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Winner Takes All?

Last week I spent some time with Peter Diamandis, founder of the XPRIZE Foundation and Singularity University (among dozens of other initiatives), who quite simply is trying to solve some of the world’s greatest problems. What was most striking about the XPRIZE vision to democratize innovation was how effectively the model corrals entrepreneurs with a very clear “call to action” – where the winner takes all.

The reward incentive competition model crowdfunds solutions – full stop – and does it very efficiently with a clear end point. The Qualcomm Tricorder XPRIZE competition is offering $10 million to the team which can build a handheld diagnostic device (the “Star Trek tricorder”); over 330 groups started to work furiously to build it – 10 are still at it. There are nearly a dozen current XPRIZE’s underway with another dozen in development.

The juxtaposition to what we are seeing today in the private capital markets in healthcare technology is striking; winner certainly does not take all but rather will have to share the spoils with many other emerging competitors. There has been an explosion in the number of start-up’s attempting to solve the numerous problems across the entire healthcare ecosystem. Providers and payors have a myriad of important and distinct business issues they are looking to the start-up community to help solve. The “call to action” is less clear, certainly not as precisely articulated as the XPRIZE model, which risks leading to too many companies solving more narrow, maybe the wrong, issues. According to Rock Health, over $4.1 billion was invested in nearly 260 start-up companies in 2014, which effectively matched the total amount invested for three years from 2011 to 2013.

The forces which conspired to make this so are reasonably well understood. Reform as evidenced by the Affordable Care Act ushered in a wave of innovative approaches such as healthcare insurance exchanges which brought millions into the healthcare system but also forced consumers to start weighing cost and quality in their healthcare purchasing decisions. The proliferation of technologies around mobility, analytics, and inexpensive IT infrastructure meaningfully reduces the friction to adopt new solutions. The aging population and better understanding of clinical pathways and disease states are driving greater urgency. And my favorite, effectively free money, has made the financing of these new start-up’s relatively straight forward.

Notwithstanding that we are talking about a $2.9 trillion slice of the economy, the question now is one of absorption; that is, can the market make productive all of these new companies? Entrepreneurs salivate about disrupting the incumbents, driving down/out waste and inefficiencies. Many of these new companies are run by people who have successfully built similar solutions in other industry verticals (financial services, commerce, advertising come to mind) over the past 20 years. But like many of those other verticals, there is a natural cycle to how these markets develop – where are we on the curve below?

Winner Take All

Maybe contributing to this phenomenon is the short attention span of VC’s. My friend Professor Tom Eisenmann at Harvard Business School partnered with DocSend (a platform for entrepreneurs to share diligence materials and legal documents with prospective investors) to analyze over 200 investor presentations. The average presentation was reviewed for 3:44 minutes – not hours. Obviously there are a number of meetings involved in the diligence process, but 41% of those companies closed their seed round of financing in less than 10 weeks – Series A rounds were even faster. The pace is frenetic right now.

This all can work with robust and predictable liquidity alternatives. A number of analysts are calling for a significant spike in the number of healthcare technology IPO’s given the level of private capital now invested in the sector, and in fact we recently saw a handful of exciting IPO’s either price or be filed (Evolent traded above $1 billion and FitBit will break the $3 billion valuation barrier on $750 million of revenues). But today more companies are choosing to stay private much longer (thanks, in part, to the 2012 JOBS Act which increased from 500 to 2,000 the number of shareholders private companies are allowed) which may create a crush at the exits when/if the tide turns.

  • Sand Hill Economics estimates that at the end of 2014 the total value of all venture-backed companies was $750 billion or ~2.5% of the total value of US public companies (ominously, the last time it hit 2.5% was in 2000)
  • Across all sectors, IPO activity year-to-date is only $15 billion which is the lowest amount since 2010
  • For venture-backed companies there has been $20 billion of “private IPO” activity year-to-date as opposed to only $600 million of traditional IPO proceeds for VC portfolio companies
  • In 2014 Second Market traded $1.4 billion of secondary shares (the alternative stock exchanges are rapidly maturing) and we are seeing the advent of private derivative contracts trading in unlisted tech companies
  • In May 2015 alone, there was nearly $243 billion of M&A activity; interestingly for the 12 months through March 2015, 13% of all healthcare companies had received takeover offers
  • Year-to-date 2015 there has been ~$100 billion of monthly corporate bond issuances

So capital is plentiful – but traditional IPO activity is meaningfully down. The implication of this is debatable. Are founders and VC’s rolling the dice, trying to thread the needle by “going long” given the seduction of the lofty valuations in the private capital markets today (obviously ignoring the complicated terms of these later stage rounds which may make high valuations illusory). Or has the world fundamentally changed? Didn’t we all say that the last time?

