playbook-A Business Model that Quintuples Your Money?-April 2012
Spend time with entrepreneurs or those following early stage, private equity activity and you’ll hear there’s no growth capital out there—none at any price. This conversation is particularly pointed when it comes to medical technology start-ups. The hottest model for early stage investing in these parts during the 1990s is today, by most accounts, all but dead.
So what to make of CR Bard’s $225 million, all-cash purchase of Maple Grove-based Lutonix, a four-year-old company without a product in the market? Announced before Christmas, the deal includes an additional $100 million to be paid by CR Bard upon U.S. clearance of Lutonix’s lead product.
Lutonix’s sale is proof that investors are interested in the life sciences space, according to the company’s cofounder, Jay Schmelter of RiverVest Venture Partners. Limited partners in RiverVest’s Fund II made 4.7 times the fund’s $5.6 million investment in Lutonix, and that will jump to eight times if clearance comes from the FDA. He says Lutonix is not a fluke. Closing the deal capped a year in which RiverVest distributed proceeds from four successful life science exits, generating returns in excess of five times investors’ money.
Schmelter’s firm is in St. Louis, but he has deep connections to the Twin Cities’ medical device industry, including past work as an equity analyst at Piper Jaffray following cardiovascular manufacturers.
Schmelter says that up through 1998, capital for early stage companies had been almost too easy to get. The best ideas and managers can still attract funding, he says, but all involved still need to understand just how scarce capital is and spend accordingly. For his portfolio companies he counsels “pay only for what you need and avoid the overhead” by outsourcing key functions to contract research organizations and others. He notes that late last year, when Pfizer agreed to buy Excaliard Pharmaceuticals (another of his firm’s portfolio companies), it had completed three Phase 2 drug trials with a staff of just six.
Another strategy of life science VCs is what the Boston venture capitalist Bruce Booth of Atlas Venture calls “go early to shape the DNA”—meaning working with the entrepreneur from day one by hammering out what key milestones are and how to reach them. RiverVest wrote the first Lutonix investor check—$5,000 for common stock. An executive who had previously joined RiverVest, Dennis Wahr, helped assess the potential of forming a company around the Lutonix inventor, Lixiao Wang, and by the time RiverVest funded it, Wahr had become its CEO.
It’s not like Lutonix was exactly bootstrapped, with three other VCs in addition to RiverVest collectively putting in more than $35 million. But they faced a large task. Lutonix was developing a ground-breaking, drug-coated balloon to treat peripheral artery disease, and the product was going to take a long regulatory path.
Branded as Moxy, the product consists of a balloon catheter that delivers the compound paclitaxel to the arterial wall in a single, short inflation. Paclitaxel is a chemotherapy drug once branded as Taxol that is now commonly used to prevent arterial restenosis, or re-blockage, of the artery. Moxy looks a lot like a standard angioplasty balloon, a mature technology, but the Lutonix version contains a special coating consisting of paclitaxel and a proprietary carrier that enables the drug’s transfer to the arterial wall. In addition to effectiveness—dropping therapeutic quantities of drug right on the target—this approach minimizes chemotherapy entering the bloodstream.
Schmelter says that along the way Wahr made a point to keep updating the “strategics,” meaning the large medical device manufacturers like CR Bard who are keen to buy or license innovative product platforms. And Bard’s interest grew so intense last year that the investors who controlled Lutonix concluded that they could orchestrate a private auction for the company.
Bard is a 105-year-old company based in New Jersey with just under $3 billion in annual sales. The problem Bard shares with a number of its industry peers is that it can’t easily generate double-digit revenue growth. Bard also has a sizable business unit selling devices for interventional treatment of peripheral artery diseases. Bard’s Lutonix announcement coincided with its annual investor conference, and Bard CEO Timothy Ring told his investors “the next big move in this space—and by big I mean greater than $1 billion big—will occur in drug-coated balloons. We see this disruptive technology as both an opportunity and a threat to our market-leading presence.” Ring explained that Bard concluded that Lutonix had a “tangible lead” in this niche and was therefore willing to pay a premium. And it is costly—with earnings dilution estimated at $.25 per Bard share in 2012—for a product two-plus years from U.S. launch, if everything goes well.
There is broad agreement with Schmelter’s thesis of the new normal in life science venture investing. Paul Knapp, of Roseville-based Space Center Ventures, says he noticed in the data from PricewaterhouseCoopers’ MoneyTree report that the value of VC-backed exits last year bounced back to 2007 levels and that median valuations upon exit have been moving up. He tells life science entrepreneurs to “Do more with less. Be more efficient with capital. But do it knowing there will be tons of people who will want to buy your company at the end.”