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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It Takes More Than a Village…

Kids are freaking fragile creatures. There is simply nothing more heartbreaking than when we hear of cases of child abuse and neglect. And now, when good healthcare is defined as more than just the absence of disease, and there is a greater focus on interconnected healthcare systems to create multiple healthcare access points, the promise of technology to address this horrific condition should never be more promising.

The underlying causes of child abuse may never be fully understood but it is clear that the rising incidence of abuse correlates to disturbing societal trends, many of which are quite obvious. Undeniably this country is experiencing unprecedented class segregation along residential, political and educational lines – all exacerbated by profoundly skewed income distribution. Ironically, demographers report that the U.S. is experiencing less segregation along religious and racial lines (inter-racial marriages were 0.7% of all married couples in 1970 and was 3.9% in 2008, per United States Census Bureau). A significant contributor to rising rates of abuse is the impact of poverty on certain populations and the associated desperation and pressures on family structure.

Earlier this year the Boston Globe reported that Massachusetts had the highest rate of abused and neglected children in the country, which quite frankly staggered me. In 2014 there were 31,867 “victimized children” in the Commonwealth which equated to 22.9 cases per 1,000 children. Of those children, 6,587 had to be removed from their homes to ensure their personal safety. Unconscionable. Nationally, there were 702,208 cases of abuse or 9.4 victims for every 1,000 children in 2014. The Crimes Against Children Research Center determined that abuse is directly tied to illegal drug use and that both poverty and a lack of affordable housing were also significant contributors to this tragedy.

Separate but related, my brother, Dr. Christopher Greeley, is a leading national expert in child abuse and has dedicated much of his career to developing community-based approaches to addressing this type of abuse. Over the years, and having heard about many of the heart wrenching cases he has confronted, I was shocked to see the incidence data above, which overshadow the data of many of the most feared diseases that we commonly discuss. My brother and other clinicians in the field are frustrated by the lack of effective diagnostic and intervention technologies that might determine more precise care pathways – all of these buzzwords are used when discussing other diseases like cancer, heart disease and even obesity.

Again, separate but related, gang violence has profoundly touched my family – twice. I am utterly baffled by the phenomenon of kids shooting kids. Inner city youth violence is one the greatest tragedies of our day and is yet another form of child abuse that we witness time and painful time again. And this too is directly tied to poverty and the associated break downs in social order.

Then there is the explosion of reported sexual misconduct cases at boarding schools. My prep school – Phillips Exeter Academy – was recently caught up in this with a series of revelations of inappropriate behavior by revered faculty. A dozen years ago the U.S. Department of Education released a study suggesting that nearly 10% of all children are the victims of “unwanted sexual attention” from educators and school employees over the course of their academic careers. Child abuse in yet another form.

Two months ago a group of neuroscientists, geneticists and social scientists convened in New York City for the “Poverty: the Brain and Mental Health” meeting. This group described the concept of “social concussions” for children raised in poverty given the multiple and chronic stress conditions that they are subjected to like parental discord, maternal depression, crime, intermittent hunger and poor nutrition. Notably, these conclusions are consistent with the pivotal Adverse Childhood Experiences study conducted in the mid-1980’s in California which studied 17,421 adults to understand how similar stress circumstances when they were children led to mental health issues later in their lives. These epigenetics studies suggested that damage from early abuse can be partially reversed through compelling community-based support systems that allow children to rebuild resilience via caring, consistent relationships with other adults, but it is an on-going struggle for most.

So how bad is it? in a meeting with Professor Robert Putnam at Harvard recently, he shared a wide range of social data which were very disheartening. Much of his research cuts across educational levels and compares those cohorts along a number of dimensions often considered predictive of childhood quality. For instance, as of 2010, for households with less than a high school education, 65% of those are single parent households; this was less than 20% in 1950. The statistics below describe children in each of those households.CHART 3

And on and on. Clearly children born into less educated, poorer households are placed into more stressful, less supportive environments – and it is only getting worse with increased income disparity. The LENA (Language ENvironment Analysis) Foundation has developed a small wearable digital recording device (LENA System) to measure language patterns in children to assess impact of poverty on development. This “talk pedometer” has exposed the dramatic fact that poor four year olds have heard as many as 30 million fewer words than affluent children by that same age.

