In a move to shift investments from traditional venture capital favorites in IT or drug-development firms, VCs show new favor for medical device startups. Per the New York Times, "In the first quarter of this year, seed investors put $1.1 billion into
such businesses, a quarterly record for the medical-device industry,
and a 60 percent increase over the same period in 2006, according to
the National Venture Capital Association, a trade group."

Medical investments are by nature high risk, and devices take time
and millions of dollars to develop. They must also be tested for safety
and usefulness and then receive regulatory approval. It is a business
that generates sales of $15 billion to $20 billion a year, and the
venture capitalists are betting on its expanding into new niches.

of the lure, analysts and executives said, is that medical devices feel
like a smarter gamble than investing in computer technology, which has
fallen out of favor with public-market investors. Interest by these
investors is critical for venture capitalists who want to profit by
selling shares of their start-ups on Nasdaq.

Indeed, with emphasis on "feels like a smarter gamble..." The coming wave of baby boomers is offered as justification for optimism, noting this demographic is relatively affluent and interested in technology. While true, the self pay market for medical devices outside fitness and health maintenance is tiny. The real market is in payor-reimbursed devices. Here's an example from the story:

“We are all used to the idea that our BMW tells us when our tire is
flat,” said Paul S. Kedrosky, executive director of the William J. von
Liebig Center for Entrepreneurism and Technology Advancement at the University of California,
San Diego. “The idea of a device telling us that our blood glucose is
low is pretty appealing to people.” A device’s function, he added, is
also easier for venture capitalists to grasp than, say, the workings of
a new drug, which can require a background in chemistry and biology to

DexCom was the first to offer implantable continuous blood glucose monitoring (more here, here and here). While demonstrably "better" - more convenient because it's implanted, and better data because it provides continuous readings - payors have yet to provide reimbursement for continuous monitoring. There is reimbursement for glucose monitoring, but it is for the much lower cost manual method (pricking fingers, taking manual readings). It turns out only a few diabetics benefit clinically from continuous versus occasional glucose monitoring. When reimbursement for continuous monitoring is available, it will only apply to a relatively small number of patients who actually need it. Will this patient population and the level of reimbursement provided be sufficient to support DexCom and pay for new BMWs for their investors? Time will tell.

The story refers to "repurposed" VCs coming from IT and drug discovery markets. I would imagine that VCs coming from drug discovery would better make the transition. While IT guys can understand the technology behind most medical devices, the IT markets provide little background into the arcane world of health care reimbursement or how products might be adopted by the fragmented (and often competing) players in health care.

Another big challenge are combination products - those that are part device and part drug (like drug eluting stents) or those that are part device and part software. Even a seemingly straight forward innovation like a new physiological parameter is risky. Startups face the choice of licensing their technology to slow to adopt established vendors, or develop their own finished medical device. The first option is time consuming, and the second takes both time and money over and above the core technology to field a competitive product. Take for example Signalife and their novel ECG technology that eliminates motion artifact, a problem that has plagued ECG recordings for many years. After several years, the company continues to struggle with finding market traction.

Finally, there's the problems caused by the VCs themselves:

There is also a general concern that these markets are cyclical.
Medical-device investing was also strong in the mid-1990s, but crashed
later in the decade as public-market investors turned to information
technology. The current record investment in devices has spurred some
to say that the market might be overfinancing technologies.

could create overheated sectors and put too much money to work,” said
Mr. Cassak of In Vivo magazine, though he added that the influx of
investments into medical-device research was a big net positive so far.
“It’s hard to see the current interest as anything but good news.”

The health care industry itself is very un-cyclical.