Venture Activity in 3Q21 – Shaking My Head…

Obviously, the venture market is on fire, likely to shatter all records this year. So far nearly $239 billion (yes, with a “2” and a “b”) has been invested in 12,837 venture-backed companies in 2021. Against a backdrop which saw the U.S. Small Business Optimism index fall to its lowest level in the last six months due to spiking inflation and labor force dislocations, venture capitalists have invested at a frenetic pace and enjoyed an extraordinary exit environment.

Contributing to this paradox has been the enormous levels of government support over the last 18 months which has allocated the risks and costs of the pandemic broadly across society.  The level of support provided since the start of the pandemic increased disposable household income 11% greater than the 18 months prior to the pandemic. In fact, after-tax profits generated by non-financial companies was 7% greater in the 18 months during the pandemic than the 18 months prior. This extraordinary liquidity and strong earnings environment has led to a marked acceleration in the S&P 500 EPS, further boosting investor confidence.

Data: S&P Dow Jones Indices division; Chart: Axios Visuals

The heightened venture investment activity was broad-based, impacting all stages and all sectors. While the overall number of investments continued its modest decline started six months ago, the dollars invested set another record and is now on pace to reach nearly $320 billion in 2021, which would be nearly 10x the amount invested in 2010 (yet only 3x the number of companies). According to Pitchbook (below), it certainly appears that we have entered a new “pandemic” phase of investment activity, arguably as important segments of the economy are re-architected.

There are a number of important implications that arise from this current fundraising environment. First and foremost, this frenetic pace has shown up in significantly increased pre-money valuations and round sizes. The median pre-money valuation for early stage deals was $30.0 million in 2020 but increased to $45.0 million in 2021 year-to-date. At the same time, the median round size for these companies increased from $7.0 million to $10.0 million (below). For late stage investments, the median pre-money valuations increased from $70.0 million to $120.0 million over those same time frames, while the median round size increased from $10.0 million to $16.5 million. 

The tremendous number of “mega rounds” (rounds greater than $100 million) over the last three quarters clearly has skewed the data. The average pre-money valuation of late stage rounds increased from $446.2 million in 2020 to $800.3 million in 2021 year-to-date, with the average round size jumping from $37.5 million to $56.4 million. In 3Q21 alone, there were 207 “mega rounds” that totaled $49.5 billion (chart below). In other words, nearly 60% of the capital invested in 3Q21 went to only 0.6% of the companies this past quarter. As entrepreneurs weigh the benefits of raising such a large round, the level of personal dilution is balanced by the competitive differentiation such a financing is likely to create. Of course, this incremental capital also creates a burden to drive considerably more shareholder value.

Mega Rounds”

This heightened level of investment has led directly to the creation of a significant number of “unicorns;” so much so that it has become somewhat passe…almost no longer remarkable. Year-to-date, 597 “unicorns” raised $136.5 billion or on average $228 million. Notwithstanding there were fewer “unicorns” in 2020 (only 333), the average round size was nearly equivalent to 2021 activity.

Number of “Unicorns”

Contributing to all of this investment activity has been the important role of non-traditional venture capital investors such as hedge funds, mutual funds, sovereign wealth funds, and strategic corporate investors. Year-to-date nearly 77% of all capital has been invested in rounds that included one of these investors. Corporate investors alone participated in 26% of all deals and those deals accounted for 51% of all capital invested. Arguably, these strategic investors are looking to access innovative solutions that may well inform their core product roadmaps, while the financial investors, in a world of nominal interest rates, are seeking greater returns above and beyond public alternatives.

And those returns have been plentiful. For 2Q21, the most recent quarter tracked by Cambridge Associates, the preliminary early stage and late stage venture returns have been 14.3% and 15.6%, respectively. Overall, the level of exit activity in 2021 has been nothing short of staggering. Exit value year-to-date is $582.5 billion, of which nearly 90% has been via public listings. Not to be lost in all of this activity is the SPAC (special purpose acquisition company) phenomenon, which has suffered somewhat over much of this year. To date, 413 SPACs have raised $109.4 billion and is estimated that there are 549 SPACs scurrying around looking for companies to acquire.

This virtuous cycle, driven by extraordinary levels of liquidity and supported by extraordinary levels of innovation, comes full circle with fundraising by venture capital firms. Pitchbook estimates that 526 funds have raised over $96 billion year-to-date for an average fund size of $195 million (while the median is only $50 million). This pace suggests that the venture capital industry will raise nearly $130 billion; ten years ago, venture capitalists raised $22.9 billion. Yet again, the average is somewhat misleading as there have been a record 19 funds raised that were greater than $1.0 billion in size coupled with a notable reduction in the number of regional and micro-funds. Another sign that there is “capital aggregation” around a more limited number of venture funds is that there may only be 150 first-time funds raised this year, which would be the lowest level since 2013. Industry analysts estimate there is now over $220 billion of “dry powder” held by venture funds.

One other indicator of industry consolidation is reflected in geographic concentration of venture capital investments. There are 24 states, nearly half, which recorded less than 50 total venture deals in 2021. Fifty deals is a mere 0.3% of all deals. Therefore, half of all states accounted for only 9% of all venture-backed companies. California alone was just under 30%. Mississippi had two companies.

When there is a correction, and there always is a correction, analysts may observe in hindsight that with flashing red lights of economic concerns, investors became complacent during the pandemic and simply invested too much, too quickly. Or some may say that the forces unleashed by Covid to restructure important sectors of the economy required the best minds to raise extraordinary amounts of capital given the enormity of the market opportunities and that these large rounds will enable the companies to power through the correction. However that plays out, it is clear that disparities are emerging: a relatively select few companies will have raised much of the capital, often times invested by a relatively select few venture firms. 

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Demand a Raise…

Setting compensation and incentive plans may be one of the trickiest, most nuanced aspects of the CEO and board’s responsibilities – made even more complicated by the pandemic and the move to remote and/or hybrid staffing models. The dramatic workforce dislocations with surging unemployment 18 months ago and the grindingly slow recovery makes a tough situation worse.

It has been a tale of two cities since February 2020. There were 10.93 million open positions or 1.3 positions for every unemployed American at the end of July 2021. While the average hourly wage has increased 8.0% to $30.73, according to U.S. Census Bureau data, this marked increase was in large part due to significant layoffs of low-skilled hourly workers and to a lesser degree, increased wages required as employers struggled to re-staff. The dramatic increase in stock market and real estate values pushed U.S. household net worth to yet another record of $141.7 trillion at the end of 2Q21. Of the $5.8 trillion increase in 2Q21, $3.5 trillion was attributed to the increase in public equities and $1.2 trillion to increased home values. Of course, not all Americans own equities or homes, exacerbating the yawning inequity gap.

 Data: Federal Reserve Bank of St. Louis; Chart: Thomas Oide/Axios

As year-end approaches, many corporate boards now are deliberating over 2021 bonuses and architecting 2022 compensation plans. In collaboration with my good friend Jody Thelander of J. Thelander Consulting, a leading private company compensation consultant, a review of the data she has collected offers insights into emerging compensation themes. And there were some quite unexpected insights that revealed themselves.

