Pins and Needles…3Q VC Data

Given the obvious anxiety and frustration that surrounds us all, the US venture industry is also exhibiting some fatigue as we finish the 88th month since the last recession. This is the fourth-longest period of economic growth in US history (admittedly, at 2.1%, the growth over this period of time is the slowest since World War II). According to the National Venture Capital Association, this past quarter $15 billion was invested in 1,810 deals which compares unfavorably to both the prior quarter ($22.1 billion, 2,034) and 3Q15 ($21.1 billion, 2,559), signaling perhaps a period of digestion given how much had been invested during 2014 – 2015 window. Notably, this was the lowest quarterly deal volume since 4Q11, a period spanning 19 quarters.

What is most interesting is the activity beneath the headline data. Year-to-date annualized investment activity suggests that 2016 will see approximately $74 billion invested in just under 8,000 companies, which would still make it the second most active year in the past decade, although with a marked deceleration. The amount invested is consistent with what was deployed in each of the last few years, but the median round size across each stage of financing has increased significantly as the level of deal activity has declined. For instance, early stage round sizes are tracking to be nearly $5.5 million this year versus $3.0 million in 2013. Just in the past six quarters, seed stage investing activity has declined dramatically: in 2Q15, there were 1,547 seed deals as compared to 898 this past quarter. As a percent of overall activity, seed investing dropped from 55% in 3Q15 to 50% in 3Q16.

The direct implication of larger round sizes is to provide companies with greater runway but this flies in the face of the capital efficiency mantra, something venture capitalists shouted from mountain tops when we were in a more challenging fundraising environment. In the early stage category, nearly 54% of deals in 2016 were greater than $5 million in size, which compares to 32% of investments right on the heels of the Great Recession in 2010. Have investors drifted, becoming less dogmatic about hitting interim milestones with as little capital as possible?

One of the emerging story lines in the back half of 2016 is the pullback of late stage “unicorn” financings – only eight new “unicorns” were created this past quarter. In 3Q16 the top ten largest venture financings in aggregate raised $2.1 billion which represented 14% of overall activity. In the prior quarter that number was 40%. The largest round in 3Q16 was $474 million, raised by a Boston-based biotech company called Moderna. Notably only three of the top ten companies were software companies, which over the past few years has been the category that represented so many of the “unicorns.”

The data also risk masking a number of other important emerging themes when considered in the aggregate, so here are a couple of other nuggets to consider:

  • The broader software category captured $27 billion to date in 2016 or nearly 50% of all dollars invested; biotech was second with $6.3 billion invested or 11% of capital
  • Through 3Q16 the 357 healthcare technology sector deals raised $2.6 billion which was 6% of the overall activity
  • Average round size for healthcare technology is $7.4 million which is meaningfully below the $9.3 million for all categories
  • The number of late stage deals (355) in 3Q16 has dropped materially from 3Q15 (429) and is down 36% from the high water mark set in 2Q14 (555), reflecting a steady decline in large mezzanine rounds
  • Just over 13% of all financings to date in 2016 included a corporate venture investor; the corporates greatest impact in 3Q16 was felt in the late stage rounds where those investors participated in 23% of those financings versus only 5% of all seed rounds
  • A dozen states had less than 3 companies venture-financed in 3Q16, underscoring the continued concentration of capital in a handful of markets

In general, investment activity is bolstered by investor confidence that a predictable exit environment will continue. In 3Q16 there were 162 venture-backed exits which generated $14.6 billion of value, coincidentally an amount just below how much was invested that quarter. The top five M&A transactions accounted for just about 50% of that value. Notwithstanding the underwhelming IPO market – year-to-date there have only been 32 IPOs with average proceeds of $67 million – the annualized exit activity suggests that there will be in excess of $50 billion of exit value created. The greatest level of exit activity over the past decade was in 2014 with nearly $82 billion of activity; the annual average for the last ten years is $39 billion.

Liquidity feeds right into the fundraising conditions for venture fund managers. This past quarter there were 56 new funds which raised $9.0 billion for an average fund size of $161 million. This is significantly greater than the $77 million average fund size in 3Q15. This fundraising pace is somewhat less than the prior three quarters but meaningfully ahead of 3Q15 which saw only $4.1 billion raised by venture capitalists. Interestingly, the top ten funds closed on $6.1 billion or 68% of all capital raised, indicating a further concentration of investment managers; in the prior quarter 62% was raised by the top ten funds. Just over 40% of funds raised this past quarter were less than $50 million in size.


The projected $43.2 billion raised in 2016 is on pace to be the strongest year since the early 2000’s. Notwithstanding this robust pace, the “funding gap” persists, strongly suggesting that non-VC’s are continuing to invest aggressively in start-ups. According to the recent Preqin Quarterly Update (3Q16), in a survey of active institutional investors in private equity, 71% expressed a “positive” perception of the asset class while 56% expected to increase their allocations to private equity (and of those, 59% planned to do so before year-end).