Earlier this year a nearly ten-year-old class action lawsuit was settled in Florida which sought to improve access to quality healthcare for children in low-income Medicaid families. It was shown that state reimbursement rates were so low that literally hundreds of thousands of children in that state had never had a check-up and that 80% of them had never seen a dentist. The primary remedy mandated in the settlement required that state contracts ensure that providers maintain adequate medical and dental provider networks so as to eliminate issues around access. While obviously not directly defined as child abuse, this structural disadvantage resulted in many cases that mirrored the impact often found in classic child abuse. The Florida legislature determined that steps taken to raise the general condition of a population ought to certainly help with overall well-being of its children.

Just a few months ago the Commission to Eliminate Child Abuse and Neglect Fatalities issued its final report after a two-year intensive study. A subtext throughout the report is a sense of frustration that technologies simply do not exist to provide an early warning system for healthcare providers. Shockingly but not surprising, the Commission identified that the best predictor of abuse is a call to a child protection hotline. Really?!? The most effective approach continues to be “home visiting” programs which unfortunately requires competent coordination across numerous public agencies, which at times can be a tall order. Sadly, buried in the data in the report, one learns that African American children die from abuse a rate 2.5x greater than the general population – shameful.

Which brings me back to my brother. Considerable VC investments have been made in disease specific diagnostics and therapeutics but when it comes to child abuse, it is very hard to precisely identify those children most at risk. Obvious cases of abuse are obvious – usually after the abuse has occurred. And while there are clear “markers” for likely conditions that would lead to abuse, such as poor maternal mental health or domestic partner violence, too often healthcare systems simply are not very good at predicting individual cases of abuse. Existing screening technologies still have far too high false positive rates; estimates for sensitivity are around 70%, which would not be commercially viable in the molecular diagnostics marketplace. “Meaningful use” was a significant step forward but too often there are stranded “data pools” that do not clearly correlate parental EMR data with related children.

In the general population the incidence of child abuse is thought to be about 1% but in “at risk” populations, the incidence spikes up to 2 – 3%. The field of child abuse prevention is moving to be more focused on population management; that is to roll out technologies to engage and educate broader “at risk” populations under the belief that a rising tide will help all children in a given community. For instance, there has been a dramatic increase in the number of “parenting apps” introduced to certain Medicaid populations; some of these require weekly recordings of parents reading to their children which both reinforces that reading is good for children and allows providers to witness those interactions for troublesome telltale signs.

Geo-coding of “at risk” populations also facilitates more sophisticated cluster analysis to see incidence patterns. Such an exercise allows providers and local governments and community leaders to better allocate resources such as community groups and other intervention programs.

And while the technologies to predict, assess and intervene in child abuse cases are developing, the clinical field at times struggles with the basic definition of many cases of abuse and neglect. Broken bones are easy to diagnose but what about latchkey children who are not eating regularly at home? Or cases of intermittent abuse – “my dad only hit me a few times” – or cases where an older child beats on a younger sibling? When does that behavior become a crime?

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Flare Team Expands…

As a team at Flare Capital we will make dozens and dozens of investment decisions together, but when we look to add to the team, well, those are decisions we will only make a few times. Fortunately, given who we have just added, those decisions were really easy to make.

Today we announced the addition of three new members to the expanded Flare Capital team. Dr. Gary Gottlieb, who currently serves at CEO of Partners In Health (PIH) and previously was CEO of Partners HealthCare, will also serve as an Executive Partner with us. Gary has run some of the most important hospitals in the country, and in his current role at PIH, is driving advanced healthcare technologies in some of the most troubled geographies in the world. Gary will provide important insights into where providers may be heading and will be an enormous resource to the teams at many of our portfolio companies.

Phyllis Gotlib is also joining as an Executive Partner. She has the distinction of having started and scaled one of the most successful healthcare technology companies, iMDsoft, which was a leader in provider-based solutions. In addition to being an extraordinary lightning rod for great entrepreneurial talent, Phyllis has an unrivaled network in Israel and other important overseas markets. We are particularly excited about the insights she will provide as our portfolio companies scale.

Additionally, we are honored to have Jonathan Gruber serve as Chair of our Industry Advisory Board (IAB). Jonathan has been at MIT for nearly 25 years as a professor of economics, but perhaps more importantly was one of the key architects of much of the healthcare reform which is framing the forces at work across healthcare today. To be successful investors in such a complex and nuanced industry such as healthcare, it is critical to deeply appreciate the regulatory landscape, so who better to help with that than the person who authored much of what we see today. Jonathan also provides an important voice on our IAB, which today numbers 20 industry leaders from all corners of healthcare.

