INVENTION TO STARTUP SOURCES OF FUNDING

1
INVENTION TO STARTUPSOURCES OF FUNDING

• Trevor Moody Frazier Healthcare Ventures
• Jens U. Quistgaard LipoSonix, Inc.

2
Overview

• Observations on the current financial climate
• Sources of funding
• Exercise potential sources and their attributes
• Quick case study SonoSite, Inc.
• Quick case study LipoSonix, Inc.
• Venture funding in depth
• What is a venture capitalist?
• Venture capital funding criteria
• What has changed recently?

3
World Market Conditions

• Fear is high
• Global credit crunch/recession
• Uncertainty about size and extent of problem
• Companies most affected have
• Operational leverage to GDP or
• Balance sheet debt

VSX Volatility Index Sept 2000- Sept 2008
Data courtesy of SV Life Sciences LLP
4
Effect on Private Companies

• Relatively limited impact on healthcare companies
• Reduced access to public markets for exit or
  financing
• Reduced availability of credit and increased
  financing costs
• Potentially longer time period to exit and lower
  exit valuations

5
Performance of Healthcare Indices

• Health sector is driven by non-discretionary
  spending and therefore traditionally a safe haven
  at times of economic turmoil
• U.S. healthcare indices have all outperformed the
  SP500 over the last 12 months
• SP 500 down 30
• Medical device (DJUSMC) down 11 and biotech
  (NBI) down 10
• Healthcare services (IHI) down 17 due to HMOs
  reduced rates of growth, credit contraction and
  fears about reimbursement

6
Performance of Healthcare Indices
12 month performance of US Healthcare indices to
5 October 2008
Data courtesy of SV Life Sciences LLP
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Healthcare Fundamentals Strong

• Recession resistant characteristics
• Rapidly ageing population
• 10 of world population is over 65
• Rising incidence of chronic disease
• Rising healthcare costs
• US healthcare spending 2.3 trillion in 2007,
  7000 per person
• Healthcare spending outpaces overall economic
  growth and inflation
• Regulation creates high barriers to entry
• Globalization and new markets
• Innovation creates new markets

Forecast rise in chronic disease 2003-2023
Predicted population growth 19
Data courtesy of SV Life Sciences LLP
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Healthcare Investing (USA)
Equity into US VC-backed healthcare companies
Pro-forma
Data courtesy of SV Life Sciences LLP
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So

• Financial markets are a mess
• Healthcare is a great place to be in these times
• Funding is still available, but
• Bar is raised for new investments
• Valuations are down
• Each type of funding is affected differently

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Sources of Funding

• What are they?
• Self
• Friends Family
• Debt
• Grants, contracts NIH, SBA, DARPA, etc.
• Angels
• Venture funds
• Crossover funds
• Strategic (other companies)
• Public markets

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Sources of Funding

• What are they?
• Self
• Friends Family
• Debt
• Grants, contracts NIH, SBA, DARPA, etc.
• Angels
• Venture funds
• Crossover funds
• Strategic (other companies)
• Public markets

12
Quick Case SonoSite, Inc.

• ATL Ultrasound parent
• Digital ultrasound pioneer
• Core competence in ASIC implementation
• The hand-carried ultrasound vision
• The internal funding reality
• DARPA dual-use program
• ATL Ultrasound
• University of Washington
• VLSI Technology
• Harris Semiconductor

13
SonoSite Getting Off the Ground

• Basic development 1996-1997
• 12.6MM DARPA matching grant
• Handheld Systems Business Group 1997
• Spin-out as SonoSite, Inc. - April 1998
• 17MM cash (13MM later)
• Technology license
• NASDAQ listed distributed to ATL shareholders
• First working prototype September 1998
• First follow-on financing April 1999 (33.8MM)

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SonoSite Lessons Learned

• Government grants are a wonderful thing
• But
• You need an impressive consortium to get large
• There are some complications
• Government technology rights
• Consortium members technology rights
• Reporting requirements
• Etc
• Being a pre-revenue public company, in my humble
  opinion, is not a wonderful thing

15
Quick Case LipoSonix, Inc.

• Originally pitched to investors by two
  individuals
• Not successful
• Picked up by a medical technology incubator
• LipoSonix, Inc. founded in late 1999
• Initial venture funding, January 2001 (1.4MM)
• IP licensing
• Exploratory work
• Series-B, tranche 1, November 2001 (4MM)
• More exploratory work

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LipoSonix The Bothell Story

• First full-time employee and dedicated facility,
  August October 2002
• Series-B, tranche 2, September 2002 (5.9MM)
• First human study, July 2003
• The joy of venture debt
• Series-C, July 2004 (27.0MM)
• More debt
• Initial customer shipment
• More debt
• Acquired by Medicis Pharmaceutical Corp., July
  2008