The other closely watched quarterly report is produced by Cambridge Associates, which recently released its Venture Capital Index and Benchmark Statistics with data as of June 30, 2016. While year-to-date 2016 performance has trailed other public indices, the Venture Capital Index consistently and meaningfully outperforms over longer periods of time. The 3-Year, 5-Year and 10-Year venture returns were 19.2%, 13.6% and 10.4%, accordingly, while the S&P 500 Index was 11.7%, 12.1% and 7.4%, respectively.

So where does that leave us as we enter the final quarter of 2016? The elephant (and donkey) in the room is the US elections, clearly. Interestingly, this past quarter the European venture capital investment pace fell by 32% in the wake of Brexit and was 39% lower than the same period in 2015, according to Dow Jones VentureSource. Isolating just the United Kingdom, the news is even more disturbing: U.K. venture firms invested only $58 million in 3Q16 versus $282 million in 2Q16 and $656 million in 3Q15 – that is what running into a wall looks like, a huuuge wall.

Here are a couple of other noteworthy developments that add to the economic commentary for 3Q16:

  • There is another group of “unicorns” out there – the human ones – the billionaires. Total wealth held globally by all 1,397 billionaires fell by $300 billion to $5.1 trillion since 2014, mostly as a result of commodity price deflation and drop in the value of technology and finance holdings, according to a report jointly published by UBS and PricewaterhouseCoopers. Family Offices are an important class of Limited Partners.
  • In the midst of unprecedented global turmoil, Saudi Arabia just raised $17.5 billion in the largest sovereign bond issuance ever; there was $67 billion of demand, making it nearly 4x over-subscribed. Why is this important? Let me count the ways: institutional investors seeking greater returns, the transition of an oil economy to a more diversified one (recall Saudi Arabia also announced the goal to create a $100 billion (with a “b”) tech fund with Softbank), strength of global capital flows, investor rotation to emerging markets.
  • Slowing growth in China compounded by extraordinary levels of debt and inflated real estate values have set off flashing yellow lights in many corners of the global capital markets. It is quite clear that credit growth is still faster than nominal GDP growth in China, and that often does not end well. Analysts estimate that the local housing sector is singularly responsible for nearly half of all investment in China today.

As complicated as the world now appears, the financing of innovation remains attractive and compelling, drawing in both investors and great entrepreneurs, hopefully making many of these issues background noise.


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Our Newest Seed Has the Coolest Name…

Venture investors have the great honor of backing some of the most talented, passionate people in the world, all trying to solve really big problems. And sometimes, their companies also have really cool names. Last week we hit the trifecta – we backed a brilliant team going after a big problem with a cool company name – Circulation.

This is my third time working with Robin Heffernan, a twice successful entrepreneur with a PhD in Chemical Engineering from Harvard. Robin worked with me as a venture capitalist at my prior firm years ago and then was one of the first employees of an exciting portfolio company of ours (which she was instrumental in sourcing). Third time is a charm – it is a great privilege to work with her again as she scales Circulation with John Brownstein, her co-founder, who is the Chief Innovation Officer at Boston Children’s Hospital and Professor at Harvard Medical School; notably, he is also the Uber Healthcare Advisor – very relevant to the Circulation story. Additionally, I happen to serve on John’s advisory board at the Hospital. Together, those two successfully bootstrapped and sold their last company, Epidemico. Circulation is also very fortunate to have as a founding partner, Klick Health, the leading digital health agency.

Turns out non-emergency medical transport (“NEMT”) services is a significant industry, with nearly $6 billion spent annually on rides to and from hospitals and for clinical trials. Utilizing its preferred partnership with Uber to access its API’s, Circulation has built a transportation exchange whereby providers, payers and companies running clinical trials can provide comprehensive transportation offerings for patients through a central care coordination platform, which basically doesn’t exist today. As providers and payers embrace “value-based” business models, there is growing demand for lower cost, more reliable NEMT services to reduce “no show” rates and to improve patient discharge processes. There are more than 3.6 million patients who miss appointments each year, much of that is due to inadequate access to reliable or appropriate transportation.

Consistent with our fund’s focus on the “business of healthcare,” seemingly mundane issues around transportation have outsized impact on care delivery models. Analysts estimate that for every missed appointment, the provider has lost nearly $150 in revenue. The ability to get patients at the time of discharge out of the hospital quickly frees up beds that can be used for new patients, say nothing of the improved satisfaction scores recorded by those patients.

And the beauty of having Uber as a strategic partner, most everyone is now comfortable with consumer ride-hailing services, with no hesitation about getting in the back seat of a stranger’s car. Obviously there is considerable sophistication in the Circulation platform (HIPAA-compliant, checks rider eligibility, driver training, ride authorization, etc.) versus simply hailing a taxi, using paper vouchers. And care coordinators embrace the level of insights from now being able to manage holistically all transportation costs while creating a detailed audit trail.

