Runaway Brides: Build-to-Buys at the Altar of Consummation (a Guide to Reinsurance) | LSI USA '25

Chris Cleary  0:05  
So I was talking to a lot of people in the audience, and all of them had the same question. Andrew, what were you thinking of when you came up with this title?

Andrew Cleeland  0:15  
I am not going nowhere near that. Chris, I thought you gonna ask. What was I thinking saying yes to you.

Chris Cleary  0:23  
All right, so let's go with what a build to buy is, and whether anyone here on stage has done one.

Hanson Gifford  0:29  
You know, a build to buy often comes about when a strategic company wants a new product in a specific sector, they have a defined interest there, and they're not seeing any likely companies that are organically being developed, they say, Let's go make something. And this can be very efficient and effective in that they can, they can fund it without spending venture dollars, which are very, very expensive due to the risk and uncertainty and illiquidity of venture investments and get more what they want, there can be a great collaboration between the startup and the and the strategic which can make the whole process more efficient and and better, frankly, and typically it's structured such that at a certain milestone, the strategic would would take it over and take it forward from

Chris Cleary  1:30  
there, yep. And look the talking about it from my former hat at Medtronic, the way we would think about build the buys would be what you said, you're building off of a proven internal interest in a product that you're not prepared to fund internally with your own dollars. You tend to pick someone that's got a proven capability to make a product and you want to get it to market, and you've got to basically make the accounting work so that it doesn't roll up on your budget. It rolls up on the startup budget that you provide financing for. And that's the rub, right? Because then it's an option, it's not an obligation. You can negotiate puts which does get done in the market, but it's an option, and it's Medtech development, and development can take anywhere from three to 10 years. And I think the rub on Bill to buy is that a lot can happen in three to seven years. The product can take longer to go to market. The market can change your estimate that you were going to be first or second to market could drop to being third or fourth to market, which changes the economic value of the project. And you know, like many things in medical device product development, you know, there's no absolute rainbow of certainty at the back end of it. So, you know, that's, that's kind of the the the things that are in play as people negotiate whether to do these and what their incumbent risks are when you actually go ahead and put one in place.

Hanson Gifford  3:01  
I think one point you alluded to Kris was the accounting issues for the strategics. And you could probably spend an hour just talking about the ins and outs and pains and how please the guys with the green eye shades who run the strategics, fundamentally every dollar that's spent on R and D is $1 less profit. And so how do you get those profits off the P and L, those R D costs off the P and L and Bill de buys. Do that if you structure the company such that the accountants can decide that that company is truly independent.

Chris Cleary  3:41  
We're not here to give anyone any accounting advice, but you know, it's a lot of structuring, and you should consult your accountant to get it off your books. But you know, the rules change. In general, the startup company has to be at risk to some degree. It can't be all the money coming from the strategic and they've got to raise their own capital. And you know this, you can't if it walks and talks like a duck, it's a duck. And the same thing, if the strategic puts all the money in, then it's on their P and L almost no matter what you do. So there's got to be some ebb and flow of who's at risk for both equity and debt on things like that. But let's presume that you can get around the accounting and you put it in place, and it's an option, not a requirement, to buy it. And now you got to go through development, and at the back end of it, you get to the altar of consummation, and a lot of stuff, hopefully hasn't changed, and the strategic goes just what I wanted. Thank you. Buy it pre, negotiate a deal, and close. That's what a build to buy looks like when it works. And I don't know, I could think of three or four that we did at Medtronic that went according to plan, where you pull the trigger on it, and it's good, but it doesn't always work out that way.

Hanson Gifford  4:51  
Tell us about some of those quiz because we're dying to hear about deals today. Oh, I

Chris Cleary  4:54  
don't know, like Ostia cool. I think we did with, uh, a list that was a straightforward. You know, buy this slide it in here, worked out just the way it did. I could think of some that were build to buys that didn't work out, where they didn't make the technical specs, they couldn't get the product cleared, and it was a clear cut, you know, you got to write that down. And there's, there's nothing to do. But you kind of look at it and say, Everybody tried, you know, couldn't build it, didn't get FDA approval, and you walk away from it. It's the stuff in the middle that I think becomes a little frustrating.

