Not surprisingly, for-profit hospital giants headquartered in Nashville or nearby are among the fund's early investors. Community Health Systems, Franklin, Tenn.; LifePoint Hospitals, Brentwood, Tenn.; and Vanguard Health Systems, Nashville, are three of the five health systems named as Heritage fund partners.
The two other investors are Trinity Health, a large Catholic system based in Novi, Mich., and Iowa Health System, based in Des Moines, which owns 10 hospitals and manages another 13 across Iowa.
Entry into the Heritage fund requires an investment of at least $1 million, but each of the five health systems agreed to commit up to $10 million. The fund has raised at least $78 million since mid-January and will seek up to $200 million, according to a notice filed with the Securities and Exchange Commission.
Iowa Health and Trinity Health reviewed the fund as they would any other investment, executives for the not-for-profit systems said. An investment committee on Iowa Health's governing board approved the investment from the system's portfolio, President and CEO William Leaver said. Trinity ran the deal past an investment consultant, said James Bosscher, chief investment officer at Trinity Health. The $10 million accounts for one-third of the venture capital in Trinity's two investment portfolios, which total $7.8 billion.
The fund promises more than a potential financial return, the investors said. The systems expect to gain exposure to new technology and be able influence product development. “This is a very experienced group of people with a lot of expertise,” said Wayne Smith, president and CEO of Community Health Systems, which owns or leases 125 hospitals in 29 states.
Venture capital investment—with its promise of higher returns, but the certainty of greater risk—is limited among not-for-profit hospitals.
Investment manager Commonfund reported 4% of alternative investments in portfolios of 85 not-for-profit hospitals and systems surveyed last year was venture capital. Alternatives accounted for 15% of the survey's combined $76.8 billion in assets of all kinds. Venture capital investments were most often found in portfolios of systems with at least $1 billion in annual revenue.
Less common are health system-backed funds that target financing for healthcare entrepreneurs, such as the Heritage fund. “I would say it's unusual,” said Susan McDermott, senior vice president and chief investment officer for the Stratford Advisory Group, a Chicago-based investment consulting firm, which vetted the fund for one of its investors.
The nation's largest Catholic health system, St. Louis-based Ascension Health, launched a $125 million venture capital fund in 2001 and partnered with three other Catholic systems to create a second $200 million fund. Kaiser Permanente, based in Oakland, Calif., operates a venture arm that has backed more than two dozen companies since it was founded in the late 1990s. Partners HealthCare System created its own venture pool four years ago to finance entrepreneurs within the Boston-based system.
Heritage Group founder Morphis said through a spokesman that efforts to slow healthcare spending among providers led the financiers to launch the fund. Indeed, the managers have touted the far-reaching healthcare law to promote the fund.
“The Patient Protection and Affordability Act passed by Congress last year contemplates and encourages innovation in numerous ways,” the fund's Web page says, and investors consider health systems “the real-world laboratory for developing solutions in a rapidly changing operating environment.”
Heritage spokesman David Jarrard said Morphis and McClellan were not available for interviews during fundraising.
The Affordable Care Act, enacted last March, includes significant insurance expansion and regulatory oversight and some alternative reimbursement models for hospitals and physicians that will be tested in coming years.
The Partners Innovation Fund, which was financed by Boston's Massachusetts General Hospital and Brigham and Women's Hospital, joins with outside venture capitalists to back technology or products developed by Partners HealthCare. Bob Creeden, the managing partner of the fund, said outside investors have been slightly more hesitant since the healthcare law, which has raised concerns that reimbursement may change under the law.
But the change that accompanies the law also creates a potentially favorable market for the startups and upstarts that draw venture capital.
Established companies struggle to adapt to major demographic shifts, such as the wave of retiring baby boomers, technological evolution or significant regulatory changes, said Michael Roberts, executive director of the Arthur Rock Center for Entrepreneurship at Harvard University.
“The reason for that is that existing incumbents in any industry have a very developed and entrenched set of practices and investments that have all been carefully designed to give them an advantage in the existing environment or the status quo,” Roberts said.
“We know from lots of experience that these incumbent players have a hard time changing those practices and making dramatic new investment that cuts against their existing strategy. Almost by definition, if they're incumbents and they've been around for a while, the things they're doing are reinforced because they worked,” he said.