Also consistent with our investment strategy is our seed program. We expect that a number of the core holdings in this fund will be derived through our aggressive seed investment program, affectionately called “Flare Ignite” (branding cred goes to my partner’s wife, Kristi Geary) As we did with our Executive Partner, Bob Sheehy in our Bright Health investment last year, Flare is excited to seed exceptional founders addressing enormous market needs. We set a relatively high bar for our seeds as we treat each of them as core holdings, committing all of the firm’s resources even though we may have initially invested only a modest amount of capital.

And not all of the Flare Ignite seeds need to have really cool names…


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Singapore Rocks…

Somewhere Over the South China Sea – What a fascinating yet complicated time to be in Singapore. In addition to the great spectacle that is Formula 1 Grand Prix racing, the weekend Singapore Summit (Asia’s version of Davos) convened business and political leaders from around the world and also served as the set-up for SWITCH (Singapore Week of Innovation and TeCHnology). A number of significant themes emerged over the three days, many of which were a function of dramatic advances in technology and healthcare.


In addition to the obsession with the US political scene (I find myself apologizing to my guests whenever I travel overseas now) and whether the Fed will raise interest rates this week, of greatest concern at the Summit appeared to be the possible, no likely, turmoil due to the rapid pace of change and the immaturity of social systems. Inevitably workers will be displaced as legacy industries falter.

Notwithstanding Singapore’s 2.1% unemployment rate, the Singapore Strait Times Index has effectively been flat for the past 12 months which has generated some local investor concerns. There are 768 listed companies on the Singapore exchange with around $130 billion of total market value. Although it has struggled with a number of high profile trading outages, Singapore is quite clearly one of the leading financial centers of Asia, if not the world, a position bolstered just in the past few days with a handful of notable corporate announcements. Singapore Airlines disclosed that it would not extend its lease on its first Airbus 380 (the double decker plane) which caused ripples throughout the global aviation industry. Today, Singapore-based Grab announced that it raised $750 million to strengthen its lead as the “Uber of Southeast Asia” while nuTonomy, a Boston start-up, started to pilot its driverless taxis in Singapore.


But there was some haze on the horizon – literally – but a lot less of it this year. Atmospheric modeling experts at Harvard this past weekend announced that over 100,000 people in the region in 2015 likely died prematurely (only 2,200 in Singapore) due to palm plantation fires in Indonesia. It was a significant issue at last year’s Grand Prix but fortunately, given the collective outrage (and rain), was not nearly as noticeable this year.

The new scourge this year is Zika, which was prominently discussed in every newspaper, every day. The call-to-action was the confirmation in late August of 41 locally transmitted Zika cases. The Ministry of Health this weekend came out with a “whole-of-society” approach to combat Zika and also indicated that it will provide free testing for pregnant women, an approach that the World Health Organization does not endorse for asymptomatic women. A number of local health insurance firms are now offering “Zika coverage.” There are 369 known cases in Singapore while the incidence of microcephaly has been between 5-12 per 10,000 live births over the past five years. Hopefully the Indonesian haze can keep down the mosquito populations.

The Singapore health system has a well-deserved reputation for delivering high quality and sophisticated care at reasonable costs. In 2012, Singapore spent 4.7% of its GDP on healthcare with dramatic outcomes: life expectancy is around 83 years which is greater than the US level of 79 years. At its core, the system drives personal accountability with significant co-pay models as well as a compulsory health savings program. Interestingly it is estimated that 80% of primary care is privately held while the inverse is true for secondary and specialist care. The government provides a strong guiding hand when it comes to healthcare priorities and appears to be very focused on the aging population and the importance of wellness as a core element of overall societal health.

A handful of recent announcements just this weekend captured both the level of innovation and the demands that a modern world place on Singapore’s sophisticated healthcare system.

  • Mount Elizabeth Novena Hospital, in partnership with IBM Watson, deployed robots to automate nurses monitoring ICU’s. The government announced that it will spend $450 million over the next three years to deploy robots.
  • The winner of the Most Promising Startup Award among all industries at the Emerging Enterprise Awards was Mirxes, a company developing cancer detection kits
  • Singapore celebrated World Morrow Donor Day this past Saturday and announced that it will focus it recruiting efforts on attracting donors from minority races. Currently there are 65,000 people registered as donors (80% are Chinese) with a goal to add another 50,000 by end of 2018. Apparently the chance for a random match is 1-in-20,000 and is greatly influenced by ethnicity.
  • The National Cancer Center Singapore (NCCS), through aggressive screening and development of advanced therapeutics, announced that male lung cancer rates were lowered from 61.2 per 100,000 in the late 1970’s to 33.7 in 2014. Current research is focused on why “never-smokers” are 3 of 10 Singaporean lung cancer cases.
  • The NCCS also announced new research focused on specific gene mutations which will add to Singapore’s strengths in the field of precision medicines.
  • Fertility is a big deal in Singapore. There were over 6,000 assisted production cycles in 2015, which was a significant jump from the 5,000 in 2012. In separate but related news, it was reported that “egg freezing” was experiencing rapid growth, which underscores the growing importance of women’s careers in this region.