Andrew Cleeland  5:28  
Yeah, I know you're both looking at me. I'm gonna I want to go back just a bit, because I think the real important point for me is I am super pro these arrangements, but they're fundamentally an alternative funding strategy for larger companies, right? That I would always say that every one of the strategics basically have the capacity to do anything, but they can't do everything. It's allowing us to work with them to find out what those underfunded opportunities, or that the opportunities that are under their funding line get up to the top, and I think that there where I was going to start to go on the analogy you've got to both go into this marriage with the same level of commitment, which I think is the there is your fundamental problem, right? Which is you have an inequity of power. The startup is all 100% focused on, on this particular opportunity, the strategic the bride, or, sorry, the groom, in this case, gets the choice of whether or not they want to actually go through with the arrangement. And that's a tension that you've got to be able to balance for, I think, throughout with making sure that there are good you've signed a good prenup, basically, and that you've got to have a good exit

Hanson Gifford  6:44  
close that prenup is super important, starting with making sure that this is a product that's fundamentally of broader interest, so that it's not just really parochially of interest to one strategic that there are Lots of other buyers who might be interested in this. So that's that's the fundamental of having alternatives.

Andrew Cleeland  7:10  
There's your power, right? That you can go to someone else, you can go to a potential competitor, and that when you get into these discussions, as we've had Kris, that is where things can go awry, because all of a sudden that becomes competitive, and some people don't like that. It's something that you need. We need to be able to get these things funded. But if it's venture funded, oh yeah, we need that. You can build

Chris Cleary  7:35  
a product that only works in one at one strategic not just can't. You got to build a medical device, and the device has to have broad market appeal. It has to satisfy all the things that a startup would have to satisfy from a market perspective, no matter what. Yeah, and as long as that's the case, if the if, for whatever, look things happen at a strategic right here, here are all the here's a partial list of everything that can happen at a strategic over a seven year development period on a build to buy new CEO, new GM of the business unit. Everybody thought that you were going to be first to market and you're fourth to market because the product development time took longer than you thought it was going to take. Blah, blah, blah, blah, blah, just keep going down and down. You thought it was going to cost X. It cost Y. Y is two times x. And you know, the the amount of money that you're going to make on it at a later market launch point is half of what the NPV was when you approve the deal, you know, six years ago. So all that stuff can happen, which is why it's an option and all because it's not of interest to this, whatever strategic you built it with, doesn't mean it doesn't have a place, somewhere in the universe for someone to buy it. And I think you just, you're like you said, that's the prenup. You've got to be able to raise money from other people. You got to be able to, you know, if, if the groom, you know, no longer wants to show up at the altar, then you got to be able to go get, you know, God forbid it turns into bachelor. But, you know, you got to have other assets. Go ahead.

Andrew Cleeland  9:16  
So I think you were saying it's, it's hard being on a panel with him, I think the other one, right? So we, we bought out the the idea of a prenup. I not having ever signed one needed, not even needing to have ever signed one. What I understand, right? You put that away, put that in the draw. And what makes these things successful or not successful is working on the relationship from the very beginning all the way through to consummation, or not consummation, and I think that's one of the key elements. We have had experience where there has been multiple changes at the business unit, and people don't own what. Other others had previously decided. So I think it's an ongoing discussion, and I think that's probably where we may have fallen off there by not having maintained those levels of communication,

Hanson Gifford  10:11  
just like just like any marriage, it's a massive trust exercise, and you have to work from day one and every day to to build trust, and that includes really direct, open communication about what's going wrong as well as what's going right. And when you build that every day, then when the inevitable bumps in the road come, there's confidence that everyone is working really hard and with with good will to get to a better answer, and that that's essential,