“I was most struck by how stable the data were and the impact of the amount of capital raised has on overall compensation” observed Thelander, who tracks nearly 1,300 private companies, half of which are technology companies. The extensive database aggregates all reporting companies by number of employees, title, sector, and amount of capital raised: all of which directly inform the composition and size of incentive plans. Against the obvious pressure to retain talent, one might expect a dramatic increase in annual compensation – that is not the case. In fact, Founder CEO 2021 levels were either flat or slightly lower than 2020 levels (see chart below).

The narrative for public companies is similar. The Conference Board analyzed CEO salaries for both the S&P 500 and Russell 3000 indices from 2018 – 2020 and observed modest reductions, likely one-time, heading into the pandemic in early 2020. Notably, public CEO compensation is 2x – 3x that of later stage private company CEOs, and not at all unexpectedly, 5x – 6x that of early stage CEOs. Somewhat surprisingly though, public company CEO median salary for the Consumer Staples sector was twice that of the Health Care sector. The Conference Board data also highlight that CEO salaries often decreased to a much greater degree than other members of the executive leadership team, often as a sign of solidarity to the rank-and-file employees.

The Thelander data also compared CEO compensation by sector and stage. The more capital raised, the greater the compensation. The greater the prevalence of advanced graduate degrees, the greater the compensation. Later stage biotech companies reported meaningfully higher compensation across all executive positions; Founder CEO median compensation for later stage biotech companies was nearly $500k and 60% greater than later stage technology CEOs.

Founders tended to receive lower cash compensation but enjoyed significantly greater equity ownership positions. For companies that had raised less than $14.9 million, the median Founder CEO ownership level was 24.0% versus 5.9% for non-Founder CEOs; median cash compensation was $200.0k (Founder) versus $218.5k (non-Founder). Similar story for later stage companies that have raised more than $70.0 million: Founder versus non-Founder median compensation and equity ownership were $400.0k versus $444.0k and 8.0% versus 4.6%, respectively.

One other quite surprising finding in the Thelander data involved geography. There is clearly a “coastal premium” paid to CEOs of biotech companies on both coasts, perhaps reflecting the relative concentration of the life sciences sector in certain key locales such as Boston, San Francisco, and San Diego. The reverse was true for the technology sector – there appears to be a modest premium paid in geographies in secondary venture capital regions. This will merit further analysis with Covid-inspired virtual workforces.

Given the obvious implication on wealth creation and shareholder alignment, most of the attention in compensation schemes is focused on equity. A recent Harvard Business School study concluded that companies with widely held equity were more likely to be successful. The Thelander data show that 78% of companies use Incentive Stock Options (ISO) versus only 11% with Restricted Stock Units (RSU), which is more prevalent with public companies. Not surprisingly, 94% of respondents have vesting with 83% using time-based vesting versus a mere 1% using only performance-based vesting – the remaining 16% have a hybrid vesting approach. Nearly 79% of those companies reporting have four-year vesting schedules, while 12% have three-year schedules (3% have one-year vesting and only 1% have more than five-year vesting). One-year cliff vesting was indicated for over 90% of companies.

The distribution of ownership by stage is tricker to discern across various cohorts given differences in the number of companies reporting but yet certain patterns do emerge. An enduring rule-of-thumb for early stage companies is that the employees receive up to 20% of the fully diluted ownership via the option pool. Initial Founder ownership levels are significant and absent further investments, will be meaningfully diluted. Companies in the Thelander database that have raised more than $90.0 million show Founder ownership levels of 4%, 8%, and 22% by quartile, respectively, as compared to initial early stage ownership stakes of 20%, 34%, and 47% (see below). Importantly, the employee ownership level remains relatively constant as companies raise additional capital, highlighting the necessity to “re-fresh” the option pool with each successive financing.

The impact of equity on overall executive compensation is most startling for public company CEOs. Base cash compensation accounted for only 22% of overall pay for CEOs of the Russell 30000 and only 10% for S&P 500 CEOs. Not surprisingly, the compensation levels for CEOs has tracked the public equity markets (see below), until very recently. The full effect of the dramatic increase in the stock market over the last three years has not yet been fully reflected in CEO compensation, as hard as that is to believe.

Source: Economic Policy Institute

And size matters – in 2020 the top 350 CEOs averaged $24.2 million in total compensation, an increase of 18.9% over the 2020 level, while the broader S&P 500 cohort earned on average $15.5 million according to Thrive. The Conference Board analyzed CEO compensation for public companies by aggregate revenue, and perhaps not surprisingly, determined that has companies scale, so did CEO compensation. It is true – bigger is actually better.

The size of CEO compensation packages has become a visible and highly charged topic, bordering on perfidy in some circles. The Financial Times recently cited a London Business School survey of public equity investors that determined 75% felt that compensation was too high while only 18% supported high pay to “recruit and retain” leadership talent. Critics of executive compensation have focused on the relative compensation of CEOs as compared to the average employee. The Economic Policy Institute calculates that the current ratio sits at 351:1, an increase from 307:1 in 2019 and a mere 21:1 in 1965. Aptiv Plc tops the leader board at 5,291:1.  

Source: Economic Policy Institute

At the risk of wading into a public policy debate, executive compensation is under an even brighter spotlight now that three federal unemployment insurance programs are set to expire. This will cause up to seven million Americans to lose a variety of unemployment benefits while another three million people will see their $300 weekly payments come to an end. Somewhat unexpectedly, the U.S. is at a record low in the poverty level at 9.1% of Americans living poverty, down from 11.8% in 2019. This is largely due to the social safety net programs that were unfurled since the onset of the pandemic. Were it not for this government support, the effective poverty rate would be 11.4%, according to a recent Columbia University study. Due to the Great Recession a dozen years ago, the poverty rate hit 16.1% in 2011.

The U.S. Census Bureau reported that 11.7 million Americans were lifted out of poverty while another 10.3 million were kept from falling into poverty by the stimulus programs over the past 18 months. In 2020, median household income declined 2.9% to $68k. If one was able to keep his/her job during the pandemic, their effective income increased 6.9%. These inequities have caused many policy makers to craft proposals to attack the “corporate greed” associated with equity compensation. One recent proposal was to aggressively tax share buybacks which, if enacted, might influence senior executive compensation plans. In 2018, the S&P 500 reported $806 billion of share buybacks as a way, in part some would argue, to prop up stock prices.

To come full circle, what will be the lasting impact of Covid 19 on compensation plans? As Thelander highlighted, the impact on executive compensation over the last 18 months has been fairly muted. Of the respondents to a recent Thelander survey, 91% of companies do not expect to modify current compensation frameworks for employees who have relocated away from company headquarters, although 87% expect to adjust cash levels based on that new location. Notably, only 10% expect to require a return to the office, while 59% expect to institute a “flexible” hybrid arrangement (only 12% expect to stay fully virtual through year-end 2021, with nearly half of those respondents already concluding that it will be permanent).  Of those utilizing a hybrid approach, 72% expect that less than 50% of the workforce will be fully remote.

All of this will be closely tracked and analyzed by Jody, and you can take that to the bank…

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“Strike while the iron is hot…”

“Battre le fer pendant qu’il est chaud…” is one of the more popular French expressions and roughly translates the title above. It also precisely captured the tone I witnessed while in France a few weeks ago. While most everyone seemed to accept the circumstances imposed by the pandemic and were dutifully masked and distanced, there was a distinct sense of enthusiasm, which is also borne out in some of the recent economic and financial data. Ironically, it is considerably harder for the French to travel to the U.S. and yet case counts there are relatively low and declining. The Covid infection rate is 106 per 100k residents as compared to 313 per 100k in the U.S. The ability to visit France now appears to be changing as the European Council just restricted Americans from non-essential travel to Europe (and France just banned all unvaccinated travelers).

