors would be looking for a pound of flesh.

"One firm was willing to consider a $30 million investment, but only at terms that were very favorable to them and unacceptable to our investors," Buckman says. "So we tried to establish a benchmark on what kind of financing terms we might accept followed by numerous board discussions." Executives and board members talked about what terms and sacrifices might be acceptable and determined that the bargains being sought by new investors didn't properly recognize the progress the company was making. "We eventually agreed to work toward financing the company under more favorable terms, recognizing that the finance world had drastically changed. All companies, both public and private, were taking significant valuation hits and we had to acknowledge that Pathway would not be immune to this."

The discussion gradually turned to the possibility of an insider round. Dan Galles, a partner at HLM Venture Partners, which acquired a stake in the company in 2005, a year after the ATI rescue, says the company's investors "quickly found where we thought the company was in valuation. We found that what we were willing to pay as insiders was greater than what we could get to bring the larger new investors into the mix." Galles says the investors decided to go it alone before going too far with any potential new investors, knowing a new investor would have introduced "painful" terms for existing investors. "We said, 'We have a good thing going here. Let's go this route as opposed to going a more painful route.'" Pathway did receive some outside capital. A limited partner of a Series C investor, Forbion Capital Partners, took this opportunity to invest directly in the company. Forbion, however, managed the financing for its investor, sparing the company from the hammer a true outside investor might bring to the table. WRF Capital, the venture arm of the Washington Research Foundation, would also commit some capital after the terms were set.

But Pathway's investors didn't just photocopy the terms from the company's Series C. "Anytime you're doing an inside round, especially when you're doing an insider round that is a down valuation, you're going to have a lot of conversations," Galles says. First, investors must settle on how much they're willing to commit. HLM, for example, stretched itself a bit, committing another $2 million to the round after already investing the $5 million it had allocated for the company at the time of its initial investment. The investment represents 5% of HLM's current fund, easily the single largest investment in the fund's portfolio. "How we look at a follow-on is similar to how we look at a new investment, particularly if we're putting so much more capital in," Galles says. "Everyone is doing more than their pro rata." Investors push and pull over valuation, hoping to settle on a price that's fair for the company yet attractive enough to sell to their own partnership. "I suppose a telltale sign that it was a pretty fair valuation was that it wasn't an easy decision," he says. "It was a nice price but not a 'blow you away' price, so it was probably in the right spot. And we ended up where all the investors were able to participate."

Company Name: Ardian Inc.

Location: Palo Alto, CA

Founded: 2003

New Round: $47 million Series C

Previous Capital Raised: $19 million

New Investors: Medtronic, Emergent Medical Ventures

Previous Investors: Advanced Technology Ventures, Morgenthaler Ventures, Split Rock Ventures

Time Spent Fundraising: Nine months

Initial Target: $30 million

Valuation: Up round

Next Financing: Undecided

Product: Catheter-based device for hypertension, chronic kidney disease, and heart failure

Stage: CE mark (European launch expected in 2010); projected US launch 2013

In a difficult market, corporate investors often can be seen as the white knights for privately held companies trying to raise new rounds. When outside venture investors are bringing too big a hammer (or chainsaw) to the negotiating table, corporate investors sometimes offer a lighter touch and a more pleasant term sheet to sign. However, Ardian Inc. CEO Andrew Cleeland says Medtronic Inc.'s leading of the company's $47 million Series C round shouldn't be seen as the company's waving of a white flag. [See Deal]

Cleeland says he reached out to strategic investors last summer, before the economic trouble swamped the venture industry. At the time, Cleeland recalls, Ardian executives had hoped to close on a $30 million round of financing by the end of the year. Ardian executives felt a strategic investor would lend a helpful hand during the company's US clinical trials on its Symplicity Catheter System, a treatment for hypertension. Hypertension affects one third of the adult population globally, presenting a potentially massive market for any strategic investor.

Cleeland says Ardian reached out to corporations first. "They are generally expected to take a little longer as they are primarily making a strategic rather than just a financial decision," Cleeland says. "Therefore they perform more diligence, which accordingly takes more time. Given that we wanted to be funded by the end of the year we felt that it was appropriate to give them a head start." A few interested corporate investors in particular might have required more time—pharmaceutical companies. Ardian had dialogue with a few pharmaceutical companies that showed an interest in a device-based treatment for hypertension as roughly one-half of the people suffering from the disease don't respond to current drugs. Cleeland says discussions, while encouraging, didn't go very far. "One of them was kicking the tires a little bit," following multiple rounds of discussions, but "given the rapid progress with the other parties, further action was preempted."

The groundwork Ardian laid out last summer proved to be crucial. When the economic troubles hit in September, many of the venture investors that Ardian might have courted over the summer lost either their willingness or their ability to invest. Firms that once had capital set aside for new commitments now felt they needed to hold onto those dollars for their own portfolio companies. "Fortunately for Ardian, given the early Medtronic commitment, the collapse in the venture market had little or no effect on our fundraising," Cleeland says. Cleeland declined to give specifics, but Ardian commanded a considerable boost in valuation. Understandable given the company's evolution into a commercial entity, but not a given in this difficult market. Emergent Medical Ventures, which counts Thomas Fogarty, MD, as a partner, provided the only other new capital to the round. Cleeland sees Fogarty's investment as further validation of the company's approach.

Cleeland pointed out, "Medtronic's value, meanwhile, goes beyond capital." Richard E. Kuntz, MD, represents the corporation on Ardian's board. Kuntz was recently named Medtronic's senior vice president and chief scientific, clinical and regulatory officer. He now oversees the company's global regulatory affairs, health policy, and reimbursement. Cleeland says Kuntz already had added valuable insights on clinical trial design prior to his new appointment. Cleeland isn't blind to the other edge of the sword that comes with working closely with such a corporate force. He's careful to point out that Medtronic's investment didn't buy the company any rights to developing or distributing Ardian's products or any rights of first refusal to counter an acquisition offer. But such appearances come with any strategic ties. "While we are thrilled to have Medtronic as a partner, that is a perception that we'll have to continue to manage," Cleeland says.