Intro to Fundraising for Healthcare Startups

An Introduction to Fundraising for Healthcare Startups from Accenture: A Discussion with Andrew Lackner

November 10, 2020 – By Jared Mueller, Director – Mayo Clinic Innovation Exchange

As part of Accenture’s relationship with the Mayo Clinic Innovation Exchange, Accenture experts meet with Innovation Exchange members both one-on-one, and via presentations on topics of interest to healthcare startups. Earlier this summer, Andrew Lackner — a leader within Accenture’s corporate innovation and new venture incubation practice — spoke with the Exchange’s members about fundraising practices and trends in the healthcare industry. Before joining Accenture, Andrew held venture capital roles at GE Capital, GE Ventures, and at Columbia Capital, a private venture capital firm with over $3.9B of assets under management.

Q: What should entrepreneurs know about the current state of the healthcare venture capital market?

AL: Prior to the current crisis, healthcare venture investment was on a dramatic rise across the U.S. and Europe. In 2017, mainstream healthcare venture capital had totaled $21.7 billion, which increased to more than $33 billion in 2018 — a high water mark that 2019 nearly equaled at $32.5 billion. Healthcare venture capital funds also raised more than $10 billion in 2019*. Much of that “dry powder” remains available as funds look to make investments in 2020 and 2021.

Digital health in particular has remained a fast-growing sector in 2020, even with the disruptions to investment rhythms in Q1 and Q2 2020 due to the pandemic. Digital health investments alone were on track to exceed $10B in 2020 in the U.S., based on the first half of the year’s data. This represents a meaningful increase from the $7.4B of venture capital investments in digital health that market researchers tracked in 2019**.

Q: How do venture capitalists evaluate technology- and science-dependent healthcare startups?

AL: Before getting into the dimensions of risks that VCs evaluate, one theme I want to drive home is: early-stage venture capital can be expensive to companies. Many very early stage or seed stage companies have high levels of team, technology, regulatory, market, and finance risks. We find that many seed stage investors will expect a greater than 20x return on their initial investment, given their seed capital may be tied up in a startup for five to ten years before an exit and the many challenges an early startup will have to survive in order to stay solvent and realize a compelling exit.

As companies mature, technology and market risk moderates. First through demonstration of product market fit, and subsequently through demonstration of the viability of the business model. As the prospect of an exit becomes clearer and nearer the cost of venture capital to a company seeking funding tends to decrease.

Investors may be willing to invest with the expectation of a 3x to 5x return on their investment in later stage VC rounds. Companies should focus on the retirement of risk as they conceive, launch, and prepare to raise their early rounds of capital. They should define their key technology, intellectual property (IP), regulatory, team, and product/market fit milestones and knock down as many as possible in advance of raising their first priced preferred equity financing.

Founders must demonstrate clarity and efficiency in their development approach of the new venture. At the founding and seed stages of a life sciences or medical device healthcare startup I would recommend early ventures first assemble credible founding teams and scientific advisory boards. This founding team first needs to demonstrate the viability of the scientific discovery. They need to document and protect foundational IP through the filing of provisional patents and license the rights to the IP (if not already owned by the new venture) from the owners of the IP (such as a university). They need to initiate the clinical trials process as early as reasonably possible in order to progress gaining regulatory approval. They also need to develop the business concept, an investor presentation, and initiate the process of forming early commercial partnerships. These efforts should be at relatively mature stages prior to raising early stage preferred equity financings.

Q: Following on that, what dimensions of risk are top of mind for venture investors as they make both “go or no go” and valuation decisions?

AL: Great investments start with a great team focused on a big problem. Based on my experience, team and market are two of the primary categories of new venture risk that are top of mind for investors. Let’s review each new venture risk category:

Team Risk:
How strong are the leaders of and co-investors in the startup? Are we confident in the founding team’s ability to launch and scale the business? Attractive characteristics of healthcare startup founding teams include unique educational and scientific research backgrounds, prior startup company experience, and/or successful prior operational experience. It is helpful if the founders are well-known within the investor’s network, as this reduces some of the risk of working with a new team. As new ventures mature, investors will look at the depth of the rest of the startup’s staff, both in terms of filled versus unfilled roles, and experience. That second dimension is what we consider the team’s maturity.

Market Risk:
Investors have to develop conviction that the startup is tackling a sizable, attractive market, and that the economics of the firm’s business model will allow it to profitably serve that market. The elements of product market fit include the scale of the problem, the value proposition of the solution, the size of the market opportunity, the profitability of the business model and reimbursement strategy, and the right to win of the new venture. The attractiveness of the business concept thesis can be evaluated along each of these investment case building blocks. In relatively short order it is expected that the founding team will be able to prove out the thesis through product sales.

