An Introduction to MedTech Valuations

In order to understand the potential returns on investment in early stage medical device company, we must first begin with a discussion of how these companies are valued.

Here is a wildly oversimplified overview of how it works.

Broadly speaking, all companies are worth the total profits generated over the entire lifespan of the company.

However, because we can’t know for certain how much that will be, the company uses forward-looking assumptions about earnings and then applies a “discount” to that number based on the various risk factors in the deal.

This is commonly known as the Discounted Cash Flow method (or “DCF”).

Now, this method is fine for large established companies who have stable cash flows…

But for early stage medical device companies – which usually operate at a loss for a while before generating any revenue – we have to base valuation models around key assumptions and risk-reducing milestones.

Key assumptions are things like:

• How big is the total addressable market?

• How much of the market can the company capture?

• What price points – and profit margins – can the company sell the products for?

• What is the exit strategy and potential for shareholder return (and how fast could it happen)?

This can give us an idea of how much the company could be worth sometime in the future…

However, because of the risk factors, there is room to negotiate the “correct” valuation of the company (and by extension, the share price).

In order to increase the valuation – or otherwise negotiate financing terms – the team needs to demonstrate to investors they have achieved certain risk-reducing milestones that would justify a higher price.

Major risks-reducing milestones fall roughly into four categories:

• Technology / IP: does it work how you say it will / can you protect it?

• Regulatory: will regulators let you sell it?

• Clinical: can you demonstrate it works in humans?

• Market: will someone want it and pay for it?

And for the vast majority of early-stage medical device companies – many of which are pre-revenue – understanding what risks potential acquires expect to be reduced or eliminated is key to understanding potential exit value.