And as we had previewed last fall, our Flare Scholars program is up and very much running. We have 17 young healthcare technology executives and academics from across the country, all passionate about the transformation of the business of healthcare. Many join us from some of our strategic investors while others are studying at leading graduate schools around the US. Serving as our “ambassadors” back on their home turf, the Scholars assist with diligence but also identify emerging talent who may want to work in many of our portfolio companies or launch the next great start-up.

This transformation of healthcare that we are witnessing now is complicated and touches all geographies of the country. As such, we look to build a team that can uniquely exploit these changes. The collision of profound change and exciting innovation will lead to the creation of important and valuable new healthcare technology companies, which will significantly improve care for all. And that is why, quite simply, we are adding to the team in such important ways to assist us in investing our new $200 million fund.



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Finally – The Lines Converge…

We have waited a long time for this to happen – the amounts of capital raised and invested by venture capitalists in a given quarter are now the same. For nearly a decade the total amount invested in venture-backed companies meaningfully exceeded the amount of capital raised by the venture industry. This “funding gap” was in large measure due to the participation on non-VC’s like hedge and mutual funds in later stage venture investments. Given the non-existent IPO market for “unicorns” and modest level of M&A activity, there appears to be evidence that those investors have started to seek returns elsewhere.

Somewhat confounding is the continued robust fundraising environment. But as with many things, there may be more than meets the eye here. According to the National Venture Capital Association, in 1Q16 the venture industry raised $12 billion across 57 funds, which with great fanfare was declared the largest quarterly amount raised in ten years when in 2Q06 the venture industry raised $14.3 billion. This past quarter’s activity was dramatically greater than the prior quarter when only $5.5 billion was raised by 51 firms and greater than the prior year’s first quarter (1Q15) when $7.5 billion was raised by 69 firms. What makes this quarter so remarkable is less the overall amount but the composition of the $12 billion; that is, the fact that 30% of the total amount raised was for just 3 funds underscores the continued concentration of capital with a limited number of firms. Couple of other fun fundraising facts:

  • The top ten funds raised nearly $7.8 billion or 65% of the total
  • While the average fund size was $210 million (completely misleading), the median was $65 million
  • There were 14 first time funds which raised $894 million or 25% of the firms only raised 8% of the total
  • The largest fund was raised by Founders Fund at $1.3 billion while the largest first time fund was raised by 1955 Capital with $200 million
  • Of the 57 funds raised, 28 were in California while 11 were located in New York; only 3 were in Massachusetts which is surprising given the historically strong VC cluster in the Bay State
  • Those top three states raised $11 billion of the $12 billion and averaged $263 million in size, while the 12 other states that raised funds secured only $1 billion which averaged $65 million in fund size
  • There were 31 funds of less than $100 million in size and in total they accounted for $797 million or 7% of the total – all of those funds collectively were just slightly larger than the fourth largest fund raised in the quarter – significant bifurcation of managers
  • And somewhat in disbelief, 14 of the funds raised were less than $10 million in size

And while it is dangerous to simply annualize a given quarter, the pace coming out of 1Q16 suggests that $48 billion will be raised in all of 2016, which would be nearly $20 billion more than 2015. Coincidentally – and finally – this is effectively the same amount that is on pace to be invested in 2016. In 1Q16 approximately $12.1 billion was invested in 969 companies, which is the same amount that was invested in 4Q15 although that was in 5% more deals. While this is the ninth consecutive quarter that more than $10 billion was invested, the amount invested clearly is now trending downwards; in all of 2015 nearly $59 billion was invested as compared to the pace suggested by 1Q16 results of just $48 billion for 2016.


The concentration phenomenon witnessed with capital raised by funds is even more acute when looking at where capital was invested. The top ten funded companies in 1Q16 received 25% of the capital. As in prior periods, the Software category captured the top spot for sectors given $5.1 billion was invested in 376 companies, which was 42% and 38% of the totals, respectively. Life Sciences, which includes Biotech and Medical Devices, secured $2.3 billion across 177 companies, which was effectively flat from the prior quarter. Consistent with the trend line from prior periods relatively more capital was invested in later stage companies. Together the number of Seed and Early deals was only 48% of the total which is down markedly from the 57% in 4Q15.

