INVENTION TO STARTUPSOURCES OF FUNDINGTrevor Moody – Frazier Healthcare VenturesJens U. Quistgaard – LipoSonix, Inc.

Overview

Observations on the current financial climate

Sources of funding Exercise – potential sources and their attributes Quick case study: SonoSite, Inc. Quick case study: LipoSonix, Inc.

Venture funding in depth What is a venture capitalist? Venture capital funding criteria What has changed recently?

World Market Conditions

“Fear” is high Global credit

crunch/recession Uncertainty about

size and extent of problem

Companies most affected have: Operational leverage to GDP or

Balance sheet debt

VSX Volatility Index Sept 2000- Sept 2008

Data courtesy of SV Life Sciences LLP

Effect on Private Companies

Relatively limited impact on healthcare companies

Reduced access to public markets for exit or financing

Reduced availability of credit and increased financing costs

Potentially longer time period to exit and lower exit valuations

Performance of Healthcare Indices Health sector is driven by non-discretionary

spending and therefore traditionally a safe haven at times of economic turmoil

U.S. healthcare indices have all outperformed the S&P500 over the last 12 months

S&P 500 down 30% Medical device (DJUSMC) down 11% and

biotech (NBI) down 10% Healthcare services (IHI) down 17% due to

HMOs’ reduced rates of growth, credit contraction and fears about reimbursement

Performance of Healthcare Indices

65%

70%

75%

80%

85%

90%

95%

100%

105%

110%

05/10/2007 05/11/2007 05/12/2007 05/01/2008 05/02/2008 05/03/2008 05/04/2008 05/05/2008 05/06/2008 05/07/2008 05/08/2008 05/09/2008

Re

lati

ve

12

mo

nth

pe

rfo

rma

nc

e

Healthcare Services Med tech Biotech S&P500

12 month performance of US Healthcare indices to 5 October 2008

Data courtesy of SV Life Sciences LLP

Healthcare Fundamentals Strong Recession resistant

characteristics: Rapidly ageing population ~10% of world population is

over 65 Rising incidence of chronic

disease Rising healthcare costs US healthcare spending $2.3

trillion in 2007, $7000 per person

Healthcare spending outpaces overall economic growth and inflation

Regulation creates high barriers to entry

Globalization and new markets Innovation creates new markets

0 20 40 60 80

Cancers

Mental disorders

Diabetes

Heart disease

Hypertension

Pulmonaryconditions

Stroke

% rise in disease

Forecast rise in chronic disease 2003-2023

Predicted population growth 19%

Data courtesy of SV Life Sciences LLP

Healthcare Investing (USA)

Equity into US VC-backed healthcare companies

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 H1-08

Am

ou

nt

inv

es

ted

($

mill

ion

)

Biopharmaceuticals Healthcare ServicesMedical Devices/Equipment Medical Software & IS

Pro

-form

a

Data courtesy of SV Life Sciences LLP

So…

Financial markets are a mess Healthcare is a great place to be in these

times Funding is still available, but…

Bar is raised for new investments Valuations are down Each type of funding is affected differently

Sources of Funding

What are they? Self Friends & Family Debt Grants, contracts – NIH, SBA, DARPA, etc. Angels Venture funds Crossover funds Strategic (other companies) Public markets

Sources of Funding

What are they? Self Friends & Family Debt Grants, contracts – NIH, SBA, DARPA,

etc. Angels Venture funds Crossover funds Strategic (other companies) Public markets

Quick Case – SonoSite, Inc.

ATL Ultrasound – parent Digital ultrasound pioneer Core competence in ASIC implementation

The hand-carried ultrasound vision The internal funding reality DARPA dual-use program

ATL Ultrasound University of Washington VLSI Technology Harris Semiconductor

SonoSite – Getting Off the Ground Basic development 1996-1997

$12.6MM DARPA matching grant Handheld Systems Business Group 1997 Spin-out as SonoSite, Inc. - April 1998

$17MM cash (+$13MM later) Technology license NASDAQ listed – distributed to ATL

shareholders First working prototype – September 1998 First follow-on financing – April 1999

($33.8MM)

SonoSite – Lessons Learned

Government grants are a wonderful thing But…

You need an impressive consortium to get large $

There are some complications Government technology rights Consortium member’s technology rights Reporting requirements Etc…

Being a pre-revenue public company, in my humble opinion, is not a wonderful thing

Quick Case – LipoSonix, Inc.

