Investors Bet on Med-Tech : Venture Capital Backs Hot Industry; County Emerging as Winner
In the beginning it seemed fairly easy to the three young entrepreneurs.
They would quit their jobs, develop a prototype for their novel precision-motion motor and start manufacturing it for a market that would run the gamut from laser surgeons to “Star Wars” technicians.
During the next 18 months, the founders of Vector Kinetic Technology Inc. pitched their plan to no fewer than 15 venture capital funds.
But not one offered funding, and on April 1 the Anaheim company quietly closed its doors.
“We assumed too much,” said William Fitzgerald, the former president. “A lot of the guys we talked to had already been burned by high-technology deals and didn’t want to touch us.”
The story is different at Retroperfusion Systems Inc.
The small Costa Mesa company, which has designed a pump to force blood back into a heart attack victim’s damaged ventricle, received a nearly $4-million venture capital commitment earlier this year after just a few months of looking.
“I can’t say that it was all that hard,” said Thomas Hines, the vice president for operations and engineering. “We just went out and looked.”
Why the difference in the two companies’ experiences?
There is an increasing wariness among venture capitalists nationally toward new electronics- and computer-related companies and a blazing market for emerging medical technology companies and specialty retail operations.
“There’s plenty of money available. The venture capitalists just want surer bets. They got burned by the electronics industry,” said Anne Bohn, a senior manager in the Newport Beach offices of the public accounting firm of Ernst & Whinney.
While there is no breakdown of venture capital funding within Orange County, Venture Economics Inc., the Wellesley Hills, Mass., research firm that monitors the industry, said that about 24% of the $2.9 billion invested by venture capital funds nationally last year went to non-technology related companies, contrasted with just 15% of the $1.4 billion invested in 1981.
Although the shift away from electronics start-ups has depressed new business formations in high-tech communities where silicon is king, the effect in Orange County has been relatively mild.
In fact, according to several business leaders, the new fervor for medical- and health-related companies is expected to firmly place the county, with its emerging med-tech industry, among the nation’s top areas for medical and biological products.
Orange County’s Role
Specialty retailing, while a popular investment in other parts of the nation, draws little funding locally because only a few such companies make their home in Orange County.
But within the last two years, say local venture capitalists and new business specialists, more than a dozen promising medical technology companies in Orange County have received venture financing. Several more deals are pending.
“Despite the pain for some, there’s been a net gain for Orange County,” said Jeffrey Weiss, founder of Southern California Technology Executives Network. The county, he said, has “a disproportionate share” of the nation’s medical technology companies, and many of them are “bound to benefit in the long run.”
But while the county is well poised to enjoy the latest boon in medical funding, there are still some who worry that venture capital history could repeat itself. Pointing to the splurge of 1982-84, when venture capitalists threw money at electronics start-ups, thinking that everyone would be a winner, some skeptics wonder if quality control is taking a back seat to visions of major successes with medical firms.
Nick Yocca, a partner in a Newport Beach law firm specializing in helping start-ups get off the ground, is one of the worriers.
Questions Some Deals
“There are more medical deals being funded today even if they don’t have the appearance of high quality,” he says. “It’s like the high-tech of a few years ago. And we all know what happened then.”
The latest move toward medical technology comes in the wake of the continuing shakeout among electronics makers. Venture capitalists also have turned to medicine because of the dearth of exciting, new electronics products and, perhaps most important, because of the ongoing losses to venture capital funds from their frenzied investments in computer-related ventures in the early part of the decade.
“It’s harder for electronics companies now to get money than it was five years ago because the venture capitalists are going back to basics,” said Stanley Pratt, Venture Economics president. “They want to back companies that want to make money, not just develop new technology.”
Analysts say the latest surge in interest for new health care companies differs markedly from the venture capitalists’ rush into the field in the early 1980s after the initial success of such venture-backed hits as Genentech Inc. and Cetus Corp.
Then, the rage was biotechnology and genetic engineering, two capital-intensive industries requiring large initial investments before producing a prototype.
Now, venture investors are targeting more specialized businesses requiring smaller, incremental investments, a change that appeals to the renewed caution among venture backers. Further, the funds are looking for a larger ownership percentage of a business in exchange for their money.
Lower Expectations
However, while the funds want to put up less money at the beginning, they are increasingly content to lower their expectations for the eventual payoff.
“We’ve moved away from the home run theory of investing that says we have to find a company that can grow to $300 million or $500 million. Now we’re looking for base hits, the $40-million to $60-million company that will be a solid performer,” said Thomas Winter, managing partner of the Costa Mesa office of Burr, Egan, Deleage & Co., a nationwide venture capital firm that moved into Orange County last year.
The county, with a longstanding community of medical device makers that grew out of American Edwards Laboratories and have been fostered by aggressive nurturing from sponsors such as the UCI Medical Center and the Irvine Co., has attracted companies that meet those criteria.
Consider, for example, the story of Pyxis Corp., a Newport Beach start-up that took its name from the Latin word for medicine box. The company was started two years ago by John McLaughlin, a retired Glendale surgeon, who teamed up with his daughter, Carol, a marketing specialist, to develop his idea for streamlining the dispensing of medicines in hospitals.
Last month, Pyxis, which originally operated out of Carol McLaughlin’s Long Beach apartment, received $500,000 in initial financing and a guaranteed future award of $1.2 million from a venture consortium led by Bio-Vest Partners of San Diego. In exchange, the venture group was given a 60% ownership in Pyxis, seats on its board and the right to name the company’s president--a professional manager.
Pyxis and many of the other small medical technology companies receiving venture backing these days also satisfy a growing need among health care providers to lower costs and improve efficiencies.
Programmed for Nurses
The Pyxis device, which attaches to each patient’s bed, is filled in advance with all of the patient’s medications and then programmed to notify the nurse when the doses are to be administered. The machine automatically records the dispensing of the medicines. By Carol McLaughlin’s estimates, the $300 device will pay for itself in one year with saved labor costs and reduced exposure to human error.
“The hot areas are the products that make the health-care process less invasive and less costly,” said Winter of Burr, Egan.
Robert Rosenbluth, the founder of Advanced Surgical Interventions in San Clemente, believes it.
Although in business less than one year, Rosenbluth raised nearly $1 million in private placement and venture capital funds in April for a product that is still in laboratory testing. And he says that he had to turn away would-be investors.
The product, which Rosenbluth declines to describe in detail lest he alert competitors, would allow a commonly performed urology surgery to be performed on an outpatient basis, a development that would save up to $3,000, or half the current cost of the procedure.
“We’re reducing the cost of medical care,” he said. “Finding the backing was a lot easier that I thought. I had venture capital companies coming to me.”
Venture capitalists say they are particularly interested in small, narrowly focused companies because they offer a great acquisition opportunity for one of the many large pharmaceutical or health care companies.
The importance of this motivation was underscored locally last month with the announcement of a pending $528-million acquisition of Caremark Inc., a Newport Beach home health-care provider, by giant Baxter Travenol Laboratories Inc.