Chris Cleary  10:47  
totally agree. Look, you, you can, you've narrowed your cap table in a build to buy to a degree that you don't do in a normal startup company. And you know that I, what I tried to do when we agreed to talk about this is like, what, what do you do if you're an entrepreneur dealing with a strategic to try to, like, hedge your risk, because it's, it is an asymmetrical relationship with respect to who's got the power. And you know, part of it is having other investors that are equally interested in the returns that the startup company can get with kind of a sure, pre negotiated exit. So you kind of taken the mystery away down to technical and clinical execution for the startup. And you you know that there's a likelihood that there's going to be a trade at that price to a to a strategic on a for an exit that otherwise for a startup, isn't guaranteed. So in that lets you not have to build a company with multiple products, and, you know, technically qualify for investment bankers to stand you up for an IPO and stuff like that. So there's an inherent benefit of that. But the hedge ought to be, have an actual cap table, don't be wholly reliant on the strategic raise money from other sources, and, quite frankly, do the same thing that a strategic or a startup company would do, and have relationships with the entire market, not just the the strategic that you're working with, which comprises your hedge. And that's right, is that practical? Though? No, that's why I was sorry I was gonna push back. That was an underhand pitch shift. Yeah, thanks. Like you can't, right? So look, I agree with you. Don't take too much money from the strategic, and given the accounting you, I would prefer to take no money from the strategic, no fund it through professionals.

Andrew Cleeland  12:42  
So professional VCs, but because you have a limit of certain amount of capital, you are only going to be able to bring in one or two. You're not going to be able to syndicate as much as you would like to. You're also, when you're running to a milestone, we're not going to go and raise money, you know, like we would normally do, you hit you're approaching a milestone. You'll go out and raise the next round so that you can continue on through in these build to buys where this, again, this inequity gets out of whack is you are running to slide into home base with no cash in the bank, true. And that's, again, that's part of the prenup needs to be an exit fee if you choose not to acquire, to not not as a penalty, but to provide that company with runway to be able to go out and syndicate with other investors.

Chris Cleary  13:32  
All right. So that's another form of hedge. So yeah, kind of like a runway fee,

Andrew Cleeland  13:37  
yeah, yeah. There's got to be a runaway Yeah, runway fee like

Hanson Gifford  13:39  
that, yeah. Well, you're right that having additional investors is perhaps the strongest form of security for startups. In general, your insider Syndicate is is going to help you live or die and make you, you know, survive until you can raise other money. It also makes the build to buy structure a little less efficient. Just to describe an example with fire, one which was set up as a bill to buy from the very start, we had two additional venture investors, Lightstone and NEA, in the deal, even though it was structured actually with covidian and they had a right to buy it, yeah, you helped set that up. And then nine months into that, lo and behold, a really unforeseen thing happened, which was the covidian got bought. And fortunately, Medtronic chose to continue the relationship. The company has gone on and taken on a very exciting but very challenging project which has taken longer and over time we got to our milestone and Medtronic, while not while still very interested in the project wasn't ready to acquire. At that point. And we were able to, since we had an existing Syndicate, expand that Syndicate, and raise a big, Pivotal round.

Chris Cleary  15:09  
It's a great example one, right? I mean, it's 10 years, right? The Canadian deal was 2015 when it closed. That was, you're working on that in 14 probably. And, you know, it's been 10 year in the 11th year, probably the timetable that we were talking about back then was seven. So, you know, it's four years over. It's still it's maybe a more attractive market now than it was then, in terms of market size and what, what a product, if it worked, would do compared to the so it's disruptive. Fits all the things I keep expecting Connor to like pop up behind me while I'm talking about fire one, but I don't think he's here, but, but yeah. I mean, it's one of those things where, who, who can't like that if it works, but the operating unit has forgotten about this at this point, right? I mean, it was at the top of, candidly, a non existing operating agreement or operating unit in covidian. When they did it, they weren't even in that market. They were trying to invest in disruptive technologies that required PMA, instead of their ordinary portfolio of 510, K development at the time. So it was really part of their like venture activity, more than anything else, and it came over to Medtronic that had an operating unit that looked at it and said, that would be super cool, but it's way out there, so it automatically became a low priority. Yeah, yeah, it's a

Andrew Cleeland  16:31  
wait and see. There's an inherent, again, inherent problem. Because, you know, as being a general manager at Medtronic a couple of times your horizon, and Chris will probably throw something at me, but it's, as a general manager, your horizons two to four years? Yeah, and these projects that we're talking about, we tried to do like a two to four year program, and it's like, Nah, we need more information, right? So that's getting pushed out now into if you get into that seven year time frame, you're outside of the range again, of that, that business unit, most likely, if they're any good, they're going to have rotated out it.

