Digital health is the convergence between healthcare, genomics, and digital technologies. It is a fast-growing sector with important implications for individuals and institutions alike. Whether it is hospitals and health systems using electronic medical record management and outcomes metrics to improve care, parents using wearables to monitor children with diabetes, or researchers harnessing precision medicine to design therapies to attack specific tumors, the digital health industry represents a market that is poised for exponential growth.
We are pleased to share our initial WSGR Digital Health Report, which is aimed at providing timely insights and updates on trending topics, and the legal and business issues that permeate this exciting and growing field. Our network of experts span the many practice areas vital to digital health, including privacy, advertising, patent, trade secret, licensing, regulatory, litigation, and corporate finance.
If you have any comments or questions, please contact your existing WSGR attorney(s) or any of the attorneys listed as authors in our report.
By Andrew Ellis
If you regularly follow innovation in the healthcare industry, it is no surprise that digital health investing has been strong since 2014. According to data from Rock Health, investment in digital health more than doubled to $4.4 billion in 2014 from just $2.1 billion in 2013. Investments remained at similar levels for the next two years, logging $4.6 billion and $4.3 billion in 2015 and 2016.1 Startup Health, another digital health organization that tracks venture funding in the sector, uses a broader definition of digital health and recorded nearly double the amount of investment, but shows the same trend from 2014 through 2016.2
Digital health has continued to strengthen in 2017. Rock Health and Startup Health data through Q3 2017 shows that 2017 has already reached $4.7 billion and $9.0 billion, respectively, exceeding any prior year of digital health investing. In addition, 2017 is also on pace to exceed the number of digital health funding deals in 2016, according to data from both providers.
Source: Rock Health Funding Research, Q3 2017
Source: Startup Health Insights, Q3 2017
In comparison, although venture investing in all industries is on pace to beat 2016 levels, according to the PricewaterhouseCoopers MoneyTree Report,3 with approximately $55 billion invested through Q3 2017, compared with approximately $60 billion for all of 2016, it has not already exceeded full-year 2016 levels. This demonstrates that digital health investing is not merely riding the general venture investment wave, but is showing unique growth in the current environment. We are excited and encouraged by the confidence that investors continue to show in digital health and believe there are a few notable trends that are important.
Investment Trends Through Q3 2017
Even more impressive than the numbers is the environment in which these investments took place. With a new president and multiple attempts by Congress to repeal or modify key components of the Affordable Care Act, 2017 has been an uncertain healthcare environment to say the least.
The resilience of digital health investment in an uncertain regulatory environment is notable, but the regulatory environment may be improving. In general, certainty may be higher in the near and intermediate terms as Congress appears ready to turn away from healthcare in order to focus on tax reform and other items on the agenda. More specifically, the passage of the 21st Century Cures Act in December 20164 laid the groundwork for digital health regulatory reform measures, and the first material step in that direction has come in the form of the Digital Health Innovation Plan, which was announced on July 27, 2017.5
The Digital Health Innovation Plan:
Digital Health Megadeals
As the aggregate amount of digital health investment has grown, so has the size of investments. According to Rock Health, there were three digital health investments of $100 million or more in 2016,6 but 2017 has already claimed eight such investments. Startup Health shows a slight decline in early-stage funding deals with a sharp increase in Series C and D deals, adding that Q3 2017 had more mid-stage and late-stage funding deals than any other Q3 on record. In addition, Startup Health shows an increased average round size from approximately $15 million to approximately $18 million in 2016 and year-to-date 2017.
Source: Startup Health Insights, Q3 2017
There may be multiple reasons for the emergence of the digital health megadeal. First, it may simply reflect confidence in the long-term value of digital health, the ability of the FDA to streamline regulatory processes, and the current positive economic macroenvironment. Second, it may simply indicate a maturing industry, where the winners have been identified, and investors are focusing their investment dollars. Third, it may actually be a side effect of relatively few exits for digital health companies in 2017, forcing investors to create enough runway for these companies to continue operations rather than seek an exit.
Where Are the Exits?
Rock Health reports a multi-year downtrend in the number of M&A transactions in digital health, with 146 digital health deals reported at the close of Q3 2015 versus 112 and 83 through Q3 2016 and Q3 2017, respectively. Because so many of these transactions do not publicly disclose the acquisition price—in Q3, only 16 out of 83 had a disclosed transaction amount—it is difficult to determine the full meaning of these reduced numbers.
