Paladin Capital Group

Paul Conley

Medical care expenditures as a percentage of GDP are on a historic rise around the globe, due to population aging dynamics and per capita GDP expansion in both developed and developing nations. Increasing demand for higher quality interventional care and the growth of new markets in preventative and value-based care has put increased pressure on medical device manufacturers to release core product updates and deliver novel therapies, methods and devices in ever expanding service offerings for treating new indications. These core product and new product offerings have expanded laterally at higher and lower price points for broader socioeconomic distribution, especially in the developing world and 3rd world countries. While ‘R&D as a percentage of revenues’ has been a reliable leading indicator for pace of technological improvement in historic economic analyses, the current environment of internal R&D at large medical devices companies has struggled to keep pace with external R&D product innovation, largely funded by venture capital. As a result, inorganic M&A of new products coming from start-ups has dominated the revenue growth and margin expansion for large multinational corporations. Early-stage medical device entrepreneurs and venture capital investors have been emboldened by the many new and exciting product offerings acquired at various stages of commercialization by multinational strategic companies. These acquisitions of innovative start-up companies and gradual integration into existing business units has become a preferred go-to-market strategy for entrepreneurs, allowing corporate marketing managers with focused expertise and larger teams to leverage existing sales and distribution processes for optimized market profitability and shareholder return on invested capital.

The cost of capital has markedly increased as a result of federal reserve actions in the wake of the COVID-2019 pandemic, global geopolitical climate, and macroeconomic inflationary cycle. Despite the current departure from the low cost of capital environment of the 2010s, medical device innovators and entrepreneurs will continue to identify urgent problems to solve and consequently need experienced capital investment to commercialize superior solutions. As witnessed in the crash of the 2000 dot-com bubble and the 2008 global financial crisis, durable early-stage investors will be critical to supporting and investing in these innovators and entrepreneurs through a challenging period. While the volume of early-stage venture investments industry-wide may temporarily dip, the road to a new golden age of medical innovation and healthcare progress will be paved for innovators that can stay the course and focus efforts on improving clinical outcomes and addressing large-volume medical reimbursements where incumbent standard of care devices are under serving patients, providers and payers.

As a co-founder and investor of innovative life sciences companies, I challenge you to see the higher innovation cost of capital not as a regression from the capital abundance and venture growth of the 2010s, but rather a re-focusing on what matters most, namely the development of quality products that tackle big challenges facing humanity and deliver healthcare solutions for people’s urgent and unmet needs. Despite the higher bar for raising venture capital for entrepreneurs and the softened return expectations for venture fund managers, our firm believes that the broader decade ahead is filled with opportunity to create category defining medical technology companies that improves standard of care for patients in broad indication segments, including but not limited to respiratory health, surgical outcomes, oncology care, women’s health, and gastrointestinal health sectors. In this period of reduced valuation multiples and lowered market return expectations, the alpha of superior actively managed venture capital funds and savvy entrepreneurs developing ground breaking technology will be more clearly recognizable compared to past years of abundant low-cost capital and market exuberance.

"Increased cost of capital will force founders to be more disciplined, practice lean start-up fundamentals and thoughtfully plan longer-term budgets for major R&D expenditures, go-to-market strategies, and commercialization milestones"

Increased cost of capital will force founders to be more disciplined, practice lean start-up fundamentals and thoughtfully plan longer-term budgets for major R&D expenditures, go-to-market strategies, and commercialization milestones. This is not a new paradigm for the medical devices sector relative to the biotechnology or healthcare IT sectors, thus providing an exploitable advantage for experienced medical device founders and start-up companies to outperform their peers in other innovation verticals in this higher cost of capital economic environment. For regulatory agencies and clinical testing programs worldwide, reduced volume in each medical device segment allows for increased focus and resources for each funded program, resulting coordination between agencies and investigators and better funded clinical studies per program.

While the total aggregate market value of medical device startups may contract over the year ahead, we expect the design quality, product-market fit and commercialization success rate of new medical devices to improve over the decade ahead. The increased cost of capital will constrain number of venture funded medical devices at each funding stage; however, I believe dedicated technologists will not be deterred and coordinate to band together behind the best projects in our ecosystem to solve the most urgent and unmet problems in healthcare. My firm, General Inception, is doubling down on medical device innovation with a longer-term outlook and focusing on company-creation fundamentals to support scientists and engineers to tackle our world’s big problems. As an institutional co-founder, General Inception brings together domain expertise, executive talent, infrastructure resources, and capital to nurture and scale growth throughout the entire company journey, supporting our founders to face the challenges that will present in this longer-term outlook.