CASE: F-299ABR

DATE: 05/08/2014

CATCH TECHNOLOGIES INC.

Point zero three percent?…You better lawyer up...because I'm not just coming back for 30 percent,
I'm coming back for everything.
— Eduardo Saverin, The Social Network

INTRODUCTION

In October 2000, David Brown was eagerly following the excitement surrounding the development
of a new medical device, the drug-eluting stent. The medical community as well as Wall Street
seemed very optimistic about its growth potential and medicinal applications. While studying
various medical journals and speaking to industry thought-leaders at Stanford Hospital, Brown
came up with an innovative medical device to be used in conjunction with stents placed in the
coronary arteries—an embolic protection device.

FOUNDING OF CATCH TECHNOLOGIES

An MD from Stanford University, Brown had an idea for a breakthrough medical device to be
used in conjunction with coronary stents for the treatment of coronary artery disease. Recognizing
the need for both engineering and management skills, Brown teamed up with two other like-
minded entrepreneurs from Stanford’s Engineering and Business Schools—Richard Kim (MBA)
and Paul Smith (Master of Mechanical Engineering).

Having formed the founding team, Brown incorporated Catch Technologies Inc. on December 31,
2000. The three founders each contributed $75,000 to the venture and bought founder shares at
$0.01 per share. With the initial capital in place, Brown and Smith worked on designing the
protocol device, while Kim focused on putting together a detailed set of projections for future
financing during 2001.

Edward S. Chung, MBA ‘06, and Ryan N. Cotton, MBA ‘07, with updates from Jay Schneider and Eric Schwartz,
both MBA ‘12, and Professor Peter M. DeMarzo, Mizuho Financial Group Professor of Finance, prepared this case
as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative
situation.

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Catch Technologies Inc. F299ABR p. 2

BACKGROUND ON CORONARY ARTERY DISEASE (CAD)

Coronary arteries supply oxygenated blood to the tissues of the heart. Coronary artery disease
occurs when the coronary arteries become hardened and narrowed due to the buildup of plaque
(which is full of cholesterol and other fatty substances) on their inner walls. This hardening
process, called atherosclerosis, restricts blood flow to the heart muscles and often results in chest
pain or a heart attack, depending on the severity of the narrowing. 1 According to a 2006 report of
the American Heart Association, more than 6.5 million people in the United States suffered from
angina, and 1.2 million people experienced new or recurrent heart attacks each year.
Approximately 40 percent of these heart attacks were fatal, making cardiovascular disease the
leading cause of death in the U.S. 2

While cardiac surgery had been the gold standard of treatment for severe coronary artery disease,
a breakthrough in the treatment of CAD came in 1977 when percutaneous transluminal coronary
angioplasty (PTCA), or balloon angioplasty, was performed. 3 Interventional cardiologists used a
local anesthetic to numb a patient’s upper thigh or groin area where the femoral artery is located.
The physician inserted a catheter (which is a long, thin tube) with a deflated balloon at the tip into
the artery and guided it to the heart. When the catheter arrived at the site of blockage, the balloon
was rapidly inflated, pushing the plaque against the artery wall to expand the opening. The balloon
was then deflated and removed from the patient’s body. 4 Overall, balloon angioplasty is
considered to be much safer, with shorter recovery times than cardiac surgery, because it is a less
invasive procedure. On the downside, procedure-related scarring within the artery—called
restenosis—occurred in anywhere from 30 to 40 percent of patients within six months of the
angioplasty as the body sought to heal the artery from the trauma of the balloon’s expansion. There
was also a recoiling effect of the arterial wall, which meant that the artery remained only partially
open after the balloon catheter was removed. For these reasons, many patients required repeat
angioplasty procedures or bypass surgery. 5

To address these problems, the bare metal stent (BMS) was developed and incorporated into the
balloon angioplasty procedure. After the balloon was inflated at the site of blockage, a stent which
looks like a coiled pen spring was expanded. The stent, which is permanently implanted,
physically held the artery open, preventing the arterial wall from recoiling. As a result, patient
restenosis (post-surgery scarring) rates declined to approximately 20 to 25 percent. Patients with
restenosis returned for repeat procedures.

1
U.S. Department of Health & Human Services.
2
American Heart Association, “Heart Attack and Angina Statistics, ” January 4, 2006.
3
The device was developed by Stanford cardiologist Thomas Fogarty who practiced at Stanford until 2007, is founder
of the Thomas Fogarty Institute for Innovation, and also owns a winery on Skyline Boulevard overlooking the Stanford
campus.
4
HeartCenter Online, “Balloon Angioplasty.”
5
Professor Stefanos Zenios, “Drug Eluting Stents: A Paradigm Shift In the Medical Device Industry,” Stanford
Graduate School of Business 2006.
Catch Technologies Inc. F299ABR p. 3

Not satisfied with the restenosis rate of BMS, the medical device industry sought improvements
in medical technology to prevent the overgrowth of normal tissue in the artery following
angioplasty and the placement of a BMS. The search led to the birth of drug-eluting stents (DES).

