VC firm Mi3 sticks with imaging after nixing Caprius acquisition

Company plans to ride long-term healthcare trends

There aren't many venture capital firms that have reaped stellar profits by focusing on medical imaging start-ups. One reason for this is that the technical nature of the specialty requires a high level of expertise to analyze the clinical and commercial prospects of a new imaging device, agent, or software program.

Improving on venture capital's track record in medical imaging is the goal of Medical Imaging Innovation and Investment (Mi3), a new VC firm formed late last year. Mi3 made an early splash in its first investment enterprise by joining with another firm, Ampersand Ventures, in making a bid for the MR mammography technology of Caprius (formerly Advanced NMR) of Wilmington, MA (SCAN 12/16/98).

That deal broke down less than a month after it was announced, however. Due to a confidentiality agreement with Caprius, Mi3 executives are unable to comment in detail on the reasons the deal collapsed, according to William McPhee, President of Mi3.

"When we reviewed it (the Caprius deal), we were not able to satisfy ourselves that it represented the potential we had hoped," he said.

With the Caprius deal put to rest, Mi3 of Wellesley, MA, is actively evaluating potential medical imaging investments, McPhee told SCAN. The firm hopes to raise $25 million to $35 million in capital and initiate two to three investments in 1999.

Mi3 was formed in November with seed funds from the department of radiology at Indiana University (IU) in Indianapolis. Ampersand, an established mid-sized VC firm, would have provided much of the funding for the Caprius investment while relying on Mi3's expertise in the medical imaging industry.

The relationship between Mi3 and Indiana University is unique in medical imaging. The radiology department provided the VC firm with $5 million in start-up capital in December. IU has representatives on Mi3's advisory board and offers technical advice on investments. In addition, Mi3 expects to work with IU in identifying investments in Indianapolis that will help develop the healthcare technology infrastructure of that metropolitan area.

The firm intends to focus on early-stage medical imaging companies, where technical and strategic expertise are more important than deep pockets, McPhee said. It will consider later-stage companies like Caprius only when it has a larger VC partner, such as Ampersand.

Medical imaging is an attractive market to Mi3 for the very reasons that have driven off typical VC funding in the past, he said. Specialized knowledge is a key requirement for investing. The technology involved in imaging is unique and encompasses a variety of products, including high- and low-technology devices, biotechnology, and software.

In addition, imaging appears to be on the verge of dramatic changes in clinical and business practice, fueled by advances in digital imaging and PACS, increased functional imaging, and the fusion of therapy and imaging, McPhee said.

"We have become convinced that the industry is about to go through an enormous revolution," he said. "The reality is that we are all getting older. This (the U.S.) is the most sophisticated healthcare population in the world, and it is very demanding. Procedural volume will rise. The pressure will be on cost management. Anything that reduces costs and improves the quality of service and diagnostic outcomes will be a superb opportunity."

The size of the medical imaging market in the U.S. is substantial at present and will grow as imaging and related technology is used to reduce costs and improve diagnostic and therapeutic outcomes, he said. Currently, the U.S. spends about $65 billion a year on the delivery of imaging services, McPhee said, based on data gathered by Mi3 over the past six months. This amounts to 7% of the $965 billion spent on U.S. healthcare overall in 1996. Some 77% of the imaging expenditures, or about $50 billion, involve technical costs.

Despite the large size of the healthcare industry, venture capital investment in healthcare has decreased following dramatic declines in the stock prices of many healthcare companies. In this respect, Mi3's decision to enter the market could be seen as a contrarian play.

"We view this trend as a temporary phenomenon and an opportunity," McPhee said. "It is very hard for a lot of companies in imaging to get as far as proof of concept and then beyond. A lot of venture capital money has shifted toward the Internet, which is the trendy thing."

One area that Mi3 does not expect to focus on is medical imaging services, McPhee said. Practice management companies have discovered over the last few years that they must make fundamental changes in operations rather than rely on continued acquisitions to fuel profits. Unfortunately, change does not come easily in medicine, particularly in radiology.

"While imaging modalities have become far more sophisticated, the practice of radiology has not changed a lot in the intervening decades," McPhee said. "Medicine is a very slow-moving industry."