Chris Cleary  17:07  
It's not going to impact anybody's career During the development period, you know. So you just have to accept that regime change is going to happen during a traditional Medtech product development cycle on a build to buy. You have to and, you know, you it's very hard to anticipate whether the new GM is going to like it, you know, tolerate it or hate it. There's

Hanson Gifford  17:30  
another thing we had that happen. 25 years ago. We had a new idea for carotid stenting. There was actually an ultra low profile, profile stent that could be placed instead of a carotid filter during crowded stinting. And talked to an unnamed strategic who was really excited about this and wanted to do a build to buy structure. And we spent six months, I don't know how many trees were felled. That was back when everything was on paper to to negotiate this incredibly detailed and elaborate agreement, and literally the night before we were all signing, the CEO of that company retired, and Somebody else moving up to their slot, and somebody else moved up, and somebody moves and the head of of corp dev changed places. I don't know why you're looking at me. I'm not looking at you. It wasn't, yeah, the company did not start with an M and the new person said I'm not signing anything at all anywhere for six months. And yeah, we were high and dry.

Andrew Cleeland  18:45  
But that, I guess that's the point you were making Kris, that sort of shit happens always, yeah. And whether it's a bill to buy, whether it's just a not, you know, your traditional startup, that that's the luck of what we all do. I think where I want to, you know, the bill to buy makes so much sense. Now we need to come up with a it's got a bad that name has got a bad rap. So we need to come up with something that's, that's why I keep going back to alternative funding, or something that's not sexy enough, but something, it's a, it's a program, though not we're not providing, I'd like to see that we're providing acceleration, not necessarily an end product. Yeah, that's that's coming from. We even talked

Chris Cleary  19:29  
about that. But you know that, look, there's a huge inherent value in developing a product outside of a large company, you know? And that if you look for like, why to build device exist, that's as a former corp dev person. That's why it existed to me. Because, you know, how long did it take you to get to where you were with 12 from, you know, when you started to when Medtronic bought it? Three years, four years. Yeah, that probably would have been, I don't know, but a year or two longer, at least. If it were apples to apples, with the internal program. And you know, for existential market that a cardiovascular company has to be in, that's a huge deal. It's that's a lot of time and money, and that's the whole point of it, that, you know, you can develop it without a an onerous quality system. And you know, like 50 people on a committee chipping in about what the product design ought to be, and you can fail faster. You were on what product rev at the 12 when Medtronic bought it, we're sorry. We went through a lot. How many? 50, right? What was it we iterated on a weekly basis for a Yeah, 50, at least, yeah, it's allowed. I think the we, we did a lot of work then at the time with because there was a metric internal metronic program. And I think one of the

Andrew Cleeland  20:47  
key discussions when we were acquired was to understand how they had gone about doing it. Their team was as smart, if not smarter, than our team. They probably were more funded in most instances are now better looking, yep, better looking, for sure, I think it was, it's decision making. And I large companies are too encumbered. So you have to go out. If you have to go out to do this, you either pick up startups, like 12 as a, you know, just a traditionally funded startup, or you, as, as Lisa was saying, you collaborate, and that's what we're talking about with the build device. Yeah, it is an essential way. It's a weapon that the large companies have to get stuff done. But there's just got to, we somehow have to break this inequity a little bit.

Hanson Gifford  21:38  
Yeah, I think it's, it's, you know, in when, when the corporate strategy changes, or the corporate financial position of the of the strategic changes and changes are made, you know, it's, it's maybe hard to recover from that. And I will say that in the build a bunch I've worked with the the teams that I've worked with at the strategics, you know, the corp dev and and other folks who are working with us. They are feeling our pain, and they're doing everything they can, yeah, to to try to be as reasonable as possible, in light of, you know, still executing the company's financial plan, you

Chris Cleary  22:27  
still can't jam a deal on a CEO that doesn't want to do it, yeah, or an operating unit leader that doesn't want to do it. And yeah, there's a lot of people that get to chip in and figure out that they want to kill a deal at a big company in a sea of changing circumstances. So it's a in you can do some things, right? You can negotiate a put. But you know, if we used fire one as an example, the put wouldn't come into play yet because the product's not ready. It's just delayed, yep. So you know, that's not a cure all. It's a It's just a fact of life that build to buy just is not a guaranteed off ramp for the highway. And you know, that's kind of the when we were talking about this panel ahead of time, which technically was last night, that that's kind of the takeaway that we had, which is it, this is not a call, a mandatory call option. It's an option. And they have to underline option. And you can structure around it, but you gotta, everybody has to go into it with their eyes wide open on it. And, you know, I don't know what the percent rate of success is for build device across mid tech writ large. I'd love to know, but you know, I doubt it's 50%