A DES looks exactly like a BMS except that the DES is coated with a pharmacologic agent that
prevents the overgrowth of normal tissue within the artery wall. Clinical outcomes have shown
dramatic reductions in restenosis with DES, with rates as low as 0 to 3 percent. Because of its low
restenosis rates, DES are widely projected to replace BMS for the treatment of coronary artery
disease. In 2002, there were approximately 1,000,000 stenting procedures done in the U.S.
According to Wall Street research, growth is projected to be 5 percent in the next decade.

MARKET OPPORTUNITY FOR EMBOLIC PROTECTION DEVICES

The common problem with balloon angioplasty, BMS, or DES in the treatment of coronary artery
disease is embolism. During the stenting procedure, debris from some of the blood clot in the
artery could become dislodged and enter the blood stream, clogging one of the coronary arteries
or their branches downstream. When used as part of the stenting procedure, embolic protection
devices can help minimize the risk of embolism and protect the patient from potential adverse
events, such as a heart attack. 6

Brown’s proprietary embolic protection device, the Catcher, looks like a fishing net (see Exhibit 1)
and is inserted into a patient’s body through the femoral artery, similar to a stent. The Catcher
passes through the site of blockage before the stent is inflated. The Catcher is then inflated in the
artery, expanding its net to be able to collect debris once the stent is deployed upstream. The
embolic protection device prevents debris from flowing downstream and potentially causing a
heart attack.

6
Boston Scientific website.
Catch Technologies Inc. F299ABR p. 4

PROJECTIONS

During 2001, Brown and Smith completed the design and development of a protocol device. The
device was now ready for pre-clinical testing. The company incurred $140,000 of research and
development expense and $60,000 of general and administrative expense during 2001, nearly
depleting the financing provided by its founders.

With a device ready for pre-clinical testing, Kim had developed a detailed set of projections
through 2009 as follows (the 2001 projections are written in the present tense for the purposes of
the case assignment):

1. Kim expects that the Catcher will be approved in late 2006 with commercial launch in January
2007.

2. Relying on industry research, Kim bases his analysis on a total of one million stent procedures
performed in the U.S. in 2002, a figure that research projects to grow at 5 percent per year.

3. Based on a literature review and interviews with physicians, Kim estimates that 15 percent of
all stenting procedures would benefit from the use of an embolic protection device. This
represents the relevant market for the Catcher.

4. Based on preliminary discussions with various insurers and a value-based pricing analysis,
Kim estimates that embolic protection devices will be priced at $1,500 once commercially
launched, increasing by 5 percent per year. He believes the company’s device, the Catcher,
will be among the first ones on the market (definitely within the same year) and will have the
same price as the competition, which will also grow by 5 percent per year.

5. After reviewing other potential competing technologies, Kim projects that the Catcher will be
able to gain 15 percent market share of the relevant market in the launch year, growing to 20
percent in the following year, and reaching 22 percent during the third year of launch.

6. Smith estimates that the company will incur $4 million of research and development expense
per year, from 2002 through 2009. Most of the R&D expense will be spent on further refining
the device.

7. Brown hired a clinical consultant to devise a clinical plan. The consultant estimates that it
would cost the company a total of $27.5 million over 5 years of clinical testing to get the
Catcher approved by the FDA. A detailed breakdown of the clinical expense per year is shown
below:

2002 2003 2004 2005 2006

$3 million $5.5 million $6 million $6.5 million $6.5 million

The consultant, who will join the company once Series A financing is completed, also projects
a need of $2 million of clinical budget per year after the device has been approved for further
studies.
Catch Technologies Inc. F299ABR p. 5

8. Brown projects a sales expense budget of $1.5 million in 2006, one year prior to launch. He
expects sales expense to increase to $10 million in 2007, increasing by $1 million per year to
reach $12 million by 2009.

9. Kim estimates that the company will incur $1 million of marketing expense in 2006. During
the launch year, he plans on a large marketing campaign, incurring $5 million. He projects
that marketing budget will be constant at $1 million after the launch year.

10. Kim projects general & administrative expense to be incurred as following:

2002 2003 2004 2005 2006 2007 2008 2009

$0.5M $0.75M $1.0M $1.25M $2.0M $3.0M $4.5M $5.0M

11. Kim expects to invest heavily in net working capital as indicated in the following table showing
the increase in net working capital in each year:

2006 2007 2008 2009

$0.75 million $1.5 million $3.0 million $3.5 million

12. In 2006, one year before launch, the company will build a plant at a cost of $7.5 million. Kim
expects $0.5 million of maintenance capital expenditures per year thereafter.