Interestingly, the impact of crowdfunding is starting to be felt, and for many entrepreneurs, these platforms are viable alternative sources of capital (in the form of early product orders). Since mid-2009, Kickstarter has raised $2.3 billion across nearly 104,000 projects, of which nearly $650 million was in 2015 alone, while Indiegogo has garnered $850 million since 2008. Analysts have estimated that 38% of all technology projects on Kickstarter were deemed “on-time” while 30% either were delayed or failed to deliver a product.

The healthcare technology sector saw continued significant investment activity. While the NVCA does not separately track this sector, StartUp Health does a very good job in cataloguing all of the transactions. Accordingly, in 1Q16 there was $1.8 billion invested in 100 healthcare technology companies, of which the top sub-sectors were Analytics, Medical Device, Patient Experience, Personalized Health and Wellness. Notably the number of deals was down from prior quarters, although the round sizes were larger possibly indicating a maturation and confidence in these companies as they raised significant amounts of expansion capital (and of course the $400 million Oscar financing arguably skews some of the data). The top ten healthcare technology companies raised over $1.1 billion or 63% of all funding.

Clearly the transformation of the business of healthcare is well underway, and where there is disruption, novel innovative companies will be created to drive that change. From regulatory reform to the aging population to the convergence of low cost, high power compute technologies which have led to better understanding of biological pathways and predictive/personalized care, all of these forces have conspired to draw entrepreneurs to the healthcare technology sector. Recently the IMS Institute for Healthcare Informatics calculated that Americans spent $310 billion on medications in 2015 – soon to be $610 billion in 2020 – which pointedly underscores the enormity of the opportunity – and challenge. According to the Robert Wood Johnson Foundation, the U.S. spends nearly $3 trillion on healthcare yet corporate America loses $226 billion each year due to sick and absent employees.

The other notable development in 1Q16 was the absolute lack of venture-backed IPOs. Of the eight IPOs this past quarter, which only raised $700 million, none were technology companies, much less unicorns (there were three “blank check” companies which will use IPO proceeds to make acquisitions). Interestingly, the companies that managed to get public were all early-stage healthcare companies, although in order to get public, there was significant insider (read, VC) support in the IPO, in many cases more than 40% of the offering was purchased by existing investors (in the case of Editas, 67%of the IPO was purchased by the insiders). Unfortunately, nine other companies pulled their IPOs while too many to count delayed their plans. This was the weakest IPO market in over six years or since the depths of the Great Recession. It also compares unfavorably to recent activity; $5.5 billion was raised by 34 companies in 4Q15 and an even more impressive $37.6 billion was raised in 3Q14. Year-to-date, the Renaissance IPO Index has generated a negative 8.0% return versus the S&P 500 which is essentially flat for the year.

SAAS slide

The IPO “air pocket” for venture-backed tech companies may be best understood when looking at forward revenue multiples for publicly traded SaaS businesses. The apparent discount between high-priced private rounds and public market valuations certainly is playing a role in the IPO market shut down, but so is investor anxiety over the quality of earnings; the S&P 500 saw earnings decline 8.1% this past quarter and the forecast for the year has already been reduced by 15%. This lack of liquidity is even more confounding now that the Russell 1000 is trading at 17.9x forward earnings as compared to 16.5x two years ago. With public equity benchmarks now within a few percentage points of the all-time highs hit in mid-2015, one would logically expect robust IPO activity.

Conversely, at the very least, one would expect significant M&A activity, but there too, most of the action has been around smaller transactions (according to Dealogic there has been 2,800 transactions valued at less than $100 million). Year-to-date there has been $282 billion of announced M&A transactions but that is overshadowed by the $340 billion of abandoned deals, in part due to regulatory scrutiny. Private equity backed companies represented only $15.4 billion of that total volume across 125 transactions, although the leading sector with 17 announced deals was healthcare. Globally, there was only $44 billion of private equity backed M&A deals, down nearly 60% from the prior year period.

At least on April 24 we will all “celebrate” Tax Freedom Day which is the date when the country has earned enough income to cover all 2016 federal, state and local taxes.



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Chilling in Chile – Stunning Natural Laboratory…

Somewhere Over the Andes – Flying back from Chile this week I was struck by the head-shaking beauty of the country, as well as the commitment to innovation and the steps Chileans are taking to diversify the economy. There are also very clear reminders of how tethered the country is to commodity markets and global political dynamics – and how little control officials have over them.