Hanson Gifford  23:44  
so actually, on that note, Larry best at Boston Scientific, did a ton of investments back 25 years ago in a variety of companies, and typically wrote in a call option at pick up Rice, just to have a call option, just in case things really got exciting. And that was the case. In hindsight, they acquired about a third of those companies, which was pretty good. They bought a third of those companies. That's great. But there was a little bit of a syndrome that evolved where almost all those companies thought, when we hit that milestone, they are going to buy us, and in their minds, they are working towards that milestone rather than working on the long term success of the business. And that was a bit of a

Andrew Cleeland  24:33  
mental fundamental mistake. Yeah, yep, yep, yep. Number one. Well, I got back to the when you said 50% if it was, be thrilled if it was 50% but I have no idea. No, I think it's this way we think, because we got to go, and I would like to find that answer, yeah, it can be done the other way around, right? So startups where we're used to from a seed funded startup to get to returning one. Times invested capital, 5% 95% don't do that. 5% make it for seed funding to so this is pre venture funding, right? So there's a lot fall out together to get to three times invested capital is two to 3% so if, if these things are batting 30% less handsome, that's a good outcome,

Chris Cleary  25:25  
man. You wonder how venture capital makes any money at all, really? Right?

Andrew Cleeland  25:31  
Yeah, thanks, yeah.

Chris Cleary  25:34  
All right. So we have two minutes left. I thought we would end this by getting the right to ask each other, a question of our choice.

Andrew Cleeland  25:42  
All right, yeah, but you've been thinking about this. You've just put us in. No, I literally just thought of it. Yeah,

Chris Cleary  25:50  
go ahead, Andrew.

Andrew Cleeland  25:54  
Why did you come up with this, and why did you pick us?

Chris Cleary  26:00  
Well, the way I think about these panels is I think about who I want to sit up here with, and then I think of a cool title, and I don't think about it beyond that.

Andrew Cleeland  26:09  
And that, by the way, was our prep. Yeah, I asked him a question yesterday. We were having a drink on something totally different, and he misconstrued, misconstrued it, thinking I was asking about the panel. And he got disgusted that I was actually trying to prepare nothing. It's like, I'm not asking about the panel. What's your question? Oh, boy,

Hanson Gifford  26:29  
yeah, I think that's, that's same thing I was, I was hoping you'd make it a point counterpoint, you know. And

Andrew Cleeland  26:35  
we got business to still continue doing. I thought this was going to be my last panel ever. Yeah, if I said,

Chris Cleary  26:43  
what's yours? Um, what's the best deal you guys ever did?

Andrew Cleeland  26:50  
Easy, best deal. Which one already guardian? What's what's gonna happen over the next few years? Yeah, just seeing what this does for Medtronic. Well, yeah, for people, for patients, people exactly this thing that you know, sorry, you've, you've, you are hitting on a sore topic. And look, give Medtronic has done. Sorry, they have done such a good job in continuing to invest and continue. Oh, yeah, they played through. Hush, they really have done remarkable. But the ability, you know, hypertension, one in three adults in the Western world, I think this is going to have a material impact. It's going to be something hopefully I you know, we can point out to our kids. Look, man,

Chris Cleary  27:34  
the the financials on this thing are a little dug in, right? Because it took so long and you had to run the trial twice and pursue adoption and reimbursement, the way that it played out. But the potential impact on patients is probably the biggest thing out there that happened during, you know, the 10 year period that I was there. So I totally agree. I think Guardian is like the, you know, the best, like health outcome for that's good for patients that came out of the pipeline over a 20 year period, probably Lockwood,

Andrew Cleeland  28:07  
a couple of ton more from Foundry, but 000, we made it.

Chris Cleary  28:13  
We we filled it up, and I don't think anyone's getting sued, so let's consider this a quiet success, right? Thank you, everyone.