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Breaking News: Flare – Up and to the Right….

Today we announce both a new brand and a new fund. While we liked our prior name – Foundation Medical Partners – it was time to refresh our presence in the market. A few other venture firms use the word “Foundation” in their names and there was chronic confusion with Foundation Medicine, a very exciting diagnostics company. Additionally, we don’t do “Medical” but rather invest in healthcare technology companies, both software and service business models. But we do very much like “Partners” thus the new brand – drum roll, please – Flare Capital Partners.

The word “flare” evokes important associations with energy, momentum – up and to the right. Flares light the way, are bursts of intense flame, they light up what is dark. We love the imagery and think it is powerful.

Separately but related, we are also announcing our new fund – Flare Capital Partners I. This $200 million fund is considered to be the largest dedicated healthcare technology venture fund raised. The transformation of the healthcare industry landscape has given rise to tremendous new market opportunities for the fund to pursue. In fact, we have already made four investments out of this fund. And we think the best way to service entrepreneurs in this large and important sector is to do so on a dedicated basis.

One of the hallmarks of Flare Capital Partners I is the composition of the Limited Partner base, which we think is highly differentiated. Many of our investors are directly engaged in the transformation of healthcare, running some of the most important companies from across the entire healthcare ecosystem. Additionally, we are privileged to partner with leading pension funds, sovereign wealth funds and family offices – all excited about the ability to build important and valuable new companies in the business of healthcare. We are honored to have them all as partners and expect that many will be tremendous assets for our entrepreneurs.

This next decade will be very exciting. Let the games begin – and let Flare light the way…

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Head Scratching Data…

Grinding through all of the 1Q15 investment data does not necessarily provide additional clarity as to where the private capital markets are heading. The number of new venture capital funds declined markedly from the torrid pace set in 2014 but new investment activity continue to crush it. Clearly non-VC’s are still piling into the early stage marketplace, looking for returns.

Specifically, 62 venture funds raised $7.3 billion in 1Q15 (recently updated from the formal announcement of a few weeks ago), which was a decline of 23% in the number of funds but was a 26% increase in the amount of dollars raised when compared to 4Q14 – 80 funds and $5.8 billion, respectively. In 1Q14, 58 funds raised $8.9 billion so it does appear that the venture industry has settled into a fundraising range of $20 – $30 billion annually, which is what it was for much of the last decade between the recessions. It also appears that the “barbell” phenomenon of the venture industry continues along and is underscored further by some specific highlights in the 1Q15 data. As a point of reference the overall US venture industry is estimated to be about $200 billion of capital under management.

  • 42 of the 62 funds raised were less than $100 million in size
  • Of those 62 funds, only 18 were considered “first time” funds, the largest of which was F/K/A Ventures which was – truth be told – the IT investment team from Atlas Venture when the firm split up
  • The five largest funds raised $3.8 billion – 8% of the funds raised 51% of the dollars
  • 32 funds were less than $25 million in size…4 of them were less than $1.0 million (not a typo)
  • The average size was $118 million which is a meaningless (or misleading) number when the median is $20 million
  • The largest fund raised was $1.6 billion – congrats Bessemer – which was 2,909x the size of the smallest

Interestingly, the pattern of hedge fund commitments has also changed significantly in the past few years with it bifurcating to support either much smaller or very large managers. Both ends of the spectrum captured most of the dollars, leaving mid-sized managers to struggle to raise capital. In 2014, “small” hedge funds – those with less than $5 billion under management (even though one of those funds is over two-thirds of what the entire VC industry raised last quarter) – raised ~50% of the total $76.4 billion of hedge fund commitments. In 2012, large hedge funds raised $93 billion while these same small hedge funds suffered aggregate withdrawals of $63 billion. Whiplash.