And, oh, there was a race Sunday night. Notwithstanding that attendance dropped to 73,000 from the 87,000 last year, this race is often described as Formula 1’s crown jewel. Formula 1 – the company – was sold last week to Liberty Media for approximately $8 billion. Singapore has the second slowest track given that it meanders through 3.15 miles of downtown streets; the race is 61 laps or 192 miles. This year the first pile-up occurred just a few hundred feet into the race which admittedly made for great fun. And unlike the race drivers, Singapore certainly is not going round and round (ouch – too much?).



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Where Do We Go From Here…

Given the amount of capital that washed into the healthcare technology sector over the last 30 months or so (as much as $16.9 billion globally according to StartUp Health since 2014), the next year may be somewhat unsettled as many of those start-up’s come back to market to raise additional funds. Typically a venture financing round is meant to provide 18 – 24 months of runway, at the end of which a company will have presumably knocked down a number of critical product, team and/or commercial milestones. Anything materially short of that and investors can be quite unforgiving, especially if market conditions have turned more hostile.

Clearly the narrative at board meetings has changed from one of unbridled enthusiasm for growth and scale, almost at all costs, to a more measured cautious focus on what will it really take to get to cash flow breakeven. Or to prove the unit economics. Or what is the real impact on clinical outcomes or cost of care models? Customers, particularly in the employer space, are much more demanding when it comes to near-term ROI on healthcare technology investments. The fact that there is dramatic consolidation in the health insurance industry, much of which is now hung up in Department of Justice litigation, has created some confusion and materially extended sales cycles.

Two contextual developments are also not helpful: questions about the efficacy of accountable care organizations (“ACO’s”) and the lack of robust investor liquidity. There are more than 400 ACO’s serving 8 million of the more than 57 million Medicare beneficiaries. The Dartmouth Hitchcock health system, one of the pioneering ACO’s, just dropped out of the federal program as cost-saving targets were not met. Public investor sentiment is also fickle. According to VentureSource, there has been 166 IPO’s in the healthcare sector between 2013 – 2015, but only 16 in 1H16 (and for half of those IPO’s, existing investors had to buy more than 50% of the offering).

Implications of this are many, and not all of them good. Clearly there will be rotation of investor interest among the sub sectors of healthcare technologies. According to StartUp Health, the top three most active categories in 1H16 were Patient/Consumer Experience, Wellness and Personalized Health, accounting for over $2.4 billion of investment in 95 companies. Those categories consistently have ranked high over the last few years and now many of those companies will have to claim the successful completion of important milestones. Absent that, one might expect to see these categories attract less capital as investors “wait and see.”


Why the focus on those sectors? Analysts (and the executive team of one of our portfolio companies!) often estimate that the determinants of one’s health status is based on four elements: clinical care (10%), genetics (20%), environmental (20%) and then lifestyle and behavioral traits (50%). So arguably the largest contributors to one’s health are the non-clinical components – and have been wholly unmanaged until recently. Thus, the great seduction for many entrepreneurs to utilize and/or develop tools from other industries and apply them to the business of healthcare. And for many, it appeared that the barriers to entry were quite low (“I solved customer acquisition issues for American Express/Amazon/Google, so I can certainly do that in healthcare – how hard can it be?”) The great frontier in healthcare is to successfully match healthcare consumers (members and employees) with appropriate healthcare resources.

The problem is that this is a non-trivial challenge, with difficult consumer engagement dynamics and elusive ROI (or at least not immediate ROI). What appears to resonate with customers are product features that better inform guidelines and evidence-based protocols, tools and incentives that meaningfully impact behavior, and platforms that influence consumer spending. These look like complex B2B products and less like B2C opportunities.

Insights may be gleaned from another industry that experienced dramatic investor interest: adtech. In 2011, $2.7 billion was invested in the adtech sector, which led to an explosion in the number of start-up’s, often tripping over themselves with largely undifferentiated offerings. Since 2012, the adtech sector has attracted approximately $1.0 billion annually, a fairly dramatic fall-off. A great many of those companies even managed to get public, leaving us today with a number of poorly valued, thinly traded public companies and many disappointed venture capitalists.


Interestingly, in the adtech sector entrepreneurs recalibrated their business models from volume-based media models to SaaS models (even rebranding their companies to be “marketing tech” platforms). Arguably, in healthcare technology a similar migration may be underway as companies move away from PMPM-based pricing models (volume) to software subscription models focused on customer ROI.

Expect to see much greater scrutiny by venture investors on issues like time to break-even, gross margins, burn rates (and burn per FTE), and important clinical outcomes. As an ode to the opening weekend in the NFL, expect to see a move away from a “west coast offense” strategy (emphasis on hyper growth, number of members, cost of acquisition, life time value calculations) to a more staid “east coast” grind it out style of company building where the focus will be on cash flow break-even and clinical relevance.




