In 2009, the life sciences sector as a whole weathered the economic downturn comparatively well. This sector captured the largest percentage of total venture capital investment at 34 percent ($6 billion) according to PricewaterhouseCoopers and led the merger and acquisition (M&A) charts with 24.9 percent of total deal value according to the 2009 Deal Drivers review. However, there is evidence that the medical device industry has not fared as well as some of its counterparts within the entire life sciences sector. Nevertheless, cash-rich large device companies recognize the imperative of capturing a portion of the robust product pipeline coming out of smaller companies in response to a growing “buy it” rather than “build it” mentality driven in part by what many view as rising barriers to entry in the medical device industry. In turn, there is growing concern that the general economy, together with potential barriers to entry, will continue to stifle venture capital investment in the device industry.

We believe that these perceived entry barriers to the medical device industry are a result of several proposed legal and regulatory changes and the resulting climate of uncertainty. First, there is significant concern that proposed changes to the FDA's premarket notification program, also known as the 510(k) clearance process, will result in many more devices having to undergo the more stringent, time-consuming, costly, and uncertain premarket approval (PMA) process. Second, the proposed Medical Device Safety Act of 2009 (MDSA) seeks to overturn the Supreme Court's 2008 ruling in Riegel v. Medtronic that held that the Medical Device Amendment of 1976 (MDA) preempted state law claims brought by parties injured by medical devices that had undergone the PMA process. If passed into law, the MDSA could allow for a significant rise in product liability litigation against device manufacturers along with the corresponding drain on resources. Finally, many of the proposals for health care reform call for significant tax increases on the medical device industry, potentially to the level of $20 billion industry wide, per year according to BusinessWeek. Further, the general climate of health care reform in the current administration has already increased pricing pressure on the industry, thereby cutting into margins.

Taken in sum, it appears that the looming specter of increased regulation, litigation, and downward price pressure is making the medical device industry comparatively less attractive to venture investors who are dealing with struggling portfolio companies and continue to seek certainty and quick returns. This is especially worrisome for early-stage medical device companies who have yet to develop an exit strategy and are heavily dependent on venture funding to keep research and development progressing. Nevertheless, we believe that funding options remain open, especially for later-stage companies. Many of these funding sources will come through partnerships, licensing agreements, and M&A deals with larger medical device companies seeking to employ the “buy-it” model to enhance their product pipelines. For example, Thermo Fisher Scientific, Inc. recently acquired Ahura Scientific, Inc. in order to enhance their position in the handheld analyzer market, while Medtronic, Inc. recently purchased Invatec S.p.A. in the interest of growing their cardiovascular business. Consistent with such recent transactions, anecdotal evidence suggests that there is significant money on the sidelines from large device manufacturers who are looking to expand market share. Whereas early-stage venture investors may be reticent to enter or further commit to the industry in light of the current uncertainty, established players need to remain competitive regardless of regulatory changes and understand that the new barriers to entry, combined with the increased time and expense required to bring products to market, make the “buy it” model increasingly attractive.

In spite of the potential impact of regulatory changes on venture investment in the short term, the improving overall economic conditions in 2010 and beyond will likely increase the volume of medical procedures, thereby boding well for the future health of the industry as a whole. In addition, to the extent that the proposed health care reforms result in more people having insurance coverage, this too may increase demand for purchase of medical devices. Finally, the increasingly aged American population will certainly continue to drive growth in the device industry. Thus, while the current regulatory climate may be less than ideal for early-stage ventures, for companies with the wherewithal to form strategic partnerships, create licensing opportunities, or involve their company in a M&A transaction with a cash-rich company, the opportunities seem promising.