Venture investment in 1Q15 totaled $13.4 billion in 1,020 companies. This is nearly a 10% decline in dollars invested and an 8% decline in companies when compared to 4Q14, but is an increase of 26% on a dollars basis from 1Q14 on about the same number of companies. Quite clearly the trend for venture-backed companies to raise larger and later rounds of private capital continues. And it is this phenomenon which further exacerbates the “funding gap” now so present in the venture marketplace. Arguably, non-VC investors have plunged into the venture asset class looking for greater returns.

Funding Gap 1Q15

It is not surprising then that seven of the top ten largest venture financings in 1Q15 were in consumer facing companies, which has drawn so much investor attention. In fact the top ten companies raised $3.8 billion in the first 90 days of 2015 or stated in another more shocking way – 1% of all companies which raised venture capital in 1Q15 soaked up 29% of the dollars invested. Some other interesting nuggets in the data:

  • Seed activity continues to decline significantly and was only $125 million (26 companies) – admittedly, we may a “quality of data” issue here as this just seems wrong
  • Expansion and Later Stage rounds captured 72% of dollars invested in 1Q15 as compared to 61% in the prior quarter, underscoring the rotation to more mature companies
  • The Biotech sector rocked in 1Q15, clearly driven by the biotech IPO window being thrown wide open in 2014 – those 124 companies raised $1.7 billion; all in, healthcare companies raised $2.3 billion
  • The largest category continues to be Software where 434 companies raised $5.6 billion for an average round size of $13.3 million
  • Sadly, the Networking and Equipment category only raised $99 million across 9 lonely companies

Liquidity ultimately drives flows of capital into the venture industry – we all know that. The industry’s ability to recycle capital is critical but may also be a poor trailing indicator of future success. This past year witnessed exceptionally strong M&A and IPO activity with $48 billion of venture-backed M&A transactions (there were 479 in all, but only 139 disclosed the transaction values, so the total is undoubtedly much higher) and 116 IPO’s which raised $15 billion of capital.

The story in 1Q15 is more disconcerting as there have only been $2 billion of announced venture-backed M&A transactions (86 in total, 16 of which had announced values) and a mere sliver of IPO activity – $1.4 billion raised across 17 companies (13 of which were biotech companies). Nearly 25% of total 1Q15 M&A volume was due to Under Armour’s acquisition of Myfitnesspal, evidently leaving a large number of modest trade sales behind. Clearly 2015 is off to a more measured pace which may limit fundraising activity in 2016, although there are nearly 55 companies currently filed publicly for IPO’s.

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What’s Going On…VC Data Spanning the Globe…

By now the 2014 data for venture capital investments from the most important regions of the world have been compiled and disseminated, and when laid out next to each other, some fascinating themes emerge. It is no surprise the U.S. continues to set the pace with over $48 billion invested in 4,356 companies, as compared to 2013 performance of nearly $30 billion in 4,193 companies according the National Venture Capital Association’s MoneyTree Report. While overall the average size per deal increased from $7.1 million to $11.1 million in 2014, when one looks closer, the rotation to Expansion Stage investment from Seed and Early Stage was quite dramatic – 41% of all capital invested in 2014 was in Expansion Stage companies as compared to 33% in 2013. The average round size of Expansion Stage investments spiked to $17 million from $9.5 million in 2013. This underscores a significant development in the venture capital market – with more sophisticated private capital markets, companies are raising larger later stage rounds and staying private longer.

Arguably venture investors are generating greater overall dollar returns by encouraging portfolio companies to stay private longer. In 1986 Microsoft went public at a $500 million valuation and traded to over $3 billion within the first year (and then increased 30-fold over the next 8 years), while Google went public in 2004 at ~$25 billion valuation and traded to over $80 billion after its first year. Facebook went public in 2012 at $100 billion valuation and, after a turbulent first year plus as a public company, finally recovered back to its IPO valuation nearly 15 months later. And of course, recently Alibaba went public at a $225 billion valuation and now trades lower at around $210 billion valuation. These are only a few of the most notable success stories but they demonstrate a company’s ability today to raise very large private rounds of capital to fund hyper-growth, affording early stage and private investors much more of the upside.