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Interesting Tan Lines in Croatia…

Croatia – what a complicated yet beautiful country, and as sports obsessed as any place that I have visited. Of the 4.19 million people, over 400,000 self-identify as active sports participants, with nearly 70% of that group enrolled as a member of a sports association (there are 4,000 members of the national chess association). Earlier this summer, the Croatian national soccer team faced disciplinary proceedings when its fans threw flares (as in fireworks – not my firm) onto the field during the European soccer championships. Notwithstanding how embarrassing these incidents were for the people of Croatia, they were bursting with pride when Dario Saric blocked Pau Gasol’s layup late in the opening Olympics basketball game in their upset win over Spain. Unfortunately for Dario, though, he is joining the NBA 76ers this fall.

Just over 20 years ago the War of Independence was settled, which exploded the former Yugoslavia into many pieces, creating Croatia. Over 200,000 Serb refugees migrated out of the country so that today over 90% of the population is Croatian; Serbs account for only 4%. The war was understandably a devastating event in the country’s history and frames many of the policies today. GDP contracted by 45% over the course of the nearly 5-year war. The Croatia Bureau of Statistics projects the population to decline to 3.1 million by 2051, which is a dramatic contraction from the start of this decade when it was 4.28 million. For a country that is smaller than West Virginia (which is the 41st largest state in the U.S.) at 22,000 square miles, Croatia is surprisingly the 18th most popular tourist destination in the world with 11 million annual visitors.

Since January of this year, the MSCI Emerging Market index has increased about 30% but unfortunately the Croatian stock market (only 22 public companies) has muddled along, increasing only 3.2% over the same time frame. With nominal GDP of $49 billion growing at an annual rate of 2.7%, the economic situation in Croatia is at best described as promising, and struggles with an unemployment rate of 13.3%. Government debt as a percent of GDP is approximately 87%. Like many other smaller economies, Croatia struggles to provide basic public services, particularly when it comes to healthcare.

Ironically, for a country so preoccupied with sports, there is an emerging issue of obesity and other chronic conditions; the European Observatory estimates that between 50%-60% of the population is over-weight. Total life expectancy for those born in 2012 is 76.9 years, which ranks lower than most of the other European Union countries. The World Health Organization estimated that over 27% of Croats over 15 years old smoke (2009). After the War of Independence, the government turned to a single payor model and created the Croatian Health Insurance Fund which is based on principles of “solidarity and reciprocity” such that contributions are made according to one’s ability to pay, and accordingly, receive care pursuant to their needs. In 2012, Croats spent $2.8 billion on healthcare which was 6.9% of GDP (it is ~18% in the U.S.) or nearly 18% of the overall state spending. There are 79 hospitals and 5,200 doctors in Croatia, or one provider for every 800 people.

Notably, there is a lack of healthcare technology infrastructure which has been flagged a few times by the legislature (2006 and 2013) in the context of broader financial reforms targeting the healthcare system. The Ministry of Health points to over 60 healthcare registries yet acknowledges that there is no central source of general health system information. Importantly, the Croatian health system has altered its focus from reducing the incidence of specific diseases to more improved population health outcomes, not unlike what is witnessed in more developed nations. While there is virtually universal coverage in the single payor framework, there is not the depth of services enjoyed in other EU countries, which is made more problematic with a declining population.

Given this backdrop, one might expect an emerging entrepreneurial community to address an obvious set of market needs, but as with many smaller countries, the level of “home grown” innovation is limited. The Croatian Private Equity and Venture Capital Association has 5 members and in fact, still advertises on its website a set of “recommended events” which all occurred in 2011 and 2012. In July 2015, the World Bank approved investing $22 million to seed a local venture industry, but has yet to disburse any of the ear-marked funds, and by its own admission rates the Overall Assessment for Risk as “substantial.” Curiously, the Croatian government recently announced the formation of a program to provide up to 135 million euros in “economic cooperation funds” via a 50% match to investment managers who raise at least 10 million euros for local investing.

To further explore the renewed Croatian focus on healthcare, I felt compelled to see another one of the “healthy” attractions while there, but I can assure you that I did not go swimming – much less, venture past this intimidating sign.



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Amazing Halftime Show

As the healthcare sector heads into the second half of 2016, there is much to be excited about notwithstanding the significant political and regulatory turbulence. Actuaries at Centers for Medicare and Medicaid (CMS) recently estimated that the U.S. healthcare system spent $3.2 trillion, or roughly $10,000 per person, in 2015 which was an increase of 5.5% from 2014. The 2015 amount was 17.8% of GDP and is now estimated to increase to 20.1% by 2025. Over 900,000 new jobs will be added in the healthcare sector in 2016 alone.

HC Bill

As these spending and hiring trends emerged, innovative companies solving problems with customer experience, drug pricing and other important areas have already made healthcare technology an attractive sector. Looking forward, venture investment will continue to increase, though other factors will undoubtedly come into play, including the Affordable Care Act and its ultimate impact on healthcare spending. With so many distinct areas in healthcare, which categories are likely to benefit from changes to the way the industry operates? The answer is complex, just like the healthcare industry itself.

The principal reasons for healthcare’s expansion, while almost too numerous to count, include the aging population, greater healthcare insurance coverage as more people purchase on the exchanges, Medicaid expansion, and sharp increases in prescription drug costs. Estimates today are that the consumer is bearing 10.6% of these expenses directly, mostly because of the advent of high deductible plans.

