Bullhorn: A History Lesson in Tech Funding

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If ever there was a company which tracks the history of start-ups from the late ‘90s to date, it is Bullhorn. Their highs and lows (they are a software solution for recruiting employees) were traced by Art Papas, CEO and founder, at the December 11th breakfast meeting of the Association for Corporate Growth held on the Boston Fish Pier.

In quick summary: Bullhorn was a dot-com start-up, which took $4,000,000 of venture capital in 2000, at the height of the market for dot-coms when the company had no customers, not to mention profits.

Along came the dot-com bust, and the company’s $235,000 a month burn rate, combined with inability to garner sale during the bust, became unsupportable. Raising additional capital to retool the company came at a huge price in terms of management dilution; the original investors had a full ratchet anti-dilution provision which almost wiped out the founder group’s equity position.

Rebuilding the company over time, in 2008 the original investors were taken out by Highland Capital and General Catalyst. Shortly thereafter, there came the 2008 crash — a bad time for a company whose sweet spot was facilitating the filling of job positions.

Sufficiently resilient to continue to grow at a reasonable pace throughout the “great recession,” in 2012 Bullhorn was acquired by a private equity firm which provided guidance for growth, supported another complete retooling of the software suite, and further encouraged growth through facilitating four acquisitions during the following twelve months.

Bullhorn now claims $67,000,000 in gross sales for the year 2013, a positive trending year for 2014, plans to greatly expand both the size of the enterprise and its top line, and an optimist future which includes going overseas to non-English speaking economies.

While not demonstrating the explosive growth shown by some of the social media or internet giants, the Bullhorn saga is a story of survival and success of a B-to-B enterprise spanning the highlights, and lowlights, of a turbulent economic period. It is stories like this which remind us of volatility over the last fifteen years.

If there is any takeaway, it is that flexibility and receptiveness to rapid change are the key elements for survival in the economic world into which we seem to be thrust.

Life Science: Early Stage Funding Trends

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What are the trends in funding early stage life science companies? A panel of seven investors speculated on the 2015 outlook, at a December 10th Venture Summit held in Dedham yesterday.

Riding an increasingly robust funding of transactions at the seed and A-round levels, the investors anticipate continued strong deal flow, driven by a reduction in the funding generally sought by start-ups. They speculated that this reduction was driven by more refined pitches and reliance on internet tools that make start-ups more flexible and efficient. Not mentioned, but perhaps another factor, is the sea change in the manner in which bio and bio-pharma companies are developing their products, in reaction to the massive capital requirements which caused negative investor reaction several years ago.

Hot areas anticipated are oncology, ocular disease, orphan diseases and, in the long run, genetic modification. One panelist, interestingly, suggested that capital is being scared off mass drug development because of the risks of liability arising from continued application of drugs to larger numbers of people over a multi-year period.

What company attributes are attracting capital these days? Robust teams. Proof of recurring revenue. A crisp story presentation. Avoidance of undue complexity (blamed on the lawyers, of course). And, although it can come in many forms, that elusive quality known as “traction.”

Trends in Public CEO Compensation

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Stock options are out, performance shares and restricted stock are in, equity may constitute 50% to 70% of the compensation of a public company CEO, and the ISS is on the move. Trends in CEO compensation for the coming year were examined at the November 11th Breakfast meeting in Boston of the New England Chapter of the National Association of Corporate Directors.

Stock options used to be the standard equity play for CEOs. For companies undertaking substantial growth, they still can constitute a serviceable compensation tool for the equity side of the equation. However, performance shares and restricted stock seem to have taken over as the equity mechanisms of choice in most instances.

Other trends include establishing ownership guidelines for a CEO, and what is likely to come next is a mandatory holding period during which the CEO must retain shares after they have vested.

Golden parachutes are shrinking in importance, the multiple of annual salaries paid to CEOs in the event they are fired after a change of control is shrinking. Nobody is any longer granting a tax gross up to these CEOs to cover the taxes in the event they receive a parachute payment.

