Are Taxes Hurting Medical Device Startups? Not Really

April 15, 2014

Is the Affordable Care Act’s (ACA) medical device tax, which went into effect in January 2013, having an impact on venture funding? Not necessarily.

Only 60 VC investments were made in the healthcare devices & supplies sector in 1Q 2014, as we report in our upcoming 2Q 2014 U.S. VC Industry Report, to be released tomorrow. At that pace, 2014 deal flow would decline about 32% from 2013 levels, which was a down year itself, 18% off 2012 levels. Compared to funding activity in other segments of the healthcare industry, devices & supplies commands much less VC attention these days (35% of deal flow) than it did in, say, 2011 (46%). By percentages, the current prom king is biotechnology & pharmaceuticals.

Source: PitchBook

Source: PitchBook

Taking a look at the capital invested numbers, though, and we find that VC firms funneled $886 million into the devices & supplies space in 1Q 2014, which is actually a little ahead of 2013’s pace ($3.4 billion total, averaged out to $849 million per quarter). Granted, capital invested in 2013 was a tad down from 2011 and 2012 levels, but both were standout years for VC dollars in devices & supplies.

With all the talk about VC investment drying up after Obamacare passed, you’d think that 2009 or 2010 would be a high-water mark for VC investment in healthcare devices. Just the opposite, actually—both deal flow and capital invested rose incrementally every year from 2009 until 2012, according to the PitchBook Platform. Devices & supplies financings, believe it or not, hit a 10-year high in 2012, two years after the ACA was passed and just a year before the medical device tax went into effect. It seems odd that VC firms, which look several years down the road before investing, would complete more financings and invest more capital in the industry every year right until January 2013.

Source: PitchBook

Source: PitchBook

From a bird’s eye view, the data doesn’t suggest the tax has been a concern for investors, unless there was widespread hope in the investment community that the tax, like so many other aspects of the ACA, would be delayed indefinitely or scrapped altogether, or that the Supreme Court would have struck down the legislation back in 2012. Now that it’s been firmly in place for more than a year, perhaps investors are adjusting to a new financial reality.

This isn’t to say that the tax hasn’t been a burden on the companies themselves. There’s plenty of anecdotal evidence that suggests raising capital is more difficult now than it was in the past.

“The venture capitalists that fund startup ventures like our company have a certain exit number in mind, which is driven by the larger companies looking to acquire,” said Matthew Frinzi, co-founder and chief business officer at device-maker PowerVision, in an interview with AllThingsD. “And now, those companies are all facing a hefty tax on top-line sales.”

According to the same piece, though, the company was looking to raise another round of funding, and wasn’t ultimately worried about getting the capital. That may be the case for other startups across the industry—longer, more burdensome fundraising efforts, but ultimately getting the money.

We suspect there may be some interesting trends in medical device company valuations, as well, particularly at the seed and Series A stages, and we’ll check back into the topic after 2Q 2014 with sturdier trend lines.

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