The promise of regulatory reform is meant to reduce overall spending growth, in large measure by driving down the percentage of uninsured Americans and also to encourage innovative new care models and solutions. A core component of reform was the introduction of public exchanges for health insurance. In 2Q16, the financial impact to many insurance companies which introduced new products started to be revealed, often with very disappointing results. For example, UnitedHealth reported over $200 million of losses last quarter alone directly attributable to exchange products. In part, and in response to a dramatically changing regulatory framework, many of the larger insurance carriers looked to merge, only to have the Department of Justice step in to block that wave of consolidation.

In 2014, 11% of the population was uninsured which is now expected to decrease to 8% by 2025; unfortunately, there are still 29 million without insurance coverage today. By 2025, Medicare estimates to have nearly 72 million enrollees, up from 54 million in 2015. As insurance coverage becomes more ubiquitous, expect the national discourse to turn to adequacy of that coverage; that is, will care be both affordable and accessible. The relationships between the patient/consumer and their care providers and insurers will evolve to be more focused on costs and value for services provided, thus ushering in the “golden age” for healthcare technology.


Against this backdrop, the healthcare technology sector continues to attract significant new investment. Arguably, regulatory reform in combination with a suite of associated technological advances (mobility, extraordinary computing power, analytics, just to name a few) are converging to drive great innovation across the healthcare system. StartUp Health recently published its 2016 Midyear report which estimated that the digital health sector funding was $3.9 billion across 234 companies, while CB Insights estimated that $3.6 billion was invested in 471 companies.

HC Funding

Although much of this activity was focused on early stage companies, just under $2.0 billion of the total was invested in ten companies, highlighting that there are now a number of substantial emerging winners. Simply annualizing the first half investment activity suggests that the healthcare technology sector will see more capital invested than prior years but in slightly fewer companies. Arguably, with nearly 1,800 companies funded between 2014 – 2015, a degree of consolidation and rationalization will be positive for the sector as emerging winners come to the forefront.

It also is clearer, as the healthcare technology market matures, that successful digital solutions are best delivered in the context traditional provider interactions. Early stage companies showing the greatest traction tend to not be stand-alone point solutions but rather augment or enhance or further the quality of the existing clinical engagement. The novelty of new solutions should not ignore its almost secondary role in providing great clinical care. These insights are starting to be manifest in which categories are attracting the greatest levels of investor capital. Perhaps these companies should be called “B2(B+C).”

Nearly $1 billion this year has been invested in 51 companies in the “Patient/Consumer Experience” category, while almost $900 million was invested in “Wellness” 25 companies. Some of the other significant categories include “Personalized Health/Quantified Self” ($525 million), “Big Data/Analytics” ($400 million), “Workflow” ($325 million), and “Clinical Decision Support” ($235 million). Notwithstanding the number of successful break-out companies in the above categories, according to StartUp Health, Seed and Series A rounds represented 55% of the deal volume with an average round size of $3.9 million.

In addition to this private investment activity, public market investors have embraced this sector as well. The Leerink Healthcare Tech and Services index increased on average 17.8% this past quarter and is now trading at 3.8x 2016 revenues and 3.3x projected 2017 revenues. Interestingly, other traditional valuation metrics also are quite robust: the index on average trades at 13.9x 2016 EBITDA and 25.8x 2016 net income (P/E). Projected average 2016 revenue growth for this cohort of 34 companies is 19.9% and 15.0% in 2017 – quite impressive growth rates.

While consistent liquidity remains elusive overall, there were some notable transactions in healthcare, although most of the IPO activity admittedly centered around the biotech sector with 15 IPO’s to date. According to Mercom Capital, 8 healthcare technology companies raised $270 million in the public debt and equity capital markets as compared to 111 M&A transactions year-to-date, the top four of which were valued at over $1.5 billion (very few of them disclosed transaction values). Undoubtedly much of the M&A activity likely involved larger platform companies rolling up smaller point solutions to extend their core offerings.

Selected Areas of Opportunities

While technology innovation promises to improve almost every element of the healthcare marketplace, there are a handful of specific themes that captured significant attention this year including issues of access to care, drug pricing, and fraud and abuse. As consumers continue to experience rapidly increasing insurance premiums and are challenged to readily find affordable care, compelling new start-ups will continue to emerge to develop solutions and services to address these needs. The healthcare consumer will want to see measurable value.

Primary Care: Much of the innovation in primary care falls along two dimensions – patient engagement to drive impact and business model changes. The first half of this year saw the introduction of the Medicare Access and CHIP Reauthorization Act (MACRA) which created payment incentives to move Medicare fee-for-service patients into risk-based reimbursement models. As primary care providers, who are a relatively small portion of overall healthcare costs, start to realize the power of the “shared savings” model, analysts expect a significant reduction in downstream specialist spend (which the primary care provider directly influences through referrals). In order to facilitate this new payment model, expect to see greater adoption of telehealth platforms, engagement solutions and bundled payment models. All of this is pointing to a world of “on-demand” healthcare.

