Business
Mapping the Medical Device Start-up Ecosystem
And identifying the niches where these companies most often thrive
Chances are, a medical device was among the first objects you touched when you arrived on Earth.
Medical devices are ubiquitous in US healthcare— everything from the delivery room’s sterile gloves and umbilical cord clamps to the breathtakingly sophisticated neurosurgical operating room’s stereotactic navigation systems. More than ever medical devices are a fusion of hardware, software, and even synthetic living material. These are the physical tools through which new life science discoveries improve our lives.
The total US device market this year will reach $170 billion and includes countless products ranging in complexity from a ‘simple’ bandage to a life-sustaining artificial heart. Surprisingly, eighty percent of medical device companies have fewer than 50 employees, and many still look to private investment to grow their businesses. Last year, private investors (angels, venture funds, private equity funds, etc.) injected about $4.8 billion into US medical device start-ups. That’s 10% of all private healthcare investment in the nation.
In a recent piece in Bioeconomy.XYZ I looked at how the very earliest type of biotech investment — government-provided NIH small business funding— flows across the different life science ecosystems in the US. I also highlighted the many-fold difference that exists in the availability of this capital between regions.
In this article, I will focus on medical device development, specifically the critical period between device ideation and company formation up until the first-in-patient experience. In the entrepreneurial finance mindset, this corresponds often to three fundraising stages: Seed, Series A, and Series B.
Figure 1 categorizes the wide range of venture entities, individuals, and vehicles that may support a growing and compelling medical device company with early-stage funding.
There are three important trends that follow the progression of investments from left to right in Figure 1:
- First, the amount of money involved increases significantly, sometimes more than 10-fold per stage.
- Second, the number of companies graduating to the next stage falls off quickly. Many more companies raise seed rounds than ultimately raise Series A rounds.
- Third, the sophistication of the investment structure increases with each stage, as do the requirements that a start-up needs to fulfill to attract new investment. If raising capital is about selling the sizzle as much as the steak, a Seed round may be mostly sizzle. By Series B, with tens of millions of dollars on the line, professional investors are going to bring a knife and fork so they can try the steak firsthand.
A company’s journey from a successful Seed round to Series A and B usually passes through the Valley of Death.
The Valley of Death usually refers to the period of time in a company’s growth where it risks failure due to:
- Overestimated market size
- Underestimated resource need
- Overly optimistic guesses at the time needed to develop its product or,
- Inability to execute on its business plan.
Historically, the Valley is the period of start-up development where much of the work described by Steve Blank gets done. Steve first laid out the principles of lean start-ups, in which he described start-ups, fairly radically at the time, as temporary organizations designed to search for a repeatable and scalable business model. That search is often not successful.
Figure 2 shows the hard numbers behind the Valley of Death for medical device start-ups and the rewards that await teams that can grow their companies and refine their business case.
Importantly, failure to advance from Seed to Series A is not a mark of a flaw in a founding team. Not at all.
Most ideas, after enough careful scrutiny, just aren’t viable. A big part of the founders’ work is in sorting out whether there’s a business case to be made for their idea or not. While dreaming of building unicorns, talented founders also create value by efficiently and quickly determining, no matter how disheartening, that the temporary organization should be dissolved.
One question I often ask technical founders (folks from a technical or scientific, rather than a business, background) is this: Is there an experiment you might run immediately that would demonstrate unequivocally there’s no way for this business to work? It is emotionally difficult to engage such work — start-ups are made of teams who find in the company both purpose and employment, and start-ups are backed by investors wanting to see the company thrive — but if the decision to wind down is ultimately going to be made, better to do it as soon as possible.
When I see a large discrepancy in the number of Seed and Series A rounds raised, part of me applauds the teams and their discipline in concluding their business idea isn’t viable.
But there are also very viable businesses that are on the road to discovering repeatable and scalable models, but which starve for capital along the way. One contributing factor in failing from lack of capital is where the start-up calls home.
It turns out the Valley of Death is not just a phase, it seems to be an actual place on the map
To fully understand the landscape for medical device start-ups, it’s useful to think beyond deal count and deal size. Seed investments outnumber Series A investments about 3-to-1, but that sobering ratio isn’t the same everywhere. Figure 3 maps the cities where medical device companies have raised early-stage capital since 2018. The broad distribution of Seed rounds corresponds closely to what I’ve shown previously with NIH small business awards and also correlates to population. What is striking is the hollowing out of much of the central US in Series A and B funding.