The reduced number of M&A transactions has not been alleviated by IPO activity in 2017. There were six digital health IPOs in 2015, three in 2016, and none through Q3 2017. In fact, according to Rock Health, 2017 may be the first year since 2012 without a digital health IPO, even though several digital health companies like iRhythm, Teladoc, and Tabula Rasa have performed quite well since their IPOs.
However, there is a silver lining in these numbers. First, because of the rising number of digital health megadeals raising private funds, there are more mature digital health companies with high valuations that may make attractive IPO candidates or may attract large buyouts in future years. Second, continued investment in digital health despite the declining number of M&A and IPO transactions may indicate a longer-term investor focus, which is yet another sign of maturity for the digital health space that helps create stability.
A Shift from B2C to B2B
Rock Health recently published an interesting survey of 85 digital health entrepreneurs regarding business-to-consumer (B2C) and business-to-business (B2B) business models.7 Thirty-four percent of the businesses they surveyed started out with B2C business models, and 61 percent of those eventually changed their business model to either B2B2C (a hybrid model of B2B and B2C) or B2B. Only 14 percent of the companies that Rock Health surveyed still employed a B2C business model. The largest investments of 2017 so far also reflect a B2B focus, as evidenced by the chart below.
Source: Rock Health Funding Research, Q3 2017
Why does this business model change affect investment trends? One of the downsides of a B2C business model in digital health has always been that it is a crowded space, and from the results of the Rock Health survey, it appears that B2B is also becoming increasingly crowded. When any space becomes crowded, the increased competition can have a negative effect on revenue and sales cycles, but this effect may be especially pronounced in digital health given the long B2B sales and implementation cycles in the healthcare space.
Several WSGR clients have reported that, while a target company or hospital may find their product attractive, they simply do not have the bandwidth in their infrastructure to onboard multiple digital health solutions in a given year. Until the digital health industry matures into a phase of consolidation, the fragmented nature of digital health solutions may exacerbate these infrastructure limitations and delay revenue from new customers, as more companies enter the B2B space.
There are a lot of things to be excited about in digital health. The industry appears to be maturing, as evidenced by more later-stage investments and larger deal sizes. The regulatory and economic macroenvironment, while imperfect, looks favorable at this time. Several high-profile recent digital health IPOs are performing well in the public markets. Most importantly, the fact that aggregate digital health investment in 2017 has already exceeded 2016 is an encouraging vote of confidence by investors.
However, despite the strong numbers, there are some headwinds: M&A and IPO activity have trended down since 2015, and Q3 investment amounts were less than the very large Q2 numbers. It remains to be seen whether the strength of 2017 will continue to build momentum into 2018 or will prove to be short-lived, but there is ample evidence to support an optimistic view.
1 See: https://rockhealth.com/reports/in-biggest-year-of-digital-health-funding-women-ceos-emerge-as-q3-2017-winners/?utm_source=Rock+Weekly&utm_campaign=937afff9ab-Rock_Weekly_10_2&utm_medium=email&utm_term=0_e44ef774d4-937afff9ab-90916197&mc_cid=937afff9ab&mc_eid=f0877c04a2.
4 See our WSGR Alert on the 21st Century Cures Act: https://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert-21st-century-cures-act.htm.
By Ali R. Alemozafar and Charles T. Graves
Practically all digital health companies are founded on the basis of ideas. For example, your company may have several ideas around a smart watch data-collecting sensor that tracks heart rate using algorithm software. The software draws correlations from the data as an actionable output. Such ideas are often subject to patent and trade secret protection, which is a key part of enabling continued growth for your company, including investment and downstream acquisition.
Understanding what warrants patent and trade secret protection is important. Additionally, selecting the kind of protection that is right for you is a careful balance between several considerations. Below are some frequently asked questions to provide you with guidance along the way.
What Is a Patent?
A patent is a government right that excludes others from practicing the patented invention for a period of 20 years, creating a limited monopoly. To be granted a patent, the ideas being patented need to be disclosed in a patent application in sufficient detail to permit the skilled person reading the patent to practice the patented invention. This often requires disclosing certain details of the secret sauce.
What Is a Trade Secret?
A trade secret is generally information, including a formula, pattern, compilation, program, device, method, technique, or process that both:
There are many famous examples of ideas that have been maintained as trade secrets, such as the formula for Coca-Cola. The term of a trade secret is theoretically indefinite so long as the underlying ideas remain secret.
Which Ideas Are Suitable for Trade Secret Protection?
A company may pursue trade secret protection for ideas that can be effectively kept a secret. The company should establish an internal policy to maintain secrecy. Trade secret protection may enable the company to keep its ideas a secret and maintain first-mover advantage, which may be important in an uncrowded segment of digital health.