Over the last few years there has been a concerted effort to strengthen the French start-up ecosystem, in part as an acknowledgment that France over the last decade has been a distant #2 (or #3) to the United Kingdom, flip flopping with Germany for runner-up status. According to EY data, 5.4 billion euros was invested in 620 companies in France in 2020, as compared to 12.7 billion euros in the U.K. and 5.2 billion euros in Germany (over $156 billion was invested in 11,024 U.S. companies in 2020). Of the 620 investments, 436 (~70%) of them raised less than 5 million euros. Between 2019 – 2020, the level of investment activity increased over 25% in France while Germany only grew 10.9% with the U.K. increasing a mere 1.7%, according to Pitchbook analyses (which also had Germany slightly ahead of France in 2020). Like many other regions, the average round size for French companies has increased significantly and in 1H21 was 32.6 million euros, in part due to the impact of the eight mega-rounds (greater than 100 million euros in size).

The formula for France’s resurgence and increased relevance in the venture capital landscape is one that other regions around the world have deployed, as well as many secondary American cities. Analysts have pointed to three significant contributors in France: (i) tax reform which has lowered rates on dividends and wealth; (ii) retention of talent via “fast tracking” immigrant visas and programmatic outreach to recent graduates; and, (iii) public sector investment to support entrepreneurial ecosystems around the country. It is estimated that Banque Publique d’Investissements (BpiFrance) was one of the top ten venture investors in France in 1H21, accounting for 20% of all early stage funding according to the Financial Times. In 2019, President Macron earmarked 5 billion euros for later stage investments with another 2 billion euros for early stage. In response to the pandemic, another 4 billion euros were set aside for entrepreneurs.  

The entrepreneurial ecosystem in France now counts 13.2k start-ups and 342 venture capital firms, with 44 angel networks and 149 incubators and accelerators, according to Tracxn. This distributed infrastructure has clearly contributed to the strengthening of the French innovation ecosystem. CB Insights reported that there was a 6x increase in start-up activity in 2Q21 as compared to 2Q20. Dealroom has identified 27 “unicorns” now in France; there were only nine in 2018. And this activity is not lost on public equity investors with the MSCI France Index ahead over 20.8% year-to-date through August 2021 (trading at 24.8x P/E).

These efforts appear to be paying off. As the French venture capital market continues to mature, expect to see a greater proportion of the financings be later (and larger) stage, which is reflected in the breakdown below (Pitchbook data). Yet still, France continues to lag in relative attractiveness by foreign investors. It is estimated that 65% of venture financings included a U.S. venture firm as opposed to more than 75% in Germany. Dealroom calculated that 31% of all capital invested in French companies this year was from U.S. investors, up from just 13% in 2020, but below the more than 40% in the U.K. and Germany. The top five French venture financings in 2020 accounted for 22.2% of all capital invested – the continued surge of foreign investors should lead to larger round sizes.

While clearly a complicated continent, Europe was the fastest growing region for venture capital investment according to Sifted (part of the Financial Times) and Dealroom – obviously, not the largest region. McKinsey analyzed the top 1,000 venture-backed start-ups in Europe, 143 of which were based in France, and concluded that most European unicorns required between 100 – 200 million euros to achieve that status, and that for between 70 – 80% of them, they were able to get there in less than 10 years. Interestingly, 24% of these companies were in the life sciences/healthcare sector (put in the “Deep Tech” category in this analysis) and appeared to be more heavily dependent upon access to great (younger) talent. “Deep Tech” unicorns required 215 million euros of funding (median) and yet only realized 8 million of revenues (median).

Laissez-faire does not seem to be the current approach in France – and the more directed strategies appear to be paying off with a more robust venture capital and entrepreneurial environment. Only hope that I am allowed back in the country at some point.

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Debt: Privilege Confers (Health) Benefits…

More than 18% of Americans at the end of 2020 were responsible for $140 billion of overdue medical debt, which is debt that has already been sent to collection agencies and, in many of those cases, is a crippling overhang to those individuals. Medical debt is the single largest source of debt that these agencies handle. “High medical debt” is defined as debt that is more than 20% of annual household income, and while only 4% of U.S. households fall into this category, the U.S. Census Bureau estimates that 11.3% of households in poverty have “high medical debt.” Coupled with last month’s Journal of the American Medical Association report finding that wealth correlates directly to longevity, the minatory impact of medical debt on the overall state of U.S. healthcare must be better understood.

While doctor visits and diagnostic procedures are relatively inexpensive, their prevalence contributing to the medical debt issue is very high per a 2016 Kaiser Family Foundation study. This likely has the unfortunate downstream implication of people deferring necessary primary care and preventive procedures, leading to more expensive future health conditions. Not surprisingly, issues concerning hospitalizations were identified as the most significant expense items, and likely were least avoidable, further contributing to an aversion to engage with the healthcare system.

Perhaps not surprising, the demographics of those confronting medical debt burdens tend to skew towards groups who have uncertain paths to wealth accumulation or historically have been disenfranchised.  Another shared attribute: those with high levels of medical debt tend to reside in states that have chosen to not expand Medicaid programs. Per capita medical debt in 2020 in those states is $375 greater than the other states and is 30% higher than before the adoption of the Affordable Care Act. Per capita medical debt in zip codes with the lowest household incomes was $677 as compared to $126 in the highest income zip codes. In 2018 the U.S. Census Bureau reported that nearly 38% of households with net worth below $0 had medical debt while less than 7% of households with a net worth greater than $500k had medical debt. Last month the Stanford Institute for Economic Policy Research published an analysis of medical debt by county (below).

This debt load tends to be more prevalent and greater in size for those least financially equipped to handle it. The Kaiser study found that 53% of the uninsured reported issues with medical debt versus only 20% of those with health insurance. Only 17% of those with medical debt obligations even had savings or investment accounts. Families with lower educational levels and families with young children tend to be burdened more often with medical debt. According to a 2014 analysis by the Consumer Financial Protection Bureau, 19.5% of all credit reports flag at least one outstanding medical debt obligation while 22% of all consumers have medical debt in collection.

The disparities have been exacerbated by Covid; over the past 25 years, the personal savings rate nationally has hovered between 5% – 7% but spiked with the pandemic lock-downs. While it is now trending back towards 10%, much of this recent wealth accumulation has benefited the higher income brackets, helping them to further service any existing debt loads.

To be clear, the U.S. consumer is perpetually navigating a minefield of debt obligations. At the end of 2Q21, overall household debt stood at $14.96 trillion, with mortgage debt accounting for the largest component at $10.44 trillion. Nearly 45% of the outstanding mortgage balance was originated in 2020 with the dramatic refinancing boom, allowing qualified borrowers to further “create wealth” through lower debt servicing demands (to say nothing of the extraordinary appreciation of real estate assets over the last two years). The outstanding cumulative credit card balances at the end of 2Q21 was $787 billion, which is quite a bit lower than the $927 billion in 4Q19 (before the pandemic), further highlighting the dramatic liquidity enjoyed by more affluent consumers.

