This article from German DeviceMed highlights various financing options for German companies that are largely applicable in other markets as well. Germany represents the largest medical technology market in Europe and also takes a leading position in a global perspective. The pace of innovation is high and the market is growing. At the same time, the market segment consists of over 90% of small and medium-sized enterprises (SMEs), and a lack of capital can put a stop to many good innovations.
The pace of innovation and the pressure to constantly develop new products and services require capital, sometimes very large sums. The new EU MDR (Medical Device Regulation) and increasing security thinking from authorities in different countries also entail rising costs. All this must be financed and there are a number of different sources of financing. But these differ for large and established companies, small or small companies and also for start-ups.
Medical technology is an innovation-driven industry – but what financing options are available for companies? This article presents the most common financing models for medical technology companies: from equity to loan financing and from crowdfunding to company acquisitions that are financed with equity and bank financing (so-called mezzanine capital *).
Research and development of medical technology is cost-intensive. Despite this, the industry is one of the few that continues to grow continuously and it is financed from various sources. However, financing through investment companies is not the only way to get money. Who finances what and how the financing takes place in detail is not so easy to see through.
What financing options are available for medical technology companies?
Companies can generally get capital from quite different sources. Some have equity, others need external capital. Everything is possible, from classic bank loans or capital from friends and relatives, to financing through investing companies. For some start-ups, crowd funding can also be an option. Already established companies must constantly finance innovations and development. Here, too, crowd funding in various areas can be interesting. In Germany, this possibility is not yet common, but it is possible. German medical technology is mainly financed by:
- External capital
- Mezzanine capital *
*) Mezzanine capital refers to company acquisitions that are financed with equity and bank financing. Banks usually grant loans up to a certain loan-to-value ratio, which, however, varies over time. A complementary form of financing has emerged, so-called mezzanine loans. In terms of security, mezzanine loans are subordinated to bank loans. The higher risk for the issuer of mezzanine loans means that the interest rate for such a loan is higher than for ordinary bank financing. In addition, there is usually an element linked to options that means that the lender receives certain compensation linked to the value development of the company.
Which source of financing is relevant for each company depends on what is to be financed. Smaller projects, which in an easy-to-understand way primarily help many people in everyday life, can be financed through crowd funding.
For very costly innovations, which are mainly used in laboratories and hospitals, this possibility does not exist; other sources are needed here. And of course, only one single source is never used. The funding is in most cases a mixture of different measures, which can also include grants or subsidies from the state, the EU or various organizations. Which projects can be financed in that way and by whom and to what extent can be read about elsewhere. This is about financing medical technology that differs significantly from subsidies and grants.
1. Self-financing or financing through equity
Self-financing means that a company invests part of its turnover in innovations to promote the development of new technology. This can be desirable because the patents from the innovations can contribute to profitability. Because medical technology is an extremely innovation-driven industry, only those companies that constantly develop new technology as a subcontractor, that are marketed themselves or that are sold to other companies usually survive.
In 2006, for example, 15,700 medical technology patents were registered in Germany. That was more than the registrations from the IT sector or the automotive industry for the same year. Not all patents lead to a product and even patents that do, do not normally do so within one or two years. But still: nine percent of the technology companies sales in 2006 were invested in research and development. How fast the medical technology industry is developing is made visible through data: in 2006, an impressive third of all medical technology products on the market were not older than three years . And the industry has been growing ever since. In 2014, the share of equity for medical technology companies was a proud 55%. Which is the average figure – large and very profitable companies significantly affect this figure.
Equity financing not only has benefits. If the equity is restricted, it cannot be used in other areas of the business. In addition, the financing of innovation and development always poses a risk. No one can guarantee that the end result will be a salable product or service. And above all, no one knows if the competitors in the end will not be faster, which may eventually lead to patent litigation. But after all, financially strong companies in particular prefer to finance through equity, and thanks to their profitable working methods, they can ensure that they can finance their innovations and further developments with the exact right mix of loans and equity.
In phases of rapid growth, however, the proportion of external financing also increases in these companies, as studies have shown. External financing will be gradually reduced again only in the years following these rapid growth phases. This highlights the benefits of mixed financing and the luxury of being able to keep these opportunities open.
2. External financing for medical technology companies
There are various forms of external financing: Medical technology companies can find investors who finance projects with their equity. This is the case for developments that a medical technology company provides as a service provider to another company that initiates and finances it. In that case, the development is admittedly paid for by an external company, but since it is a joint project, this form of financing is still counted as “equity”.
External capital comes as loans from banks and credit institutions. Another possibility for external financing is public financing, which in addition to loans with special conditions for start-ups or special eligible areas also includes grants and subsidies from the state or the EU. But these opportunities are not normally described as external capital, even if they are technically so. These funds are often booked either as loans (subordinated loans with partly the same characteristics as equity) or as equity (Private Equity or Venture Equity).
Those who are interested in subsidies or grants should look for information in different places because the possibilities are extremely many and very different. Many public funds have few conditions but are only granted depending on the current economic situation. Interested companies should therefore not only apply because the conditions theoretically entitle to a grant, but possibly also wait for the right time for their application.
On the other hand, when capital from companies, business angels or investment companies is used to finance development projects in medical technology, we are talking about mezzanine capital *. Technically, it is true that it is about external capital and thus loan financing, but often the characteristics of this capital are more like self-financing. The financing of medical technology is not so much about dividing it into equity or loan capital, but more about where the capital comes from. Decisive for a division are other aspects, namely to what extent, to what conditions and whether repayment is to take place at all, as well as whether a repayment is conditional on a profit sharing and the like plays a major role. As always in the financial sector, there are no easy answers.
