Hospital systems investing in startups whose products they use

When the founding investors in Ingenious Med, developer of a popular patient-encounter platform for clinicians, recently cashed out, the company's executives recapitalized with a traditional venture capital firm. But they also included capital from venture funds run by several not-for-profit health systems that use the company's products.

S. Hart Williford, CEO of the Atlanta-based company, said he told North Bridge, the lead investor, that he wanted to involve health system-affiliated venture funds in the recapitalization because they truly understand healthcare. And he wanted to have his hospital customers participating with their own investments and membership on his company's board.

This investment approach is increasingly common among not-for-profit health systems. About 40 systems have started venture funds. The lure is the potential for big payoffs, as well as the promise of getting in on the ground floor with effective new healthcare technologies and services. Some systems have found venture funds an attractive investment approach, given low bank interest rates and modest returns from securities. Over a seven-year horizon, it's not uncommon for health venture funds to triple their investments, fund leaders say.

Still, MyCapital, a website connecting venture capitalists and startups, cautions that 20% to 90% of portfolio companies fail to deliver a return on the venture capitalist's investment. “There are no guarantees,” said Dave Chase, who founded Avado, a patient relationship software developer sold to WebMD in 2013 for an undisclosed amount. He warned health systems that “any venture investing comes with risk.” That risk may be partly offset by the fact that health systems may benefit from using the technology products developed by the companies.

Venture firms generally have found that companies involved in healthcare information technology and health services are attractive for investment. Of $49.3 billion invested in venture funds in 2014, $6 billion went to biotechnology, $2.6 billion to medical devices and equipment and $356 million to healthcare services, according to the National Venture Capital Association Yearbook 2015.

Why are health system leaders starting venture funds? Ezra Mehlman, vice president of Health Enterprise Partners, a New York-based growth equity firm, said the past five years have been a time of immense change and uncertainty for hospital executives. So they're experimenting with new ways of doing business and seeking growth opportunities outside their core businesses, including launching strategic investment groups.

Health system venture funds typically act as co-investors or strategic investors, performing their own due diligence, while also relying on research performed by lead firms or large venture firms.

In the case of Ingenious Med, which automates the capture of physician charge data at the point of service, strategic investors include:

Ascension Ventures, a subsidiary of St. Louis-based Ascension Health, which has $550 million in capital under management. Its limited partners include Catholic Health Initiatives, Decatur Memorial Hospital, Dignity Health, Intermountain Healthcare, Mercy and Trinity Health.

Kaiser Permanente Ventures, the corporate venture capital arm of Kaiser Permanente in Oakland, Calif., which has invested in 55 healthcare health-IT, health-services and medical-device companies since 1997.

Heritage Group, a Nashville-based venture capital firm whose limited partners are a blend of not-for-profit and for-profit health systems, including Cardinal Health, Community Health Systems, Intermountain Healthcare, LifePoint Health, Memorial Hermann, Tenet Healthcare Corp., Trinity Health and UnityPoint Health.

Matt Hermann, senior managing director of Ascension Ventures, said investing in new technologies makes “a ton of sense” when a hospital group is enthusiastic about a particular technology, wants early access, and seeks to help guide its future.

Ascension's medical staff liked Ingenious Med's charge-capture product, which replaces index cards physicians carried in their pockets for recording encounters. “We got excited by other aspects of Ingenious and about their growth strategy to improve patient care and physician efficiency,” he said. “We shared their story with our physicians and IT organization.”

Roshen Menon, general partner at North Bridge, which has $3.8 billion of its capital under management with a focus on high-growth companies, said that when health systems serve as strategic partners as well as technology users, it helps open doors for technology developers inside hospitals. “That's an important value-add that hospital groups bring,” he said.

David Tamburri, general partner at Health Enterprise Partners, which has a $148.5 million fund with approximately two-thirds of it coming from healthcare organizations, said many strategic investors, including hospital-based investment funds, feel more comfortable investing alongside more traditional funds or serving as limited partners in a healthcare fund. Making direct investments requires expertise that hospital funds may not feel they have.

“Investing in a fund affords hospitals the ability to share in the upside they create through commercial relationships, while avoiding the challenges associated with managing a dedicated investment vehicle,” Tamburri said. “In addition, the right strategic co-investor can have a tremendous impact on the company's ability to accelerate its commercial efforts, while also providing additional credibility in the marketplace.”

Dan Burton, CEO of Health Catalyst, a Salt Lake City-based data warehouse and data-analytics startup, said strategic investors such as hospital funds typically will not lead an investment round.

