Issue 2 - December 2010
Early Stage Partners Ends 2010 On An Upbeat Note
The worst of the financial crisis appears to have passed and, though the last two years have been challenging, we and our portfolio companies are still standing. Every company in ESPs portfolio in January 2008 is still operating today, and some are positioned for outstanding success. A number of our companies successfully completed financings this year, and several of the most mature ESP portfolio companies had outstanding years: Sometimes down markets accelerate the adoption of new technologies and products. Of particular note, EcoSmart has achieved broad market penetration with its environmentally friendly pesticides; TOA Technologies had a very strong year booking new orders with Fortune 50 companies; and Simbionix continued to outpace its segment and competitors with rapid sales growth.
In this issue we are pleased to profile Mike Bunker, who leads our Life Sciences practice.
Q: Mike, what types of life sciences investments is Early Stage Partners making?
A: We’re primarily looking at dramatic improvements in patient outcomes and ways for doctors to improve their practices with better procedure success rates. We focus mostly on devices, which is consistent with my prior corporate experience making acquisitions. With the IPO market less than robust, we count on strategic exits to be the path to liquidity for our investments. ESP tends to focus on markets and technologies in which we have direct business experience so that we can offer significant guidance and networks.
Q: The financial markets have been challenging over the last several years. Has Early Stage Partners adjusted its investment style accordingly?
A: Absolutely. We’re usually the first institutional capital in an early stage company but, because of the cost of bringing a new medical device to market, we are increasingly joining or catalyzing investor groups that ensure, at a minimum, several rounds of capital are showing. In some of our recent investments, all the capital the company needed to get to significant milestones and potentially an exit was showing in the first round.
Q: How does your corporate acquisition experience at Medtronic and CR Bard help you manage investments?
A: Great question. In my corporate M&A days, I was surprised at how many times we had to unwind legal agreements or tie up loose ends in companies we were acquiring. This took extra time, increased our diligence expenses, and reduced the valuation we paid for the company. This even caused a few deals to fall apart.
For instance, I led the due diligence in a company in the arrhythmia management market that involved a license to a university technology. Medtronic wanted to ensure that the university wouldn’t be able to later license a competitor using an enhanced version of the technology we were acquiring. The university was unwilling to include rights to enhancements in the license and the deal was killed. This could have been avoided by a stronger original license between the start-up and the university.
With this experience, I can help young companies avoid the mistakes I witnessed in my corporate days.
Q: Congress passed major healthcare legislation last year, and we’re just beginning to understand the many ramifications of it throughout the healthcare system. How does this impact your investment decisions?
A: Simply put, cost savings are a must. A focus on comparative effectiveness is the new norm. A technology or procedure must not only improve patients outcomes, but do so cost effectively.
During my time at Medtronic we launched a new implantable defibrillator in the United Kingdom. At the time, the U.K. was adopting the NICE guidelines that are used to determine if a procedure or device will be reimbursed. Cost considerations are a major component of the decision. NICE wanted better outcomes for British patients, but also required proof of direct cost savings compared to the gold standard, which was pharmaceutical therapy. It forced our marketing team to examine the total cost of a life-saving technology compared to alternatives. We were able to demonstrated that an implantable device that cost $40,000 was actually less expensive than three or more years of pharmaceutical therapy, and the device was approved. That experience has stayed with me today. If you are not capturing economic outcomes in every clinical protocol, your product may not get the reimbursement needed to gain adoption.
Q: How does Early Stage Partners see the general investment climate for venture capital, from the LP perspective?
A: The last few years provided a unique set of conditions that negatively affected investor views of venture capital. Returns have been depressed because the IPO window has been narrow, M&A activity slowed to a crawl, and businesses are both uncertain and cautious about the future. Not many other investment classes have performed much better, though, and conditions for VC investments are improving.
Those of us with capital to deploy are seeing very strong, high quality deal flow and favorable terms. This is particularly true in the Midwest, where many states and metropolitan areas have supported the building of entrepreneurial ecosystems. Entrepreneurs seem to be realistic both about terms and about the business plans needed to drive a business to exit. There is little capital competition for deals; cooperation is more the norm. We have actually been very active during this period and made a number of new and follow-on investments over the last two years. This convergence of events provides a unique opportunity for LPs willing to consider an overlooked region.
In new investments, we’re particularly focused on deals—across all of our investment practices—that are capital efficient. Lower burn rates and virtual business models are the order of the day. We are very disciplined in refining the business plan and milestones before we invest and in monitoring the team that is executing the plan after we invest. Most of our portfolio companies also are focusing on obtaining grants and other types of no-dilutive capital. To achieve a good return on investment, total investment capital has to be kept reasonable and timelines shortened.
In the follow-on area, we have had to be creative over the last two years. The venture capital industry is in a down cycle and there is less reliable follow-on capital than we had hoped for when we made some of our earlier investments. We increasingly have had to access alternative sources of capital among high net worth individuals, angel networks, and family offices. A number of our portfolio companies have done follow-on financings of this type recently. This is hard work, but generally a better outcome for our LPs than failure.
Company Profile: HistoSonics
When Early Stage Partners hired Mike Bunker to lead life sciences transactions, his experience making acquisitions at large medical device companies and his national networks of physicians and investors were important considerations. Mike can pick the phone and quickly find experts in many areas of medicine. This network helped Mike to evaluate HistoSonics, an Ann Arbor, Michigan spinout of the University of Michigan that is developing a non-invasive surgical technology based on histotripsy, the cavitation created by ultrasound. The investment is consistent with ESP’s commitment to carry its investment strategy into Michigan.
Surgery is increasingly moving towards minimally invasive techniques. Benefits include reducing the time of surgery, reducing the trauma and blood loss of surgery, shortening healing times, reducing hospital stays, improving outcomes, and reducing costs. Histotripsy has the potential to achieve all of these benefits, and more
ESP portfolio company Simbionix is benefiting from this trend; its simulation technology increasingly is being used to enable surgeons to practice in advance of minimally-invasive procedures.
HistoSonics is the result of a decade of research by a team of co-inventors at the University of Michigan. Histrotripsy involves focusing a beam of ultrasound on internal organs to liquefy tissue. The ultrasound beam creates cavitation—tiny, high-energy bubbles—that ablate tissue without radiation or the high-intensity heat of other techniques. The risk of corollary damage to surrounding tissue is minimized.
Early Stage Partners has significant experience with cavitation through its investments in Five Star Technologies and Arisdyne, which are using cavitation in industrial processes to, respectively, manufacture electronic materials and process biofuel feedstocks.
The first market application being explored by HistoSonics is Benign Prostatic Hyperplasia (BPH). This is a swelling of the prostate gland that affects 2 million American men, 400,000 of who are treated surgically each year.
The financing of HistoSonics was characteristic of the types of deal in which ESP is participating in life sciences. The deal included five venture capital investors, with enough capital among them to carry the Company through clinical trials to FDA submission. The investor group contains people with a wide variety of skills, experience, and contacts. The strength of the HistoSonics technology, investor group, and management team resulted in the successful recruitment of former FDA Commissioner Andy Von Eschenbach to the board.