An insidious characteristic of medical debt is relatively high default rates which sit unresolved on consumers’ credit reports. Paying a healthcare provider for services rendered months or years earlier will rank lower than keeping a house or buying food. The lack of price and cost transparency to the consumer contribute to the perception of the capricious nature and randomness of healthcare bills. The U.S. healthcare system is the most expensive of the 36 nations in the Organization for Economic Co-operation and Development which is not lost on most U.S. healthcare consumers, some of whom may simply feel over-charged. According to a recent Axios analysis, the healthcare industry enjoyed a 9% profit margin in 2Q21.

The “rich versus poor” debate is playing out among countries too. In developed countries the fully vaccinated rate is ~40% while it is just 11% in the developing economies, per a recent New York Times analysis. A great fear of this disparity is that new variants will continue to cycle around the globe. If this were to be the case, the International Monetary Fund estimates the global cost over the next four years to be $4.5 trillion in lost gross domestic production. The cost of poor healthcare and structural debt to a country can be devastating. Case in point is Haiti, which has suffered enormously over the last decade. Over 200 years ago, France demanded a 150 million franc payment for its independence, a crushing burden that the country is still trying to service.   

Ironically, all of this is playing out against a backdrop of exceptional financial liquidity. Globally, corporations have $6.84 trillion of cash on-hand at the end of 2Q21 according to S&P Global data, which is 45% greater than the annual average over the five-year period pre-Covid. Over $16.5 trillion of debt globally now trades at a negative yield, according to Barclays. Simply unprecedented. All of this liquidity has led to a global M&A boom with $855 billion of deal activity in 2Q21 (Pitchbook), an increase of 12% over 2Q20.

With greater income and wealth inequality analysts anticipate greater disparities in health outcomes. While perhaps controversial, policies that lessen the medical debt burdens, thereby lessening the disparities, arguably should improve overall public health. While $140 billion of medical debt is an extraordinary number, in the context of a nearly $4 trillion U.S. healthcare system and nearly $15 trillion of household debt, one might dream that policy makers could architect a solution. In the face of the pandemic, over 11.8 million loans were approved as part of the Paycheck Protection Program (PPP) which had a total of $953 billion available for forgivable loans. It can be done.

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Super Smart – Healthcare Workforce Intelligence…

Great healthcare is ultimately provided by exceptional human-to-human interactions. Analysts estimate that 80% of all healthcare is delivered by people. Workforce intelligence tools have never been more important, made even more so in the shadow of the surging Delta variant.

Notwithstanding the very strong jobs report this past week, showing the addition of 943k jobs in July coupled with a 4.0% bump in average hourly earnings over last year, the complexity of managing the healthcare workforce is particularly acute today. It is estimated that there are nearly 19 million healthcare workers in the U.S., with almost 40% of them in the hospital setting. Over one million of these workers are doctors, while there are four million nurses.

Who are these people? Who are they really? The overwhelming need to provide timely, accurate and detailed credentialing for the healthcare workforce has been made even more urgent as the healthcare system is transformed and with the introduction of novel care delivery models such as telehealth providers. Relevant data are broadly distributed across all corners of the healthcare ecosystem, siloed and hard to access. Developing a “single source of truth” for each individual provider is mind-numbingly slow and fraught with friction, often taking many months to assemble.

Please welcome Axuall, Flare Capital’s most recent portfolio company, to solve what has been a frustrating and expensive process. Time is money – an average doctor will generate $2.4 million in annual revenue ($9,150 per day) so any tools that can collapse a multi-month process to days allows providers to both more profitably and effectively deploy their most precious resources. A recent study determined that the Axuall solution will increase revenues by $75k per physician hire.

As exciting and important the market opportunity is, we were particularly eager to once again partner with Charlie Lougheed, the founder and CEO, who had been the co-founder and President of Explorys, a company he sold very successfully to IBM (Explorys went on to become the cornerstone asset of IBM Watson). I worked with Charlie when I briefly served on the Explorys board through its sale to IBM. We are also excited to work again with Steve McHale, who was Charlie’s co-founder and CEO at Explorys; Steve is now on the Axuall board. It is all about the team.

Axuall has built a workforce intelligence blockchain platform on top of a national real-time practitioner data network, drawing from several hundred different data sources to create a powerful “digital wallet.” These sources include data on education, training, licensure, certifications, affiliations, skills, professional references, insurance, history of adverse events, and publications. Such a platform reduces onboarding and the enrollment of newly hired providers, as well as facilitating network planning, deployment, analytics, and reporting. The Axuall platform enables the secure sharing of digitally verified credentials between clinicians, authorized verifiers, and employers. Target customer segments include healthcare systems, staffing firms, health plans, and other emerging providers like telehealth companies.

While early, the market opportunity is very compelling. Everywhere one looks, there is simply too much friction in the system. Like many other tasks that will be automated, credentialling and more effective workforce intelligence solutions are required as the healthcare system is transformed. Greater data liqudity is needed. Individual providers are fatigued, having rallied beyond comprehension these last 18 months.

It was also nice that within weeks of closing the financing, Charlie and the team closed a multi-million dollar new account. Seems like he has assembled a very intelligent workforce…

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2Q21 Digital Health – Halftime Show…

Good golly. The mid-year funding data were released this week and the numbers are nearly off the charts – literally. In 2Q21, $75.0 billion of venture capital was invested in 3,296 companies across all sectors, bringing the total through June to $150.0 billion, according to National Venture Capital Association and Pitchbook data. Were the year to end today, it would be the second most active year of all time, just behind 2020 (which is only about 10% greater than where we are now). This is the all-time greatest level of quarterly venture activity, only tied with last quarter. Globally, Crunchbase identified $288 billion of venture capital investments in 1H21, more than 2x last year’s pace.

The greatest contributor to this surge was the prevalence of Late Stage investment activity, which was nearly 69% of all capital invested in 2Q21 (and perhaps not unexpectedly only 31% of all companies given relative round sizes). Mega-rounds (greater than $100 million) accounted $42.2 billion (56%) of the activity across 198 companies in the quarter. CB Insights tallied 136 new unicorns created in 2Q21. A number of non-venture investors (hedge funds, mutual funds, private equity firms) have become considerably more active in this market, accounting for over $116 billion (77% of the total) in 1H21, more often than not investing in significantly de-risked Late Stage companies. The presumption of significant Late Stage “up rounds” may be contributing to the recent spike in Series A valuations.

Surging public equity valuations, robust M&A activity, and greater investor liquidity bolster later stage investor confidence. According to the CFO Journal, there was $1.74 trillion in M&A transactions that involved U.S. companies in 1H21. In that same period, Refinitiv recorded $2.82 trillion of global M&A volume across 28k deals, an increase over 1H20 levels of 132% and 27%, respectively. Pitchbook identified a blistering $372 billion of exits across 883 venture-backed companies already this year, and importantly, 2Q21 is the fourth straight quarter with exit proceeds in excess of $100 billion.

In the past six months, U.S. venture firms have raised over $74 billion in new funds. Preqin reported that over $459 billion was raised by private equity and venture firms globally so far this year. According to recently released Cambridge Associates data, venture capital returns in 1Q21 and the 12 months ending 1Q21 were 16.4% and 81.9% (horizon pooled returns), respectively, which is driving much of the obvious investor interest.

Not even the specter of inflation can dent investor enthusiasm (yet). While the Consumer Price Index spiked up 0.9% in June and increased 5.4% since June 2020, many analysts dismiss this as “transitory” as supply chains stumble back into place.  Against that backdrop, the S&P 500 Index soared 14.4% in 1H21 finishing with an aggregate market capitalization of nearly $36 trillion. FactSet data for 2Q21 forecasts that S&P 500 earnings should increase 64% year-over-year, while earnings in the healthcare sector is expected to grow only 11.3%.

