Achieving the Exit with Paul Buckman & Pathway Medical

Today, we’ve got a contributed Q&A from our friends over at Shareholder Representative Services on how to structure exits. This will be available at their website later on today. Paul Buckman was president and CEO of Pathway Medical Technologies, which was bought by Bayer Healthcare affiliate MEDRAD last year. He spoke with SRS; the transcript is below.

Q : What factors led you to become the CEO Pathway?
I joined Pathway’s board in 2007, prior to becoming CEO in 2008. When I joined the board, Pathway had just been recapitalized and had essentially refocused their business on manufacturing and marketing medical devices for the treatment of peripheral vascular disease. Pathway’s initial focus had made it difficult to raise capital because there was a limited market opportunity. Once I was on the board, I really tried to help the CEO, Tom Clemens, a good friend of mine who I’d known from my previous life.

In 2008, the board decided to bring in a new CEO with more commercial experience to lead the company, since Tom’s background was more of a technical, R&D background. He agreed, and I offered to take over as CEO in September 2008.

Q : What was your primary strategic challenge?
The biggest challenge was that we were the fourth entrant into the market. Arriving late to the interventional device market was difficult because, like in any market, many of the beachheads had already been won and many of the physicians’ practice patterns were already established. Instead of creating the market, we had to go out and take market share from another company. That’s always difficult as a late entrant.

We decided that we really needed to focus on differentiating our technology and have a very strong sales presence in the hospital space. We were in a clinical space where the physicians want the sales people to be present on the procedures. That meant we had to put together a sales force with high clinical selling and consulting capabilities and credibility. Often that’s not easy to do. Those people have to come from the bigger companies and be convinced to take a bigger risk with a small company. It’s a big sales job.

We were very successful in putting together a terrific sales organization. Combined with what I thought was a differentiated and unique technology platform, it gave us the ability to go out and penetrate the market even though we were a late entrant.

Q : What were some of the tactics that you used to recruit the sales team?
We started by hiring some sales reps from the larger interventional companies–the Abbotts and the Boston Scientifics, et cetera–because they have the biggest footprint in the interventional space in clinical selling. We recruited managers with the intent that they would go out and tap into their past relationships and really get sales reps with the caliber and pedigree that we were looking for. I also tried to leverage my relationships to bring in a really blue ribbon class of sales people.

We offered them a little equity, but more than anything we gave them a high level of cash compensation. Unlike most startups where you try to save on the cash compensation by giving people equity, we had to offer a little of both. We had to ante up to get these people. The whipped cream on the top was that we really sold them on the vision of our technology and the fact that we had a better mousetrap than the competition.

Q : What is the best way for a CEO to leverage the board for executing the company’s strategy?
It depends on the makeup of the board. Early stage, VC-backed companies tend to end up with VCs on their board. Sometimes they have operational experience and sometimes they don’t. I think one of the things the CEO has to determine is where the board can add value and how to use them in the right way. Don’t expect the board to do things they aren’t equipped to do. I was fortunate at Pathway and felt like I had a very good mix of directors with operations backgrounds and venture capital backgrounds. That made my life a whole lot easier.

Generally, the board should be used for guidance. Some CEOs, particularly if they are inexperienced, will rely too much on their board to direct everything they do. When a company has a more seasoned CEO with a board that has confidence in him or her, the board can be more effective because their role is to confirm decisions or reinforce strategies and to provide some additional background information. The CEO should take the reins and use the board as a way to provide some additional support.

Q : What financing options did you consider when you needed to raise money in the later stages of the company?
We did obtain some venture debt financing from Silicon Valley Bank and Oxford Finance. Venture debt is a nice tool to have at your disposal because it’s not quite as a dilutive as normal equity financing. Sometimes you can’t get as much money, but it can be a nice adjunct to an equity raise that increases the amount of money you’re raising overall. It can also serve as the financing to get you to another milestone or two, so you can do traditional equity financing at a higher valuation. So, it can be a very useful tool.

Q : Did your team ever limit the capital you raised because you were worried about dilution?
Sometimes the thinking is, “let’s just raise enough money to get to that next set of milestones that are going to increase value,” which makes sense because you want to raise that money when you have a higher value so it’s less dilutive. The problem is that those milestones can be elusive and sometimes milestones change, timelines change or things happen. You don’t want to be in a situation where you then have to go raise more money and you don’t have any good news to share. That’s hard.