Across active ecosystems, there are large differences in follow-on investment relative to Seed investment
To look at this more closely, I’ve re-cut the medical device investment data by using core-based statistical area. CBSA is a method used by the US Census Bureau and Office of Management and Budget to group geographic regions. It considers both population density and the intermingling of employees between nearby towns and counties. The left panel in Figure 4 reflects the relative number of Series A rounds — often the first ‘institutional’ investments companies receive — to the number of Seed rounds by CBSA. The panel at right shows the absolute number of deals, by stage, in the area over the past 3 years.
There’s tremendous variation in the number of Seed investments relative to later-stage investments across US biotech ecosystems. There have been three Series A investments for every four Seed rounds raised in the San Francisco-Oakland-Haywood statistical area since 2018. During the same period, for start-ups in the Pittsburgh region, Seed rounds outnumbered Series A rounds by more than 10:1.
Differences exist even with megaregions
Interestingly, several of the most active regions for medical device start-up creation in the US reside on the I-95 corridor between Washington, DC, and Boston. Figure 5 shows the relative activity between the ecosystems centered in Boston, New York City, Philadelphia, and Washington, DC.
The thinning out of later stage investment isn’t as strongly geographic as seen nationally, but as mapped in Figure 5 and quantified in Figure 4, there are important differences between major metropolitan areas in terms of later stage investment activity.
Why do these differences exist? Some Hypotheses.
That there are real regional discrepancies in the rate of start-up advancement from Seed to later stage financing suggests something structural is at play.
In my experience, some ingredients of the not-so-secret sauce of successfully building start-ups include access to talent, influential users, and capital. There are important differences regionally for each of these that probably contribute to such wide differences in device start-up evolution.
- Talent. Thinking about start-up talent, you need to consider employees, management, and directors. The types of teams that attract Seed capital are different than those that attract ‘lettered rounds.’ Research universities are mostly plentiful throughout the US and produce graduates eager to fill important roles within local start-ups. But for leadership and directors, talent can be harder to come by. In particular, the CEOs most likely to raise later stage investment rounds are serial entrepreneurs (see here, here, and here). Investors are more comfortable with road-tested leadership. The most important talent advantage some regions possess may not be accessible to a pipeline of PhDs. It may be the availability of repeat founders.
- KOLs, Early Adopters, and Evangelists. While not always a necessity, many device start-ups benefit from proximity to health care systems. Customer discovery can happen anywhere. But larger systems in larger metropolitan areas provide a greater density of user candidates for discovery conversations and beta testing and a greater likelihood of engaging with key opinion leaders and future product evangelists at major research or clinical institutions.
- Capital. At my first company (located in Ann Arbor, Michigan), my co-founder and I frequently struggled with venture investors who all but excluded any investment opportunity that required air travel for face-to-face meetings. ‘You’ll need to move your company’ was rarely heard among likely angel investors but was a common refrain from coastal investors capable of leading Series A investments. As I’ll expand upon below, regardless of where you are in the country, sources of Seed investments (often less than $1m) provided by individuals are more plentiful than larger investments backed by institutional investors.
Proximity to investors historically has mattered a lot, and it’s almost always a shorter drive to the nearest angel investor than to the nearest venture fund
To further understand the separation between these Seed and Series A and B investments, it’s useful to think about the investors themselves. By SEC rules, angel investors have historically needed $1m in investible assets — a proxy the government uses rightly or wrongly to identify who among us is sufficiently sophisticated to make risky bets and sufficiently wealthy enough to survive being wrong. Comparably speaking, and certainly relative to the number of venture capitalists, there are tons of these folks around, even in regions with few venture capitalists. I pulled data from the US Census to compare the number of high net worth individuals to the number of venture funds in each state. Plotted in Figure 6, the correlation is striking.
Consider the absolute difference in the local availability of the two types of investors. Take a middle-of-the-pack state like Wisconsin. There are approximately 50 venture funds of any size and sector that call the Badger State home. According to 2020 census data, there are more than 138,000 households meeting the high-net-worth threshold. This wild disproportionality exists everywhere.
If only a small sliver of high-net-worth individuals in a region are interested in angel investing, they still far outnumber the local number of institutional investors. Start-ups everywhere can find a local Angel. Not so much a Series A investor.
Should Start-ups Move to Raise Money?
Looking at these trends, some medical device start-ups located beyond the main business cradles may be tempted to move. On average, I believe that is not the best path forward. Moving is expensive and very time-consuming, and moving to high-start-up-activity regions will bring increased costs from rent and salary. For many early-stage companies, a major move would also likely pull apart, possibly fatally, the founding team.