For a country of just under 18 million people and a GDP estimated to be around $275 billion (the US is $17.4 trillion), there is a remarkably robust innovation ecosystem. StartUp Chile reported that between 2000 – 2014 there were 1,054 privately financed companies, of which 334 stayed in Chile and continue today. Given the relatively modest amount of early-stage capital, another 324 companies emigrated to other countries. They even have a “unicorn” valued at $1.8 billion called Crystal Lagoons, which has technology to produce enormous man-made lagoons.

Corfo, the country’s economic developmental agency, reports that there are approximately 40 PE/VC funds which collectively manage $550 million; only three of them are considered early-stage. It is estimated that angels invested $9 million last year, thus the focus on developing more sources of early-stage capital becomes even clearer. Over the last five years, there was $122 billion of foreign direct investment, although very little of that was early-stage capital. Unfortunately, it is very difficult and quite restrictive for local pension funds and institutional investors to invest in venture capital funds.

As a guest of Corfo, I was speaking at the annual Chilean Venture Capital conference to share “lessons learned” from the US venture perspective, but also to discuss how other emerging markets imported the VC model. Corfo is acutely aware of the ingredients that are required to be successful: there are 14 co-working spaces across the country supported by a network of 1,000 mentors, all of which have a stated goal of launching 1,000 companies each year. Additionally, Corfo has a very directed effort to create venture funds by offering a 3:1 match program to leverage early-stage capital commitments. Alongside that, there are robust grant programs which this year will provide $110 million in research tax credits, up from only $40 million in 2013, with a $150 million target by 2018.

So it was somewhat ironic that across town the world’s largest miners and commodities traders were at their annual conference, likely lamenting the protracted decline in copper prices. To underscore the structural issues in global commodities markets, it is estimated that there are $2 billion of copper inventories stockpiled in China (according to the Shanghai Futures Exchange). The reasons for this are murky ranging from something affectionately called “copper-collateral financing” where copper is backing shadow financing schemes across China to the concern that Chinese smelters may be deliberately flooding local copper exchanges to depress prices given their exposure to derivative contracts. Either way, given that Chile is the world’s largest copper producer, none of this is good news. Last year, Codelco, the Chilean-owned miner, lost $2.2 billion after having earned $3 billion in 2014.

But Chile also has the world’s leading observatory infrastructure as 70% of all space monitoring activity is conducted in the Atacama Desert, which is known as the driest non-polar place in the world. It is therefore not surprising that an emerging data mining infrastructure is developing here. Other sectors with significant comparative advantages appear to include the concept of “smart mining” otherwise known by the tiresome “IoT of Mining” moniker, as well as technologies in agriculture, solar, marine energy, and biotech applied to fishing.

When visiting with US Ambassador Mike Hammer, I had an opportunity to also meet senior attaches from the three US armed forces (I am always so proud of these people who are so dedicated and mission-driven) and learned that the US is also involved in sponsoring early-stage innovation in Chile. Turns out that the Department of Defense has awarded $6 million in Latin America in R&D grants since 2014, over $2.3 million of which has gone to Chilean universities to assist in developing relevant technologies to the military (Brazil was runner up with $2.2 million).

The other fascinating development this week was the release of the “Panama Papers,” which also touched Chile. For the past year or so, Chileans have followed successive revelations of corruption involving illegal political contributions which have snared senior political and business people, many of whom were also listed in the Panamanian documents (including the owner of the largest local newspaper, El Mercurio). While in Chile this week, the Chilean Senate passed a bill which would punish anyone who publicly releases information about existing investigations which is now referred to the “gag law.” And while I found myself often apologizing to my Chilean hosts for the US presidential elections, they all with knowing smiles assured me I was not alone as they have their own presidential election next year.

The Santiago Stock Exchange was established in 1893 and today has a market capitalization of $260 billion with just over 300 publicly traded companies. And while essentially flat over the last twelve months, the stock market more than doubled in the last 10 years. There are thought to be 10 billionaires in Chile according to Forbes who have an aggregate net worth of $29 billion or 11% of the stock market capitalization. In conversations with some of these investors, there is a clear interest in diversifying their holdings and the innovation economy is of particular interest.

Given how a local artist depicted me (which looked like Batman’s nemesis, the Joker), I am thrilled that any of them wanted to meet with me at all!