I guess the lesson I’ve learned in this respect is to be conservative. If I only need $20 million to get to my next milestone but I can raise $30 million and it’s going to be easy to make that round at $30 million or $35 million, I’m going to be pretty open minded to doing that to be on the safe side. Although it’s more dilutive, it’s a nice insurance policy to have. It’s nice to have that extra breathing room and runway to do what you need to do. I’m not sure everyone agrees with that approach, but I can tell you it’s not much fun raising money when you’ve missed a milestone or you are running your business on fumes.

Q : How did you balance your investors’ expectations with your selection of the right partner for Pathway Medical going forward?
I did two things. Venture investors logically look at how much they’ve invested in terms of the exit they expect because they want to make a certain return. One expectation I tried to manage with my investors was that nobody cares how much money they’ve invested. It’s like buying a house for a million dollars and then market value goes to half a million dollars–nobody really cares what you paid for it, they only care about what it’s worth today.

The price has nothing to do with how much money has been invested. It’s based on how much you think it’s worth, what the models say–cash flow, earnings multiples, revenue multiples, whatever measures potential buyers are using–that is what’s going to dictate how much they are willing to pay. I tried to manage the valuation expectations based on that.

The other expectation I tried to manage was that the highest value offer is not always the best offer, usually because a lot depends on structure and a lot depends on the deal actually being completed. The deals with less cash upfront and less backend risk can often be much better deals, especially in this environment.

Q : How did the deal with MEDRAD come about?
I was constantly in contact with people I knew at bigger companies that were potential acquirers of Pathway one day. Fortunately, because of my background, I knew most of those executives personally. I kept them up-to-date on what we were doing and made sure that Pathway was on their radar. I also wanted to find some new companies that were not traditional interventional players but moving in the right direction, and MEDRAD was one of those. I reached out to MEDRAD two years ago and starting talking with them about the possible fit of Pathway into their portfolio.

During that time they went through a management change, and I had to start over. They brought in new management team members that had some interventional experience, which was nice. I had an initial dialogue with them a little over a year ago and I also met with the executive in charge of Bayer Healthcare, which owns MEDRAD. He gave me an hour of his time to let me pitch Pathway, and he was very intrigued by the idea. Bayer was interested in expanding in the medical device space, and he thought this might be a really good fit with MEDRAD.

He supported our idea and combined with the interest that had already been generated with the other MEDRAD folks, we entered into a lengthy process of them doing due diligence on us, which ultimately led to their offer to buy the company.

Q : What steps should management take to retain employees post-merger?
When there is a change of ownership, there is always going to be some turnover and disruption. There are some things that can be done to minimize employee losses. The acquiring company needs to come in during a transition, identify key employees and make sure there is an adequate retention plan in place. I’ve seen time and time again that companies don’t have that type of plan out of the gate, until they see there is going to be an issue or people start leaving. Then they put the plan in place, but sometimes it’s too late.

You need to do that upfront. I’ve personally found that the more you can communicate upfront and make sure people have clarity on what the plan is, the better off you are. You risk people leaving the more you wait or delay communicating. Key team members need to know not only that there is going to be a financial incentive for them, but also that they are key people. The acquiring company needs to acknowledge that and take steps to keep them there. When companies struggle to put that sort of plan in place, it opens the door for people to leave, and that creates uncertainty, which is what you don’t want in these types of transactions.

Q : Looking back what lessons did you learn as CEO of Pathway Medical that you can share with your industry peers?
There are a few pretty obvious ones that were reinforced at Pathway. One is that you need to be very careful about not getting ahead of yourself spending money. Even if you have been successful raising money and getting it in the bank, the recent financial crisis has taught us that you really have to preserve cash to keep the company going as long as possible. You have to be disciplined. Companies will often fall into that trap where they raise some money and start hiring people and doing this or that and it can really create problems later on. I think being very cautious and conservative about spending money is one lesson.

The other side of that coin is when you raise money, you should raise as much money as you can, when you can. Don’t ever be so confident to think that if you need more capital you can raise more in 6 months or 12 months because you really just don’t know that. I think this current environment has really confirmed that for a lot of people.