Against this backdrop though, there is the explosion in the number of early stage companies being formed, many of them are not raising traditional venture capital. In 2014 over $718 million was invested in 192 Seed Stage companies by venture firms as compared to over $1 billion in 2013 in 235 Seed Stage companies. Crunchbase in 2008 had over 25,000 companies in its database; today that number is converging on 700,000, a very small percentage of which raised capital from VC’s. One might now argue that with fewer active venture capital firms, the VC industry may not be well-positioned to provide seed capital. Maybe VC’s are not able to compete as effectively against other sources of capital such as incubators, super angels or crowd funding platforms? Or maybe VC’s are simply being more discerning given the lack of differentiation between so many look-alike start-up’s?

Harvard Business School Senior Lecturer Shikhar Ghosh recently studied 13,500 venture-backed companies to see how many failed to return 100% of the capital to first-round investors, and the results are disturbing. Since 1990, 76% of the companies in this study failed to return 1.0x to first-round investors (82% in the 1996-2000 vintage were particularly guilty of that). Even more troublesome, although perhaps on reflection not that surprising, in cases when the founder is fired, 90% of those companies failed to return all the capital invested by first-round investors. According to Pitchbook, 40% of all 2014 VC-backed exits were more than $100 million which means one of two things (or both): most of those returns went to the later stage investors or the capital loss rates for the other 60% of companies must be very high, that is, many were sold for well less than invested capital.

A couple other notable trends emerged in the data in 2014…

  • Healthcare (biotech, medtech and services) killed it last year, having raised in aggregate over $9 billion (19% of total dollars raised) as opposed to $6.9 billion in 2013, which clearly reflected the extraordinary investor liquidity in biotech. Average round size for healthcare was $16.5 million
  • Software companies raised $19.8 billion or 41% of all dollars invested in 2014
  • Media and Entertainment more than held its own, raising $5.7 billion across 481 companies (average round size of $12 million)
  • Clean-tech financings came in around $2 billion for 2014 which is more than 50% below what it had been in 2011 ($4.2 billion) but up nicely from 2013’s pace of $1.4 billion; 151 clean-tech companies raised capital last year
  • Telecommunications came in last place of the 17 categories tracked with only $324 million invested in 43 lonely companies
  • Nearly $7.4 billion was invested in first-time financings or 15% of all dollars invested; 40% of the $7.4 billion was invested in Software companies, mirroring the broader investment activity
  • While innovation is a global phenomenon, Silicon Valley just crushed it again in 2014 accounting for $23.4 billion (49% of the total) across 1,409 companies (32% of the total). Interestingly, round sizes were meaningfully larger for Valley-based companies – $16.5 million versus around $11 million for New England and NYC Metro-based companies. So much for capital efficiency!
  • New England and NYC Metro were both a distant #2 accounting for $5 billion each…including the Valley, those three regions were nearly 70% of all investment activity
  • 20 states had fewer than 3 investments in 4Q14 (10 of those had no investments) which always amazes me

Another exciting geography is obviously China, which showed dramatic growth as $15.5 billion was invested or twice the previous record set in 2011 according to VentureSource, but still about one third of the U.S. level. In 4Q14 alone, over $6.8 billion was invested in 243 companies. Much of the investment activity was centered on consumer-centric businesses. IPO activity on local exchanges recently returned as Chinese regulators spent nearly a year overhauling the process to take companies public to provide greater transparency for investors. There were 61 IPO’s in China in 2014 valued at $7.2 billion, and while down from the 141 IPO’s in 2010, it was meaningfully greater than the 15 IPO’s in 2013. Clearly the “Alibaba halo” still shines bright. Chinese venture capital firms raised $4.2 billion in 2014 while private equity firms in China raised $47 billion.