13. Once the device is approved in late 2006, the company in 2007 will begin to build its embolic
protection device in its plant (devices used during clinical trials are outsourced and its expenses
are included in the clinical budget). The company expects to incur a fixed cost of $5 million
per year. In addition, its variable cost per unit is expected to be $1,000 in 2007, dropping to
$850 in 2008 and $650 in 2009. The drop is driven by larger unit production, increasing
efficiency due to movement down the learning curve in the production process, and improving
purchasing terms with its vendors.
Catch Technologies Inc. F299ABR p. 6

FINANCINGS

Founder Round
On December 31, 2000, the three founders each contributed $75,000 to the venture and bought
founder shares at $0.01 per share. The founders thus held a total of 22.5 million shares.

Series A
Armed with a protocol device, a clinical plan, and detailed projections, the company’s founders
were able to secure an $8 million Series A Preferred Stock financing on December 31, 2001, from
Medical Ventures. The Series A financing will be able to fund the company’s operation during
2002. As part of the Series A round, the board also agreed to authorize 4.5 million additional
shares as part of an Employee option pool to be used to attract new employees. Key terms of the
financing are found below:

Securities Series A Preferred Stock (“Preferred”)

Aggregate Proceeds $8 million
Price $0.80
Number of Shares to be 10,000,000
Issued upon Conversion
Option Pool The option pool available for future issuance will consist of 4,500,000 shares
with an exercise price of $0.00.
Dividends None
Liquidation Preference In the event of a Liquidation, the holders of the Preferred shall be entitled to
receive, in preference to the holders of the Common, an amount equal to
their purchase price per share of Preferred.
Conversion Each holder of the Preferred shall have the right to convert his or her shares
of Preferred at any time, at the option of the holder, into shares of Common.
Anti-dilution None
Adjustments
Voting Rights The holders of each share of Preferred shall have the right to a number of
votes equal to the number of shares of Common issuable upon the
conversion of Preferred.
Board of Directors The Board shall consist of a total of six members. The holders of a majority
of the Preferred shall be entitled to elect two representatives on the Board of
Directors. One outside member shall be mutually agreed to among the
holders of a majority of the Preferred and Common. The remaining three
members shall be from Company’s management team.

With the Series A financing, the company made significant progress during 2002. The company
completed all of its pre-clinical testing successfully and received approval from the FDA to
conduct human clinical tests. In addition, the company has made several key hires including
additional personnel in research and development and clinical testing.
Catch Technologies Inc. F299ABR p. 7

Series B
At the end of 2002, the company began to seek a Series B financing to fund its operation. Despite
the progress made in 2002, the overall financing environment for the medical device industry had
soured during the year. As a result, the company faced a difficult funding environment.

Ultimately, Catch was able to secure $22 million in Series B financing on Dec. 31, 2002. Series
A investor, Medical Ventures, invested 25 percent of the Series B round while a new investor,
GSB Venture Partners, led the round with 75 percent of the round. Prior to the closing of the
round, the board agreed to authorize another 5 million options (exercise price of $0.00) so that the
firm could continue to attract and retain key personnel. Series B holders will elect one new
member to the Board; all other key terms are identical to that of Series A shares.

QUESTIONS

1. Catch Technologies will need to raise additional funding by the end of which year?

2. How much will Catch need to raise in its Series C financing in order to avoid having to raise
additional funds in the future? (Round up to the nearest $10 million.)

Suppose that at the time of the Series C financing, the company has a 25% chance of failure. If it
is successful, it expects to be acquired in 2009 by a large publicly traded medical device firm.
Recent transactions suggest that in an acquisition, Catch can expect a valuation of 5.0x 2009
revenues plus ending cash, to be received December 31, 2009.

3. Estimate the value of Catch Technologies if it is successful in being acquired at the end of
2009.

4. If Series C investors demand a 15% return on their investment, what terms will Catch receive
in its Series C financing? 7

5. Suppose that at the time of the Series B financing, investors believe Catch has an additional
30% chance of failure prior to the Series C round. If Series B investors demand a 15% return
on their investment, what terms will Catch receive in its Series B financing?

6. What returns will investors earn, and what payoff will the founders receive, if the firm
succeeds?

7
For simplicity, assume that in the event of failure, assume Series B and C investors are junior to Series A investors
and receive nothing.
Catch Technologies Inc. F299ABR p. 8

Exhibit 1
Embolic protection device, the Catcher

Source: Boston Scientific Corporation, 2003.