The Paper 510(k) StrategyMar 02, 2022
Written by Eric Sugalski
Many medtech leaders are pressured by investors and others to rapidly achieve regulatory clearance with a product design that is not intended for the market. This is sometimes referred to as a “paper 510(k).” It is labeled “paper,” because that’s all it is – there is no intent to commercialize this version of the product.
What is the motivation to achieve this “paper” milestone?
For some, regulatory clearance is viewed as a significant de-risking accomplishment that triggers a valuation bump. It is believed that this milestone can unlock additional funding or open doors to commercial partnerships.
For others, this paper 510(k) is believed to make subsequent filings less onerous. Gaining clearance for an early-stage device could theoretically streamline future submissions, since the original cleared device can then be used as a predicate.
Is there any legitimacy to these perspectives?
Lets’ unpack the first one – valuation bump. The most common form of valuation method is Net Present Value (NPV), which is based on a Discounted Cash Flow (DCF) analysis. The DCF method attempts to capture the value today, based on projections of how much money the investment will generate in the future.
There are two important components of DCF – 1) discount rate and 2) future cash flows.
Discount rate is the return that investors expect relative to the risk of the investment. This financial risk can range from losing an investment outright to falling a hair short of projected cash flows. The higher the risk, the higher the expected return. As you would expect, early stage medtech investors have a much higher risk tolerance (and thus accept higher discount rates) than large publicly traded companies.
So, does the paper 510(k) milestone then reduce the discount rate?
There is no intention of selling the product used in the paper 510(k) pathway. Most teams pursuing this route will freely acknowledge that the design of the product is not intended for market, despite the “market clearance” gained through the regulatory process. The market clearance is symbolic, artificial, on paper only.
Since the financial risk of an investment is measured by its ability to generate future cash flows, and since the paper 510(k) does not increase the salability of the asset, it does very little to reduce financial risk and the corresponding discount rate.
Now, let’s move on to the second component of DCF – future cash flows.
The time horizon to generate future cash flows is a critical element of the DCF analysis. As the saying goes, a dollar today is worth more than a dollar tomorrow (or a year from now). So, if a company can accelerate sales by launching a marketable product sooner, then it will be able to generate cash sooner, which can result in a significant boost to an investment’s valuation.
The paper 510(k) does the complete opposite – It lengthens the time horizon for future cash flows.
A company may believe that the “quick and dirty” paper 510(k) version can shortcut steps, but typically this is not true. The product needs to be real – as does the documentation and data submitted. In addition to testing data, the product needs to be supported by product labeling, instructions for use, specifications, design controls, risk assessments, and more. This product and its documentation may not need the polish of a version intended for market, but the same contents need to be generated, verified, and validated. Lastly, the 510(k) submission also requires a truthful and accuracy statement to assert the validity of the contents of the submission. Compromising there opens a whole other can of worms – think Theranos.
When it comes to the commercial product, the design is a redo. The manufacturing is a redo. The V&V process, including long-term performance testing (biocompatibility and sterilization validations), is a redo. Most steps and expenses will be incurred twice. So, what have you really gained with the paper 510(k) path?
Some may argue that the original 510(k) filing will be suitable to support the future product with documented justifications. Under this premise, the timeline will not be compromised as significantly as stated above.
Is this a reasonable argument?
Generally, no. The challenge with this argument that by using the paper 510(k) as the predicate, you are locking yourself into an obsolete design from the start. To achieve the rapid 510(k) clearance, you will likely be minimizing (or foregoing) important steps, such as user testing and optimization, design architecture and cost optimization, component selection and supply chain refinement. You may be able to justify minor changes, but most often when you rush through the process the first go-around, you will need a design overhaul that will require new risk analyses, risk mitigations, new verifications, and new validations. In most of these cases, you’ll be doing a second 510(k).
Since time to market will be extended *significantly* by inserting the paper 510(k) step, this will push potential cash flows out further into the future. This, in turn, reduces the valuation of your asset or company, at least based on the DCF method.
The other suggested motivation for investors and managers seeking the paper 510(k) status is to make future regulatory clearances less onerous. Is this true?
For the 510(k) pathway to be applicable, a device needs to be substantially equivalent to a legally marketed medical device. From fda.gov, “substantial equivalence is established with respect to: intended use, design, energy used or delivered, materials, performance, safety, effectiveness, labeling, biocompatibility, standards, and other applicable characteristics.”
Let’s say you find a predicate device that you think is suitable. We’ll call that product “A.” Your initial paper 510(k) product is product “B.” To establish equivalence, you assert that A=B. You then develop your new, commercial version of the product. We’ll call that product “C.” You use B as the predicate in filing the 510(k) for product C. So, B=C. But couldn’t C use A as the predicate instead? After all, A=B, and B=C, so A=C, right?
Many companies taking the paper 510(k) path think that “C” in the case above can embed some new and novel features that may qualify for the equivalence requirement of 510(k), since a similar version of the product has just been cleared. This is a naïve perspective – new elements that change the intended use, indications, foundational user needs, and risk will be flagged immediately. If those new and novel features weren’t part of your product “B”, then you just spent a lot of time and money creating a version of the predicate that offered little benefit to your future marketable version.
A much better use of time and resources is to leverage FDA’s pre-submission process, which is specifically designed to answer the types of questions that often motivate companies to insert the paper 510(k) iteration. The pre-sub process is a takes much less time, is negligible in cost, and will provide FDA perspectives on the real topics that matter for regulatory approval of product “C” – the version you intend to commercialize.
Aside from the valuation and regulatory matters, there are some other factors to consider in this paper 510(k) route.
Since the time to future cash flows extends, this will require you to float your company for a longer period. This will extend all operating expenses of the business, which will ultimately require a larger investment. Since the future cash flows will remains the same, while the initial capital outlay increases, the valuation of your venture or asset will decrease even further.
And now the topic of team churn.
Unfortunately, many of the investors that initially push for this paper 510(k) route then want to see if this initial crude version sells. So, they drive the management team to get the product out into the market. And as expected, the market debut is a complete faceplant. The existing CEO and other managers are left holding the bag – suddenly responsible for poor sales resulting from a product that was never intended to be marketed. Unfortunately, new investors were not privy to these earlier conversations and old investors may have selective memory regarding the “paper 510(k)” route and rationale. In situations like these, it’s often suggested that a different set of skills is needed, and the management team needs an upgrade. Thus, more time, effort, and investment are dumped into recruitment, onboarding, new thinking, new strategies, new partnerships, etc. This requires even more capital, thus decreases the investment return even further.
As typical in life, the shortcut almost always turns out to be the long haul. Recovering from a poorly planned and implemented first go-around requires more time and effort than just doing it right the first time. Doing the right research, assembling a solid strategy, and implementing the right design that meets market needs beats the shortcut strategy every time.
If you are looking for support in developing your commercial strategy, designing your product, and achieving the right regulatory milestone, Archimedic may be able to help. Feel free to Contact Us if you would like to explore possibilities together.
Get these articles emailed to you
Drop your email in the form below, and you will receive our latest medtech articles.
We promise - no spam ever. Unsubscribe at any time.