Planning a Medical Device Business is Not for the Faint of Heart

By Greg Johnstone

Creating a business plan for a medical device company is a complex challenge, even for the most experienced founder and management team.

A medical device business must contend with many of the same issues that face other technology-driven businesses. These include difficult engineering challenges, fundamental physical or biological constraints, complex patent landscapes, and customer inertia, just to name a few. But in addition, these enterprises must also overcome numerous hurdles specific to the medical device industry: conducting pre-clinical (animal) and clinical (human) trials to prove that the device is safe and effective; obtaining regulatory clearance from the Food and Drug Administration (FDA) and/or international counterparts; and building a value-based business model that is attractive not only to patients but also to public and private insurers, hospitals, and physicians, all of whom are critical decision-makers/gatekeepers with their own economic interests.

The CFO’s Role in Business Planning in Medical Devices

Although addressing each of the issues above requires expertise beyond the domain of a CFO, it is critical that the CFO be willing and able to ask the hard questions to ensure that the management team is adequately addressing all the factors that will be essential for the company’s success.  The CFO is often brought in to lead strategic planning for a company at the seed or Series A stage of development, in many cases before senior executives are in place to lead marketing, clinical, or regulatory and quality functions.  In these cases in particular the CFO must take an expansive view of the role and provide leadership that extends beyond finance and accounting matters.   And, I might add, this is doubly true when working with a first-time founder/CEO at a medical device company!

Based on my experience as the CFO at numerous life science businesses over the past 20+ years, here are key topics I keep in mind when leading the planning process at any pre-revenue medical device company:

Identifying the Path to Regulatory Clearance (FDA or Foreign Equivalent)

Regulatory clearance is obviously critical, because a medical product cannot be brought to market without it.  This raises key questions for the company’s plans, such as:

• Does the company have a clear idea of how the device will be regulated? (For example, will it be considered a device or a drug-device combination?)
• Will it require a 510(k), De Novo, or PMA clearance?
• What clinical data will be required?

A company should hold pre-submission meetings with the FDA as early as practical to make sure it is designing its clinical studies in a way that will satisfy the agency, and this communication and analysis should be conducted by experienced specialists (often consultants).  Good regulatory consultants are pricey, but they can play a vital role in the company’s success.

Designing Clinical Studies

Regulatory bodies require clinical trials (studies) to demonstrate the clinical benefits and risks of a medical device.  There are many variables in a study’s design that can make or break the usefulness of the study for obtaining regulatory clearance.  Furthermore, an excellent study design can provide a wealth of additional data that can help guide the roadmap for future product refinements and for marketing the product.  (I can’t count the number of times I have heard, after the fact, “It was such a shame that the study didn’t capture data on ____.”)  For these reasons, budgets must provide for either key employees or specialized consultants who can design a first-rate study.  These people—who may not be the ones who will lead the execution of the study itself—are expensive but are crucial for a device company’s success.

Budgeting Realistically for Clinical Studies 

In my experience, once a medical device company begins clinical trial(s), clinical expenses are typically its second largest expense after employee costs.  The costs of clinical studies are also one of the most variable and difficult-to-project expenses, and studies are notorious for running behind schedule due to slower-than-expected patient enrollment.  Such delays add to costs, as the study’s recurring monthly costs add up and as additional measures are taken to boost enrollment (e.g., adding additional clinical sites, increasing travel to maintain awareness of the study among staff at existing sites, etc.).  Meanwhile, the company’s fixed monthly cash burn must be supported even while the non-clinical portions of the team may be largely in a waiting mode pending results from the study.  My recommendation here is for CFOs to “execute frugally, but budget liberally”.

Understanding the Impact on Clinical Workflow

To adequately assess and plan for the challenges a medical device company will face in commercializing its product, the CFO must understand the impact the product will have on the procedural workflow of the clinical settings where it will be used.  Does the device fit into the existing workflow at a hospital or clinic, or does it require a significant change in the way the treatment is provided to the patient?  Fitting into an existing workflow will in most cases make product adoption easier and therefore faster.  Radically altering a workflow may bring huge benefits if it significantly improves patient outcomes or eliminates costly and/or time-consuming steps, but such major change generally takes a lot of time for healthcare systems to adapt their processes in order to adopt the new product.  And a slower rate of initial market penetration translates to a longer period of burning cash, something that must be taken into consideration in budgets and financing plans.

Planning the Path to Reimbursement and Getting Paid

For venture capitalists, uncertainties related to reimbursement by insurers is often THE key risk factor to consider, and for good reason: as difficult as it may be to achieve FDA clearance to market a medical device, the route to getting PAID for the product is in most cases far more complex.

Except in a few specialty areas like aesthetic surgery, out-of-pocket payments from patients cannot typically support a commercial business model for a medical device in the United States.  No matter how great a product or procedure may be for patients, hospitals generally won’t buy the product and physicians won’t use it unless they will be reimbursed by payers (Medicare and/or private insurance companies) at a level that allows them to make a profit after paying for the device.  And payers will generally not pay for a new procedure unless it reduces cost (for similar clinical outcomes) or provides such a superior clinical benefit that they cannot ignore it.  The amount of data—both clinical and economic—required to convince payers is often far higher than that required for FDA clearance, and significant lobbying of payers and relevant medical societies is often necessary.