Trade secret protection may not be suitable if the ideas are subject to publication, may be readily reverse-engineered, or derived independently by another company in a fast moving area of digital health.
What Is the Duration of Trade Secret Protection Versus Patent Protection?
Trade secret protection is indefinite but thin, while patent protection is time-limited but thick. However, if an idea that is maintained as a trade secret is developed independently by a competitor, made public, or is reverse-engineered, then the trade secret protection may no longer be available.
On the other hand, while the period for patent protection is limited to 20 years, the patent may be used to stop a competitor from practicing the invention covered by the patent, regardless of whether the competitor independently derives the invention.
When Would It Make Sense to Pursue Patent Protection?
Ideas that are generally difficult to protect under trade secrecy may be better suited for patent protection. For example, if an idea may be readily reverse-engineered or derived independently, then patent protection may be the more suitable type of protection.
What Are the Benefits of Pursing a Patent?
A patent may protect ideas regardless of whether such ideas are subsequently reverse-engineered or derived independently by others. In addition, a patent may enable a third party, such as an investor or acquirer, to place concrete value on a company’s ideas. This may be important for early-stage companies seeking financing.
With a trade secret, such value may be more difficult to show, given that the value of a trade secret is based on the underlying ideas not being generally known to the public or others.
What Are the Risks When Pursuing Patent Protection?
To be granted a patent, the idea being patented needs to be disclosed in a patent application, which is filed with a patent office and typically published. The patent application is reviewed by the patent office to determine whether the idea being patented meets a requisite legal threshold, including whether the idea is the right subject matter, new, and non-obvious.
An idea directed to a process, machine, manufacture, or composition of matter may be the right subject matter for a patent. This review may involve a technically and legally intensive negotiation process with the patent office, called patent prosecution.
Some ideas are more difficult to patent than others. For instance, ideas around algorithms or health data are generally more difficult to patent than ideas around hardware. If the patent office finds that an invention being patented is directed to an abstract idea, a law of nature, or a natural phenomenon, then they may find that it is not directed to the right subject matter for a patent.
There is no guarantee that a patent will be granted from a patent application. A risk with pursuing patent protection is that a patent application can be made public without giving the company any patent protection. In this circumstance, the ideas in the patent application will be dedicated to the public.
Can You Take a Hybrid Approach and Pursue Both Trade Secret and Patent Protection?
A company may keep certain aspects of its technology as a trade secret, while pursuing patent protection around others. For example, a digital health company has software with a particular machine learning algorithm and a sensor for collecting data. The company may keep the machine learning algorithm as a trade secret and pursue patent protection around the sensor.
By Rachel Landy and Jennifer M. Halbleib
The last few years have seen an explosion of wearable digital health products. Where a doctor’s visit used to be required for a basic check-up, now a patient’s health status is increasingly at his or her fingertips. We have the ability to track fitness levels, monitor lung and heart capacity, check skin temperature, and observe blood pressure with a simple wearable device.
Product warranties give consumers confidence that these devices will perform as expected. But overzealous marketing can also be interpreted as implied warranties that the manufacturer never intended, which expose the manufacturer to potentially significant liability. This is especially the case with devices used to track disease or improve health. Liability may arise under a number of theories, including false or deceptive advertising, as well as under warranty law.
ABCs of Express Warranties
Consumer wearables are often accompanied by express warranties—promises made by the manufacturer or retailer to the consumer about the functionality of a wearable device. For example, a warranty may state that the manufacturer warrants against defects in materials and workmanship of the product in its original packaging, but only when the product is used normally for its intended purpose. Any warranty also will include information on how to submit a claim and the consumer’s remedy, if there is a defect.
Legal Framework for Warranties
In drafting a consumer warranty, it is important to keep in mind the basic legal framework. Consumer warranties are governed at the federal level by the Magnuson Moss Warranty Act (MMWA). Notably, the MMWA does not require that a warranty be provided with a consumer product. Instead, it sets forth certain requirements for any written warranty that is provided including:
Some states have additional statutes that supplement the MMWA. If you are contemplating business in a specific state, it is important to review any relevant state statute. For example, California’s Song-Beverly Act includes terms that apply specifically to health devices. Under the Song-Beverly Act, “assistive devices” intended to assist consumers with physical disability, injury, or disease treatment are subject to more strict warranty requirements. For instance, warrantors of most types of assistive devices must adhere to specific replacement terms in the event of a defect.
