Investing in the life sciences industry without an understanding of the key regulatory factors that could determine a product’s success or failure could cost you millions of dollars.

As the industry readies itself for the 2019 edition of the annual pilgrimage to the J.P. Morgan Healthcare Conference in San Francisco, our market-leading Global Regulatory Team has prepared a series of updates covering the following topic areas that we hope will help guide your 2019 investment decisions.

Regulatory hurdles vex medtech startups: Factors to consider when investing in R&D projects

Imagine your company just acquired a new entity with a hot new product. Things appear to be great until the FDA shows up to inspect your new facilities. At the end of the inspection, you are blindsided by FDA’s issuance of a lengthy 483 to the company, citing various violations of FDA’s regulations. Two weeks later, you also receive a FDA Warning Letter, reiterating many of those violations and alleging that the company’s product is illegally marketed due to off-label promotional claims—the very claims that drive over 90% of the company’s revenues. These issues hit the trade press, stock prices and sales fall rapidly, and your company must expend significant resources to fix the problems.

The scenario above is all too common. Due diligence is critical to properly determining risk associated with medtech transactions, as well as proper valuation of the target. Spending the time and resources up front to critically look at key risk areas to identify compliance issues, as well as knowing FDA enforcement priorities, can save a company millions in post hoc remediation and reputational harm. Strong regulatory due diligence is the way to be part of the next big thing and avoid being part of the next big mess! Here are some key questions to consider when choosing to invest in a medtech startup or research & development project:

Is the regulatory pathway viable?

The regulatory pathway and timeline to achieve pre-market authorization for new and innovative medical devices is not always clear. Startup companies, in particular, while developing some of the most exciting new medical device technologies, tend to be inexperienced in understanding and interpreting FDA’s regulations. This often results in a misunderstanding of FDA’s regulatory paradigm and how it will impact both the regulatory pathway and data requirements for their innovative medical device technologies. Expecting one pathway and discovering post-investment that the pathway is much longer or will require significant additional, costly research puts investments at risk.

Given these risks, an investor should assess the strength of the proposed regulatory pathway for a novel device as part of its due diligence activities. For example, an investor should consider whether a target company has obtained an outside regulatory pathway assessment from a qualified third party, such as regulatory counsel, or obtained a formal opinion from FDA as to the regulatory pathway. Regulatory due diligence should include a review of documentation from a qualified third party or FDA that confirms the target’s understanding. To the extent that such an opinion has not been obtained by the target, use of competent regulatory counsel during the due diligence process will help investors determine next steps, the timing of the regulatory pathway, and exactly what will be needed to bring a product to market.

Is there adequate supporting data?

In order to gain premarket clearance or approval for novel medical devices, substantial preclinical testing – and often clinical testing – is required. As part of due diligence, medtech investors should explore whether the target has a good understanding of the likely data requirements to support pre-market authorization. These requirements are often linked to the regulatory pathway for the device; for example, PMA submissions universally require substantial clinical data, while only about 10-15% of 510(k) notices require clinical data. Knowing the likely data requirements for the target technology, as well as the company’s plan for obtaining these data, is a key component of assessing the timeline and likelihood of successfully brining the product to market, which allows for proper valuation of the target.

Have modifications imposed new requirements on a device?

For 510(k) cleared devices, it is essential to understand the extent to which the device has been modified since it was last cleared by FDA. Medical device manufacturers are allowed to modify their devices without submitting a new 510(k) notice, so long as the changes could not significantly affect safety or effectiveness and do not amount to a major change to intended use. This standard is frequently misapplied by industry, with FDA’s focus being on could, and industry’s focus being on significantly and major.

Investors should be wary that FDA will take the position that a new 510(k) clearance is required for a modified device. For example, if a target company has implemented multiple changes to its products without obtaining new or additional clearances, there is a risk that FDA could take action, including requiring new clearances, issuing a Warning Letter, or even requiring a cessation of distribution or recalls.

Are key promotional claims lawful?

Although violative promotional materials and practices can be remediated relatively quickly and easily post-close, to the extent that the company’s valuation is tied to its ability to make certain key promotional claims, it is critical to understand whether those claims are consistent with product clearances or approvals. This is particularly tricky for 510(k) cleared devices, which are often cleared for general indications for use that do not support claims for more specific uses. Thus, where maintaining existing promotional claims or obtaining certain promotional claims for novel devices is a key concern for valuation, due diligence activities should evaluate the extent to which these claims comply with FDA’s (and FTC’s) expectations for advertising and promotion of medical devices.

Has poor performance jeopardized a product’s profitability?

Understanding how products are performing in the field is critical to quantifying the risk associated with the transaction. An investor should consider how many customer complaints a company has received; any trends that may highlight a problematic failure mode; and whether there are adverse events, including patient deaths, injuries or malfunctions that have been reported. This assessment is crucial to identifying whether there is a true opportunity to grow, or if future product recalls, products liability risks, or product redesigns that require new FDA submissions will drive up the risk associated with the company.

Are quality control systems established?

A review of key quality system procedures and data can reveal a lot about a company and its commitment to product quality. For example, if a company has zero product complaints or adverse events, this may be a sign that the product design is flawless and the product is performing well in the field; however, it may evince a weak quality system that is not capable of identifying or handling key information. On the other hand, while addressing quality or safety issues through Technical Bulletins or other customer-friendly communications may signal that a company is committed to its customers, it may also show a failure to recognize that such communications have been identified as recalls by FDA. As part of the due diligence process, competent FDA regulatory counsel can identify risks that are not obvious from a review of the company’s data.

Does a company’s history show risks of noncompliance?

Evaluating and understanding a company’s compliance history and reconciling it with current FDA priorities and guidelines is imperative to identifying post-acquisition risk. Looking at indicia such as the frequency of FDA inspections, the magnitude and number of 483s previously issued, whether there are repeat observations, whether there are open inspections or Warning Letters, and gauging corrective actions and the veracity of company responses to FDA observations can help identify potential compliance risks.

Beyond reviewing all of these areas, understanding what these factors mean and how they impact a company is critical to assessing potential future liability, resources required for remediation, integration challenges, and the real value of an acquisition.

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