Investment activity in Europe was also robust – $8.9 billion (7.9 billion euros) was invested across 1,460 companies in the Continent (average round size ~$6 million as compared to $11 million in the U.S.). Arguably this activity was also tied to strong IPO activity as there were 55 IPO’s in Europe which raised 3.7 billion euros (as compared to 18 IPO’s in 2013 which raised 500 million euros). And like in the States, Europe has seen innovative new funding models develop such as “equity crowdfunding” platforms where the site takes equity in the start-up’s. However, the U.K. Financial Conduct Authority recently raised significant concerns when it noted that 62% of U.K. investors on crowdfunding sites had no prior investment experience! U.K. regulators estimated that $127 million was raised on these sites last year.

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“Fastest Turtle” — Healthcare Investing and the U.S. Economy…

Given the investment horizons for venture capitalists, we do not necessarily try to time public markets when making new investments – although they obviously influence pre-money valuations, particularly for later rounds. Greater concerns revolve around portfolio companies’ ability to access capital on reasonable terms, and that the general macroeconomic environment is conducive to strong revenue growth. Notwithstanding the confusing economic signals that abound today, conditions continue to be supportive for new company creation, particularly in the healthcare tech sector.

Call it the “fastest turtle.” The U.S. economy continues to be one of the most robust and attractive markets in the global economy, despite the fact that 4Q 2014 GDP growth was recently revised downward to 2.2% from initial estimates of 2.6%, which is significantly down from 3Q 2014 growth of 5.0%. Arguably the dramatic decline in the price of oil has yet to be fully reflected in consumer spending although consumer sentiment has meaningfully improved over the past year, bolstered in large measure by the relatively low unemployment rate of 5.5%.

The current environment is complicated and quite confusing, though. There remain significant and disturbing geopolitical risks: Russia’s aggressive and blatant expansionist activities in Ukraine and elsewhere; the barbaric and senseless behavior of ISIS; and the looming Greek debt crisis. On top of such factors, given high European unemployment and all of the attendant social unrest that is causing, there is the need for the European Central Bank to take steps toward quantitative easing. All of these risks will obviously impact domestic economic activity.

There now is the specter of rising interest rates in mid-2015. After a nearly 6-year period with targeted fed rates between 0.0% – 0.25%, Fed Chairwoman Janet Yellen recently signaled that rates may rise to be 2.5% by year-end 2016. This is particularly notable given that the Fed’s balance sheet now stands at approximately $4.5 trillion as compared to $1.0 trillion in 2008. Arguably, since 2000, the U.S. economy has experienced steadily declining interest rates (as well as two difficult bear markets), which has now sparked another emerging concern: the under-funded status of corporate pension funds. Pension fund managers are in the business of matching their assets and liabilities, which has been particularly difficult over the past decade as fixed income yields are effectively zero. With the dramatic improvements in healthcare, pensioners are living longer, often outstripping their assets to cover healthcare costs. Estimates are that domestic pension funds are underfunded to the tune of $800 billion, which is comparable to the size of the infamous TARP (Troubled Asset Recovery Program) of the Great Recession.

Broader equity valuations are also cause for increasing concern. Investor sentiment has quite clearly moved from positive to neutral this past quarter, even in the face of consensus analyst GDP growth for 2015 between 2.5% – 3.0%. Currently the S&P 500 index trades at 17.5x trailing earnings which is well below “bubble territory” of 25x witnessed in 2000, yet the NASDAQ has just eclipsed 5000 and other public equity indices are regularly setting all-time records. The U.S. stock market trades at 155% of GDP, comparable to 2007 levels. Arguably private equity valuations for break-out companies have never been higher, causing consternation among many later-stage private investors.

Healthcare Environment

Broadly, there are a handful of powerful and disruptive themes evident in the healthcare technology marketplace today: (i) the shift to risk from fee-for-service (aka “volume to value” whereby providers are assuming more of the responsibility for clinical outcomes at lower costs); (ii) tiered and innovative new healthcare delivery models; (iii) the role of the patient as a consumer of healthcare services; (iv) the demand for mobile-based 24/7 solutions; and (iv) novel “diagnostics” that include many different variables, not just DNA or protein biomarkers but possibly even your FICO score or zip code. And there are many other themes – each one potentially creating exciting and valuable new companies.

