Hospital-based venture funds bet big on health startups

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When Vivify Health sought additional capital last year, the healthcare software developer had a multitude of traditional venture capital funds to choose from.

The company, which offers clinicians remote monitoring of chronically ill patients, was an attractive investment. It already had millions in revenue, 500 hospital customers and proven technology and processes.

Rather than go with New York funds or one from Silicon Valley, Vivify chose one of the hospital system-based investment funds that have sprouted in recent years. Besides money, the venture arm of UPMC, the giant Pittsburgh-based health and hospital system, offered to help Vivify scale up its operations to reach even more customers, Vivify founder Eric Rock said.

Moreover, UPMC, unlike many venture capital funds, promised to hold onto its Vivify equity indefinitely rather than pressure the company to sell itself in two or three years so it can monetize its investment, “It was not a flip-and-turn approach,” Rock said.

These are boom times for healthcare startups, which are flourishing amid the historically high investment directed their way by venture capital firms. In 2016, venture capital funding in healthcare companies surpassed $5 billion for the first time after hitting $4.6 billion in 2015 and $4.7 billion in 2014, according to Mercom Capital Group.

Each of those years saw a huge step up from 2013, when venture capital investment reached $2.1 billion; $1.2 billion was invested in 2012, Mercom reports.

What's fueling the boom is the shift from fee-for-service reimbursement to value-based payments that put providers and insurers at some risk for the cost and quality of care.

Hospitals and physician groups began seriously hunting for software tools and data analytics around 2010. They needed new approaches that would allow them to improve their management of groups of patients and step up the clinical efficacy and productivity of their employed doctors and clinicians.

The investment surge coincided with passage of the Affordable Care Act, which brought the healthcare industry to the realization that value-based reimbursement was inevitable. Providers recognized they needed to step up their innovation efforts. “It created this energy and movement,” said Matt Hermann, senior managing director of Ascension Ventures, the enterprise arm of 141-hospital Ascension.

Ascension was one of the first hospital systems to plunge into the venture capital game by setting up a dedicated fund and putting in place an organization with managers skilled at the art of investing in healthcare startups and technology.

Since founding its venture capital division in 2001, Ascension—with contributed capital from other not-for-profit health systems representing 500 hospitals—has raised $800 million and invested in 57 healthcare companies, Hermann said.

Ascension Ventures raised $255 million in its fourth fund in December. It almost immediately put a chunk of that capital to work in January by investing $20 million in Reputation.com, an online reputation management company that helps businesses respond to what customers are saying about them on social networks and review sites.

With healthcare consumerism on the rise and more Medicare pay pegged to patient satisfaction, hospitals and physicians are paying attention to reviews.

In fact, the 1,200-physician Henry Ford Medical Group in Detroit is changing compensation next year for its primary-care doctors so that 50% of pay will be pegged to how many consumers choose a particular doctor as their primary-care physician, rather than have the bulk of compensation based on throughput and the difficulty of care.

That will put a premium on how good those doctors look online as patients seek a primary-care doctor for their primary access to the system, group CEO Dr. William Conway said.

Until the ACA, most health systems were satisfied with occasionally investing in homegrown companies that helped them solve a problem, Hermann said. Now, the investment criteria have changed.

Hospital-sponsored venture funds still need a return on investment. And they are still looking to address specific problems. But, Hermann said, sophisticated funds today are choosing emerging technology companies whose products and services can be scaled across large systems, with management that can execute a growth strategy.

Dozens of hospital-sponsored funds that not only want a return but the ability to get first crack at technology that the hospitals can widely deploy have sprung up alongside traditional venture capital funds in hotbeds such as New York and San Francisco.

According to Accenture Strategy research, 60 hospital-sponsored or corporate venture capital funds are now actively investing in healthcare startups. From 2009 through 2015, they invested a combined $10 billion in healthcare technology companies, with that investment more than doubling in the past four years.

But trend watchers expect hospital systems to take the lead in the years ahead. Hospital-sponsored investment in health companies is expected to reach $7.5 billion annually by 2020, Accenture said. Investment by corporate venture capital, by contrast, was $3 billion in 2015.

One hospital system newcomer fueling the surge is Spectrum Health in Grand Rapids, Mich. The midsize system with 12 hospitals this year created a $100 million fund to invest in new technology companies.

Vivify Health has relied solely on hospital-sponsored venture capital and that of other healthcare vendors such as Envision Healthcare and Laboratory Corporation of America to raise more than $25 million over its seven-year history, said Rock, who previously founded and sold Medhost, a touch-screen software company for managing care in emergency departments.

Based in Plano, Texas, Vivify offers a cloud-based remote care-management product that connects providers with their patients via wireless mobile devices. Rock said providers representing more than 600 hospitals and health plans use the technology to ensure that patients at home are taking medication and staying on their treatment regimens. Vivify Health has revenue of about $10 million.

When it was time to raise money beyond the seed-capital stage, Rock said he turned for capital to Ascension Ventures and the Nashville-based Heritage Group, another fund capitalized by healthcare companies, for Series A funding in 2013. Then LabCorp and Envision Healthcare funded the first part of a Series B financing in 2015 before UPMC funded the second part in early 2016.

Rock said the healthcare-based venture capital funds were willing to not just solve population-management problems by investing in startups, but were eager to offer management resources to refine the product.

Tal Heppenstall, president of UPMC Enterprises and treasurer of the integrated health system, said its plan for investing in Vivify and the other 15 companies in Enterprises' venture portfolio is to grow the company, not sell it.

The fund likes to hold its stake because the goal, besides eventually making a return on investment, is to gain technology that solves problems confronting UPMC and other hospitals and systems. Before UPMC officially created the Enterprises division about two years ago, the system had successfully grown several businesses, including a health plan that now has about $8 billion in annual revenue.

More recent homegrown companies that are growing revenue with customers beyond UPMC are Curavi Health, a telemedicine solution for nursing homes, and Prodigo Solutions, a software company that directs hospital supply buyers looking to purchase products and services to vendors where volume discounts are available.

While Heppenstall declined to detail the size of UPMC's investment portfolio or its return on investment, he did point to one big success—its 20% stake in Evolent Health. That stake was purchased for about $38 million in 2011 and 2013 equity financings when the population health management company was still in its infancy. But after Evolent Health went public in 2015, that stake ballooned in value to $300 million, with UPMC realizing $76 million on the subsequent sale of some of its shares and it's still holding nearly $200 million worth of shares.

Of course, there are substantial risks for hospitals getting into the venture space that may leave system leaders regretting their plunge into investing. Traditional venture capitalists have long recognized that many investments don't pan out, said Ben Foster, a principal focused on healthcare at KPMG.

Without pointing to any specific corporate venture funds, Foster said hospitals are really good at providing care. As a general rule, their performance in other businesses often tails off the farther they get from care provision, he said. “There are much better things to do with the limited capital they have,” Foster said.

Hermann at Ascension Ventures said a “gold rush mentality” has filtered into startup investing as funds have piled in looking for financial returns and the latest technology. Whether new venture capital entrants see either probably won't be known for at least another five years. “After five or seven years, I think folks will be able to do a look-back and see if they were able to deliver on the value.”