The Altarum Institute calculated the trailing 12 months of healthcare spend to be $3.98 trillion through April, which remarkably is now on pace to be back to pre-pandemic levels. At the outset of the pandemic, monthly healthcare spend declined ~20% when compared to 2019 levels but have since surged back over the past few months as in-person visits increased and delayed procedures ramped back up. Interestingly, the healthcare sector experienced little inflationary pressures (below) as compared to other sectors over the course of the pandemic.

The pandemic, move to value-based care models, and cost pressures have conspired to drive frenzied adoption of novel innovative solutions in healthcare. The next two years will define the strategic agenda for the next five years; the next five years will frame the next twenty years. This is not lost on venture investors. According to Rock Health data, through 1H21 there was $14.7 billion of investments in the digital health sector across 372 companies (average deal size of $39.6 million). For 2Q21, the $8.0 billion was another highwater mark, surpassing the $7.7 billion for all of 2019, a mere 18 months ago. Notably, the digital health sector in 2Q21 was nearly 11% of all venture capital investment activity, up from just 5% five years ago. Almost 60% of the capital invested was in 48 mega-rounds ($100 million or greater), already more than the 44 companies that accomplished that in all of 2020.

While multiple winners can co-exist given the extraordinary size of the healthcare market, those with first-mover advantages will enjoy a valuation premium which is driving such urgency. And the activity was broad based: six categories accounted for 80% of the capital invested. Year-to-date, the drug R&D solutions category accounted for $2.7 billion of investment, on-demand care was $2.6 billion, and fitness/wellness was another $2.0 billion. Treatment of disease, consumer, and non-clinical workflow categories were an additional $4.5 billion collectively. Highlighting the adoption of intelligent solutions to connect consumers with payors and providers, the Consumer Technology Association estimates that there will be $13 billion of health and fitness devices sold in 2021. According to a recent U.S. Census Bureau survey, 24.5% of all Americans has had a virtual visit in the last month.

A powerful new investment theme has been the creation of dedicated care models by disease, tailored to the needs of those specific populations, often times taking risk on outcomes. Rock Health also analyzed the 1H21 data by clinical indication and holding steady at the top of the list is mental health with $1.5 billion invested in that category. The remaining five leading indications are cardiovascular ($1.1 billion), diabetes ($957 million), primary care ($910 million), substance use disorders ($706 million), and oncology ($654 million).

An important implication of this surge of capital into the digital health sector is directly related to the increase in average size of financing by round. Perhaps not unexpected given the size of the market opportunities entrepreneurs are going after, dramatically increased post-money valuations can be challenging should a company stumble. While round sizes increased across all stages, the most notable expansion was seen for Series D rounds; in 2020, the average size was $76 million and in 1H21, it was $131 million. Across the earlier rounds (Series A, B, C), the increases ranged from 1.1x to 1.4x in round size. Presumably, this phenomenon is providing greater runway to achieve important value-creating milestones. If that does not happen, it may be problematic for those companies.

Amidst all of the investor euphoria, a number of important business models have taken hold and are scaling. Obviously, the role of the consumer is critical, and as such, in 1H21 27% of all investments were in B2C models, a nearly 2x increase from levels seen four years ago. The seduction of the market size is enticing but can be illusive. Often requiring out-of-pocket payments (or via HSAs) and sophisticated customer acquisition skills, entrepreneurs new to healthcare tend to gravitate to these models.

Four other models that are well-understood are defined by the customer base served: payor, provider, employer, and pharma. These B2B models accounted for 52% of all companies funded in 1H21. Investors have come to appreciate the idiosyncrasies of each vertical (i.e., how painfully slow decision-making can be) and are factoring that into financing strategies. SaaS and PMPM pricing models dominate and the ever-present hope for “at risk” revenue streams endures, notwithstanding the paucity of those arrangements. Another emerging model that is getting traction (finally) is in the digital therapeutics (“software as a therapy”) space. The blurring with biotech business models that come with regulatory and reimbursement risks can be challenging for tech investors to intuit.

Liquidity has been exceptional over the last six months and puts 2021 on pace to be one of the strongest years yet. According to Rock Health, there were 131 digital health M&A transactions in 1H21 with just over 60% of those being acquisitions by another digital health company, suggesting we may be entering a phase of some significant consolidation. Given the profound sense of urgency entrepreneurs are operating with today, this is perhaps not unexpected; arguably over the next few years, this sector will establish category-leading companies that will scale over the next decade plus.

Given the stepped-up increase in investment activity between 2014 – 2016, it is also not surprising that mature healthcare technology companies are now going public in such a strong capital markets environment. In 1H21, there were 11 public offerings (6 IPOs, 5 SPACs) with another 11 announced SPAC mergers in process for 2H21. Rock Health is tracking 39 announced SPACs with $9.5 billion in proceeds that have a stated interest in the healthcare technology sector. Notably, though, the basket of 18 public digital health companies that Rock Health follows under-performed in 2Q21 when compared to broader benchmarks.  

While not quite as buoyant as the trading activity with the S&P 500 Index, the broader Leerink Healthcare Technology/Services Index increased 11.2% in 1H21 and an impressive 67.7% over the last twelve months. At the end of 2Q21, the mean revenue multiple for the Leerink index was 6.9x and 5.7x for 2021 and 2022, respectively. The comparable EBITDA multiples are 16.1x and 14.8x. The forecasted revenue growth for the composite is a healthy 19.5% (2021-22) and 18.5% (2022-23), contributing to the attractive valuations in the public markets and leaving public investors quite insouciant heading into 3Q21.

So, where does that leave us? It certainly feels like the healthcare technology sector will see low to mid $20 billion of investment this year across approximately 700 companies. While investors should be wary of “capital absorption” issues (is too much coming in too fast?), the enormity of the market opportunities and the quality and impact of the solutions being delivered, provide some degree of comfort that these investments will continue to be productive and profitable. Undoubtedly, there will be examples of pain given that valuation levels arguably are ahead of fundamentals for many companies, but entrepreneurs who are focused on building solutions that (i) significantly lower clinical/administrative costs in the near-term and (ii) have a compelling outcomes story in the medium to long-term, with full attribution, will create important and valuable companies.


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Personalized Medicine vs. Unwarranted Variation…

It is believed that approximately 250k people die each year due to medical errors, which makes this the third leading cause of death in the United States, according to data from Johns Hopkins University and the National Library of Medicine. The National Practitioner Data Bank tallied an annual average of 12.4k cases filed for medical malpractice between 2009 – 2018. Nearly $9.8 billion of direct medical professional liability insurance premium was written in 2019, according to the National Association of Insurance Commissioners, in order to insure against all of these malpractice claims. These are significant numbers describing significant issues confronting the healthcare system.

Much of the promise of technology in healthcare (artificial intelligence (AI), predictive algorithms, clinical decision support, robotic process automation (RPA), etc) is to standardize and automate the practice of medicine, thereby making it “better” – more efficient, less costly, more responsive, and hopefully, safer. Important elements of the healthcare delivery system are being automated with exciting advances in AI and RPA in order to usher in the great promise of precision medicine, which is expected to be a massive market opportunity. A recent analysis in Nature Biotechnology sized the global precision medicine market in 2028 at $217 billion.

