Venture Capital Notebook: Medical devices are getting a healthy infusion of cash

Forget software and Internet technologies, the real activity in Seattle is happening
in medical devices.

At least that conclusion could be drawn after three local medical-device
companies — Spiration Inc., Vertis Neuroscience Inc. and Calypso Medical
Technologies Inc. — raised significant venture rounds in the past 50 days.

By JOHN COOK
SEATTLE POST-INTELLIGENCER REPORTER

Together, those companies have raised $87 million, more than all of the dollars
invested in all private companies in the state in the first quarter. The investments
also represent three of the top five private equity deals in the state this year.

Furthermore, rumors are circulating that another medical-device start-up —
Kirkland-based Cardiac Dimensions — raised about $12 million this month. If
that’s the case, investments in medical-device companies are quickly
approaching the $100 million mark.

The investment activity surprises even some longtime venture capitalists who have
historically placed bets in the sector.

"That’s pretty amazing," said Alan Frazier, managing director of Frazier & Co., the
founding investor of Seattle-based Calypso Medical (See related story, E1).

But Frazier, whose 11-year-old firm invests about one-quarter of its funds in
medical-device companies, believes several factors are driving the trend.

"I think part of what is taking the money there is that devices are real tangible
things," Frazier said. "If you look at the IT (information technology) side people
are running away from anything that isn’t hard-core, real company kind of stuff and
there may be a tendency of leaning towards tangible products, whether in biotech
or devices."

Spiration and Calypso have yet to bring a product to market, and Vertis only
recently received Food and Drug Administration approval for its
back-pain-alleviation device. But investors like these kinds of companies because
they have specific, well-defined markets. Venture capitalists not only can test the
products, they can also get a sense of how big the market is by looking at those
who suffer from back pain or lung disease.

No wonder that the $37 million investment in Seattle-based Vertis was
oversubscribed with 11 venture capital firms participating.

Another factor playing a part in the growth of the sector here is Scout Medical
Technologies, a venture capital incubator formed by some heavyweights from the
medical-device field. The Kirkland firm includes James Fitzsimmons, a former
executive at Guidant Corp. and Eli Lilly, John Adams, co-founder and former chief
technology officer at InControl Inc. and Clifton Alferness, who spent 14 years as
director of research at Physio-Control Corp.

Their expertise has already led to the formation of Spiration, Cardiac Dimensions
and other companies.

Richard Shea, president and CEO of Spiration, a 40-person Redmond company
developing devices for the treatment of lung disease, benefited from the newfound
interest in the field. His 3-year-old company raised $22 million this week from a
group of investors that included Sprout Group, Three Arch Partners, New
Enterprise Associates and Versant Ventures.

Two years ago when the company raised a $12 million round, Shea struggled to
get recognized as many venture capitalists chased software and Internet deals.

"When we went out to raise money two years ago, the audience was very small.
A lot of the venture folks who followed devices, because of the hot IT market,
swung and changed their practice to IT deals," Shea said. "This time a lot of
those same venture companies have flopped back and the professionals that were
following devices before are back on it."

Although most industry sectors experienced significant declines in the first
quarter, investments in medical devices remained stable at $409 million on a
national basis. That means the medical-device category now represents a larger
piece of the venture capital pie. In the Pacific Northwest, this appears to be the
trend as well. During the three year period from 1997 to 1999, 16 medical-device
companies raised a total of $37 million. So far this year, twice as much has been
raised by just three companies.

But while money continues to flow into medical-device companies, Frazier is
quick to point out that investing in the sector is full of pitfalls.

That’s because medical-device companies, like biotechnology firms, are subject
to a long regulatory process. In addition, because medical devices involve a
manufacturing component the capital expenditures needed to bring a product to
market are usually extremely high.

Frazier said those factors have not made the medical-device sector the easiest
place to make money over the years. Even though Kyphon Inc., a Sunnyvale,
Calif., device maker, successfully completed an $90 million initial public offering
last month, Frazier said the device field has not been the best place for
blockbuster IPOs.

"I think the biggest issue is the lack of history of big IPOs; it is not like biotech,"
Frazier said. "Maybe everybody has forgotten that it is hard to do and they are
rushing" to invest in medical-device companies.

Yet, he is confident that Seattle can produce two or three solid opportunities in
the field each year.

So is Thong Le, an associate with WRF Capital in Seattle.

"We have a strong base of researchers at institutions like the University of
Washington that often see the problems and complications associated (with) a
number of invasive medical procedures," said Le, whose firm has financed local
firms such as Therus Corp. and Ekos Corp. "I also see a growing base of local
talent to draw upon for early-stage device companies and think that the presence
of high-quality medical-device incubators will help develop the next generation of
medical-device companies that will put the Pacific Northwest at the forefront … of
innovation."

P-I reporter John Cook can be reached at 206-448-8075 or
[email protected]. For more information on Seattle-area start-ups or
venture capital firms, visit http://www.seattlepi.com/venture.

http://seattlepi.nwsource.com/business/75494_vc21.shtml