We recently closed a growth investment in Circle Cardiovascular Imaging to support its continued global commercial expansion and distribution deal with GE Healthcare (more details here and here). Our investment strategy in the Healthcare IT (“HCIT”) vertical continues to evolve and this is a great opportunity to share our emerging thinking. We welcome your engagement and discussion.
We’ve been the most active HCIT investors in Canada since 2011 as the vertical fits strongly with our Fund investment theme (Healthcare Productivity). We believe digital health solutions are key to increasing productivity and efficiency of the healthcare system and to enabling patients and caregivers to be better informed and better connected thus resulting in improved quality of care.
Over the past five years, we’ve had reasonable success with a couple of early-stage investments (beta-stage product, minimal customer traction) but our focus going forward will be on Breakout opportunities (i.e. those breaking out to industry leadership and those developing “big idea” opportunities in new areas).
Why are we evolving our focus to Breakout opportunities?
Refinancing Risk. “HCIT is more capital and time efficient than traditional life sciences” we hear people claim this way too often… Few notable exceptions exist (Veeva is the most capital efficient exit of a VC-backed company, even ahead of WhatsApp) but it’s generally a myth. Truth is – Getting to a beta product and securing some early flagship clients (i.e. providers like the Mayo Clinic and Kaiser Permanente, who by the way, are not an indication of future widespread adoption) may require less time and capital than developing a drug through proof of concept, but scaling a HCIT business and eventually getting to a significant exit point for investors (most of these companies get acquired on Revenue or EBITDA multiples) is a completely different story. To quickly test the validity of this statement, check all publicly-traded companies in the space and you’ll notice that except a few outliers (Imprivata -2001-, Teladoc -2002, Evolent -2011-, and Veeva -2007-), most companies with a market capitalization of $300M+ were born over 20 years ago, raised in excess of $50M in angel/venture funding pre-IPO, and grew at no more than 10-30% per year (no hockeystick) including many accretive acquisitions in some cases. In fact, most of these companies really owe their current status and more recent growth to quasi-government subsidies received through the Health Information Technology for Economic and Clinical Health Act (HITECH) of 2009, which allocated close to $20B towards the development of HCIT and effectively kick-started the entire sector in the United States. Another disturbing observation: the billion-dollar club in the space is so small you could probably fit all its CEOs in a standard board room.
As an aside, the conventional wisdom about IT/Software ventures being more capital efficient to exit than Healthcare/Life Sciences space is also wrong. If you believe in this myth, I highly recommend a CB Insights or PitchBook subscription; numbers don’t lie. Going back to HCIT and to give an illustrative example we know quite well: Circle Cardiovascular Imaging did not secure its 600 hospital clients overnight; When the journey started in 2008, the company quickly secured over 45 beta sites in 12 countries (see comment about early flagship clients above) but it took almost 8 years of hard labour, patience, continuous product development, a dedicated team and responding to hundreds of RFPs, attending tradeshows, performing customer demos…etc., for the company to build a solid base and a leadership position in the industry. Luckily, the Circle team has been exceptional with use of capital and achieved a lot with a small, first institutional round in 2011 but we’re well aware the recipe needed to be different if we wanted to accelerate our growth and maintain our dominant position in CMR.
Liquidity Risk. There is a lot of talk about the explosion of digital health funding but not enough about exits. Since 2011, investors have poured over $20B in the space; if we use 2011 as a vintage investment year and assume 2016 will attract as much investments as in 2015 (why not right? Let’s celebrate another record year!), the sector would have used ~$30B of disclosed venture funding over the 2011-2016 period and will need to generate aggregate exits in excess of $100B over the next five years if we were to project a modest 3X for a theoretical 10-year fund. To achieve that, the sector will require over 100 IBM/Merge-like exits or 25 such exits each year over the next four years.
That’s very unlikely to happen: if we assume the past to be a good predictor of the future, well the M&A/IPO landscape has not been very robust over the past five years. Many optimists will claim my argument does not really hold as the past can not be indicative of the future in a fairly “new” industry and that the best is yet to come – blah blah blah… I can’t really decide if I agree but ok, I take this one back.
Total venture funding in the space is high and growing and that’s not a bad thing.
My concern is half of the deals closed since the enactment of HITECH were for $1M or less (see median in the graph above) and given the average of this set is only $5.6M with a bunch of mega deals accounted for (Privia, Proteus, Nanthealth, Teladoc. etc), the $20B+ funding was really scattered over thousands of teeny-tiny deals, supporting companies that are most likely to disappear or become zombies over time; call it an at-scale spray and pray strategy. A recent Accenture report based on the analysis of 900 HCIT start-ups highlighted the same issue.
Don’t get me wrong, I still believe some companies and their financial backers will do really well. I just think focusing on opportunities that are on the cusp of breaking out to industry leadership (more specifics below) is more likely to generate good investment returns and I fail to see a compelling reason for going in very early (exception made for “big ideas” in new areas ; to be described later on this post).
I will try to distill what we’re specifically looking for using Circle and other portfolio companies as examples whenever appropriate. I won’t elaborate on the obvious fundamentals (large market opportunity, strong value proposition, aligned syndicate…etc.):
1- Companies Breaking out to industry leadership – Circle Cardiovascular Imaging:
Stage: the why has been discussed above; we’re looking for opportunities requiring capital for acquisitions, roll-ups or market expansion.