There was speculation that activist shareholders might be holding down run-away CEO pay, and there was debate over the efficacy or non-efficacy of the proposed SEC disclosure rule which will require information about the “all in” compensation of CEOs expressed as a multiple of the median employee salary. This metric, long overdue, creates problems for companies with international operations, where compensation of a US CEO will be perhaps thousands of times higher than median pay if most employees are located in places like India or China. It was suggested that alternate metrics could be provided, in addition to the required disclosure, perhaps also expressing CEO compensation as a multiple of median United States-only employees.

The influential Institutional Shareholder Services, which advises investors as to whether boards should be supported, is introducing a variety of changes to its outlook on CEO compensation for the 2015 proxy season. In terms of disclosure, credit will be given to companies for positive forward-looking compensation disclosures (historically disclosures have been more backward looking), and in evaluating plans for equity compensation the ISS will be more holistic, considering such matters as planned cost to shareholders (SVT or “shareholder value transfer”), grant practices (including historical plan grant burn-rate), and plan features (minimum vesting periods, minimum holding periods and clawbacks).

The ISS is also considering gender diversity, indicating that boards without women pose a higher government risk to investors based upon academic studies, and is also considering the number of financial experts on an audit committee (implying that having more than one such expert may result in less governance risk).

Getting Reimbursement Codes for Med Devices

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Over the last few years, medical device companies have learned that in order to get financing at any level it is not only necessary to establish efficacy and potential economic benefits, but also necessary to understand a strategy for obtaining reimbursement for these benefits. A medical device company, to obtain financing, must show value to the party making the payment, not to another party in the use of the technology.

At MassMEDIC’s November 7th conference discussing markets for medical devices, it was suggested that one way to prove efficacy might be to target a smaller cohort notwithstanding the fact that one’s device might have general applicability. Proof of efficacy in the smaller cohort, and obtaining a reimbursement code, may be easier if focus is narrowed.

Noting that the United States is an outlier in the world’s healthcare universe, spending a disproportionate amount per person on healthcare, it was also noted that the value of a medical device in the United States market is higher by definition. Spending one day in a Unites States hospital is three or four times more expensive than one day in a European hospital. The United States also has an unusual model in that doctors are paid separately, which increases the likelihood that individual doctors will support new devices.

Some key take-aways with respect to the reimbursement system in the United States:

Reimbursement depends upon the setting, with different codes and different rates for the same procedure dependent upon whether that procedure is performed in a doctor’s office, a hospital ambulatory setting, or a hospital inpatient setting.

In the coming year, new ICD-10 codes, with far greater granularity, will be introduced in the United States, with mandatory usage beginning October 1, 2015. This will have huge impact on hospitals. (Coding for doctor offices and for outpatient treatment will continue to be under the CPT system.)

For a variety of reasons, many medical devices these days are first introduced in Europe, in the UK or Germany or Nordic countries. Most of Europe is on a single payer system. We thus have an anomaly: the value of medical devices is highest in the United States but the preferred path of introduction nonetheless is moving toward Europe in any event, by reason of ease of regulatory clearance and obtaining payment.

Why cannot a Med Device be more like a Molecule?

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At the November 7th MassMEDIC Boston conference on medical devices, a panel suggested that the medical device industry could learn a lot about how to finance early stage development by looking at the bio pharma model. It was posited that the bio tech model was better, in every year studied, in raising Series A funding and in reaching the IPO market. Why?

One reason: the potential rewards are higher. A single successful drug can sell billions of dollars per year. Further, some bio tech inventions create a platform which may provide the basis for a variety of drugs, or the application of the technology to a variety of diseases, thereby providing the potential of greater ultimate return. Another argument, somewhat circular, is that bio deals can exit at an earlier stage, so the investment is de-risked.

The panel then took a swipe at engineers who design medical devices. Engineers always seek perfection. In bio, once you have a molecule that is done, it is ready for the clinic and then to go to market. Engineers are always tinkering with machines. And, you also have to build machines, which is more complex then replicating a successfully designed molecule. (Whether these arguments are accurate or not I cannot say, but they were advanced by the panel.)