The Agency for Healthcare Research and Quality recently reported that 1% of all patients account for 22% of all hospital costs, which calculates to nearly $98,000 of annual costs incurred per patient in this 1%. Notwithstanding that Medicare spending “only” grew at 3.4% in 2013, important initiatives across the entire healthcare ecosystem are being adopted to drive down costs and improve efficacy. This environment continues to hold great promise for new and valuable healthcare businesses focused on technology infrastructure to be created over the next decade.

As of year-end 2013 nearly 190 million people in the U.S. (or ~60% of the population) were covered by private health insurance. Due to Obamacare, more than 10 million new members enrolled taking the uninsured rate down to 12.4% in 4Q 2014. Consumer out-of-pocket spending (co-payments, deductibles, services not covered) was $339 billion or approximately 12% of the national healthcare spending in 2013. Clearly the growing role of the patient as a consumer is a powerful force as healthcare models are transformed.

Other pressures are increasingly evident such as the fact that over 257,000 doctors incurred 1% Meaningful Use penalties for failure to comply. As financial incentives become more apparent, expect changes in behavior and increased adoption of new solutions. According to Healthcare Growth Partners (HGP), nearly $1 of every $4 spent in hospitals was spent on overhead. HGP further observed that the U.S. ranks #46 out of 48 countries in healthcare efficiency, just one rank behind Iran.  As greater transparency of actual costs incurred becomes more evident, expect increased investment in healthcare IT infrastructure to better manage new risks and revenue streams.

The Federal Health IT Strategic Plan 2015 – 2020 calls for five broad initiatives to be implemented over the next five years: (i) expanded adoption of health IT across the ecosystem; (ii) advanced and more secure interoperability; (iii) strengthened healthcare delivery systems; (iv) programs to promote greater wellness; and (v) continued investment in research and innovation. Novel solutions will be developed across each of these activities that will result in new company-building investment opportunities.

Analysts estimate that nearly $7 billion of private capital was invested in healthcare IT companies in 2014, nearly double the amount invested in 2013. Of this total, approximately $4 billion was invested in early-stage and growth companies; in fact the top six financings in 2014 raised over $1 billion collectively. Some 376 healthcare technology companies raised capital in 2014, although there were only 7 IPOs, in part a reflection of the sharp decline in some of the public healthcare technology stocks in 4Q 2014. Importantly, according to Rock Health, there were 95 M&A healthcare technology transactions with an aggregate disclosed transaction value of $20 billion. This underscores the encouraging evidence of investor liquidity through increased M&A activity. In particular, there was a strong acquisition focus on population health and care coordination companies; other categories such as consumer digital health and EMR vendors appeared to lag somewhat.

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Bet the Jockey…Bet the Horse…and Bet the Track

Earlier this month we announced a new investment in Iora Health, a fascinating company run by an extraordinary entrepreneur transforming an enormous sector of the healthcare economy – primary care. Rushika Fernandopulle (CEO and co-founder) is fundamentally re-architecting how many of us will buy and consume primary care and in so doing, he has created a passionate mission-driven culture throughout the company.

A fundamental premise to this investment is that the US is marching toward a tiered healthcare delivery system, where brand means something and the price of services provided actually corresponds to services received. Providers are no longer being asked to manage just facilities but rather populations, and in so doing, will quickly see the wisdom of investing in wellness and preventive measures to lower overall costs. Healthcare is moving – erratically some might argue – from a B2B transaction model to a B2C model. Some analysts speculate that within five years as many as 100 million Americans may be purchasing healthcare coverage on exchanges, which would place Iora in a fascinating market vortex.

Consistent with this trend, the Department of Health and Human Services (HHS) recently suggested that more than 30% of all Medicare payments by 2016 will be value versus volume based. Furthermore, HHS set a goal that this should be 90% by 2018, creating a great environment for disruptive value-based payment models like Iora’s. In 2014 Medicare fee-for-service payments totaled $362 billion – almost $1 billion each and every day.

