Understanding the Reality Behind a VC “Yes”
The LSI Europe event provided a forum for senior leaders of the industry to provide clarity on the most perplexing part of capital acquisition what is required after an investor expresses an interest in the investment. The due diligence panel within the medtech conference shared that many times commitments (whether verbal or continuations through a term sheet) are not executed as full completion of a capital acquisition.
The professionals participating in this discussion were a varied group of experienced medical technology industry participants, including investors, attorneys, and the entrepreneurial community. Collectively they offered considerable insights regarding advances in fundraising and capital acquisition practices while demonstrating the increasing complexity, scrutiny and detail within this arena.
As we now seek to fund companies within the medical technology sector; we are dealing with extended due diligence timelines, heightened scrutiny by investors and evolving types of negotiations to complete these funding transactions. At the conclusion of the medtech conference discussions, the panel identified several key components that will enhance a company’s chance of creating a successful investment – such as, operationally ready – financially prepared – transparently discussing financial and regulatory issues – and developing strong operational plans.
The Many Shades of Investor Commitment
A common subject discussed throughout the medtech conference Europe panel was that not all investors giving you a “yes” has the same level of certainty.
For the most part, investor commitment is contingent upon some internal approval, approval from other members of the syndicate that will be participating or further investigation into the deal before doing a possible investment into your company.
It is not unusual for a founding entrepreneur to be told that the investor is going to support your company but, later on down the road, that person may express concerns, which can ultimately cause the deal to not go through.
For entrepreneurs who are developing medical technology (medtech), understanding the reality of how funding works is very important. Fundraising in the med-tech industry takes time, you must be prepared and you need to find ways to keep your momentum going while working with uncertainty throughout the fundraising process.
It is also important to note that panelists advised that the entrepreneur should not consider investor verbal support as a “done deal” until such time as the entire investment has been finalized.
Venture Capital Due Diligence in Practice
After a term sheet is issued, the real work often starts. Venture Capital (VC) due diligence involves a comprehensive review of nearly every aspect of the company.
In general, when it comes to medical device investments, investors look at the following:
Investment due diligence typically consists of:
- Financial records
- Intellectual property (IP)
- Clinical development strategy
- Regulatory strategy
- Customer contracts
- Government and board structure
- Team leader
- Operational risk
For Med-Tech (medical technology) companies, this phase can be especially intense, as investors want to fully understand the long-term risk profile of the company before they invest large amounts of cash.
During LSI Europe, the panelists stressed the importance of transparency during the due diligence process. If an investor uncovers any undisclosed issues during their due diligence process, that could cause significant damage to their trust in the company and could even result in the end of the negotiation process.
Why Communication and Process Management Matter
One of the key topics discussed at the Medtech Conference was how critical it is for founders to have an active involvement in the diligence process. Excellent communication among the founder(s), their legal counsel, and potential investors can cut down on delays, ambiguity and wasted resources. Organized communication among the parties involved is a strong indicator to an investor about how well the company as a whole is being run.
In order for partnerships to work, founders need to be responsive, transparent and engaged during all discussions with regards to fundraising.
Panel members further stated that while outside advisers may help facilitate the diligence process, it is critical that founders remain part of the leadership team involved in the negotiation or diligence review.
Negotiating More Than Valuation
Although fundraising typically focuses on valuation, panel participants said that governance and control terms tend to become even more significant as time passes.
Examples of governance concerns include board membership, reporting requirements, rights of investors, and voting structures, all of which can dramatically affect the way a company operates after the agreement has been executed.
In the case of medical technology companies, product development cycles are long, and future financing rounds are quite standard. Therefore, poorly structured governance and control terms can create problems for the medical technology company for many years after funding occurs.
The panel advised medical technology innovators to evaluate very carefully what they are willing to cede prior to negotiations, as decisions made in early rounds of funding will likely have substantial effects on flexibility in future rounds of funding and operational control.
Alignment Between Founders and Investors
The LSI Europe meeting conveyed that alignment of vision and growth strategy between the investor and founder is critical. If there is a misalignment of growth strategy and company vision, tension may arise later on leadership decisions, acquisition opportunities, or operational priorities.
Most successful medtech partnerships are established by sharing expectations from the outset of their relationships. Investors and founders who understand each other’s long-term objectives and are in alignment will have the ability to foster fruitful relationships through all phases; including times of growth, uncertainty, etc.
The Hidden Risk of Legacy Terms
In addition, the panel pointed to the long-term implications that deal structures developed in early financing rounds have on future funding rounds.
Terms that are manageable to a Series A raise may cause substantial difficulties in funding those deals in the future. New investors often evaluate each and every existing agreement in depth, with a focus on the protections granted to existing investors and the governance rights provided by existing investors.
For med tech startups, it is critical to maintain clean and balanced deal structures not only for their current fund-raising success but also to secure future funding opportunities from new investors.
This issue will be especially significant for companies in the med tech sector, where there are frequently multiple financing rounds that occur prior to reaching the commercial stage.
Why Venture Capital Due Diligence Matters More Than Ever
At LSI Europe 2023, the conversation highlighted how important it is that venture capitalists conduct due diligence as a major phase in the venture capital investment process. This is a critical phase of determining investor confidence in the company, structuring the company to build investor confidence, and identifying the potential for future growth.
For innovators in the medical technology (medtech) field, fundraising is dependent on the ability to demonstrate: transparency, preparation, strategic thought and the alignment between the vision of the founder and the vision of the investor.
As the medtech industry continues to evolve, conferences like LSI Europe and other prominent events are still very important to medtech investors, founders, and advisers in order to collectively discuss their experiences with developing and financing healthcare innovations.