Another major problem is that you cannot easily do clinical trials in the United States on medical devices, which creates a problem for investors.

Then there is the issue of being able to scale in order to earn money. There is high capital expenditure, in order to reach scale and lower the cost of goods, when you are building a machine. This is not true, it was contended, with respect to chemicals.

Finally, it was speculated that the robust level of communication between investment bankers and the bio tech community is not echoed in the medical device field. Medical device companies, it was alleged, don’t really reach out to the investment bankers and tell their story.

Trends in Med Device M&A, IPOs

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At the MassMEDIC conference in Boston last Friday, Neil Oboroi of BOA/Merrill Lynch, an investment banker based in New York, discussed the M&A market for healthcare in general and medical devices in particular. As befits an investment banker, he was enthused with the increasing volume of healthcare M&A, and furthermore had statistics to demonstrate a positive link between M&A activity and stock price.

His belief is that stocks of companies effecting acquisitions in the life sciences out-perform their peer group (companies not undertaking M&A transactions) by 8% based upon share value. He predicts that consolidations in life science will continue, with acquirors seeking return on investment capital as opposed to looking only at earnings per share impact.

Many of the larger deals in the life sciences involved devices and diagnostics. Valuations, which peaked at about five times forward revenues in 2007 and fell to about three times in the ensuing years, are now up ticking again, in part because of the prevalence of cross-border transactions.

He also noted that larger publicly traded medical device companies were now trading at a little bit over twenty-three times forward earnings, down from approximately thirty-two times forward earnings a decade ago; so market multiples are falling. He also noted that many of the larger companies that had undertaken M&A were now choosing to report based on earnings per share, in addition to using a GAAP standard; earnings per share reporting allows easier comparison of companies, particularly as they are emerging.

Oboroi also touched upon inversion transactions, noting that earnings always were taxed where earned. The real play, made harder by recent tax changes, is the ability to utilize offshore cash domestically; the only way today to effect an inversion is through an M&A transaction.

There was also a discussion of the life science new issuance market, which is extremely robust and on a pace to equal or surpass the previous heights of the 2007 IPO market. The criteria for going public with a device company today: hard revenues, with a $25,000,000 to $50,000,000 minimum run rate, a growth curve, and a robust management team. The IPO market was viewed as synergistic with and consistent with the strong med tech M&A market.

New Seed Life Science Funding Source

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The Massachusetts Life Science Center announced at the MassMEDIC conference in Boston last Friday that it had established a new competitive grant program designed to provide seed funding for emerging life science companies in order to de-risk subsequent angel and VC financing.

A life science company within broad categories of eligibility, having previously raised at least $50,000 but not more than $1,000,000, can apply for a grant of between $50,000 and $200,000 in order to reach specifically stated milestones identified in the application. The milestone goal might be development of a product, or reaching a certain stage of clinical trials, or obtaining a strategic positioning, or the grant of a patent or the filing of a patent, by way of example.

The application period begins December 8th and ends at noon on February 2nd; informational programs will be held in late November and early December in Boston, Beverly and Cambridge.

The program, called MAP, can be reviewed in detail at the following website: [email protected].

VCs, FDA, Corporate investment in med-tech: Dr. Fogarty speaks

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The idea that venture capital has returned to the marketplace in order to finance life science companies, and particularly device companies, is simply not true, says Dr. Tom Fogarty, world renowned inventor and entrepreneur and most recently founder of the Fogarty Institute for Innovation, where he develops life science companies, in Mountainview, California.

Actually, Dr. Fogarty’s description of the non-presence of venture capital in the marketplace was a bit more descriptive, but I am not quite sure what the standards are for making reference to bovine excrement.  He delivered his remarks at today’s Medtech Showcase conducted in Boston by MassMEDIC.

Other gems:

            The problem with FDA clearance procedures is that the examiners belong to a union and do what they want to do.

            Corporate investment in life science is impeded in that large corporate investors give new technology to their own in-house people to evaluate; new technology that is better than in-house technology will not get funded on that model.

            Academics are no good at commercializing their technology, particularly in medicine.

