Incubators boost IT startups

More than a dozen business incubators devoted exclusively to hatching health information technology firms have sprung up across the country in the past three years. They are seeking to cash in on the trend among healthcare venture capital firms toward investing in health IT rather than drug or device startups.

One of the startups taking advantage of the incubator movement is Chicago-based Ludi, which is developing a software program called DocTimeLog to help organizations and physicians track their contracts and keep from running afoul of the law. Entrepreneur Gail Peace is operating her fledgling business out of an incubator called HealthBox.

The idea behind the business came from a problem she ran into while working for a major hospital system. Physicians that sign contracts with hospitals for limited hours sometimes wind up facing a Stark law violation if they log too many hours.

“I put those complicated deals together, but I didn't spend a lot of time on how they were tracked,” said Peace, who previously worked as a vice president of business development at Vanguard Health Systems' Chicago operations, acquired last year by Tenet Healthcare Corp. Now, “we help the physician track it in real time on their smartphones.”

The health IT incubator movement (some business development cognoscenti call them accelerators) got its start in 2011. The catalytic events were the 2009 passage of the American Recovery and Reinvestment Act with its $22.5 billion in health IT incentive money for adopting electronic health records and the 2010 Patient Protection and Affordable Care Act with its push toward payment models that reward care coordination and accountable care.

The incubators provide the new companies with seed capital up to $100,000, office space, mentoring by experienced health IT entrepreneurs, legal and other business services. Their managers also provide introductions to potential healthcare industry customers and angel investors. In return, the incubator operator receives an ownership slice in the startup, with 6% to 7% being typical.

The startups being nurtured by the incubators are chasing a growing pot of venture capital money looking to cash in on the health IT boom, according to Healthcare Growth Partners, an Elmhurst, Ill.-based investment bank focused on healthcare IT. Healthcare IT firms raised $2.7 billion last year in 267 private equity and venture capital transactions, both records, according to HGP.

Incubators are “serving a great need,” HGP Managing Director Christopher McCord said. “It's very hard to fund companies, prerevenue. Statistically, a lot of those are going to fail, but it's better to fail small than fail big, and that's how they're set up. They're going to have some big wins and those are going to offset the small losses.”

Perhaps. The jury is still out on whether the incubators will be able to generate a steady stream of successful startups. “I'd like to see a product working in a hospital, in a live environment, and then I might be interested in putting some money into it,” said Todd Cozzens, a venture partner and senior adviser at Menlo Park, Calif.-based Sequoia Capital.

Not-for-profit incubator RockHealth launched in 2011 in San Francisco as one of the pioneers in the field and recently published its first annual report. It claims 55 active companies in its portfolio with 436 jobs. Those firms have raised more than $100 million in follow-on funding from investors, including some that have graduated to their own digs in nearby Silicon Valley.

One of them is drchrono, a Mountain View, Calif., developer of a mobile EHR for the iPad. The firm graduated from RockHealth. “We found a large number of investors and a large amount of developers in a small amount of time,” said Daniel Kivatinos, the chief operating officer of the firm.

Dr. David Brailer, founder and CEO of the San Francisco-based healthcare investment firm Evolution Partners, is clear-eyed in that he assumes most of the incubator graduates “will disappear.” But, for healthcare leaders, Brailer said, “This is learning. It's experimentation.” It's the kind of thing you'd want, “to have 100 experiments going on,” if you're a healthcare organization CEO, and, “if you want to learn.”

Of course, that's not the view from the startup workbench. Peace, 46, in Chicago already has a few paying customers after being part of several startups. This is “the first one that I've been bootstrapping,” she said.

The incubator's “strategic partners” attracted Peace to HealthBox. They include St. Louis-based Ascension Health and Chicago affiliate Alexian Brothers Health System; the Community Health Network of Indianapolis and the Ridgeview Medical Center of Waconia, Minn., near Minneapolis. “For me, it's all about growth,” Peace said.

In addition to making contact with potential customers, Peace said a surprising benefit she's received from the incubator has been the close connections she's made with her incubator colleagues. “It's very lonely when you're out there on your own as a CEO,” Peace said. “There's nobody to talk to about what you're going through.”

At the incubator, “we work at a table in a loft. I'm running my business three feet away” from the next startup. “We're able to learn from each other. If I ever go back into the hospital world, I'd have all the executives do the same thing.”

Since its founding in Chicago in January 2012, HealthBox has run similar programs in Boston, Nashville; Jacksonville, Fla.; and London. “Part of the reason why we do this is we feel that healthcare innovation happens across the country and across the globe,” HealthBox founder and CEO Nina Nashif said. “Healthcare organizations are everywhere. Clients (that is, tech entrepreneurs) are everywhere.”

But IT venture capital funding is concentrated in Silicon Valley and Boston. That allows incubators to serve the function of bringing a city's most promising startups into a one-stop shop where they can be showcased for investors. Strategic investors “don't want to miss the next opportunity,” Nashif said. “The incubators are able to find the chosen few with promising ideas and businesses.”

Some of the firms, such as Peace's Ludi, already have customers and sales. Others are little more than an idea. Either way, no one is asked for a credit check. HealthBox selectors focus on only a few questions: “Is there a market need for this (and) how much do we believe in the founders?” Nashif said.

Different regions have different strategic partners and investors. In Chicago, supporters for HealthBox operations and its investment fund include Walgreen Co., the retail drugstore giant; Express Scripts, a pharmacy benefit manager; Blue Cross and Blue Shield Venture Partners, an investment fund of 22 Blues plans; Merge Healthcare, a health IT developer; and SandBox Industries, a tech incubator working outside the healthcare industry. There are also several venture capital firms involved.

At the end of the entrepreneurs' training period comes “demo day,” when they get up in front of a roomful of potential investors and pitch their wares in five-minute spiels. “I go to all the demo days,” said Missy Krasner, a Mountain View, Calif.-based adviser at Mergenthaler Ventures who canvasses health IT incubators for investment opportunities. With more than a dozen incubators now in operation, “the independent accelerator is at its tipping point.”

Follow Joseph Conn on Twitter: @MHJConn