Traditional venture capital firms are struggling to remain relevant to new company formation, the development of new technologies, and the capability of bringing new medical device technologies to market. Although my comments are specific to medical device venture investing, my friends in Silicon Valley will agree, if even only in a quiet moment of reflection, that the same applies in biotechnology and general technology investing.
There are four reasons the traditional venture capital model has failed with regard to backing medical device companies.
With a permanently-closed IPO window for devices, buyouts are the way to go. The big companies readily admit they can’t invent their own products, and look to acquisition as the way to fill their needs. They complain, however, venture-backed pickings are not attractive. Targets are too expensive, and it is too difficult to incorporate bloated venture-backed companies into their own infrastructure. They want products, not companies.
Also, larger funds reward partners more through management fees than carry. A $500 million fund returns $100 million to its few partners over 10 years. Nice living! There is no need to actually deliver successful products—that is why returns are remain low.
Larger funds must make bigger investments; corporate buyers are unwilling to pay double-digit multiples for the resulting investments. Larger investments both reduce the chances of success and extend the amount of time it takes to deliver a product—something VCs are increasingly averse to as they look to prove returns to fidgety LPs. Fewer than 5 acquisitions per year are >$100 mm, while 150-190 acquisitions per year take place, typically at $10 million to $90 million. Unfortunately, most VC’s cannot make “skinny” investments–blame their fund structure and partnership incentives.
None of us knows what the future of medicine will look like—all claims to the contrary notwithstanding. We make our major advances by accident. Shooting for small ‘wins’ results in major wins. Shooting for major wins results, for the most part, in failure.
Now, LPs see that med devices had the best IRR’s 10 years ago—when most VC firms were young and willing to invest small and stay by their investments. The returns from the flagship med device VCs have been in the basement for years—but the message has yet to get through. Since most LPs are poorly paid and stay in their position for much less than the lifetime of a fund—they go along with the cycle hoping that the old, good performance returns.
As a result of the above observations, we formed a fund which is “early in, early out.” We sell our medical devices just after we’ve proven that they work, or after FDA approval—no infrastructure, no management, and no duplication that the acquirer needs to get rid of. It’s more honest—and a lot more fun.
John Lonergan is the managing member of Mach Ventures. The opinions expressed here are entirely his own.