Next week I will post a series of blogs on other take-aways from the MassMEDIC Showcase, covering a variety of subjects (new funding available through Massachusetts Life Science Center; the state of medical device M&A; the state of medical device IPOs; relative strategies for med device reimbursement in the United States as compared to Europe; a fascinating panel on why medical devices cannot seem to attract investment capital as easily as biotech).

American Law Uber Alles?

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How far can American hegemony extend when it comes to laying down the law of international transactions?

Buried in Section B of yesterday’s Wall Street Journal are two articles which suggest that the United States, the world’s most robust economy, is attempting to not only establish a capitalist world, but also to bring along American legal structures that will regulate it.

A Federal Court of Appeals is now determining whether Motorola can bring a treble damages anti-trust case for price fixing against a group of Asian companies which fixed the price on liquid crystal display panels. Motorola purchased about $5,000,000,000 worth of LCD panels for its Razr phones and other uses, but purchased them (fully manufactured) through foreign based affiliates, without United States contact, in 99% of the cases. Do our anti-trust laws reach sales by foreign companies, to foreign purchasers which may be owned ultimately by United States companies, and which occur offshore?

The SEC and the DOJ long have been vigorous in enforcing the United States’ Foreign Corrupt Practices Act, which prohibits bribery of government agencies and government owned companies around the world. The WSJ reports a reduced fine to Avon, an American company, for bribes paid through subsidiaries in Africa and Australia, and the SEC suggests that the fines were greatly reduced by Avon self-reporting its violations to the SEC. DOJ Criminal Fraud Section noted that voluntary disclosure is “a huge factor” in fixing sanctions. The article contrasts Avon ($5,000,000 fine) to Marubeni, a Japanese trading company which did not report and this year agreed to pay $88,000,000 in fines. A commentator, cited in this article, noted that foreign companies are particularly insensitive to the subtle DOJ message that self-reporting is the path to a better economic result.

The international nature of all business raises the need for an international matrix of appropriate, non-obtrusive regulation. Will the relatively strict American legal system end up as the international standard?

And, if you want to truly understand the international nature of things, note that Motorola, claiming anti-trust violations by its Asian vendors, recently was purchased by China’s Lenovo. We have a Chinese parent claiming violation of United States anti-trust laws by Asian vendors supplying LCD screens to non-US subsidiaries outside the United States.

Trends in board’s role in strategy

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 The just-released Blue Ribbon Report of the National Association of Corporate Directors on the board’s role in corporate strategy identifies the growing complexity of the marketplace, and the accelerating pace of change, requiring a “new level of board engagement.” Since directors long have considered strategic development as their core obligation, what more is being suggested?

Although the Report is full of specifics and flow charts which are useful, the bottom-line distillate is to move strategic discussion from an annual or quarterly basis to a continual process, identifying strategy as a year round central focus. This new focus is driven by marketplace realities, not by any change in the underlying law.

Not to be critical of the specific recommendations of the Report, which are both informative and cautionary, but one can read the report as primarily suggesting “do more of the same but do it better.” There are no startling “how to do it” revelations, which when you think about it is not surprising.

One interesting suggested innovation did catch my attention: executive sessions at the start and finish of every board meeting to permit independent directors to discuss strategy. The trend towards greater use of executive sessions, rubbing up against the practicalities of timing for board meetings, continues onward.

To the extent these NACD recommendations find their way into the directorship community, we might anticipate: it will take more time to be a director; there will be greater pressure in off-loading the other demands of directorship in favor of greater focus on strategy, which may create time tensions relative to committee service; there may be a subtle rethinking of the definition of a “good director” and an attempt to define the specific slot(s) as a “strategic director;” a change, through decided case law, in the standard of diligence required from directors under the so-called Caremark standard of duty to monitor (that whole area already is fuzzy in terms of its actual scope); and, a necessarily closer correlation between strategic consideration and enterprise risk management in a fluid environment.

Finally, it is good for directors to remember the following working definition of strategy: “the means to create economic value by gaining competitive advantage through unique value proposition.”