Health systems turn to venture capital amid financial challenges

Hartford HealthCare’s new administrative headquarters are in a nondescript building, on a street lined with other nondescript buildings. But the 110,000-square-foot building, which cost the system around $14 million to renovate, is flashier inside. Visitors are greeted by a setup that looks straight out of Silicon Valley: a professional TV and media studio, murals, inspirational photos and phrases on the walls, and a wavy-looking ceiling meant to indicate change and innovation.

Six weeks after it opened the doors of its downtown location in October, the seven-hospital system announced partnerships with two venture capital firms, the Morningside Group and Connecticut Innovations, to bring startup leaders into the incubator space to develop pilots and work with clinical experts. The initiatives are similar to another venture capital collaboration Hartford made in March 2020 with the Israel Innovation Authority, an Israel-backed venture fund.

“Embracing innovation is a central part of our culture and we needed to bring people together in an environment that could foster it,” said Hartford President and CEO Jeffrey Flaks.

Across the country, health systems are responding to financial struggles and competition from retail and big tech disrupters by working with venture capital firms and their portfolio companies to implement digital health technology across clinical and administrative systems. The goals are to enhance operational efficiencies and increase access to care. Ethicists say, however, that health systems need to be careful not to breach clinician and patient trust in the name of added revenue.

“It’s a super difficult operating environment,” said Dr. Ron Paulus, former president and CEO of Asheville, North Carolina-based Mission Health and an adviser at venture capital firm General Catalyst, which has partnered with 15 health systems. “When you’re at a health system, you’re so consumed by the day-to-day activities and challenges, it’s hard to put your head up above the clouds and look around. That’s exactly what VC firms do every day.”

Hartford's venture play

As they’ve grown in popularity, agreements between health systems and venture capital firms have come together in different forms. Typically, health systems will invite startup companies in which a VC firm has invested to collaborate on tools addressing clinical and economic issues. Sometimes, provider organizations will invest and hold equity, or ownership rights, in these startup companies; at other times, the agreements hold no financial considerations.

At Hartford, leaders from early-stage startups work on pilot projects, for which the health system and the company set clinical and financial goals. For example, Wellinks, a startup funded by the Morningside Group and Connecticut Innovations that aims to treat chronic obstructive pulmonary disease, has reduced COPD readmissions by 10 percentage points since its tools were implemented at the system. The company’s technology is being tested across a wider patient population at Hartford and other providers.

Venture capital firms will also sometimes compensate Hartford for the right to build and refine the startups’ technology in its various clinical settings, Flaks said.

“We are working with startups to solve a problem in our organization,” said Dr. Barry Stein, Hartford’s vice president and chief clinical innovation officer. “We’re getting equity at the same time. We can also potentially co-invest to help them scale their company. If they’re successful, we then get an alternative revenue source. All of a sudden, the one cent we put in there is now worth one dollar.”

Holding equity in a company may mean getting offered a better investment rate when the company has a larger funding round, Stein said.

In general, Hartford’s partners like Morningside and Connecticut Innovations have different reasons for collaborating with the health system, leading to a variety of deal formations. The system declined to offer financial details about how much it has invested through venture capital partnerships.

“In areas where we make a financial investment, we are good stewards of our resources,” Flaks said. “We work to be very prudent and diligent about the companies we select for that level of partnership.”

Hartford leaders pointed to the need to put funding and staff time toward such arrangements.

“If you’re not investing in innovation, you’re going to be behind and you’re not going to survive,” Stein said. “And you’re not going to be a leader. Hartford HealthCare wants to be a leader.”

Beyond financial partnerships

In November, General Catalyst, one of the most active digital health VC firms, announced it had selected 15 health systems as strategic partners.

Unlike Hartford’s deals with Morningside, Connecticut Innovations and the Israel Innovation Authority, these health systems aren’t investing in or taking equity in General Catalyst-backed startups. Instead, the firm serves as a “think tank” allowing the health system partners to access startups’ technologies.

Investment opportunities may arise over time, said Scott Nordlund, executive vice president chief strategy and growth officer at Banner Health, one of General Catalyst’s strategic partners. Working with a venture capital firm allows the health system to more easily find the right startups to work with in a crowded market, he said.

“They can take this wide-open world of innovative companies and then siphon them down to a manageable group that can apply directly to challenges that we have,” Nordlund said.