Drug Pricing: While prescription drugs only account for approximately 10% of national healthcare expenditures, according to the Bureau of Labor Statistic’s Producer Price Index year-over-year pharmaceutical pricing increased 9.8% through May 2016. The lack of pricing transparency, exacerbated by complex discount and rebate programs, frustrate both lawmakers and consumers to no end. According to IMS Health, total prescription drug spend in 2015 was $425 billion, making this an attractive market for innovation and disruption. In addition to novel digital adherence solutions and direct-to-consumer ecommerce platforms, expect to see further payment model innovation which ties drug pricing to outcomes. These “value-based” payment models will introduce pricing discounts if certain clinical end-points are not achieved.

Notably, with a greater emphasis on precision medicines, an increasing number of patients are expected to turn to expensive specialty pharmaceuticals, which will likely put additional upward pressure on prescription drug spend. Anticipating this development, CMS recently announced proposed changes to Medicare Part B injectable drug payments in 2017 which will allow manufacturers greater pricing flexibility tied to outcomes.

In response to upward trend in drug pricing, 30 of the country’s largest employers formed the Health Transformation Alliance in an effort to push for greater value for drug spend. Initially focused on renegotiating existing pharmacy benefit management contracts, expect to see more sophisticated data analytics to identify other sources of savings. Notably, 170 million Americans rely on their employers for health benefits (and while the Alliance above only accounts for 6 million of them, the group spends in excess of $20 billion a year on benefits).

Fraud and Abuse: Earlier this summer, CMS announced that over two years (2013 – 2014) nearly $42 billion of fraud was prevented through more effective provider oversight and screening. The agency estimated that for every dollar invested in the technology to manage the program’s integrity, precisely $12.40 of savings were realized. Superior analytics undoubtedly will improve patient care through greater clinical insights but these tools also will have dramatic impact on work flow and the management of the healthcare system overall.

And in the breaking news category, the Justice Department just announced its largest criminal healthcare fraud case which involved $1.0 billion of fraudulent Medicare and Medicaid billings in South Florida. The interagency Medicare Fraud Strike Force, which has gone after 2,900 defendants ($10 billion in billings) since 2007, relies on a network of nine locations and mines multiple databases to identify suspicious billing behavior.

Obviously the case studies of how innovative technologies impact healthcare are nearly infinite. Providers and payors will continue to focus on population health management, value-based care models, supporting solutions such as wearables and remote monitoring and telehealth, to continue to provide more effective care at acceptable costs.


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Oops!… I Did It Again…

As the immortal singer, Britney Spears, shared with us over 15 years ago, the venture capital industry “did it again;” that is, in 2Q16 it has invested more capital than it raised. While the amounts raised and invested in the 1Q16 were effectively the same (initially estimated to be $12 billion), during this past quarter VC’s invested at a pace nearly twice the amount that was raised, $15.3 billion versus $8.8 billion, respectively (per NVCA data). Yet again, the financing gap has re-emerged.

The last 90 days were tricky. Notwithstanding current estimates for 2Q16 GDP growth of 2.4%, and a June employment report which was startlingly robust with nonfarm payroll jobs increasing by 287k, heading into this past quarter 1Q16 GDP growth was a disappointing 1.1%. June unemployment came in at 4.9% and notably wages grew a reasonable 2.6% year-over-year. More importantly, some level of “clarity” was brought to the national election stage but alongside a steady drumbeat of horrific terrorist events around the world. Over the course of 2Q16, analysts’ expectations for S&P 500 earnings estimates declined 2.7%, with the tech sector forecast being lowered by 7.2% according to FactSet. Perhaps it is not surprising that the amount raised declined nearly 27% quarter-over-quarter given some of this turbulence and uncertainty, but it is curious that the amount invested spiked up over the same period.

U.S. venture firms raised $8.8 billion across 67 funds which compares to $11.1 billion and 82 funds in 2Q15 and $14 billion (final tally, up from $12 billion preliminary estimates of a few months ago) and 67 funds in the prior quarter; in fact, 1Q16 was the strongest fundraising quarter in the last decade. Of the 67 funds raised, 48 were follow-on funds which means just under 30% of funds raised were from first-time managers. As is consistent with the capital concentration theme that emerged over the past few years, the venture industry continues to consolidate around a handful of global brands leaving numerous smaller focused funds to fill in the gaps.