“They'll tag along and often feel much more comfortable with a pure VC doing all the deep due diligence on a company, validating that they feel it's a good investment,” he said. “When they see someone like a Sequoia Capital or a Norwest Venture Partners leading an investment round, they'll often participate as a co-investor.”

Health Catalyst has raised $165 million in venture funding. Strategic investors include Kaiser Permanente Ventures and CHV Capital from Indiana University Health. In addition to venture groups, health systems such as Minneapolis-based Allina Health and Boston-based Partners HealthCare have invested directly in Health Catalyst. “Our mission aligns tightly with health systems' missions,” Burton said. “So having health system VCs invest in our company helps preserve that mission and orientation.”

He said investments by health-system venture groups and health systems create “anchor customers” for new technology and helps shorten the sales cycle. “It aligns us with these important anchor customers in ways that are just very productive for everyone involved,” Burton said.

For example, Allina recently signed a $100 million contract with Health Catalyst. Burton said he would not have a direct relationship with Allina's top executives without the Allina investment in his company. “That relationship is probably the single biggest benefit to me,” he said.

About two years ago, not-for-profit Providence Health & Services, which operates 34 hospitals on the West Coast, started Providence Ventures to extend its core mission and create a platform to help evaluate new technologies, said CEO Dr. Rod Hochman. Providence earmarked $150 million to invest over five to seven years in innovations to improve patient care.

The Providence Ventures fund focuses on early to mid-stage companies involved with online primary-care access, care coordination and patient engagement, chronic disease management, clinician experience, data analytics and consumer health and wellness services. Providence hired Aaron Martin, a former executive with Amazon's Kindle group, to lead the fund.

Hochman and Martin have spoken to other hospital groups about establishing venture funds. Hochman noted that health systems often feel overwhelmed by entrepreneurs' pitches for new technologies. “Every vendor has a solution for you and it's hard to separate the wheat from the chaff,” he said. “Having a methodology by which you can really evaluate technology, for me as a CEO, is essential.”

For instance, Seattle-based Swedish Health Services, a Providence affiliate, needed rapid access to a larger pool of medically trained language interpreters, especially for the emergency department. Providence's venture fund team recommended investing in Seattle-based InDemand Interpreting, which provides online, round-the-clock access to medically trained interpreters in 200 languages.

“If somebody walks in speaking Russian and we need to be able to take care of them, the caregiver brings out a laptop, selects a gender and language and there is a Russian-speaking interpreter right there on the screen,” Martin said.

Earlier this year, Providence Ventures co-invested alongside Health Enterprise Partners in InDemand Interpreting, which serves about 500 healthcare facilities daily. The two groups have invested a combined total of $10.4 million in the company.

“If we're going to work with a company that we think has value, it would be a good thing to be invested in it as well,” Hochman said.

While Providence often gets involved with technology developers outside its own health system, Mayo Clinic Ventures in Rochester, Minn., is focused primarily on bringing technologies to market that Mayo clinicians and scientists have developed or enhanced.

James Rogers, chairman of Mayo Clinic Ventures, a $100 million venture and growth fund, said Mayo never serves as a lead investor. As a co-investor, it looks for partners to commercialize products.

“There has to be a Mayo value-added component so we're not just venturing for the sake of venturing,” he said. “We're not venturing other people's money. It's our own money. It allows us to be at the table and put some investment into the companies as we're moving the companies down the road.”

A recent success story is Menlo Park, Calif.-based Nevro Corp., which manufactures the Nevro Senza high-frequency spinal-cord stimulation device to treat chronic pain. The device uses Mayo-developed technology, and Mayo Ventures provided seed funding to start the company. The Food and Drug Administration approved the Nevro Senza system in May to help manage chronic intractable pain in the trunk and limbs. Nevro went public last month, at a valuation of more than $1 billion.

“It's just a great story,” Rogers said. “We've got multiple others like that.”

Rogers said Mayo likes to start small in investments and set milestones. His fund has dropped some technologies that didn't meet its goals. For him, the ultimate determinant of a successful investment is a product that provides value in healthcare delivery.

Avado founder Chase said health systems that don't get into the venture-capital game risk missing out on transformational care-delivery advances that are coming in the next few years.

“The biggest blind spot I see with health systems is not investing in breakthrough new healthcare delivery models such as direct primary care,” he said. “To my surprise, many health system executives are blind to those companies, while they focus on technology investing. So far, the most disruptive companies I've seen aren't technology companies.”

He said provider firms such as CareMore and Healthcare Partners are achieving excellent results in improving care and reducing costs. “It's easy to discount companies when they are small, but they build up a head of steam that becomes unstoppable,” he said.