Andreessen Horowitz, a venture capital firm based in Menlo Park, California, announced a similar, non-financial partnership in November with rural health system Bassett Healthcare Network based in Cooperstown, New York.

Bassett President and CEO Dr. Tommy Ibrahim said Andreessen Horowitz has not pressured the system to work with any particular companies and no financial commitments are required for either party. But there’s potential in the future to gain equity, he said.

“There could be opportunities for us to earn royalties, particularly as we demonstrate the success factors of these solutions,” he said. “That might be out there. But as of this moment, there really isn’t any financial or economic benefit.”

There is a practical benefit, however: The rural health system doesn’t have the bandwidth to solve many of its biggest challenges around staffing and operational efficiencies. Partnering with Andreessen Horowitz allows it to bring in already-vetted startups to address these challenges at no cost, Ibrahim said. For example, Bassett offers its employees access to resources and support through Homethrive, a family caregiving tech platform.

In return, health systems provide a testing ground for firms’ portfolio companies. Dr. Vineeta Agarwala, a general partner at Andreessen Horowitz, said real feedback is one of the reasons it entered into the agreement with Bassett.

“We’re not trying to have partnerships where we install companies and then don’t hear anything about what went right or if they decided not to work with the [startup],” Agarwala said. “Feedback is a gift to startups and there’s no better place to get it from.”

Startups are more likely to work with a venture capital firm with health system connections, said Michael Cantor, board chair of Connecticut Innovations.

“We can make one phone call and get them in touch with [Hartford],” Cantor said.

Rather than turning to outside firms, some health systems have created their own in-house venture capital arms. The arrangements vary based on the provider organization, but are typically an opportunity for systems to commercialize intellectual property derived from their research and pilot projects.

Rochester, Minnesota-based Mayo Clinic has a $250 million fund focused on venture capital and growth equity opportunities. The health system said the startup investments from its ventures arm last year were valued at $176 million. The value is determined by sales and financial performance of the startup, management representation and market analysis, according to Mayo.

Navigating the ethics

Ethicists point to potential conflicts of interest for health systems to be aware of when partnering with venture capital firms. Matthew McCoy, assistant professor of medical ethics and health policy at the Perelman School of Medicine at the University of Pennsylvania, said health systems might not apply the same level of skepticism to a proposed digital health solution if they invested or have an equity stake in the company that developed it.

“You need to have the right sorts of governance mechanisms around this and make sure you have an independent review of the investments you’re going to make,” McCoy said. “I think that will help you think seriously about the opportunity costs of these investments, and whether or not that same money might have more of an impact spent in another way.”

Venture capital-health system arrangements with any financial stakes involved represent an ethical minefield, given potential conflicts between economic interests and care missions, said Genevieve Kanter, associate professor of public policy at the University of Southern California’s Sol Price School of Public Policy.

“A particular technology may not always be best for patients, and it may not improve outcomes,” Kanter said. “But since it’s [the health system’s] own baby, it’s not going to be an ugly baby. So there’s going to be some attachment to it.”

Stein said Hartford’s compliance and legal teams are involved with any deal to mitigate potential conflicts of interest.

In-house VC arms could merit even more caution, since the health system is likely taking equity from the onset, some experts said.

“Some of these hospital systems setting up their own venture capital arms ... may run into challenges because there are complicated tax questions,” said Rachel Sachs, a professor of law and health policy expert at Washington University in St. Louis. “There are potentially questions about some fraud and abuse laws depending on what the technology is and the way in which it relates to the health system.”

Mayo Clinic Ventures Chair Andy Danielsen said the health system addresses conflicts of interest by not accepting any royalties from technologies and devices it recommends to patients where it also has an equity stake. According to Danielsen, the organization has a committee to review policies and prioritizes transparency regarding its investments.

“We want to separate any institutional value from the clinical care decision,” Danielsen said. “Our patients have to trust that when we tell them to use a device or therapy that all we’re concerned about is what’s best for them and not any sort of financial considerations.”

Kanter said patients should have to give consent for participating in pilots with more than minimal risks to their safety. Third-party reviews should also ensure patient data used in the pilot aren’t getting misused for the startup’s benefit, she said.

Nonetheless, there is reason for optimism about venture capital-health system relationships, said Dr. Kyan Safavi, medical director of clinical integration at Boston-based Mass General Brigham, who has led research examining health systems’ investments in venture capital deals.

“Health systems have a major opportunity to contribute to this space because they understand frontline clinicians and how they’re interacting with patients,” he said.