Medical device valuation for startups has always been challenging as the use of traditional valuation methods have not provided a defensible model. The challenge of regulatory approval, difficulty of determining the competitive landscape, ability to determine accurate risk and ability to predict adoption thus accurate forecasting have proven to be significant hurdles. The operational characteristics and valuation needs of startups are different from established, mature firms. For this reason, typical valuations methods are inadequate for medical device startups who have unique valuation considerations.
A startup in the formation phase requires more attention from senior management for day-to-day operations. Many startups work with medical device consulting firms to secure assistance with additional fundraising and exit events. The trend of independent reviews of internal valuations or valuation opinions is also growing.
Defining The “Value”
Though defining the “value” of a business where comparable entities exist may be reasonable following accepted financial process, valuation can be challenging when the innovation does not have comparable technology against which to compare. Medical device consulting firms consider requisite aspects to develop the actual analytical framework to determine value. The following are the vital concepts for understanding the meaning of “value”. These concepts are essential in defining valuation specialist engagement.
Standard of Value
The standard of value defines value for a specific engagement. Identifying the appropriate standard of value is the starting point of every valuation. The following are the common standards of value for medical device startups
Fair Market Value
This standard of value is used in business appraisals. Fair market value is the price at which an asset changes hands between a willing and able seller, and willing and able buyer in an open and unrestricted market. Both the seller and buyer have the required knowledge and neither seller nor buyer is under compulsion to sell or buy.
Fair Value
For a startup valuation, fair value is the standard defined for financial statement reporting purposes. It is the price that would be paid to transfer a liability or received to sell an asset in an orderly transaction between the participants at the measurement date.
Investment Value
It is the value to an investor based on the requirements and opportunities of a particular investment. Investment value reflects the expectations, knowledge, economies and synergies of the scale of an investor. Valuation professionals use investment value to advise their clients while selling the business or executing some other specific transaction.
For defensible medical device valuation and pricing strategy, a medical startup must work with niche consultants having experience with unique medical device industry dynamics. Consulting true manufacturers in tech can also provide critical insights, as these entities understand the authenticity and quality standards required in the industry, which is essential for developing reliable medical devices.Especially with dynamics and regulations in the Asian market where device registration in Asian markets like Hong Kong is voluntary in Hong Kong for Class II and above medical devices and Class D IVD devices. It is also important to understand that valuation knowledge and industry knowledge are not synonymous.
Approaches to “Value”
Asset, income and market are the three approaches to determine business value. Each approach has specific methods to determine value. A medical device startup must consider all three approaches.
Asset Approach
This approach examines the cost to be incurred to reassemble the assets and liabilities of the company. The asset approach is inappropriate for a medical device startup unless it is in a very early operational development stage. For a startup, this approach provides valuation benchmarks after completion of fund-raising rounds.
Income Approach
This approach is based on the expectation of future cash flow. The focus is on potential future economic benefits the company can generate. The mechanics of this approach require the estimation of future cash flows and discount rate to determine the present value of expected future cash flows. This approach has a wide range of methods typically categorized into one of the following two categories:
- Single period capitalization
- Discounted future benefits
The income expectations are often characterized by a period of anticipated increasing capital needs and operating losses. This is followed by payoff in the form of strategic acquisition or any other exit event. The above two categories are rarely appropriate.
Market Approach
This approach involves a comparison of the recently transacted similar businesses. This comparison is made with valuation metrics implied by transactions involving similar companies or investments in publicly traded companies.
When sufficient quantity and quality of appropriate data is available, companies prefer the market approach. However, not all startups have sufficient information for enterprise value determination with the market approach. There is an exception for a very late stage startup. Prior financing rounds often provide meaningful value indications.
Medical device valuation has always been a challenging requirement for startups. Getting help from medical device consulting firms is in the best interests of a medical device startup.