American Tourist: VC in Germany…

Having recently returned from Germany, I was quite surprised to learn that record Covid-19 daily case counts (37.1k) were set there last week – twice. Notwithstanding the current political turbulence with three parties attempting to build a governing coalition after recent federal elections, everything seemed in good order with relatively robust investment activity. While it certainly appears that the Social Democrats (SPD), the Free Democrats (FDP), and the Green Party will come to an accommodation, there are real debates about reducing Covid-related stimulus and whether to start to limit expansionist policies.

The somewhat unsteady economic indicators are not helping. Industrial production declined 1.1% in September over the prior month, which had declined 4.1% in August. With unemployment now at 5.4%, supply chain issues continue to hamper the recovery. The Halle Institute for Economic Research, one of Germany’s leading research firms, recently reduced its 2021 GDP growth forecast from 3.7% to 2.4%, and now expects the German economy to not reach pre-pandemic employment levels until 2023.

Furthermore, there are significant debates roiling the broader European Union. Over the next two years most of the major countries in the EU will have national elections which, like in Germany, could see fundamental political changes. Today, for instance, Poland is aggressively challenging a number of EU laws which the country’s leadership considers to be in opposition of Poland’s national interests, perhaps threatening the sanctity of the EU altogether.

Against this backdrop it was encouraging to see the level of venture capital investment activity across Europe by American investors, who appear to be convinced of the attractiveness of that market. Pitchbook recently announced that through 3Q21 US VCs participated in 50.8 billion euros ($58.9 billion) rounds of financings in European companies. It is estimated that 21.2% of all European deals in 2021 had at least one U.S. investor in the syndicate as compared to 17% in 2020 and 15% in 2019 – a marked increase in U.S. participation. Could not help but think that the dramatic liquidity created in the U.S. may now be spilling into other important markets.

Data: Pitchbook, Axios

Consistent with what investors are witnessing in the U.S., there has been an explosion in exit activity across all of Europe as well. Through 3Q21, it is estimated that there have been in excess of 12k M&A transactions which is driving nearly 120 billion euros of exit value across Europe. Notably, much of this activity is being driven by robust public listings; leveraged buyouts tend to still be a rather inconsequential source of investor liquidity. The 2021 exit levels are likely to be nearly 5x that of 2020.

Data: Pitchbook, Axios

According to BVK (the German Private Equity and Venture Capital Association), nearly 1.9 billion euros of venture capital was invested in 654 German companies in 2020, which was a marked decline across all stages from 2019. Quite surprisingly, less than 6% of all investments were in seed stage companies. One might expect that there may be a future resurgence of entrepreneurial activity given the dramatic influx of immigrants over the last handful of years. In 2015, Angela Merkel facilitated the resettlement of nearly one million immigrants, making Germany the second most welcoming country in the world. Importantly, it is thought that nearly 25% of all Germans have immigrant roots. As has been proven in other innovation hubs, robust immigration policies often lead to strong entrepreneurial ecosystems.

Given the impressive technical capabilities of both the academic and industrial sectors in Germany, one might have expected a greater level of novel intellectual property licensing to early stage companies. As shown below, according to analysis prepared by Frontline @ SpeedInvest, Germany is a powerhouse in terms of the number of patents filed each year.

German venture capitalists have historic strengths in industrial automation, cleantech, and increasingly, in healthcare, most notably in medical technologies. Notwithstanding those attributes, according to BVK data, the German venture capital industry raised less capital in 2020 (1.6 billion euros) than it did in 2019 (nearly 3.0 billion euros). Of the various private capital asset classes, venture capital is consistently the largest segment of overall fundraising, which may be poised to increase dramatically. Earlier this fall, German-based World Fund set out to raise the largest European cleantech fund, targeting 350 million euros.

Healthcare has been one of the most important sectors of the German economy. Overall healthcare expenditures in 2019 were estimated to have been 410 billion euros or 12.5% of GDP. The German medical technology sector is thought to be $35.8 billion in size and accounts for more than 25% of the entire European industry, according to Germany Trade & Invest. Of the more than 83 million Germans, it is believed that 7.5 million of them are employed in the healthcare industry.

As is the case in many other developed countries, the digital healthcare sector is witnessing explosive growth. Germany Trade & Invests estimates that the sector will be 57 billion euros by 2025. All of the urgency exhibited by providers and payors in the U.S. healthcare technology sector triggered by the pandemic are appear to be evident in Germany. Furthermore, the German legislature instituted a series of reforms that have facilitated the advancement and adoption of this important sector. In particular, there were three important pieces of legislation: the 2019 Digital Healthcare Act, the 2020 Hospital Future Act (KHZG), and the 2021 Digital Care Modernization Act.

In addition to meaningful financial incentives of 4.3 billion euros to accelerate the adoption of digital solutions for providers (EMRs, etc), important reimbursement frameworks were established for digital therapeutics. The push for the German healthcare system to be more virtual, more responsive, more intelligent, and more predictive should have profound benefits for the population.

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3Q21 Digital Health: Perpetual Motion Machine…

A whirling dervish…a ball rolling downhill. The investment activity in the digital health sector is extraordinary – and arguably overdue given the enormity of the market opportunity and the urgency created by the pandemic to re-architect such an important sector. According to Rock Health data, this past quarter saw $6.7 billion invested in 169 companies for an average deal size of $39.4 million. The investment activity for 2021 is on pace to reach $28 billion, which would effectively double the 2020 highwater mark of $14.6 billion.