Instead, I believe founding CEOs are wise to cultivate relationships with local Angels, accelerators, and governmental economic development agencies to create partnerships leading to Seed investments. Importantly, the budget for the Seed round needs to explicitly include plenty of travel budget — both to cover travel costs and to socialize the team and the board to the fact the CEO will be spending plenty of time out of town prior to the next round. For very small teams, an early hire with strong operational experience can help lessen the impact of a necessarily absent CEO.
Will telecommuting change everything?
The COVID-19 pandemic has scrambled historic early-stage investment calculations. A tremendous amount of pent-up capital is intersecting with an intense interest in the life sciences. Life science start-ups have offered hope for ending the pandemic while being resilient to many of the economic and workplace disruptions that have upended the global economy. Meanwhile, video conferencing has become second nature both by virtue of its technical quality and by a recognition of the time efficiency video calls can provide for many needs. An early teleconferencing concern expressed by folks on both sides of the fundraising table — namely that it was difficult to gauge the character and intent of negotiating partners — seems to have subsided.
My sense is that telecommuting may significantly lower distance barriers to medical device fundraising (and fundraising in many verticals) bidirectionally. As institutional investors become increasingly comfortable tracking progress remotely, they may be more inclined to make remote investments. Likewise, angel investors may increasingly have access to distance investing. Thus, angels in regions of the country where they historically haven’t had access to many investment opportunities may suddenly have many more choices.
I’d expect these changes to expand the universe of investible device start-up epicenters. Institutional investors going further afield will uncover hidden gems. Start-ups in less prolific regions will also need to become competitive earlier as local investors will be less confined to local investments — never before has it been easier for Angel investors to look over the horizon for opportunities that had once been limited to their back yard.
Concerning talent, it’s difficult to fully predict the impact of the Great Resignation and the sudden outflow of talent away from historically active regions.
During the pandemic, millions of mid-career professionals — including many in pharma and biotech (your narrator included) — quit their job in what is now known as the Great Resignation. Many have relocated or are in the process of doing so. As a result, we are in a moment where start-up talent has the ability and inclination to flow into previously underfilled areas of the country. These changes are so recent that their impact on how and where new medical device companies are launched will take a couple of years to understand. The big question for me is to what extent that most powerful start-up ingredient — CEOs who are not in their first rodeo — will take part in this migration and thereby re-draw the medical device start-up and financing map.
Questions? Comments?
ArgoPond is forever upping its game, and our team is interested in questions and comments that arise among readers and what types of analysis you’d like to see in future research notes. Get the conversation started and leave comments below. You can also reach out to us directly via info@argopond.com.
Notes on data sources and modeling
- The data stack in this note includes Crunchbase Pro, the Google maps geocoding API, and geographic-specific information from the US Census and the Federal Communications Commission. The Crunchbase data set was downloaded July 30th, 2021, and included life science investment disclosures from Q1–2018 through Q2–2021 (14 fiscal quarters total). Contact me for details regarding the query structure.
- Any database of investment deals comes with limitations. A data vendor can only know what it can discover, and start-ups and investors vary widely in their willingness to share deal details. Crunchbase uses a combination of self-reporting, AI/ML algorithms, a community of users providing deal insights, and human curators. Ultimately, these data sets are incomplete. The issue then becomes whether data are missing in a systematically biased way such that conclusions are incorrect, rather than just quantitatively imprecise. I have not seen evidence that would change the ‘polarity’ of the conclusions in this note, but acknowledge the magnitude of effects and specific counts (e.g., the number of VC funds in the US, the actual number of Seed investments made in a particular region) are necessarily estimates.
- I define the I-95 corridor here informally as the region of the northeast US bound by (-78.5 < Longitude < -69.5)(38 < Latitude < 43).
About the Author
A physician-scientist by training, John Younger is the Managing Director at ArgoPond, LLC, a life science advisory and investment company that provides analytics and diligence services to companies and funds engaging the life science space. In 2015, ArgoPond joined its first cap table, and continues to expand its investment portfolio in early-stage life science and biotech companies and in companies that are essential for ecosystem success. John has served for years as an advisor to the NIH and has provided congressional testimony on how best to support early-stage biotech companies. That testimony can be seen here. He represents ArgoPond as a member of the Life Science Committee of New York Angels, one of the most active angel investment groups in the world.
John’s LinkedIn profile and contact information are here.
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