Strong customer base: as mentioned earlier, securing some early adopters is not an indication of future widespread adoption; while we won’t expect companies to have 100+ clients, we want to see the technology garner interest from “mainstream” providers just as much as it attracts leading innovative institutions.
Circle’s solution is now broadly installed in multiple geographical regions and different healthcare settings including public and private hospitals, private clinics, teaching hospitals and research centers; the company enjoys a high satisfaction rate with the installed base.
Value proposition: already proven through previous trials and pilots (published data) for solutions with a price point requiring multiple approval levels or very clear and tangible benefits to users for solutions requiring only champion’s approval and/or department head.
Based on feedback we collected, cardiologists love Circle’s product suite; it just makes their lives easy, saves them tons of time and improves accuracy of diagnostics thus having a direct impact on their patients, at a fairly reasonable price that flies below the radar of CFOs/CEOs of most hospitals.
Innovative product with few competitors and potential for a dominant position: generally, a solution that alleviates most pain points experienced by users, with a clear and ambitious product development roadmap, a realistic plan to sustain a long term competitive advance.
Circle has few solid competitors providing cardiac specific analytical tools to the CMR industry and the company consistently wins in almost all competitive situations. The Company’s products were designed by cardiologists for cardiologists; By focusing in a specific clinical area, Circle has developed the world-leading and most innovative analytical tools for CMR.
The technology is a platform: critical both from a usability and market potential perspective.
While Circle started with a focus on diagnostics, the platform has the potential to migrate downstream (in fact, our product development on that front is already well underway) to interventional cardiology.
Team: Companies in this space tend to be light on IP but heavy on business model execution and growth. One of the main challenges we face here is finding very experienced management teams that have a proven track record for scaling-up businesses and that are deeply immersed in their target markets with strong networks in the payors and providers communities.
Circle was founded by an internationally recognized clinical cardiologist who wanted a more efficient means to evaluate and report multiple cardiovascular images, reducing errors and lowering costs of treatment. The company’s CTO is one of the few cardiologists trained both as a physician and a software developer. Together with the founder, they have experienced firsthand many of the challenges with the diagnosis of cardiac disease that are now being addressed with Circle’s solution. The company’s CEO worked at leading healthcare companies in various sales and management positions for over 20 years and has already demonstrated his ability to start and scale a business through his previous exit (theheart.org, sold to WebMD in 2005). This team has been expanded to over 50 talented employees in the past years including a brilliant sales organization and development team.
2- “Big ideas” in new areas – PHEMI Systems, Clearwater Clinical and Imagia Cybernetics:
On an exceptional basis, we will do small-sized investigational rounds where we would back a very experienced team with a big idea, trying to solve a big problem, with the objective to raise a much larger round within 6-18 months. For these deals, we established a strict fund discipline to avoid supporting false-positives indefinitely; in other words, clear guardrails are set at the time of the initial investment to avoid falling into the trap many (even the most experienced) VC investors have experienced at least once: getting dragged into cutting corners and keeping the start-up on life support for as long as available capital permits. We also like to structure these deals in such a fashion to get a board seat early on as well as super prorata rights on upcoming rounds.
PHEMI Systems: we first committed a small investment to PHEMI in February 2014 with a decent understanding of the big idea but not with a fully mapped out plan. Our thesis then mostly revolved around backing a high profile team that wanted to leverage their strong heritage in IT to bring big data solutions to healthcare (a pretty hot space). While still in its early commercialization phase, we’re very satisfied with PHEMI’s performance: the company is becoming a key player in the healthcare big data arena, raised a subsequent round with external investors exactly 18 months after the first round and is also making significant commercial progress.
Clearwater Clinical: the original idea here was to back a serial entrepreneur, well known to our firm, who partnered with a very innovative and entrepreneurial physician to bring to market, disruptive and cost-efficient mobile health solutions for the diagnosis or treatment of common medical conditions thus accelerating democratization of healthcare access. Our plan with Clearwater is to grow the existing business, acquire other players in the objective of building a mobile health franchise. Lots of work ahead of us on this one but very pleased with the progress thus far.
Imagia Cybernetics: yes, we too could not resist the “deep learning” temptation. More seriously, our interest in Imagia stemmed from the fact that some of Imagia’s key principals are well known entrepreneurs (we successfully backed them before) with privileged access to one of the founding fathers of deep learning as well as some key IP rights in the areas of image processing and machine learning. We closed a seed deal with a group of well-known syndicate partners late last fall with the objective of doing an early proof of concept and raising a significant financing round to fully develop the solution and go to market.
I hope this post does not give the impression I am bearish on the sector. While I think only a few investors will make money in the space, I believe the HCIT enterprise segment will remain solid over the next years: the ongoing regulatory and reimbursement changes are forcing hospitals to speed up their adoption of technology and as a result the hospital purchasing trends will continue to be positive with IT budgets either stable or increasing. In addition, the continued hospital consolidation will also likely create many replacement and workflow efficiency-related opportunities.