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LipoSonix Lessons Learned

• Top-drawer investors really help!
• Be aware of capital structure issues associated
  with incubators
• Be aware of capital structure and terms issues
  associated with venture financing
• Multiples requirements
• Liquidation preferences (!)
• Etc
• Venture debt is a wonderful thing
• If you can get it, and use it appropriately

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Different money sources are likely to be involved
as the company grows
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Funding needs increase significantly as the
start-up moves towards commercialization
Typical Funding Requirements Through a Company
Lifecycle
20
Sources of Funding Venture Capital

• What is a Venture Capitalist?
• What criteria do VCs use to decide what to invest
  in?
• What has changed recently?

21
What is a Venture Capitalist?
Follow the Money
Investments in US Healthcare Portfolio Companies
The General Partner And the Fund
Sources of Capital

• Retirement funds
• University endowments
• Families / high net worth individuals
• General partners

Update!
22
What is a Venture Capitalist?

• Typically small partnerships made up of a few
  General Partners (2-10) and other staff
• General partners collect a percentage of the
  profits
• Payouts over several years
• Lucrative but high risk
• Manage one or more funds raised sequentially over
  several years
• Fund sizes range from lt5MM to gt2B
• Some firms have been around for gt50 years but
  vast majority have emerged in the last 15 years

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Medical Device VCs are looking for the most
exciting new technologies
A typical large healthcare VC may see 1000-2000
plans per year and invest in only 10

• Opportunities of great interest to medical device
  companies
• Innovations that will be rapidly adopted by
  physicians

• Incremental improvements
• Products, not companies

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The Medical Device Investors checklist

• Management / Founder Teams
• Big Markets / Rapid Adoption
• Regulatory/Reimbursement pathway
• Early Clinical Proof-of-Principle
• Patents

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Management/Founder teams

• Most startups wont have a CEO who has taken 3
  companies public

• Experience in other successful ventures
• Have recruited top-tier mentors, board members
  and advisors
• Open to adding other great executives to the team
  
• Deep understanding of the target market and
  technology

• Just want money, dont want a partner
• Unrealistic expectations of how hard it will be
• Looking for a quick win

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Big markets/Rapid adoption

• A very large existing or potential market is
  critical for generating investor interest

• Physician specialty has demonstrated that they
  will rapidly adopt new technologies
• 1B potential market
• Targeting procedurally oriented specialties e.g.
  cardiologists, orthopedic surgeons, etc

• Challenging physician referral patterns
• Requirement for large upfront capital outlays

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Regulatory/Reimbursement

• FDA and CMS challenges are often underestimated
  by founders

• Clear FDA approval requirements
• Compelling economic argument to key decision
  makers e.g. physicians, hospitals
• Physician community excited enough about
  technology to lobby for reimbursement

• Trials requiring long follow-up
• Great macro-economic argument but no-one incented
  to adopt

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Early Clinical Proof-of-Principle

• A rapid path to clinical proof-of-principle
  greatly increases the fundability of a company

• Rapid, ethical path to early clinical feasibility
  testing
• Early clinical data that is highly suggestive of
  likely success of the pivotal trial

• Need to run large, lengthy clinical trial to see
  if it works
• Mediocre efficacy results

29
Patents

• Strong patent protection is essential in a
  technology-driven venture

• Very strong protection around key innovation
• Building a patent thicket to cover other
  related inventions
• Broad early patents (an added bonus)

• Sloppy patent strategy / disclosures that have
  limited patentability
• Freedom to operate concerns

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What is the impact of the economic crisis on
venture capital?

• Limited impact in the short term in 95 of
  cases, funds will continue
• Quality VCs raise money from quality, long-term
  Limited Partners (LPs)
• VCs have not typically used debt fortunately
• Potentially dramatic impact in the long term
• Exits Definitely delayed significantly
• LP appetite for VC investments will decline over
  time
• VC investment criteria will be more conservative
• Early-stage VCs will still invest in early-stage
  companies but hurdles will increase
• More sensitive on capital needs, time to market
  etc.

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Wrap-Up

• Healthcare - Perhaps no better place to be
  driving innovation
• Buyers less affected by acute economic turmoil
• Insatiable demand
• Demographics
• Lots of money still out there the bar is much
  higher but great opportunities and great teams
  will get funded
• Take a strategic approach to fund raising. Target
  the best sources of money given your opportunity
  and stage of development
• Expect to spend a lot of time raising money