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When a Unicorn Stumbles…

Sometimes when I walk by my kids’ room and they are watching a scary movie, I just can’t seem to look away. I stand looking back over my shoulder waiting for a commercial break, sometimes grimacing. That’s what it has been like for me as I watched the Zenefits saga play out, and with the stabilizing influence of the new CEO David Sacks, it now finally appears that there is a break in the action.

In general, there are two paths for innovation: one is the creation of a new industry and the other is to reinvent an old industry – it appears that Zenefits told the first story line when in reality it was more the latter. Potential upside for the former path is arguably much greater. Under the extraordinary expectation and self-induced fanfare of having raised $580 million, most recently at a valuation of $4.5 billion early in 2015 – only to see in September 2015 one of its largest investors (Fidelity) mark down the company’s valuation to $2.3 billion – the senior team set ambitious growth expectations and drove the company unsustainably hard. And while the growth was indeed impressive for the less than three-year-old company, at those valuations there is no safety net for a unicorn that stumbles. In January 2016, the company announced that annual recurring revenue for the year would “only” be $60 million which was meaningfully below the $100 million initially forecasted. After a series of embarrassing disclosures (“please no sex in the stairwells”), the CEO was fired. This past September, 17% of the staff was laid off – mostly in insurance sales.

The proposition of Zenefits is quite clever, but not a new industry. Many would simply refer to it as a tech-enabled business service. Customers were provided “free” technology packages to automate payroll and benefits administration, and in exchange, Zenefits would receive commissions for all insurance products sold on the platform. The company competed against old-line insurance brokerages by giving away software, and in so doing was remarkably disparaging of them. By the end of last year, Zenefits claimed to have over 10,000 accounts (which, by the way, implies that the average account was well less than $100k in annual revenue to Zenefits which makes the economics somewhat problematic; analysts estimated commissions to be around $450 per covered life).

The level of fear in the traditional benefits brokerage community was rising over the last few years. Position papers were drafted by large agencies on how best to sell against Zenefits. In May 2015, Benefits Selling magazine published a survey entitled “The Sky Hasn’t Fallen Just Yet” (true story) which highlighted the level of brokerage anxiety, particularly within small agencies, over the impact of technology. Nearly all brokerages of less than 25 employees felt commission revenues would decline between 25-50% by 2016; only 33% of those firms thought they would exist in five years. More than 50% of brokerages in excess of 1,000 employees were developing proprietary online tools; 88% felt that offering technologies to customers was a business necessity. Over 85% of all respondents indicated that they would be forced to offer ancillary products such as life, dental, vision and disability just to be viable. Brokers talked about becoming “solutions providers” – in large part as a response to Zenefits’ presence in the market.

While the full impact of the ACA on the health insurance brokerage industry is still playing out, there were a handful of market developments that contributed to the (partial) commoditization of that industry. Community rated plans, where the cost of the products for groups of less than 50 employees are based on demographic data by geography meant to preclude discriminatory pricing practices, made products more uniform, competing largely on price. Brokers pushed certain employers to increasingly look to partially self-insured plans as alternatives to traditional fully insured community rated plans. As state regulators encouraged greater plan flexibility, they also increased dramatically the reporting and compliance burdens on small employers, who now required even more from their brokers. So with less attractive core insurance product margins, increasing costs and complexity to provide adequate customer service, and an overarching trend to outsource non-core activities by customers, the pressure on brokers became intense.

So against this backdrop, along comes Zenefits. The seduction of high software gross margins is real – VC’s love SaaS business models – but when a company gives away the software (resulting in negative gross margin), attention has to turn to other revenue streams like insurance commissions. How ironic for what was heralded as a “SaaS” company. Under extreme growth pressures, corners appear to have been cut. A series of states have launched investigations into fundamental business practices. The Massachusetts Division of Insurance is looking into whether employees were properly trained and licensed to even sell group insurance products. According to BuzzFeed, 80% of all sales in Washington were by unlicensed brokers. And in California, it is now evident that brokers lied about how extensive their training was, which makes it even more understandable why so many insurance sales staff were let go last fall. Ironically, the company which provides benefit administration tools allegedly failed to properly pay overtime to employees in California. More evidence of the product’s immaturity.

