VCs Weigh Pros and Cons of Health Care

PEWeek, March 29, 2010, by Constance Loizos

Among the issues of concern is an excise tax at the point of sale for
every medical device company

The health care bill that President Barack Obama signed last week
looks like a boon for a lot of health care startups, and potentially
ruinous for others, according to VCs who’ve been following the debate.
David Jones, founder and managing partner of Chrysalis Ventures in
Louisville, Ky., says that some of the bill’s biggest beneficiaries
will be “young startup health care companies that make information
more cost-effective and accessible.”

Jones adds that Chrysalis made six new health care-related investments
just last year, including Cleveland-based CerviLenz. The company
produces an FDA-approved disposable device that is used to predict the
risk of preterm birth in pregnant women. If diagnosed early, doctors
can use progesterone suppositories to prevent some of those early
births, and save billions of dollars in health care expenses, Jones
points out.

CerviLenz has raised $2.1 million in venture funding from Chrysalis,
Arboretum Ventures and Jumpstart Inc.

“I can’t say [the health care bill] is an unmitigated great thing, but
money will begin flooding in, and in the context where everyone knows
that costs are running out of control, we expect a lot more demand for
the productivity enhancing products and services that are our bread
and butter,” Jones says.

Other health care startups, including those with long FDA approval
processes, may not be so lucky, suggests Alan Frazier, founder of
Seattle-based Frazier Healthcare Ventures.

“One can make the argument that we on the VC side should be thinking
of low-cost type products that provide better diagnostics or cheaper
therapeutics, but the FDA isn’t going to give us much of a break,” he
says. “They want us to do trials that show cost-effectiveness, but
it’s hard to come up with cheap products that do great work and that
will still fit in this [new] system.”

Medical device companies, in particular, may be hardest hit by health
care reform, says Lisa Suennen, the Corte Madera, Calif.-based
co-founder of the health care-focused venture firm Psilos Group. The
problem, she says, is the Medical Device Company Excise Tax, a
provision in the new health care bill that, beginning Jan. 1, 2013,
will impose a 2.9% excise tax at the point of sale for every medical
device company, big or small.

“For medical device companies that are truly better from a clinical
outcome standpoint and can reduce the cost to the health care system
or reduce costs per procedures,” the new bill is largely a positive,
Suennen says.

On the other hand, she adds, “they’re also taking it hardest from a
tax standpoint. A nearly 3% tax on revenue—not on profit—is going to
be fairly onerous for small companies, which will one of two choices:
raise more capital to operate their business or raise their prices.”
Suennen says she doesn’t “think that’s what was intended,” calling the
health care bill “pretty flawed.”Designed to revamp the $2.5 trillion
U.S. health care industry, which accounts for one-sixth of the
country’s economy, the health care law will extend health insurance to
32 million Americans who lack it. It will bar practices like insurers’
refusing coverage to people with pre-existing medical conditions,
expand the Medicaid government health insurance program for the poor
and impose new taxes on the wealthy.

Obama acknowledged the bill was “not perfect,” but listed what he saw
as numerous benefits, such as tax breaks to help Americans buy
coverage.

In the wake of the newly signed health care law, investors interviewed
by PE Week do not plan to heighten their commitments to finding health
care opportunities.

John Steuart, managing director Claremont Creek Ventures in Oakland,
Calf., says that the firm is “staying the course.

“I wouldn’t say the bill is going to encourage us to put more dollars
to work in [health care], but it won’t discourage us,” he says When
Claremont goes shopping next, he adds, it will look not just at
startups providing better care, but “better value care.”

Steuart says that one Claremont portfolio company that could
potentially draft off the new health care legislation is Mountain
View, Calif.-based Tibion. The company accelerates recovery time
cheaply, through a robotic device that promotes rehabilitation,
including helping knee-surgery patients. Steuart points out that
Tibion’s products are designed to replace occupational therapists. The
eight-year-old company has raised $6.64 million in VC funding from
Claremont and Saratoga Ventures.

Meanwhile, Jones of Chrysalis—which divides its portfolio evenly
between IT and health care companies—says that he and his firm have
actively sought deals, even as many health care investors were waiting
out the reform debate.

“We made six new health care investments last year that center on
productivity and efficiency,” he says. “Our view was that anything
being talked about in Washington, D.C., would make these issues more
important and that even if the overhaul didn’t happen, the cost
problem was still going to be out of control.”