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Device Startups Struggle With Obamacare Excise Tax Industry leaders worry tax can dampen growth and innovation.

By Arlene Weintraub

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

On April 4, the Senate Finance Committee passed a tax reform bill that failed to address one of the most hotly debated provisions of the Affordable Care Act, otherwise known as Obamacare: a 2.3 percent excise tax on the sale of many medical devices. The "tax extenders package" that passed that day covered 50 provisions worth $85.3 billion, but left unanswered the question of whether the device excise tax should be repealed.

The medical device excise tax, in effect since 2013, has been controversial since the day it was enacted. Legislators who support the tax say it's a justifiable way for a very profitable industry to help fund Obamacare. But industry leaders say that because it's a tax on sales, it can hamper startups by delaying profitability, for example, or forcing cutbacks in the research spending that's needed for the industry to produce more innovations in the future.

Belmont, Calif.-based PowerVision, which is developing an intraocular lens for use in cataract surgery, is still a couple of years away from getting its product on the market, but co-founder and chief executive officer Barry Cheskin says he's already thinking about the potential impact of the excise tax long-term. "This tax doesn't directly affect us today but it does affect potential acquirers," he says. While larger medical device makers may be able to make up for the cost of the tax by raising their prices, Cheskin says, it still puts pressure on their sales and profits. That could restrict available funding for mergers and acquisitions. "The tax somewhat tempers their interest," he says.

Although PowerVision has been successful in its venture-raising efforts—it recently raised $20 million, bringing its total funding to $87 million—other medical device startups have not been so lucky. Total VC funding of medical device startups fell 17 percent in 2013 over the previous year to $2.1 billion, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association.

Shaye Mandle, chief operating officer of LifeScience Alley, a trade organization outside of Minneapolis, says one reason VCs are likely shying away from the device industry is that the excise tax not only makes acquisitions more difficult, but it also makes it harder for small companies to reach profitability on their own. "In the medical device arena, because the pathway to having a product that you can sell is long and expensive, you have to generate a fair amount of sales to get to profitability," Mandle says. "That makes the pathway for investors getting their dollars back longer."

Another challenge for medical device entrepreneurs has been figuring out exactly which devices are subject to the excise tax. Some products, such as gizmos sold directly to consumers at drug stores, aren't subject to the tax. But for some manufacturers, the tax is a decided gray area. "There are battles being fought right now, for instance, over mobile health apps and software products," says Clinton Mikel, a partner at The Health Law Partners in Southfield, Mich. "If you have a medical app cleared through the [Food & Drug Administration's] process as a medical device, are you now subject to the medical device excise tax?" The government has not stepped in yet to answer those questions clearly, he says.

In the meantime, the medical device industry continues to fight for a repeal. In February, the Washington, D.C.-based medical device trade group AdvaMed estimated that based on a survey of 38 of its members, the tax may prompt medical device companies to eliminate 165,000 existing employees or planned new hires. That may be a bit of an exaggeration—some critics have blasted the organization for releasing figures based on such a small sample size—but AdvaMed is still trying to get the tax repealed.

JC Scott, senior executive vice president of government affairs for the trade group says AdvaMed is evaluating the legislative landscape to try to find another opportunity to get a repeal built into ongoing tax-reform efforts. "This is very much a jobs issue," he says. "We're continuing to make sure that this stays top-of-mind for policy makers."

Arlene Weintraub has over fifteen years of experience writing about health care, pharmaceuticals and biotechnology and the author of a book on the anti-aging industry, Selling the Fountain of Youth (Basic Books, 2010).She has been published in USA Today, US News & World Report, Technology Review, and other media outlets. She was previously a senior health writer for BusinessWeek.

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