And while some in the brokerage community believe all of this will continue to unravel – if Zenefits loses its various insurance licenses around the country, carriers are likely to terminate their relationships “for cause” – the new CEO appears to have brought “law and order” back to the company. According to Glassdoor, while the company is rated only 2.9 out of 5 stars from employees, and only 47% would “recommend to a friend,” David receives an extraordinary 86% CEO approval rating. Ironically, many employees commented that the company’s benefits package was “mediocre at best.” And when the question about employee morale was put out on Quora, the most recent answer simply stated “it’s gone.”

Like many other explosive growth companies, after lofty expectations are not met, those companies often retrench to survive. It is not unusual to see a prolonged period of slow steady growth emerge when proper controls are put in place. There are undoubtedly a host of other insights, maybe lessons learned, about how much capital to raise and at what valuations. For a company that was just over two years old with only around 1,500 employees, it is not clear why there was the need to raise over half a billion dollars. But it was quite evident that the prior CEO, who was very focused on optimizing valuation, failed to understand that Fidelity as a mutual fund company would post the valuation of its position.

MG Blog Post 2It is quite likely that Zenefits will recover and probably prosper. Ironically, Fidelity, which was so visibly associated with the last (very) high priced equity round, is also rumored to be launching private exchanges in all 50 states to sell insurance products (they already provide extensive record keeping, billing and wide range of administrative services). Other large companies – ADP comes to mind, which loudly disputed Zenefits’ claims last year about cutting off integration due to the risk of exposing sensitive employee data – are developing compelling platforms for employers to manage employee related matters. And so while maybe little in the near term has changed for brokers because of the ACA, the future will force continued consolidation and the requirement to reinvent their core offerings.

And I am really glad my office has no stairwells…



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Bolus of Capital…Hard to Swallow?

It has been exactly seven years to the week that the American Recovery and Reinvestment Act was signed into law, committing the federal government to invest $787 billion (later “bumped” up to $831 billion) across a range of economic stimulus measures. Nearly $150 billion was directed toward healthcare, of which $36 billion was budgeted as cash outlays for Medicare and Medicaid incentives to deploy health information technologies; as of January 2015, $29 billion of that had been deployed. What has been the impact from all of that investment?

Arguably, as has been shown over many generations, the period after significant government investment in critical infrastructure (railroads, highway systems, airports, broadband), profound waves of innovative products and services were unleashed. Now that EMR penetration is nearly ubiquitous, a number of new value-added solutions are being introduced to drive greater utility from this significant infrastructure investment. In fact, we are already entering a comprehensive upgrade and replacement cycle of early EMR deployments, a sign of market maturation.

Stepped up investment and regulatory reforms have contributed to business model innovation as well as creative partnerships and acquisitions between technology vendors and healthcare companies in every corner of the healthcare industry. The recently announced acquisition of Truven Health Analytics by IBM for $2.6 billion is enormously validating. Another example of the forces of change at work would be the accelerating consolidation of Managed Care companies, which is generating significant pressure on drug discovery and distribution companies, leading to fascinating PBM consolidation. The ripples spread far and wide.

This is not lost on many entrepreneurs who seek to exploit this recently installed digital infrastructure. Attendance last year at the Healthcare Information and Management Systems Society (HIMMS) annual conference was 43,129, which was up meaningfully from the 35,065 attendees just two years before (interestingly, last year 44% identified themselves as being from a “Provider” and 31% declared that they were from the “C-Suite”). A more powerful barometer of healthcare technology’s importance is the amount of venture capital invested in the sector. The three most commonly cited sources tabulated a 2015 range from $4.3 – $5.8 billion:

  • Rock Health – $4.3 billion which was essentially flat from 2014
  • StartUp Health – $5.8 billion which was a decrease from the $7.0 billion in 2014
  • CB Insights – $5.8 billion (see below)

Digital Health Funding

At a time when there are 500 million primary care visits each year, and yet across all telehealth providers there might just be 2 million telehealth interactions, the role of technology is only just beginning to be felt. According to Berg Insights, only 5 million people globally are monitored remotely and yet there are over 7.3 billion of us (United Nations Department of Economic and Social Affairs – July 2015). Furthermore, technology companies from outside of healthcare are getting in on the action, with a no more intriguing case study than that being of Uber and Lyft entering the medical logistics space (Medicaid spends around $3 billion per year on third-party transport services). The potential for technology in healthcare continues to be very seductive.

A number of investment themes seem to be emerging from the 2015 funding data which should inform what we might expect to see over the next few years, so in no particular order, below is a list of some of the specific areas of investor interest.