Recently the Centers for Medicare and Medicaid Services (CMS) made a series of announcements that underscore its commitment to fundamental healthcare transformation. The most notable one involved the CMS Innovation Center commitment of $840 million to the “Transforming Clinical Practice Initiative” which will encourage 150,000 providers to share best practices. CMS also announced that healthcare costs rose only 3.6% in 2013 in the U.S. to $2.9 trillion, marking the fifth consecutive year of spending increases below 4.0%. Arguably insurance cost-sharing initiatives like expanded deductibles and the proliferation of innovative healthcare technologies are beginning to have an impact on overall healthcare spend. Notwithstanding that relatively good news, many analysts expect the rate of healthcare spend to increase in 2014 and 2015 by as much as 5.6% and 4.9%, respectively, as more than nine million additional Americans gain coverage. Overall healthcare’s share of the U.S. GDP was 17.2% in 2012.

The brilliance of the Iora model is centered around the notion that doing a number of little things right every day will have enormous downstream benefits. We are not talking about sophisticated genomic sequencing or expensive diagnostic imaging but rather simple effective care, based on a patient-centric approach. A better and more diligent focus on basic care such as improving diets (tragically, it is cheaper to eat at McDonalds than to buy a bag of apples – maybe we should more aggressively tax unhealthy foods?).

Not to be lost in the excitement around the innovative healthcare technologies flooding the market today is the fact that when you cut through it all, effective care is provided by one person helping another person sitting directly across from him/her. Rushika understands this to his core, given he is a doctor who has retained the clear sense of mission that initially drew him to medicine – and it is this force of personality that pervades the company now. Arguably, given the complexities and nuances of healthcare, successful VC-backed entrepreneurs in this sector will likely be more experienced, having ideally developed products and/or sold to healthcare customers and/or having some clinical training so they will better understand the “voice of the customer.” Entrepreneurs with such a sense of purpose make it easy to bet on the jockey.

Iora is a special company. Start-up’s that succeed tend to do two things really well: attract killer talent and have customers eager to be in business with them. The company clearly checks both of these boxes. To an individual, the senior team is tremendous – each of the employees undoubtedly could work anywhere they wanted to but are drawn to Iora by the deep sense of mission. The breadth and depth of customers – both existing and in the pipeline about to launch – is unrivaled. This horse was a sure bet.

The primary care category is enormous. And totally broken. VC’s salivate to find markets this large, so ripe to be re-invented. It is quite clear that we have entered a period where patients will act as consumers and will demand healthcare services as simple and effective as those that they receive in banking or retail. We have raised a fund to place a number of bets at this track.

This past summer my daughter and I lived in a Panamanian orphanage for a week and while there we saw a different type of primary care model. The nuns cobbled together broken weight training equipment for rudimentary physical therapy; they resuscitated an old dentist chair and basic equipment to clean the kids’ teeth. Notwithstanding the really tough conditions, these kids appeared well cared for and in quite decent shape. Obviously the nuns are mission-driven and passionate about these kids.

Quick interlude: the orphanage apparently has an international following – while we were there a KLM crew of flight attendants showed up with bags of donated clothing from Holland which is something they bring every time their flight takes them through Panama City – and which is why I now will go out of my way to fly the Royal Dutch Airlines.

Panama 2014

Second interlude: while in country, my daughter and I toured the Panama Canal – what were they thinking over a hundred years ago?!? It is over 80 kilometers long and involved removing over 200 million cubic meters of dirt (if that dirt was put on trains, the trains would circumnavigate the globe over four times). Other fun Canal facts:

  • 75,000 men worked on the project over the dozen or so years it took to build
  • 4,000 containers cross the Canal every day
  • With the expansion underway now, that number will increase to more than 13,000 containers
  • More than 14,000 tankers cross the Canal every year
  • And the person who owns the contents of the middle right container on the tanker above is furious…

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Land of the Giants…

The 4Q14 venture industry fundraising data (compiled by the National Venture Capital Association) were just released which always makes me sit up straight and take notice – it’s kind of an industry scorecard. In addition to being baffled by the fact that the amount my industry invests chronically outstrips how much we raise (see below), I am intrigued by the other forces at work as the VC industry risks behaving more like a money management business. But first the facts…

Last quarter nearly $5.6 billion was raised by 75 funds, of which 27 were “first time” funds. While the number of funds raised was 14% ahead of 3Q14, the amount of dollars raised dropped 9% from 3Q14 (as compared to 4Q13 – a year ago – the number of funds was up 17% while the dollars raised was effectively flat). For all of 2014, $29.8 billion was raised by 254 funds, which effectively returns us to 2007 levels when $30 billion was raised. This compares to nearly $48.3 billion that VC’s invested in 2014 in 4,356 deals. The “funding gap” in 2014 of $18.5 billion is unprecedented – in fact if you lay out the data for the past 30 years (which I just did), up until 2002 the amounts raised vs. invested every year basically tracked each other; six years ago a persistent and growing “funding gap” started to emerge.