Originally pitched to investors by two individuals Not successful

Picked up by a medical technology “incubator”

LipoSonix, Inc. founded in late 1999 Initial venture funding, January 2001 (1.4MM)

IP licensing Exploratory work

Series-B, tranche #1, November 2001 ($4MM) More exploratory work

LipoSonix – The Bothell Story First full-time employee and dedicated

facility, August – October 2002 Series-B, tranche #2, September 2002

($5.9MM) First human study, July 2003 The joy of venture debt Series-C, July 2004 ($27.0MM) More debt… Initial customer shipment More debt… Acquired by Medicis Pharmaceutical Corp.,

July 2008

LipoSonix – Lessons Learned Top-drawer investors really help! Be aware of capital structure issues

associated with incubators Be aware of capital structure and terms

issues associated with venture financing Multiples requirements Liquidation preferences (!) Etc…

Venture debt is a wonderful thing If you can get it, and use it appropriately

Different money sources are likely to be involved as the company grows

Funding Source Prototype Pre-Clinicals Clinical Proof

IDE Approval Pivotal Trial FDA Approval

Commercialization

Angels, Grants etc.

Venture Capitalists

Corporate

Public Markets (IPO)

ConfidentialConfidential

5%

25%

45%

15%

60%

100%

10%

Funding needs increase significantly as the start-up moves towards commercialization

Typical Funding Requirements Through a Company Lifecycle

Sources of Funding – Venture Capital

> What is a Venture Capitalist?

> What criteria do VCs use to decide what to invest in?

> What has changed recently?

What is a Venture Capitalist?

Follow the Money

The General PartnerAnd the Fund

Sources of Capital Investments in US HealthcarePortfolio Companies

• Retirement funds

• University endowments

• Families / high net worth individuals

• General partners

0

1000

2000

3000

4000

5000

6000

7000

Inve

stm

ent (

$MM

)

1996 1997 1998 1999 2000

Update!

> Typically small partnerships made up of a few General Partners (2-10) and other staff

> General partners collect a percentage of the profits

> Payouts over several years

> Lucrative but high risk

> Manage one or more funds raised sequentially over several years

> Fund sizes range from <$5MM to >$2B

> Some firms have been around for >50 years but vast majority have emerged in the last 15 years

What is a Venture Capitalist?

Medical Device VCs are looking for the most exciting new technologies

> Opportunities of great interest to medical device companies

> Innovations that will be rapidly adopted by physicians

> Incremental improvements

> “Products, not companies”

A typical large healthcare VC may see 1000-2000 plans per year and invest in only 10

The Medical Device Investor’s checklist

Management / Founder Teams

Big Markets / Rapid Adoption

Regulatory/Reimbursement pathway

Early Clinical Proof-of-Principle

Patents

Management/Founder teams

> Most startups won’t have a CEO who has taken 3 companies public

> Experience in other successful ventures

> Have recruited top-tier mentors, board members and advisors

> Open to adding other great executives to the team

> Deep understanding of the target market and technology

> Just want money, don’t want a partner

> Unrealistic expectations of how hard it will be

> Looking for a quick win

Big markets/Rapid adoption

> Physician specialty has demonstrated that they will rapidly adopt new technologies

> $1B + potential market

> Targeting procedurally oriented specialties e.g. cardiologists, orthopedic surgeons, etc

> Challenging physician referral patterns

> Requirement for large upfront capital outlays

> A very large existing or potential market is critical for generating investor interest

Regulatory/Reimbursement

> Clear FDA approval requirements

> Compelling economic argument to key decision makers e.g. physicians, hospitals

> Physician community excited enough about technology to lobby for reimbursement

> Trials requiring long follow-up

> Great macro-economic argument but no-one incented to adopt

> FDA and CMS challenges are often underestimated by founders

Early Clinical Proof-of-Principle

> Rapid, ethical path to early clinical feasibility testing

> Early clinical data that is highly suggestive of likely success of the pivotal trial

> Need to run large, lengthy clinical trial to see if it works

> Mediocre efficacy results

> A rapid path to clinical proof-of-principle greatly increases the fundability of a company

Patents

> Very strong protection around key innovation

> Building a “patent thicket” to cover other related inventions

> Broad early patents (an added bonus)

> Sloppy patent strategy / disclosures that have limited patentability

> Freedom to operate concerns

> Strong patent protection is essential in a technology-driven venture

What is the impact of the economic crisis on venture capital?

> Limited impact in the short term – in 95% of cases, funds will continue> Quality VCs raise money from quality, long-term Limited Partners

(LPs)> VCs have not typically used debt … fortunately

> Potentially dramatic impact in the long term> Exits – Definitely delayed significantly

> LP appetite for VC investments will decline over time

> VC investment criteria will be more conservative> Early-stage VCs will still invest in early-stage companies but hurdles

will increase> More sensitive on capital needs, time to market etc.

Wrap-Up

> Healthcare - Perhaps no better place to be driving innovation

> Buyers less affected by acute economic turmoil

> Insatiable demand

> Demographics

> Lot’s of money still out there … the bar is much higher but great opportunities and great teams will get funded

> Take a strategic approach to fund raising. Target the best sources of money given your opportunity and stage of development

> Expect to spend a lot of time raising money