  • More dynamic and flexible EHR products which will aggregate, analyze and present disparate data generated across numerous devices and platforms, often gathered in non-medical settings – arguably V2.0 which will get at issues of interoperability
  • Greater transparency as to the cost, pricing and availability of healthcare services and products
  • More effective search and navigation tools as the consumer strives for greater healthcare data access and understanding, and then better outcomes
  • Greater emphasis on wellness
  • Better tools around medication management and adherence (interestingly, less than 2% of hospitals are thought to engage with patients via text messaging)
  • Impact of less expensive genetic sequencing and multiplexing those data with other data for more precise diagnostics

But as exciting as all of that sounds, there are also concerns on the horizon. The general economic backdrop has clearly – and materially – changed. In early January 2016, S&P 500 earnings were forecasted to increase 0.8% this quarter; 45 days later that same indicator has been revised downward to a decrease of 5.3%. That is a significant re-set. Shockingly, Walmart today announced its first annual sales decline since 1980 – 35 years ago – with uninspiring guidance for 2016.

Additionally, regulators seem to be directing more scrutiny at healthcare technology solutions increasing the clinical burden to prove outcomes and efficacy. Not lost on anyone has been the harsh light pointed at Theranos, and less brightly on Lumosity, which paid a $2 million fine to settle FTC claims of deceptive advertising linked to boasts of “brain training” (this does not include the $50 million judgement, suspended because it would bankrupt the company).

Of particular interest to track will be the return expectations associated with the $10 – $12 billion invested over the past 24 months in healthcare technology. Venture investors look to generate at least 4 – 6x return from any given investment, ideally meaningfully more if possible. The CB Insights data suggest that approximately 1,600 companies were funded over the past two years, implying that they are expected to collectively create between $50 – $60 billion of value over the next few years. At a 2 – 4x multiple of forward revenue (there has been significant multiple compression over the past few months), generating $15 – $17.5 billion of incremental revenue in the near to medium term by these companies may seem like a stretch but attainable, although many will fail along the way. Obviously this math is crude but directionally highlights the potential for investor disappointment.

It also underscores how hard it is to successfully scale a healthcare technology company and the need to be very thoughtful about operating milestones, capital efficient product development roadmaps and effective “go-to-market” commercialization strategies. Obsession to growth to support lofty valuations appears to have led to a series of significant management lapses now unfolding at Zenefits. In 2014, revenues were estimated to be $20 million with a $100 million target for 2015, which is well ahead of the $70 million estimated to have actually been achieved. Another high flier is Oscar Insurance which expanded to California this year. According to Covered California, the state’s insurance exchange, Oscar only acquired 2,000 new members or 0.1% of the 1.57 million people who purchased on that exchange.

This issue of “capital absorption” plays itself out time and again in the investment world. Sectors get hot, too much capital floods in which drives down returns, with tears soon to follow. Undoubtedly the broader venture capital market is cooling. The unicorn phenomenon looks perilously under siege. Ironically, just when SEC regulations no longer force companies to go public when above a certain shareholder count, and with the JOBS Act of 2012 now firmly in place, being public appears to be less interesting to many companies, certainly given recent stock market volatility. Of the 142 biotech IPOs in the last three years, 74% of those companies are trading at levels below the IPO price (median decline is 35%). Case in point, LinkedIn saw nearly 50% of its market capitalization erased two weeks ago when reporting disappointing guidance.

Against a back drop of more and more “pulled IPO’s” we are starting to see pre-emptive lay-offs at venture-backed companies as they brace themselves for more hostile capital markets. While Sound Cloud is not a healthcare technology company, investors were shocked to see that the company was issued a “going concern” opinion by its auditors last week, and this after having raised $80 million at a $700 million valuation a little over a year ago – and Sounds Cloud has 175 million subscribers. This will not be an isolated phenomenon.

Gallows humor occasionally likens venture capital investing to philanthropy, particularly in times when losses are widespread. So as an interesting point of comparison, the Top 50 benefactors donated $7 billion in 2015 to charitable causes (nearly 20% more than was invested in healthcare technology companies); this was down quite sharply from the $10.2 billion gifted in 2014, according to a recent Chronicle of Philanthropy study. Notably, since 2000, the “Tech 50” donated a total of $33 billion which is a pittance when compared to the “Finance 50” who crushed it with $82 billion in donations over the past 15 years. Must be all those evil hedge fund managers – certainly not the VC’s.

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