Here is what I am struggling to reconcile: all of these advances and yet errors are still rampant. And with these advances come a roster of nettlesome legal and ethical issues, that are only now beginning to be raised, much less answered. The movement to a more intelligent, always-on, virtual care delivery model challenges even the definition of what is deemed healthcare data (video feeds from someone’s home?). A greater respect for social determinants of health introduces new insights to advance whole person care models while expanding the definition of who is a care giver – and whether they are bound or covered by HIPPA.

Algorithms can be deterministic yet have been shown to have certain biases based on the training sets of data used to create those algorithms. A number of issues are revealed when new AI algorithms are asked to coexist with long-established clinical guidelines based on empirical evidence and codified by regulatory approvals. If the premise that AI actually can improve upon existing standards of care, how then does the clinician reconcile opposing or differing recommendations between guidelines and AI tools? Does this introduce new liabilities?

The standard to avoid malpractice claims is for a provider to simply deliver care consistent with similarly trained providers (and that there not be an injury). Issues and legal exposure start to arise when the provider deviates from standards of care in favor of recommendations or insights provided by AI tools, even if they are thought to be superior. If the AI tools, in fact, are inferior or misapplied, and the provider has deviated from standard of care presuming the tools to be of acceptable quality, now the legal exposure is potentially significant, to say nothing of the risks to the patient.

It is this scenario – or the specter that it is even remotely possible – which has created reticence among many clinicians to embrace AI tools. Settled case law is considered quite conservative in this jurisdiction which has limited the clinical adoption even of proven healthcare technologies.

The actual medical liability costs are understandably hard to ascertain. A detailed Harvard University study in 2010 calculated the total cost to be $55.6 billion. The staggering size of this issue continues to motivate entrepreneurs to develop innovative solutions to whittle away of the problem. According to Rock Health data, just the clinical decision support sector received $2.0 billion (35 companies) and $647 million (8 companies) of investment in 2020 and 2021, respectively. This does not even begin to reflect the extraordinary amount of funding into general purpose AI companies. Perhaps not surprisingly, the American Medical Association (AMA) sees the problem as even more significant pegging the costs associated with medical liability between $84 billion – $151 billion.

The AMA recently studied “ambient intelligence” platform technologies in hospitals and cited that video surveillance and transcription systems risk capturing novel data without patient, much less worker, consents. Video of common spaces inside hospitals risk identifying patients and compromising expectations of privacy. Furthermore, if certain clinical issues are identified (in an unstructured format) and nothing is done, does that now introduce liability.

The costs to society of not using novel technologies developed in other industries for healthcare applications is hard to measure but likely quite significant. Law enforcement has struggled with facial recognition, leading to stricter regulations and limits on its use, but similar image algorithms are powerful in the detection of certain skin cancers. Amazon has received a fair bit of public scorn for the way it monitors and evaluates employees’ productivity, but similar technologies power remote patient monitoring solutions that dramatically improve virtual care. The utility of these technologies ultimately should push adoption and acceptance.

It is near-impossible to code for a person’s ability to decipher nuance. The electronic vehicle (EV) industry is struggling with similar issues. Obviously, each of us as drivers are regulated at the state level yet the federal government oversees EVs. This patchwork has created confusion as this industry comes of age. In the event of a driverless EV accident, where does the liability lie? When faced with a terrible dilemma such as to either run over a pedestrian resulting in near-certain death or crash into a school bus, how does the EV make that decision? Who is responsible for the outcome?

As other industries sort out these intractable legal and ethical questions, the healthcare industry may set certain precedents.


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Painful Labor: Man vs “Machine” …

With turmoil in the jobs market, the data last week from the Labor Department recording only 266k net new jobs in April, meaningfully below whisper estimates of at least one million new jobs for the month, was followed by numerous accounts of what might have caused such a miss. Was it due to overly generous unemployment benefits? Fears of infection? Lack of childcare with so many schools still closed? Around the distant edges of the healthcare economy, we may also be seeing the impact of robotic process automation – arguably, the next “new new thing.”

What a paradox: since March 2020 BC (before Covid) the number of new job openings across the economy has increased 34% according to iCIMS, a recruiting platform, and yet as of mid-April, there were 16.9 million Americans receiving jobless benefits. At its peak in June 2020, this registered a staggering 32.4 million of an estimated 160 million working Americans. It is estimated that total employment has declined by 8.2 million people. Over 4.2 million people are considered “long-term unemployed” (more than 27 weeks), while 2.6 million people are unable to work as they are caring for someone who is ill or ill themselves. With the labor force participation rate now at 61.7%, the effective average hourly income was $30.17 in April with 35 hours worked on average each week. To put this in context, the federal unemployment benefits equate to approximately $15 per hour and are set to expire in September.

Data: FRED; Chart: Axios Visuals

As usual, the situation in the healthcare industry is more complicated. The great promise of healthcare technology is to both reduce clinical and administrative costs while improving outcomes, and yet the U.S. has one of the most expensive healthcare systems (17.7% of GDP in 2020) and in recent years has shown declining life expectancies (life expectancy at birth in 1H20 was 77.8 years, down from 78.8 years in 2019). In early 2020, total employment in the healthcare sector was approximately 16.5 million which dropped dramatically to nearly 14.9 million according to Bureau of Labor Statistics data. The declines were unevenly felt across the various specialties with nursing homes and other residential care facilities showing declines of 15-20% in employment and no meaningful recovery. After equally dramatic declines at outpatient care centers and medical laboratories, those sub-sectors now have higher levels of employment when compared to early 2020. 

Overall, there are approximately 16 million healthcare jobs today. There was a 4k job loss in April, which masked the 19.5k decline of nursing home jobs last month. Tragically, the nursing home sector saw nearly 2k Covid-related deaths among its employees, to say nothing of the more than 132k Covid deaths of nursing home residents. Overall, nursing homes experienced a 204k reduction in total employment since early 2020. While hospitals saw nearly 6k of job losses in April, one bright spot was the 21k increase in ambulatory care jobs. Interestingly, a recent American Medical Association study found that in 2020 nearly 40% of all physicians were employed by hospitals which was a meaningful increase from 29% in 2012; 40% were in private practice, down from 60% in 2012. Perhaps not surprisingly, nearly 75% of all residents surveyed by Merritt Hawkins preferred to work in an urban setting.

Clearly, the pandemic is the fundamental contributor to the significant job losses over the past year, but there is an expectation that the automation of certain tasks will begin to redefine and likely reduce the number of future healthcare jobs. The ability to streamline certain operations to both reduce costs and errors are the promise of robotic process automation (RPA). The use of RPA puts enterprises on the path to more robust intelligent processes. RPA software deploys bots to handle rules-based activities that tend to be repetitive and labor intensive. These solutions are implemented on top of existing operating systems, allowing for relatively easier deployments, while not creating parallel workflow processes.

Getting a precise handle on the size of the RPA market is tricky but there is clear consensus that this software category is poised for exceptional growth. A recent Morgan Stanley analysis of 94 occupations estimates that 40% of all American workers hold jobs in positions that are 70% likely to be automated. Allied Market Research has the RPA industry at $1.6 billion in 2019, increasing to $19.5 billion by 2027. Forrester Research believes that the RPA industry will reach $2.9 billion in size this year.