3. Mezzanine capital leaves medical technology companies many freedoms
The term mezzanine comes from the architecture and denotes a low floor between two higher ones. It is thus literally imagery when talking about mezzanine capital as an intermediate form of equity and loan capital. And that’s exactly where mezzanine capital is legally classified; it takes precedence over equity but is subordinate to external capital. This has nothing to do with the share of the total financing, but describes the form of repayment and legal claims in the event of bankruptcy.
Mezzanine capital is interesting for the financing of medical technology because, like equity, it is available financially or in the balance sheet. However, the capital owner does not have the right to participate. There are no claims to voting and co-determination rights or assets because the donor of mezzanine capital is not a partner. This is especially important when there are disinterested (altruistic) motives for research and development and when the purpose is to improve a current situation. Or when innovations are to be driven whose potential profitability does not (yet) matter at all (yet). Especially when it comes to life-saving technologies, purely financial motives must be left out. When this is the case, mezzanine capital enables financing completely separated from the economy and the end product. And of course, this gives the developing company or those involved in the projects the greatest possible freedom in development.
If the mezzanine capital comes from banks, this usually means higher interest costs than usual loans and credits, which also have completely different terms. Since mezzanine capital granted as a loan by the credit institutions is counted as equity for the project in question, the creditworthiness of the company or project also increases through the mezzanine capital, which creates scope for higher creditworthiness. The mezzanine capital can thus also, carelessly expressed, be used to play a little. That it does not “play” too much is normally ensured by the credit institutions’ higher interest rates.
Mezzanine capital in the form of subordinated loans or as a passive holding is primarily suitable for small and medium-sized companies, SMEs. These SMEs benefit most from this form of financing. But there is also the possibility of using profit-sharing loans. This financing is also included in the mezzanine capital and, in addition to SMEs, is also interesting for large companies. Start-ups and very small companies do not normally have the opportunity to receive mezzanine financing.
4. Other financing
Funds and venture capital companies
The size of each company affects choices and opportunities for financing. Very small companies are referred to capital from business angels and also use this form of financing more often.
Small and certain medium-sized companies, on the other hand, can obtain capital from venture capital companies, while larger medium-sized and large companies can use share capital. Both Private Equity and Venture Capital are forms of financing for equity. These are linked to a time-limited exit strategy. The special thing about these forms of capital is that there are usually no dividends. Profit is achieved through only the sale of the shares.
Private equity in this case is capital from private sources. With this, shares in the company or project are acquired, but outside the stock exchange. Private equity is considered to involve low risk.
Venture Capital, on the other hand, is venture capital because it finances the entire chain from the start of the company, the first development steps in medical technology and also the desired growth. This means higher risk. When financing through Venture Capital, the company management also receives greater support from the capital donors.
When it comes to what form of financing is meaningful in medical technology, one must also make sure what exactly is to be financed. When financing a company, the legal capacity to act must be ensured. But when projects in medical technology are to be financed, it is a question of investment plans. Usually you then form a project company, ie a so-called Special Purpose Vehicle. This project company focuses exclusively on a specific, predetermined investment project. The whole thing is refinanced by the future cash flow from the project. And of course, these projects can also be company-wide.
Crowd funding – new opportunities through crowd-pleasing ideas
The so-called intelligence of the swarm has long been used for investments in all possible areas. The idea is simple: projects are presented to the public and private individuals can invest small or very small grants (usually three- to four-digit amounts). The Aescuvest platform, for example, also offers not so wealthy but interested private individuals the opportunity to participate in the financing of medical technology innovations. However, not all projects are accepted without further ado, but they are carefully examined by health and financial experts. Only after that does a fundraising campaign start.
Financing new projects with crowd funding is also no longer uncommon in medical technology.
In order to succeed with crowd funding, the projects must be prepared so that they effectively attract interest. Some prerequisites are that each project is well described and easy to understand and that many people can understand primarily the real benefit of it and secondarily the financial success. However, many medical technology projects are so abstract and detailed that they are not suitable for public funding.
Crowd funding-finansierade projekt i Tyskland 2011–2017 (miljoner euro)
Where and in what technologies is currently being invested in medical technology?
At present, the medical technology industry in Germany is characterized by a high export ratio (over 60%) and a high proportion of innovations. After the United States, Germany is considered the most innovative country in this field, although several medical technology companies fear that advances in medicine will take longer to reach the patient. In addition, medical technology in Germany is mainly characterized by SMEs, which represent 90% of all companies in the sector.
Exactly how a company in medical technology secures its financing, however, varies greatly. During the first years after the establishment, financing seems to take place mainly through cash flow and own funds such as profits and reserves. Venture capital from business angels or holding companies in young companies accounts for only a small part of the entire financing volume. And the larger and more established a company is, the greater the external financing through banks and credit institutions.
But also the financing through authorities or the state in the form of subsidies and grants as well as from other companies increases with the age of the company. Interestingly enough, subsidies and the like are the key that opens the door to other sources of capital. Even if the sums are small, more sources of capital can be used and thus play a major role in the overall financing.
All in all, medical technology in Germany is perceived as a growth engine. But this does not mean that all projects or plans have a good chance of finding funding. Everything that has to do with digital health is right now in the spotlight. Here, the trends in health and digitalisation meet and mix. In this area, there are the smart watch that monitors, evaluates and shows the heart rate while running, intelligent insulin pumps for children and IT that is used in the operating theatres. Even artificial intelligence and ditto therapies are no longer castles in the air because learning systems are already used in various sectors.
This is a translated and edited article from DeviceMed.