Funding Gap 2014

So either these lines will converge rapidly – that is VC’s simply shut off the investment spigot (which is easier than raising materially larger funds – more on that below) or there is a more profound evolution of the early stage capital marketplace. In an environment of basically free money and zero interest rates, Limited Partners are increasingly looking to the VC asset class to drive investment returns. Cambridge Associates just released its “Endowments Quarterly – Third Quarter 2014” report where the average US Endowment and Foundation universe in 3Q14 returned -1.3% (yes, negative 1.3%). Those with top quartile overall performance had the greatest PE/VC allocation which was 12.8% of all assets managed and generated 17.4% return for the 12 months through 3Q14. Notably the bottom quartile performers had only 2.4% PE/VC exposure. Notably – again – the US PE/VC index one-year return performance was 24.4% for the 12 months through 3Q14.

We know that capital follows returns but arguably something equally important is also occurring, and that is the dramatic rise of the secondary market. According to intermediary Setter Capital, total secondary volume in 2014 was $49.3 billion – an increase of 37% from 2013. As greater liquidity comes to this part of the capital markets, Limited Partners in VC funds increasingly have credible alternatives to sell a VC fund commitment, perhaps making it more of a “trading asset” or at least, create the appearance (illusion?) that these commitments are no longer 10+ years in duration. The Setter report observes that there are increasingly very large buyers coming into the market buying positions in a wide array of private investment vehicles such as real estate, PE, venture, hedge and infrastructure funds. In 2014 there were 1,270 transactions in the secondary market.

But neither of the above observations accounts for the entire “funding gap” – clearly the investment data are capturing non-VC investors. This is in part the “Uber phenomenon” where a venture-backed company raises billions of dollars and it all gets lumped into the venture category (last month, Uber raised ~$1.8 billion from the Qatar Investment Authority, Goldman Sachs, Baidu, assorted hedge funds). Clearly non-VC investors are looking for greater returns and have come down market to find them – either investing directly into portfolio companies or into venture funds – which in turns drives up the investment activity and pace (and valuations for break-out companies).

And as always there were some fascinating nuggets buried in the detailed fundraising data which serves to better clarify what may be really going on underneath the headlines…

  • Of the 75 funds raised in 4Q14, the Top Five took home $2.3 billion or 41% of all dollars raised…the Top Ten scoped up $3.3 billion or 59%
  • While the average fund size was $74 million, the median was a paltry $14.7 million…think about that long and hard
  • So naturally I looked at the other end of the list – the Bottom Ten funds raised totaled $8.8 million or 0.15% of all dollars raised – not a typo
  • One new fund was listed as having raised $40,000 – really?
  • Of the 75 funds raised, 50 of them were less than $100 million in size – but it gets better
  • 27 funds were less than $10 million in size
  • Over the course of 2014, there were 96 first-time funds raised (of the 254 total new funds) – those first-time funds totaled $3 billion – so 10% of all dollars raised in 2014 was by nearly 40% of the funds (the largest first-time fund was Presidio Partners at $140 million – congrats)

Lost in all the news about domestic VC fundraising, two other important geographies were making their own noise. The State Council of China announced this month plans to establish a $6.5 billion fund to provide seed capital for start-up’s. According to Zero2IPO Capital, a PE investor in China, the estimated the size of China’s venture capital industry was $6.8 billion in the first half of 2014, so this is a potentially a big deal in China. And not to be left out, buried further in the announcement, China’s Insurance Regulatory Commission made clear that it would allow insurance companies to now invest in venture funds. And on the other side of the world, the Israel Venture Capital Research Center released its own 2014 data which showed that $914 million had been raised, which was an increase of 68% over 2013 levels. The largest Israeli fund was raised by Carmel Ventures at $194 million.

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