By Walter Linder, Amy Judge-Prein, and Jonathan Zimmerman
Investors in medtech companies are willing to take risks. However, they will expect their investment to be put to effective use with defined objectives, and their diligence will focus on identifying potential impediments to those objectives. Because momentum is important when seeking investment, it is critical that the company has its fundamental regulatory, intellectual property (IP) and governance matters in order before diligence begins. The inability to ensure investors that these matters are properly addressed may slow and complicate the investment process. It may even derail the process all together. Investors have been known to leverage diligence concerns to negotiate price concessions. Here’s what to consider before engaging investors.
The regulatory path on the way to bringing a new product to market is often strewn with obstacles. Investors may not be surprised that your efforts are encountering challenges. However, it will be important for you to provide a narrative demonstrating that you are on the right track, and that you understand and are prepared for the challenges ahead.
Marketing Your Product. Be sure that your chosen U.S. pathway to market (whether it be the predicate product-based 510(k) process, the more lengthy pre-market approval (PMA) process, or some other regulator exemption) is truly applicable to your product. Determining the correct regulatory classification and areas of regulatory enforcement discretion can be difficult. This problem is compounded by shifting mandates of the FDA and other regulatory bodies. Increasingly, products such as software, apps, tissue and lab tests require complex analyses to determine which regulatory requirements apply. There can be significant hurdles, for example, due to increased time and cost requirements if the PMA process is necessary. Describe your strategy and outline the steps of your approval process plan and associated time frames in detail. If you have internal personnel or outside consultants with FDA experience, identify them and the scope of their involvement.
Studies. Be transparent about your pre-clinical and clinical studies. If they have not yet begun, describe the anticipated scope and timeline for those studies and how those studies relate to the marketing approval process, the product’s intended use and product claims. Both negative and positive outcomes should be addressed. Be prepared to show that you have appropriate agreements in place with all research collaborators, study committees, Contract Research Organizations (CROs), and research sites. Demonstrate compliance with relevant research regulations, including animal care and use requirements, informed consent and the Institutional Review Board (IRB) review.
Marketing Materials. Intended use is a critical aspect of product classification. Be sure your company’s internal and external communications describe product positioning within your targeted regulatory scope. And don’t forget to check marketing on social media. Inconsistencies in your intended uses may cause investors to question your regulatory strategy and your sophistication — and can also raise liability issues.
Reimbursement. No matter how efficacious your company’s product, the inability to secure reimbursement may present a substantial impediment to success. If you are still in the product development stage, explain your strategy for seeking reimbursement. If on the market, be prepared to disclose the current state of reimbursement for the product, any challenges you are facing, and how you are handling those challenges.
Your company’s IP may be its most important asset. Your investors will also want assurances that you have sufficient rights and abilities to distribute your product without infringing on the rights of others. Sophisticated investors are likely to expect these issues to be buttoned-up by your company.
Ownership. Clear up-front ownership or license rights sufficient for the intended use of your company’s product are important to avoid potentially troublesome disputes down the road. Absent proper legal documents, it would likely be a mistake to assume that you have these rights from either employees or paid consultants. Employees should have written invention assignment obligations covering their entire periods of employment, and you should be sure they are not subject to obligations of former employers. Similarly, you should have written invention and copyright assignments from consultants, especially those developing software. If any of the technology arose from federal government-funded research, a situation not uncommon for technology licensed from universities or non-profit research organizations, you may be expected to show that your licensor complied with requirements of the Bayh-Dole Act needed to obtain and pass on those rights.
Freedom to Operate / Infringement Charges. No investor wants to buy into a company staring at the potentially significant costs of patent litigation. For this reason, sophisticated investors may perform their own independent patent search to determine whether your company is able to commercialize its product without significant risks of infringing third-party patents. You should be able to assure investors that you have conducted a thorough freedom to operate review, and that you update that review as appropriate as your company’s technology develops.
Similarly, if a third-party infringement charge or offer to license has been made against your product, your investors will likely want to know of that development. Irrespective of how the third-party patent came to your attention, you should be able to explain that you have determined that you can operate without significant risk of infringement. Credibility for that explanation will likely require an opinion of patent counsel.
IP Strategy. Because of the importance of IP, your company can demonstrate a high level of sophistication to investors by showing it has developed and follows a defined IP strategy. Such a strategy need not be time consuming or expensive to implement. Components may include a senior member of the management team tasked with IP responsibility as part of their day-to-day activities, incentives to employees for submitting invention disclosures, regularly scheduled IP committee meetings to review the disclosures, and regularly obtaining patent landscapes on technology developments. Your investors will be impressed if you can show them that you know more about the patent landscape than they do.
Business Organization and Governance
Whether organized as a corporation or some other business structure, investors will want assurances that appropriate documents are in place to ensure sound governance and compliance. They will expect solid corporate governance, sufficient access to management and transparency to monitor their investment. Many of these controls will be put in place through the investment documents negotiated during the transaction, but having a strong foundation and culture will give investors confidence.
Organizational Documents. Investors will want to review the documents setting out the structure of the organization. Those documents may include charters, operating agreements, bylaws and qualifications to do business.
Control and Ownership Documents. An experienced management team and a respected board of directors are likely table stakes. Investors will want to understand how the existing equity owners and board exercise control over the company and its decisions. This includes reviewing minute books, committee charters and principles of corporate governance, as well as voting, shareholder and member control agreements.
Capitalization. Understanding the company’s capitalization is critical — investors need to know the size of the pie to understand how much their slice is worth. This requires a review of stock ledgers, investment documents, stock certificates, warrants and equity compensation plans and award agreements.
Financial Documents. Investors will likely want to review several years of financial statements, as well as IRS filings. If possible, having an audit completed prior to investment will bring significant comfort and can reduce time to closing as investors will be less likely to do extensive financial diligence.
Be prepared to tell your potential investors a compelling story. And have your data room loaded with the information they are sure to seek. The ability to carry momentum through the diligence process will enhance the speed and likelihood of success of your financing transactions.