By this time next week, along with a contingent of our clients who run medical device companies, we'll be on Capitol Hill sharing the perspective of innovative life science startups that are facing increasing headwinds in starting, funding and growing their businesses.
It's a big issue, so this trip is focused on eliminating just one artificial barrier to our clients' success: the medical device tax.
Unless Congress takes action, a 2.3% excise tax on the U.S. revenues of medical device companies will take effect on January 1, 2013. We believe this tax will have a dramatic, unintended and adverse effect on the medical device industry and, in particular, on high-growth medical device manufacturers - the very companies our country needs to innovate to improve patient care and reduce health care costs. We urge Congress to repeal the tax or, at a minimum, delay its effective date until they have time to address a comprehensive solution in 2013.
If unresolved, the device tax won't just penalize device companies, it will pose the following risks to our economy and our country:
- Less innovation to improve health care outcomes and reduce costs
- Delayed patient access to advances in medical technology
- Fewer high paying jobs
- A continuing decline in U.S. leadership and exports
Device start-ups need to invest heavily over many years to develop new technologies, obtain regulatory approvals, and commercialize their products. Since the device tax is a tax on top-line revenues (not on profits), it will place an enormous burden on smaller companies. Even with revenues of up to $100MM, many device companies are only reaching the stage at which they are profitable.
For companies whose revenues do not exceed their expenses, there are only two ways to pay the device tax. Neither is good for the company or for the country:
- One, investors shoulder the burden of paying the tax. This will reduce the funding available to finance other start-ups. Based on historical investment data, we estimate that if investors cover the cost of this new tax, it will translate into a loss of funding for on the order of 50 new startups. That's a lot of lost innovation.
- Alternatively, companies pay the tax by cutting off other investments in R&D, hiring, and new manufacturing facilities. This hurts the companies, and it hurts our economy by reducing innovation and eliminating jobs.
The structure of the device tax will add new compliance costs, which smaller companies will struggle to absorb. The fact that the IRS has not yet issued final regulations only increases the cost and uncertainty facing smaller companies.
The device tax will act as one more reason for companies to focus their development and commercialization efforts overseas - adding to the risk that the United States will increasingly lose the "spoils of innovation" such as job creation, GDP growth, R&D reinvestment, taxes, and access to cutting edge medical innovations.
The Ultimate Risk: Fewer New Companies, Fewer Life-Saving
and Life-Enhancing Products
In recent years, device companies have seen a sharp increase in regulatory costs, delays and uncertainty. At the same time, the number of companies that succeed or "exit" successfully has remained largely flat, and even down in some years. Together, this has stifled the amount of capital available to fund device startups.
Venture capital investments in medical device companies declined every quarter in 2012. In Q3, they hit their lowest quarterly level (by dollars) since 2004. For the full year 2012, we expect device investments will reach an eleven-year low.
The number of venture funds actively investing in life science start-ups is also shrinking. The industry contracted by about 40% from the 2005-2008 period compared to the 2009-2012 period. We expect another 25% decline in the number of active life science investors during the next four years.
The shortage of capital hurts both existing companies and new start-ups. Since 2000, approximately $38B has been invested in more than 1,600 life science companies. These companies are still working to overcome the regulatory and funding challenges to reach a successful exit. However, the increasing regulatory and costs have left many of them cash and capital-strapped.
Looking forward, the picture is even more alarming. Life science venture funds have been investing more capital than they have raised for a number of years, which means that even today's level of investment isn't sustainable.
Regulatory and market headwinds are also affecting the pattern of innovation. In order to create an effective, affordable health care sector for the long term, we need to address serious issues like diabetes, obesity, and vascular disease. But investments in these and other capital-intensive sectors are particularly scarce. Since 2005, significantly fewer device companies in these and other capital-intensive sectors have been funded - meaning critical health care issues for the most costly chronic conditions are not being addressed.
The United States has always led the world in creating and commercializing new solutions to improve patient outcomes and reduce the cost of care. We are at risk of losing our lead. With the right actions - and the right sense of urgency - we can reverse this trend.