And this sector is now squarely on the venture capital industry’s radar. Crunchbase identified over $1.0 billion in funding in 2018, declining to $920 million in 2019 and approximately $300 million in 2020. The activity in 2021 has been frenetic, punctuated by the $750 million Series F financing of UiPath earlier this year. A partial selection of recent RPA companies tracked by CB Insights is highlighted below (and does not even reflect Flare Capital’s own Cohere Health).

McKinsey identified $180 billion in opportunities in healthcare finance and operations to reduce costs through automation. Some of the most dramatic opportunities involve electronic benefit verification (EBV), prior authorization, and claim status inquiries. For instance, according to the 2019 CAQH Index report, there were nearly 10.3 billion EBVs annually, of which 16% are done manually, costing approximately $10 per manual verification. Similarly, of the 112 million prior authorizations, 87% of which are manually adjudicated at $14 per, the opportunity to remove significant operating costs via RPA is dramatic. It is thought that 30% of the 5.8 billion claim status update inquires are handled manually at a cost of $10 per inquiry. And on and on….

Notably, the BBC recently published a study that found 745k people literally died in 2016 from working long hours. If tedious mind-numbing jobs contributed to that tragedy, hopefully RPA can help address that issue as well.

My thanks to my colleague, Parth Desai, who is spending a lot of time with RPA companies seeking to dramatically change the operating costs of healthcare entities.


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Gambling: Roll of the Dice…

This past weekend, in addition to an estimated 120k mint juleps consumed, it is thought that over $150 million was wagered on the Kentucky Derby (spoiler alert: Medina Spirit won going out at 12-1 odds). This is a fraction of the $500 million wagered on this year’s Super Bowl. And it almost does not even register when one considers all legal and illegal betting in the U.S., thought to be well north of $200 billion according to the American Gaming Association (AGA), which is approximately the GDP of Greece.

Studies by the National Council of Problem Gambling concluded that 15% of all Americans gamble once a week, while 2-3% are considered to have a “gambling problem” (i.e., addicted). How much is lost every year due to gambling is obviously quite difficult to determine, but according to the research firm H2 Gambling Capital, bettors in the U.S. are thought to have lost $117 billion in 2016. A new generation of gamblers appears to have been created as it is now believed that 6-9% of all youth have serious gambling issues. estimates that 6% of all college students are addicted. estimates that 750k people between the ages of 14-21 are gambling addicts.

It is important to put the gaming industry into some context. The American Gaming Association (AGA) sizes the industry at $261 billion, slightly larger than all advertising spend in the U.S. Proudly, the AGA counts 727k employees and observes that gaming contributes $40.8 billion in annual tax receipts. It is that last claim that makes determining how damaging gambling is to the health of Americans so tricky to assess.

The pandemic was obviously not kind to the gaming industry this past year. According to AGA data, total “gross gaming revenues” (GGR) – the legal portion of gambling activity, which appears to reflect only about a quarter of what is actually bet each year – was $30.0 billion in 2020, a 31% decrease from 2019. Slots and table games accounted for $18.9 and $5.1 billion, respectively, and both declined 34% and 39% year-over-year. Much of the growth in gambling has shifted to sports betting ($1.5 billion, 69% increase year-over-year) and “iGaming” ($1.6 billion, 199% increase). According to AGA forecasts, those two categories are projected to be $8.0 and $20.0 billion in revenues by 2024, respectively. While monthly GGR snapped back reasonably quickly, it still has not quite recovered to pre-pandemic levels.

To be clear, the data above are revenues, not the amounts wagered. In 2019, according to the AGA, legal sports gambling was estimated to be $13 billion, which generated $909 million in revenues. In just the first two months of 2021, sports betting was $7.8 billion, generating $576 million in revenues; January 2021 alone was $4.4 billion of wagers.

The obvious driver of sports betting was the 2018 Supreme Court ruling which allowed states other than Nevada to offer sports gambling. Today, 21 states and Washington, D.C. offer such services. Interestingly, and perhaps not surprisingly, according to a recent WalletHub survey, Nevada was ranked #1 as the most “Gambling-Addicted” state while Utah was ranked #50. Unfortunately, Nevada only ranked fifth for states offering gambling treatment services, and even though Utahns for the most part do not require such services, the Beehive State ranked an impressive twentieth in the level of services offered.

Coincident with the change in state laws (although the 1961 Wire Act still stands which restricts remote gambling across state lines), there was an explosion of sports gambling websites and apps such as FanDuel and DraftKings, both of which kick-off with enticements of fantasy experiences. The power of the gamification of sports gambling boomed this past year with most people locked down, eagerly searching for novel forms of entertainment. InvestGame identified $33.6 billion worth of deal activity across 664 transactions in 2020, of which $5.9 billion was private investments (versus $15.1 billion in public offerings and $12.6 billion in M&A deals). The profitability and growth opportunities in gambling are not lost on public equity investors.

Data:, Yahoo Finance; Chart: Axios Visuals

Arguably, the most developed country in online sports gambling is the United Kingdom, which according to data from Global Betting and Gaming Consultants, was $7.3 billion in size in 2020. A recent U.K. House of Lords analysis determined that 60% of sports gambling platform revenues come from just 5% of users. Japan is thought to be the next largest market at roughly half the size of the U.K.

Much has been made about the convergence of investing and gambling. In fact, fortunes have been made over recent years by obfuscating the distinction – see Bitcoin, GameStop, Tesla, SPACs, NFTs. With interest rates hovering just above 0.0% and a population largely shut-in their homes, investors witnessed a series of frightfully irrational waves of trading across certain stocks and digital assets. Nearly all of this activity was uncoupled from fundamental economic valuations, yet undoubtedly created the same adrenaline rush experienced when gambling.

According to Financial Industry Regulatory Authority data, at the end of February 2021 there was $814 billion of margin debt held by investors, which is an increase of 49% year-over-year, and may create significant issues should there be a swift and unexpected correction. A recent Wall Street Journal study found that 41% of all financial assets held by individual U.S. investors was now in stocks, the highest level since 1952.

One of the leading online trading platforms is Robinhood, which itself is expected to go public this spring and likely will be valued around $50 billion. So, while its stated mission is “to democratize finance for all,” the gamification of investing with digital confetti raining down after your first trade was recently removed to be more adherent to regulators’ concerns. In fact, Massachusetts recently sought to revoke Robinhood’s registration as a broker-dealer given concerns over its business practices and aggressive marketing activities. Even Warren Buffett is nervous.

Undoubtedly, online gambling (and investing) platforms have invested enormous resources to acquire, engage, activate, and incent online users – not unlike every other consumer-facing industry. The challenge here is that there is a potentially devastating downside that comes with their success. It is well-understood that compulsive gamblers are 50% more likely to commit a crime, in large measure to fuel their addictions, and that these gamblers are 7x more likely to be arrested.

Even more disturbing concerns emerge when looking at the mental health comorbidities that are associated with gambling addictions. Studies have clearly shown that these addicts suffer from much greater levels of depression, alcohol and substance abuse issues, and have an elevated risk of suicide and suicide ideation. A 2016 study in Finland showed gambling addicts had a 5% incidence of suicide and suicide ideation when compared to 0.1% for the general population. More than 88% of this cohort acknowledged “emotional harm” and 87% experienced “health harm.” Younger addicts reported significantly greater levels of financial and health issues (underscoring concerns about youth addiction associated with sports gambling and online investing platforms).