Marketing Missteps: Unintended Implied Warranties
In addition to express warranties, warranties can be implied by the official product description or marketing. It can be easy to inadvertently run afoul of the warranty statutes by making claims in marketing materials that look like warranties or promises as to how a device will work, but are simply intended to be promotional. For example, in 2015, a group of consumers brought a class action suit against Fitbit, alleging that Fitbit’s marketing of its sleep-tracking functionality—which included promises about specific results—breached the implied warranty of merchantability under the MMWA, and also constituted deceptive and unfair trade practices, among other things. The plaintiffs argued that the messaging in Fitbit’s product packaging did not accurately reflect the device’s capabilities. All claims survived a motion to dismiss last year and the litigation is ongoing. Similarly, in 2015, Nike settled a class action alleging similar claims against its FuelBand product, including the product’s inability to accurately track calories and steps.
When bringing a product to market, it is important to consider the following to avoid claims that the MMWA or any related state laws were violated:
By David Hoffmeister and Charles Andres1
Another essential area is diagnostic software, which can make diagnoses independently of a healthcare provider or act as a diagnostic aid to providers. ARK Investment Management estimates that the total global addressable market for diagnostic software could reach $16 billion.4 With so much at stake, both in terms of patient outcomes and market share, all software developers—including diagnostic software developers—should understand how medical software is regulated in the United States.
The U.S. Food and Drug Administration (FDA) has the authority to regulate some software as a medical device. It is important for developers to know if their software meets the definition of a medical device, how it will be regulated, and whether regulatory approval or clearance is required before it can be commercialized.5,6
Background on the Act
The 21st Century Cures Act was signed into law on December 13, 2016.7 Section 3060 of the act amends the Federal Food, Drug, and Cosmetic Act (FDCA) to exclude certain software from the definition of a medical device. This is important because the excluded software—so long as certain conditions are met–is exempt from FDA regulation, creating a faster and more certain path to market. Clinical decision support software (CDSS) is one of these exclusions.
CDSS can aid healthcare professionals in making diagnoses. Providers, like radiologists, who make diagnoses based on images face several difficulties. They need to review images from potentially hundreds of patients daily and often in stressful settings such as an emergency room, which may create decision fatigue.
Additionally, image blur and regions of overlapping tissues can contribute to incorrect diagnostic decisions. These factors and others can cause healthcare professionals to order unnecessary medical procedures, such as a skin biopsy for a lesion that turns out to be non-cancerous. This exposes the patient to increased medical risks and increases the cost burden on healthcare payers.
Section 3060 of the act,8 which is relevant to CDSS, recites in part that the definition of medical device shall not include software for the purpose of:
(i) . . . Analyzing . . . medical information about a patient . . .; and
If the CDSS meets the criteria in Section 3060, the CDSS has a statutory safe harbor, with the FDA not having jurisdiction to regulate it.
It is crucial to note that there are two broad situations, or exclusions, where CDSS can nevertheless be regulated by the FDA as a medical device. The first is where software “is intended to acquire, process, or analyze a medial image or signal from an in vitro diagnostic device or a pattern or signal from a signal acquisition system.”9 For example, software that makes diagnostic recommendations based on the analysis of a medical image (e.g., CT, radiographs, or MRI) would not be entitled to the Section 3060 safe harbor. Rather, these CDSS products would require approval or clearance by the FDA.
The second exclusion, where the FDA can regulate and take the CDSS of the regulatory safe harbor, includes the following:
(i) The Secretary makes a finding that use of such software function would be reasonably likely to have serious adverse health consequences if it does not operate as intended; and
To meet the criteria above, various factors are required to be considered, and certain procedural due process requirements must be adhered to.11
CDSS will play an increasingly important role in the day-to-day practice of medicine. Developers of CDSS should understand how their CDSS will, or will not, be regulated by the FDA. Consulting early with regulatory counsel can help clarify the regulatory status of CDSS products.
1 The information herein is provided for informational purposes only and should not be taken as legal advice. Legal counsel should be consulted for questions regarding the regulation of software as a medical device and the 21st Century Cures Act.
2 Evan Blass, “Robot surgeon performs world’s first unassisted operation,” Engadget. See: https://www.engadget.com/2006/05/19/robot-surgeon-performs-worlds-first-unassisted-operation/.
4 James Wang, “Deep Learning Based Diagnostics: Unlocking a $16 Billion Market,” ARK Invest, December 22, 2016. See: https://ark-invest.com/research/deep-learning-based-diagnostics.
6 Mobile medical application developers should also be familiar with the FDA’s regulatory framework for mobile medical applications. The FDA issued a Mobile Medical Applications guidance in 2015. The definition of medical device in the guidance is outdated, so the guidance should be consulted with caution.
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