There’s No Immunity From the Medical Device Tax in Silicon Valley

Nearly a year after the medical device tax went into effect as an early provision of the Affordable Care Act, Silicon Valley companies are still weighing the impact it will have on business.

Meanwhile, venture capital funding for medical device startups has contracted, according to new data compiled by PricewaterhouseCoopers, potentially compounding problems for those looking to get new devices off the ground.

“It’s bad,” said Matthew Frinzi, co-founder and chief business officer at Belmont-based PowerVision. The company makes intraocular lens implants for people suffering from presbyopia, a condition that impacts focus on close objects, and cataracts. “I think [the device tax] can have an impact on the funding environment.”

PowerVision was founded in 2002 and remains in the clinical study phase. Since it’s not yet commercial, the medical device tax does not apply.

Right now, the company is looking to raise a fourth round of funding as it prepares for the FDA approval process. Frinzi said that, while ultimately he’s not concerned about getting the money, this round of fundraising has been more arduous than it was in the past.

“The venture capitalists that fund startup ventures like our company have a certain exit number in mind, which is driven by the larger companies looking to acquire,” he said. “And now, those companies are all facing a hefty tax on top-line sales.”

The 2.3 percent medical device tax was introduced in 2010 as part of the Affordable Care Act, with the hope that it would bring in about $30 billion over the next decade to help fund the expansion of health care in the U.S.

The tax went into effect earlier this year, applying to all medical devices sold in the U.S. (not foreign exports) after Dec. 31, 2012, with some exemptions — such as devices like eyeglasses or hearing aids that are generally purchased at retail.

Since then, large medical device companies such as Minnesota-based Medtronic, Inc., have supported a repeal of the tax, with many in the industry stating it would result in job loss and drive manufacturers overseas.

More recently, it became a sticking point during the government shutdown, with House Republicans initially pushing for a two-year delay of the medical device tax. That was scrapped, as Congress eventually came to a deal with Senate leaders to end the shutdown.

It’s unclear how much money has been collected from the tax to date. The Congressional Budget Office and IRS have not responded to requests for data or comment.

The theory that the medical device tax will result in job loss or a shift toward foreign manufacturing is still a hot topic of debate. Economist Paul Van de Water, a senior fellow at the Center on Budget and Policy Priorities and a former assistant director at the Congressional Budget Office, has stated he does not believe the medical device tax should be repealed, refuting claims that the tax will impact innovation or production.

“The notion behind the tax is that, basically, a wide range of industries are going to get more business as a part of health reform, and are being asked to pay for it in one way or another,” said Van de Water. “And that includes medical devices.”

He cited a study by Wells Fargo Securities, which found that the new health care law will increase device sales by 1.5 percent next year and by 3.6 percent overall through 2022 — enough to sufficiently offset the tax for companies.

“You can’t just repeal the tax and let it add to the deficit,” Van de Water said.

In Silicon Valley, where companies large and small contribute to the $110 billion dollar med-tech sector, those in the industry express divergent views.

The chief executive officer of Palo Alto-based Varian Medical Systems, Tim Guertin, has been quoted as saying he believes the tax will give unfair advantage to manufacturers offshore. Varian, which makes large-scale oncology and X-ray equipment, employs around 6,300 workers, with more than half of those in North America.

The company’s chief financial officer, Elisha Finney, said the medical device tax is costing Varian about $10 million per year.

Abbott Labs in Santa Clara, one of the world’s largest medical device companies and the largest in the Bay Area by fiscal-year revenue, declined a request for an interview. But a spokesperson did say that while the company has accounted for the tax in its 2013 expectations, it supports the position that the tax is “adversely impacting patient care and innovation.”

In startup land, the tax doesn’t always apply, since many early-stage medical device companies aren’t yet shipping their products.

Still, confusion exists around the tax. Some products, such as DNA testing kits that are sold directly to consumers but could end up in the clinical realm, fall into murky territory.

Mountain View-based Scanadu, which makes a smartphone-linked medical “tricorder” called Scout, is another example.

“We’re in a unique position, as we’re selling to the consumer first and giving them a device that will put the experience of the emergency room in the palm of their hands,” wrote chief executive officer Walter De Brouwer via email. He went on to note that Scanadu believes in the “democratization” of health care and health data.

However, the company is still not clear on whether the medical device tax will apply to its tricorder or another product in development, an at-home urine test kit called Scanaflo. A spokeswoman for Scanadu said the company has hired consultants to help it navigate this unchartered territory.

Scanadu just secured $10 million in funding.

But others might not be so lucky.

According to new data analyzed by PricewaterhouseCoopers and the National Venture Capital Association, investments in the medical device industry are down 40 percent from 2007, dropping to $2.14 billion this year.

The number of medical device deals this year in Silicon Valley, specifically, dropped to 925 from 1,205 a year ago.

Mike Carusi — a venture capitalist at Advanced Technology Ventures, which is heavily invested in local health-tech companies, including PowerVision, GluMetrics and Second Genome — agrees that the tax is having a negative impact on the flow of capital.

“It’s problematic because the tax is on revenues, not profits,” Carusi said. “So, even if these companies are still small, even if they’re losing money, they’re still paying the tax on sales.”

Carusi also cites the FDA approval process for new devices as a significant roadblock in the industry. “The tax is now just one more thing on top of a bunch of other challenges,” he said.

Not all feel that the tax or current environment for medical devices is a dire one. Krishna Yeshwant, a general partner at Google Ventures who is also a physician, said that while the tax is generally “not a great thing,” it has the potential to spur innovation and “totally change the economics of treatment.”

“If you look at medical devices in the right way, they can really be a replacement for years and years of pharmaceutical therapy,” he said. “You can pay $40, $50, $60 a week for the rest of your life for a drug, or you can look to a new, completely innovative device that is possibly going to cure this problem. The overall dollar amount might work out in the future.”

Even Carusi is somewhat optimistic. “It’s not all bad news,” he said. “I think this sector was probably over-funded in the mid-2000s.”

He added: “And if you look at the history of venture capital, the sectors that really thrive were usually in a bad place three or five years prior. So I think we’ll shake out.”

A version of this article was previously published as part of a reporting project for Stanford University’s Peninsula Press, as well as in the San Francisco Chronicle’s SFGate blog.

Feature photo courtesy of Lenore M. Edman, www.evilmadscientist.com, under Creative Commons Attribution.