Whether on balance gambling is a positive or negative to overall societal health is a tricky debate. Undoubtedly, the level of tax revenues enjoyed by governments can be utilized for a roster of social services (ironically, some of them necessitated by issues brought on by gambling addiction). The gaming industry has created a lot of jobs and has, in some cases, created hubs of sustainable economic activity (see Las Vegas, do not look at Atlantic City).

The costs to individuals and society from gambling are relatively self-evident. Studies have shown that 10-20% of gambling addicts will eventually be bankrupted by their addiction, and many of those will go on to be homeless. Other studies have concluded that 20-30% of gambling addicts will develop alcohol and other substance use disorders, which have nearly immeasurable and direct/indirect costs to family members. Gambling addiction is expensive to treat and those afflicted will have much greater levels of lifetime debt, leading to further burdens on loved ones.

Fortunately, according to the National Center for Responsible Gaming, nearly one-third of all gambling addicts are able to treat their addictions without formal intervention. It is near-impossible to predict who those lucky ones are – kind of like whether you are going to roll boxcars or snake-eyes.

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1Q21 Digital Health – Up, Up and Away…

By almost any measure, 1Q21 was an extraordinary 90 days, from the political turmoil, progress on the pandemic, and to the “devil-may-care” financial markets. At the intersection of all of those forces sits the healthcare technology sector, which witnessed a record quarter for investment activity. According to a recent Rock Health report, $6.7 billion was invested in 147 companies in the digital health sector, absolutely crushing the prior quarterly high of $4.1 billion in 3Q20. MobiHealthNews pegged the activity this past quarter at $7.1 billion invested in 99 companies.

The start of the year mapped to 2020’s trendline until March, when $4.0 billion was invested in 74 companies in that month alone – average round size in March was $53.6 million. There were 25 “mega” deals of greater than $100 million in 1Q21, ten of which closed in March. For the quarter overall, average deal size was $45.9 million, a marked step-up from the 2020 average deal size of $31.7 million. Arguably, we have entered a phase when investors appear to be “anointing the winner” in particular categories. The average duration from company inception to the close of the “mega round” for this cohort was a mere six years. The annual investment pace six years ago (2014, 2015) for all of digital health was approximately $4.5 billion in ~300 companies. This coincided with the implementation of the Affordable Care Act (as well as the founding of Flare Capital Partners), laying the foundation for the number of break-out companies seen today.

Interestingly, round sizes for later stage digital health financings have meaningfully increased. While the size of the average Series A round modestly moved from $12 million to $15 million (~1.3x) between 2018 – 2021 YTD, Series B and C round sizes increased from $24 million to $49 million (~2x) and $39 million to $77 million (~2x), respectively.

Why are these metrics important? The healthcare technology sector is now operating with a great sense of urgency, in part due to the demands/opportunities created by the pandemic. The next two years will determine what will happen over the next five years; the next five years will set the stage for the next twenty years. While multiple winners can co-exist given the extraordinary size of the healthcare market, those with first-mover advantages will enjoy a valuation premium. Investors today are debating how enduring are these increased valuation benchmarks. Have we fundamentally reset valuation multiples in healthcare?

Rock Health highlighted three sub-sectors within digital health which saw the most activity: (i) on-demand services ($1.2 billion); (ii) drug R&D solutions ($1.1 billion); and (iii) population health management ($850 million). The next most active categories included “treatment of disease,” consumer health information, and fitness/wellness. Of the numerous specific conditions, behavioral health was the leading category – likely in response to issues compounded by the pandemic.  

The broader context is also quite informative when looking at the healthcare technology sector. Global venture funding recorded all-time highs with $125 billion invested in 1Q21, according to Crunchbase. According to Refinitiv data, global M&A activity hit $1.3 trillion, a quarterly record, which was nearly 100% ahead of the 1Q20 level (although only a 9% increase in the number of deals). And while unemployment levels continue to decline (improving from 6.2% to 6.0% in March), admittedly in fits and starts with a long way still to go, there is recent evidence that investor cupidity may now be somewhat in check. The number of new SPACs (special purpose acquisition company) formed has declined precipitously from a ridiculous pace of 5 – 10 per day earlier in the quarter. Some recent high profile IPOs have either struggled out of the gates or have been downsized.

The “mega round” financing phenomenon is not at all limited to the healthcare technology sector. According to PricewaterhouseCoopers and CB Insights, there were 184 “mega rounds” in 1Q21 (of which 25 were digital health) raising approximately $40 billion (average deal size of $217 million). As shown below, this past quarter saw a remarkable step-up in late stage venture investing, highlighting continued crossover investor enthusiasm. It also helps that preliminary 4Q20 venture capital IRR data from Cambridge Associates shows early stage and late stage returns to be 30.8% and 20.0%, respectively. For some context, the S&P 500 Index is up 9.9% year-to-date, while the S&P Healthcare Index has advanced 3.9% in that same period (although the NASDAQ Biotechnology Index is down 1.8%, perhaps reflecting some risk aversion). The Leerink Healthcare Tech/Service Index increased 3.0% in 1Q21 (the Provider sub-sector increased a dazzling 18.4%).

Data: PwC/CB Insights MoneyTree report; Chart: Axios Visuals

The volatility index (VIX), a barometer of expected volatility in the next 30 days, traded below 17 this past week, near a 52-week low and down from a 52-week high of just under 48 at the outset of the pandemic last spring. One starts to get nervous with professional investor complacency. Oh, and unsustainable levels of debt: according to the Financial Industry Regulatory Authority, investors had a record $814 billion of margin debt at the end of February 2021 (see Archegos Capital for what can go wrong). At least the Citi Panic – Euphoria Index is settling down, now at a still-elevated 0.98 versus the wobbly 2.01 from earlier this year.

As was mentioned earlier, driving much of this activity has been extraordinary levels of liquidity and M&A volume. In the healthcare technology sector, there were ten SPAC offerings in 1Q21 in addition to 57 M&A transactions. While there were only two traditional IPOs in this sector, Rock Health is tracking 43 private companies which have each raised in excess of $220 million and stand as strong candidates to be public companies. Underlying all of this is the realization that, notwithstanding it may well take a few extra years and an additional round or two of private capital, healthcare technology companies that are able to both reduce costs (clinical or administrative) and improve outcomes with credible and defensible claims of attribution, significant economic value will be created.

Unfortunately, now SPACs are so yesterday…NFTs are where it’s at. When Jack Dorsey of Twitter and Square fame can sell his first ever tweet for $2.9 million as a non-fungible token, investors are left slack-jawed trying to understand is this the next big thing. SPAC investor sentiment has cooled significantly toward the end of 1Q21 (red line below), after arguably getting way ahead of itself over the winter. Average first trading day gains were a miniscule 0.1% in March after seeing opening trading increases of 5% in January and February. Year-to-date SPACs have raised $95 billion versus $80 billion in all of 2020, and yet since 2019 only 25% of listed SPACs have actually gone on to acquire a company.

Investor activity was not the only thing to get out-of-hand during the pandemic. According to the American Psychological Association, 42% of all adults in the United States have reported “undesired weight gain” on average of 29 pounds due to Covid. We might expect to see the “Fitness/Wellness” category move up the league tables next quarter. Good thing that the best performing asset class in 1Q21 was something called “Lean Hogs,” which while sounding entirely oxymoronic, traded up 43.8%.

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