  • The Top Ten funds raised $5.5 billion or 62% of all dollars yet were only 15% of the number of funds, while the Top Five funds raised $4.0 billion or 45% of the total. In shorthand, less than 10% of the funds raised just about half the capital
  • There were two funds of over $1.0 billion in size
  • Median fund size was $37 million while the average was $131 million, which is quite misleading given the handful of mega-funds
  • Funds were raised in 15 states although 50 of the 67 funds reside in California, New York or Massachusetts
  • The remaining states accounted for only $1.1 billion or 12% of the capital (and one of those funds captured $525 million or nearly half that amount)
  • Nearly 7% of the capital was raised by first-time managers with an average fund size of $34 million, and the largest of these was Liberty Mutual Strategic Ventures which is corporate-sponsored
  • 43 of the 67 funds were $100 million or smaller in size, while 16 were smaller than $10 million

Liquidity tends to be the most reliable predictor of limited partner interest in venture capital. Woeful IPO activity has been widely reported, even though public equity markets were hitting all-time highs. There were only a dozen IPO’s in 2Q16, nine of which were biotech companies, and only $893 million was raised. To put that in some context, 961 companies raised venture capital in that same quarter – quite a narrow funnel to get to IPO. According to NVCA, there were 64 M&A transactions involving venture-backed companies, which was meaningfully down from the 91 in 1Q16. Another source, Pitchbook, tallied 153 M&A transactions valued at $15.2 billion which calculates to less than $100 million on average, which likely indicates that there were a lot of distressed sellers last quarter when taking into account some of the few exceptional outcomes which would have captured much of that value. This current year is trending to be the weakest M&A year since 2010, which is striking given the low-growth environment and nominal cost of capital.

In an effort to improve prospects for liquidity, the Jumpstart Our Business (JOBS) Act was passed in 2012 which instituted new rules as of June 2015 called Reg A+, which promised to reduce reporting and legal requirements to assist smaller companies going public. According to the Securities and Exchange Commission, while 94 companies had filed to raise $1.7 billion pursuant to these new Reg A+ rules in the past year, only a few have managed to get public. Issues have involved challenges to raise investor awareness given how small some of these offerings are to conflicting state regulations (fascinatingly, Reg A+ allows companies to publicly raise up to $20 million without an audit, which is illegal in many states). As a point of comparison, at the end of 2Q16 the China Securities Regulatory Commission reported that there were 894 companies waiting to go public on Chinese exchanges.

Interestingly, Cambridge Associates recently released 1Q16 venture capital performance data (there is a one quarter lag given reporting delays) that show 1-, 3-, 5- and 10-year returns of 6.6%, 20.6%, 15.0% and 10.4%, respectively. Across the board this performance was 300 – 500 basis points better than the associated Dow Jones Industrial Average and S&P 500 indices (in fact, it was more than 1,000 basis points better for the 3-year benchmark). And in an environment when interest rates are basically zero, risk assets like venture capital continue to be able to raise funds, even with modest and inconsistent liquidity.


So given all of this VC enthusiasm, at least relative to 1Q16, where did the invested capital go? Consistent with the concentration theme witnessed for fundraising, the top ten companies (0.5% of the total companies) captured over $6.0 billion of the $15.3 billion invested (40% of the total dollars). This was the tenth consecutive quarter with investment activity in excess of $10 billion. Across all 961 companies in 2Q16, the average size financing was $15.9 million (which was larger than 20 of the funds raised in that period!).

While there is some movement quarter-over-quarter as to which stage and sector are hottest, Software continues to dominate with over $8.7 billion (57% of the total) in 379 companies (39% of the total), which runs somewhat counter to the notion of capital efficient business models and is likely due to the “Uber” effect where software unicorns suck up most of the later stage capital in order to scale as private companies.

  • 2Q16 was the fifth straight quarter of declining deal volume which has not been below 1,000 companies since 1Q13
  • Biotechnology was the second largest category with $1.7 billion invested in 100 companies which is off somewhat from the $2.0 billion in 1Q16. This level of activity has been reasonably consistent over time, even in light of the tremendous IPO activity, although recent declines in public biotech stocks likely account for this quarter’s softness
  • There was evidence of a pullback in the Financial Services category which raised $0.6 billion across 25 companies and is down from the $0.8 to $1.3 billion per quarter pace over the last year. The consumer online finance sector has been hit hard recently with questionable activities at some of the more notable names. According to Venture Scanner, there are now 1,379 fintech companies which have raised a total of $33 billion, causing some concerns about the ability to generate compelling returns across that entire group.
  • Silicon Valley companies raised $8.2 billion (53% of the total) across 311 companies (32% of the total), suggesting perhaps that Valley-based companies are raising larger rounds in general.
  • Interestingly, LA/Orange County clocked in as the second most active region with $2.1 billion and 70 companies, pushing NY Metro ($1.4 billion and 124 companies) and New England ($1.0 billion and 97 companies) back to third and fourth places.
  • All of California had 404 companies raise $10.7 billion
  • Twenty states had less than 3 companies raise venture capital; 8 had no companies

The stage of investment often reflects risk tolerance for venture investors. Seed and Early stage investment activity were both down in 2Q16 (5% and 12%, respectively), while Expansion increased 112% with an average size financing being $29 million. Quite clearly investors are doubling down on their perceived winners and are less likely to take on new perhaps riskier ventures. Consistent with that, First-time Financings (companies raising their first round) declined 8% to $1.7 billion. Later stage activity declined 35% reflecting investor fatigue with inflated valuations for many of these companies. Much of the dialogue in the market now is focused on getting to break-even as opposed to growth simply for growth’s sake.

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