Investors will also want to understand if the startup has a right to win in the market and a sustainable competitive advantage. Sustainable competitive advantage can be developed through technology and patents (covered in the next section), but it also can be a function of the business model. For example, it can result from reaching critical mass of users, syndicated data or user generated content, stickiness or high switching cost of the service or product, or a cost advantage.

Technology and Regulatory Risk:
Both of these categories of risk are especially salient in healthcare. How unique or defensible is the company’s innovation? If its intellectual property position is not strong, an innovative company may not be able to defend itself against talented “copycats” over the medium or long term.

Regulatory processes are very complex in the U.S., Europe, and other major healthcare markets. Has the company demonstrated expertise managing the regulatory and clinical trial process? Technologies that involve less regulatory risk, and may not require years and hundreds of millions of dollars to bring to market, often can appeal to a broader set of investors.

Financing Risk:
Businesses that are capital intensive (hundreds of millions) carry more risk than businesses that are more capital efficient (tens of millions). This is because higher capital intensity often requires the addition of deep-pocketed new investors in later rounds. The need to bring on additional investors introduces risk.

Capital intensity is often also used as a proxy for ease of scalability of a business concept. Meaning that if a lot of capital is required to complete R&D, build manufacturing capacity, or finance long-term customer contracts, that this then means scaling the business will be hard and risky. Yet, hard doesn’t always mean poor returns. Returns in biotech, a capital-intensive industry, have been strong!

Generally investors that are actively investing in capital-intensive industries have specialized in those industries and understand what it takes to make these investments successful. Investors will want to know that you also understand what it takes. They will want to understand the projected costs, timing of product development, regulatory impact, revenue projections, gross margins, operating expenses, capex, cash flow, and capital required to get the business to profitability. They will also want to understand the exit strategy.

Investors will also want to make sure that the particular deal’s terms are structured in a way that enables them to minimize financial return risk and provides them with adequate governance control over the company. Investors might reduce their risk by structuring a deal that gives them a board seat or other control provisions over a company’s direction. Generally in the US, venture deals — especially in earlier rounds — start from the standard National Venture Capital Association (or “NVCA”) deal documents. All founders should download these documents and be familiar with the standard VC terms.

Q: Which categories of investors and sources of funding would you advise that healthcare startups keep in mind?

AL: In addition to traditional venture capital firms and angel investors, healthcare and life science entrepreneurs should consider the full range of dilutive (funding tied to the sale of equity of the company) and non-dilutive sources of capital. These include non-dilutive funding sources such as federal grants from the National Institutes of Health, the National Science Foundation, the Department of Defense, and — in some cases — major foundations focused on particular therapeutic areas or diseases. A drawback of these funding sources is that they can be time-intensive to apply for, and to adhere to the grants’ reporting requirements. Aside from their non-dilutive nature, another advantage of winning grants from these institutions is that they can serve as important validators for other investors.

Family offices, accelerator programs that involve an equity transaction, and corporate or major non-profit investors are additional sources of dilutive funding. A risk of accepting funds from a major pharma or medical device company is that it sends a signal to the market that your startup may have moved away from market neutrality — and may be unwilling or unable to fully partner with other market participants that compete with your investor. As such, some companies opt to wait till later rounds to invite strategic or corporate investors to invest.

Q: What breakthrough innovations in healthcare delivery or technology excite you most?

AL: Outside the obvious answer of COVID-19 vaccines this is a tough question. Healthcare is in the middle of a massive transformation by both incumbents and non-traditional players — think Amazon, Apple, and Walmart. If I had to pick one that personally excites me most, it would be the promise of patient digital front door innovations. With consumers taking more of an interest in managing their own health — digital therapeutics, telehealth, wearables, self-triage tools — patients are proactively seeking care based on health notifications they are receiving on their devices, for example.

We need not forget that patients are at the core of this transformation and how we can keep them engaged in the information age is of utmost importance. I am also excited about potential of health and wellness applications and innovation occurring at the intersection of behavioral applications; wearables; mental health; and activity, diet, and treatment adherence tracking.

* Silicon Valley Bank: Healthcare Investments and Exits 2020 Annual Report
** Rock Health: 2020 Midyear Digital Health Market Update

Views expressed by guests are their own and do not necessarily reflect the views of Mayo Clinic. As a not-for-profit 501(c)(3) charitable organization, Mayo Clinic does not participate in political activities.