And the robust investor enthusiasm is not exclusively a U.S. phenomenon. According to CB Insights data, across all of healthcare globally there has already been $97.1 billion invested, putting this on pace to be nearly $130 billion, which would be nearly 60% greater than last year’s highwater mark of $79.9 billion. Interestingly, CB Insights flags that the 3Q21 investment of $30.5 billion marks a deceleration from the prior two quarters although the number of deals spiked to 1,901, which is 15% greater than 2Q21, and itself the most active quarter ever. 

As highlighted with the Rock Health data, we should pause on the average round size to better understand what appears to be unfolding. Year-to-date there have been 62 “mega rounds” of financing (greater than $100 million) which represents nearly 12% of all financings. Arguably, the digital health sector is entering an “anoint the winner” phase. Entrepreneurs and investors today experience greater urgency than ever as the next few years may well define the sector’s strategic agenda for the next five years – and the next five years will quite likely define the landscape for the next twenty years.

This commentary is too central to be incidental and influences financing strategies and product roadmaps. The irony of the need to accelerate development cycle times in an industry that confronts crushingly long sales cycle times is not lost on many investors. Companies today appear to be raising larger rounds to bridge this divide. Typically, product/market fit is clarified during the Series A and B rounds. Rock Health data (below) illuminates this dynamic: early stage round sizes have significantly increased in size, yet the average age of the companies has remained relatively constant – plus or minus a quarter. Focusing just on averages can at times be misleading, but directionally the average Series B company had raised just under $50 million in 2020 and now in 2021 that amount is running just over $60 million. Building an enterprise-ready digital health company will take over five years and $60 million – no small undertaking.

The Series C round, in general, is considered to be the “commercialization” round. Of course, management is selling throughout the life of the company, but the first handful of years are mostly spent nailing down product/market fit. The implication of the chart above is profound: nearly eight years and now another $100 million is required, thus the increased incidence of the “mega rounds.” This is compounded by the heightened levels of investment between 2018 – 2020 as all of those companies are coming back to market.

One might also expect an increase in “private-to-private” mergers as many companies struggle to get through this knothole. Typically, each round of financing provides another 15-18 months of runway before management needs to think about the next round; not a lot of time given the intense competitive dynamics of the digital health sector today. A common critique is that too many companies have built too narrow an offering: it is a more limited point solution, and the customers require a broader, deeper set of capabilities. Expect also to see horizontal acquisitions that seek to expand into adjacent customer bases (providers + payers) or bolster distribution capabilities, especially for those companies that may not have sorted out product / market fit (see below).

Notwithstanding those concerns, there is ample evidence that the healthcare technology sector has created a number of important companies that are reducing clinical and administrative costs, while improving outcomes – while creating extraordinary shareholder value. According to an analysis prepared by Flare Capital, these last five years (2015 – 2020) has witnessed a 4.4x increase in market value of both private and public companies to $271 billion. Over the course of that same period, per Rock Health, $42.3 billion was invested in this sector. According to EY, there have been 132 healthcare start-up IPOs already in 2021 (admittedly, though, a number of them were biotech companies).

Essential to the healthcare technology sector’s success has been the emerging evidence of impact that these solutions are having in the market. Clearly, the pandemic has also super-charged the need for a more responsive, intelligent, predictive, and virtual healthcare system. In a recently published report by the Centers for Medicare & Medicaid Services, the CMS Innovation Center reflected on the more than 50 test models introduced over the last decade. While only six of them are considered to have created material savings to the system, just in the last two years alone over 28 million patients have been served. The insights from these models support a narrative that technology will be able to drive important improvements to care delivery in profound and systemic ways. This augurs well for an important upcoming decade as these lessons are more broadly deployed.

Notably, the research firm ATI Advisory recently released an assessment of how Medicare Advantage (MA) members have managed through the pandemic as compared to traditional “fee-for-service” (FFS) members and the results were striking. Mortality rates for hospitalized MA members with Covid were 15% as compared to 22% for FFS members. This is in light of the fact that 7% of all MA members have tested positive for Covid as opposed to only 3% for FFS members. Much of this improvement is attributed to the fact that risk-bearing models tend to provide more responsive, flexible care and offers a more-appropriate menu of supplemental benefits.

Naturally, investment capital has tended to be directed toward diseases that either exhibit the greatest urgency or burden on the healthcare system. Year-to-date, according to Rock Health data, $3.1 billion has been invested in companies that are addressing mental health conditions, while cardiovascular disease, diabetes, and primary care have attracted $1.4 billion each. Oncology ($1.2 billion) and substance use disorder ($0.8 billion) make up the next largest categories tracked. These six clinical indications accounted for nearly 45% of all digital health funding in 2021. Mercom Group (below) tracks venture investment by technology category, highlighting that telehealth investment activity was both the most active sector these past two years and also spiked in 2021. This is not at all surprising given the urgency to create robust virtual care offerings.

Finally, the lingering question for entrepreneurs and investors centers around what the next handful of years will look like. With nearly $4.0 trillion of healthcare expenditures in 2020 (per CMS data), the enormity of the need coupled with the size of the market opportunity strongly suggests a continued robust investment pace. Undoubtedly, in certain sub-sectors and with certain companies, valuations are heady and arguably ahead of the reality of those companies, but directionally this is a category that can productively support investment levels at this pace.

I have been a broken record on this analogy. The U.S. advertising industry is a massive industry – $240 billion spent annually – and over the last twenty plus years as that sector was re-architected over $10 trillion of venture-backed public market capitalization (Google, Facebook, Apple, Twitter, etc) was created.

The U.S. healthcare industry is nearly 17x larger…


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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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