The components of achieving reimbursement (coding, coverage and payment) are complex and subject to frequently changing policies, but a medical device CFO has no choice but to develop a working knowledge of this topic and to pay for expert guidance to plan and execute a sound reimbursement strategy.

Developing a Per-Procedure Recurring Revenue Stream (Where Possible)

Like any firm, a medical device company must have a clear understanding of its commercial offering and the economics for both the company and its customers.  What exactly is being sold?  Most experienced medical device investors prefer business models that involve a high-margin consumable component (which may be used in combination with a low-cost durable device, in which case it could be referred to as a “razor/razorblade” model) .  The rationale for this is that the economics of consumables are typically more favorable to the company than are capital equipment sales, and adoption is more straightforward for the hospitals and clinics who make  purchasing decisions.

If procedure volumes and physician satisfaction are high (admittedly, an important “if”), then a company selling a consumable product or component will likely enjoy much lower selling costs than if it were selling capital equipment; much like a SaaS model, the sale of a single piece of equipment may generate significant recurring revenue for years.   For a hospital, purchases of expensive capital equipment typically require approval from a finance/investment committee that must consider the economics of the up-front purchase (or lease payments), per-procedure reimbursement and expected utilization rates, among other factors.  In contrast, consumable products with costs incurred on a per-procedure basis present hospitals with a simpler adoption decision because the economic risk related to forecasting procedure volumes (equipment utilization rates) is lower than it is with large capital purchases.

Is a Revenue Forecast Necessary?

Conventional wisdom would say that a business plan must have a revenue forecast.  However, the reality is that revenue forecasting for a seed-stage or Series A medical device company is essentially an exercise in educated dart-throwing, and wise VCs know this.

More critical for these enterprises at this early stage is to identify a market that is currently both under-served and very large (even when accurately segmented to include only the portion that is truly addressable), for which the company’s product provides a solution that will better address medical needs AND reduce cost AND deliver high gross margins.  When this is done credibly, most experienced early-stage medical device investors recognize that there is indeed a “pot of gold at the end of the rainbow”. As such, they realize that detailed sales planning and revenue forecasting are lower priorities than addressing larger and more immediate risks (technical, clinical, regulatory and reimbursement).

Spending Priorities: Addressing Fundamental Risks First

Early financing dollars are the most expensive, so it is important to spend them on activities that will clearly justify an increased company valuation, thereby making later financing dollars cheaper.  Investors are not like high school math teachers—they don’t give partial credit for half-achieved milestones—and so it is critical to focus on completing “bankable milestones” prior to raising the next round of financing.

This is true of any startup business, but medical device companies typically face large inherent uncertainties related to the time (and therefore funding) required to address and retire technical and clinical risks.  Therefore, these companies must be extra prudent about avoiding the temptation to expend resources on parallel efforts (R&D projects for potential follow-on products, publicity, building a sales team, etc.) that may have high value and/or may be critical eventually but which are not essential for reducing the more immediate fundamental uncertainties the company faces.  Most experienced medical device CFOs have seen (and perhaps been brought in to clean up) sad situations where a business has run low on funds, wishing in retrospect that the company had focused on completing one or two key objectives rather than spreading its resources across too many initiatives simultaneously.

Understanding the Professional-Political Landscape (i.e., Whose Toes Are You Stepping On?)

If a device will shift treatment (and therefore income) of a medical condition from one physician specialty to another, the pushback from powerful professional medical societies against this economic disruption could be huge, costly, and possibly fatal for your company.  Thus, this factor must be considered and, if unavoidably necessary, an appropriate plan of action must be crafted and budgeted for.

Financing the Commercial Launch: The Sales Challenge

Medical devices don’t sell themselves.  If a new drug works well (i.e., has clearly superior efficacy and safety), it can be rapidly adopted because it is relatively straightforward for doctors to understand the drug and write prescriptions.  With medical devices, however, physicians and other professionals must make a significant commitment to adopting a procedure that includes understanding the economic impact on their own practices, undergoing extensive training, acquiring, and setting up required equipment, and establishing new protocols/workflows.  Sales representatives who can credibly explain complex medical procedures to an audience that doesn’t tolerate puffery or imprecision—because patients’ health is at stake—are not cheap.  Therefore, a full product launch is very expensive, and the CFO must ensure that the launch plan has a sufficient budget and includes checkpoints to ensure that the plan is performing adequately at a small scale before committing resources to expansion.

In my experience as a CFO at medical device companies, I believe that rather than turning a blind eye to these topics or deciding to play it by ear, it is better to address them up-front and swallow any bitter pills sooner rather than later.  Here at FLG Partners, the “product” we sell is strategic and financial leadership in challenging business situations where experience and judgement count.  If your instincts are telling you that your team may be in over its head, consider reaching out to us to see how we can help ensure that your business plan earns a clean bill of health and your company is set up for success.