Strategic Healthcare Insights Shaping Our Investment Approach by Shira Eting

May, 2024

Shira Eting

Part 2: Strategic Healthcare Insights Shaping Our Investment Approach

In the first part of this blog, we discussed the strategic foundations of establishing a healthcare-focused Fund of Funds at Vintage. We covered the critical importance of selecting the right funds based on access and past performance and the benefits of having a focused investment strategy. Now, we delve deeper into insights gained per each sub-sector, and how they shaped our investment decisions.

Acknowledging that there can be overlap, we simplified the healthcare fund landscape into 3 sub-sectors: Digital Health, Life Sciences, and Tech-Bio. Meeting with dozens of funds (and companies) in each category has enabled us to generate sector-specific insights which refined our fund selection criteria and could be valuable to others.

1. Digital health

Amongst the three sub-sectors, digital health – comprised of health IT and tech-enabled services – is the closest to generalist tech investing. It is quite common to find companies using technology to make delivery and data more efficient, offering s/w only solutions and using recurring business models. Additionally, many of these Healthcare companies exist at the intersection of AI, fintech, cyber and other sectors. This has led many generalists to invest in digital health, but it is not as easy and straight-forward as it may seem.

Healthcare delivery is particularly complex, which makes it more challenging for companies and investors to succeed. In the U.S., incentives between consumers (patients), payers (health plans or employers) and providers (health systems) are misaligned. Put simply, patients desire to maintain health without high costs, providers are incentivized by a fee-for-service model to offer unnecessary care, such as prioritizing surgeries and medications over preventative measures, and payers are focused on reducing their medical loss ratio by lowering their direct care payments. The shift to Value Based Care is intended to solve many of these complications but is progressing more slowly than anticipated, currently representing only 10% of the market. All of this doesn’t even consider regulatory hurdles and the ever-changing policy landscape. This leads to two important dynamics: (1) G2M often matters more than technology itself and (2) achieving product-market fit and generating early revenues usually takes longer than in general technology sectors.

Additionally, while Covid clearly inspired more innovation and interest in healthcare – which is a good thing – it also introduced several market challenges. For instance, virtual care, despite its rapid adoption, was sometimes found to be unsustainable, the market saw an influx of funding for numerous point solutions which overwhelmed employers, and, like in other sectors, some companies raised substantial funds or went public too early with unproven business models. Since there are so few pure digital health companies that are publicly traded, this further complicated questions around comps and major KPIs for a successful outcome (acquisition or IPO).

The digital health funds we committed to include 7wire Ventures and Virtue – as well as General Catalyst Health Assurance and a16z Bio+Health, which we have prior exposure to – and all have detailed and nuanced theses around these topics and play a meaningful role in helping their companies deal with those challenges. For example, 7wire Ventures has developed a unique thesis around the “Informed, Connected Health Consumer” and assembled a coalition of strategic LPs that are committed to scaling those solutions. Virtue, a pre/seed emerging manager, provides first capital to build new companies and proactively helps founders overcome G2M and funding challenges. General Catalyst has established a unique model in which they serve as a digital transformation partner for 20+ healthcare systems, helping them utilize technology to provide a more proactive, affordable, and equitable system of care. Finally, a16z Bio+Health is at the forefront of reimagining healthcare and has published dozens of content pieces about the future of health, including a specific focus on AI (check out this Fireside chat).

2. Life Sciences

The development of new therapeutics and diagnostics is a holy grail. Demand is immense and patent cliffs require continuous innovation. However, it is not for the faint-hearted. It demands that companies be built on scientific breakthroughs, have experienced management teams, and have access to large pools of capital.

Therefore, the structure of funds and companies in Life Sciences (LS) is very different from traditional tech. For example, most LS funds are strategically located next to strong research hubs such as Boston, Silicon Valley, New York, and Basel. Furthermore, these funds often assume management positions within their portfolio companies from the outset, reflecting a deeper level of involvement required in this complex field.

Today, very few funds (less than ten well-known brands) are focused on company creation. These funds dominate talent and science transfer and succeed via high ownership in companies.

When we started analyzing LS performance, we observed that the DPIs of LS funds are better on average than general tech funds. This might be explained by the fact that in LS, IPOs are often a fundraising event rather than a real “exit.” In contrast, average TVPIs in LS funds are not as high as in tech – strengthening the case for portfolio diversification between Digital Health and LS.

During the last few years, public markets’ performance in LS has been at an all-time low; many companies are still traded below their enterprise value and struggle to raise. We think this creates interesting opportunities for later-stage investments and acquisitions.

All in all, given fundamental changes in both supply and demand, including a major patent cliff on the horizon, stabilization in interest rates and the recovery of public markets, we are optimistic about future returns in the space.

Geography wise, while having strong scientific organizations, the EU and Israeli markets are more nascent and have less downstream capital, relying more heavily on U.S. growth investors for both capital and expertise. This has led us to a larger U.S. exposure.

We are excited about our recent investment in Versant Ventures, a leading fund with offices in the US, Canada, and Europe that does company creation and early-stage investing, as well as our existing long-term investment in Pontifax, an Israeli-based multi-stage fund that invests globally.

3. Tech-bio

In recent years, everyone has heard about the huge promise of Tech-Bio, since

software, hardware, data science and lab science are all finally mature enough to mutually reinforce one another. Risk is shifting from biological to engineering which is more manageable and less binary. As a result, companies can generate revenues earlier. Furthermore, the Tech-Bio market shares more similarities with the tech sector in terms of talent, business models, exit markets and cap-tables, attracting interest from both generalist funds and Life Science funds.

Another intriguing aspect of tech-Bio is its applicability of scientific breakthroughs beyond healthcare, extending to sectors like agriculture and chemicals, offering opportunities for additional diversification.

However, while indeed exciting, business models in Tech-Bio are still unproven as many companies have tried to innovate but eventually, they can either sell a drug or provide services to pharma companies. The number of successful public companies in this field is still quite small, leading many early enthusiasts to approach the sector with more caution. Coupling that with the gen-AI hype that inflates valuations, Tech-Bio investments necessitate experience, discipline, and expertise.

During our research we have met an increasing number of funds investing in Tech-Bio, but only a select few that are focused exclusively on this sub-sector. We see this as a strategic opportunity to own the category. We are excited about our first two commitments in the space: KdT Ventures, a leading pre/seed Tech-Bio fund based in Texas, which is among the first funds globally to focus solely on Tech-Bio (check out their newsletter and podcast); and Amino Collective, an emerging Berlin-based manager that invests in both Tech-Bio and Digital Health and is actively fostering innovation in Europe.

We are very excited about our inaugural Healthcare Fund of Funds, as we believe it has the essential elements for financial success and the promotion of healthcare innovation. Our commitment to this sector is for the long term. We will continue to refine our investment strategy, invest in top-decile managers, and add value to our portfolio funds, companies, LPs and partners, ensuring sustained growth and impact within the industry.

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