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Schulte invests in startups for the venture arm of health care company McKesson Corporation
Dave Schulte is Managing Director leading McKesson Ventures alongside Tom Rodgers. He brings more than 17 years of experience as an investor and investment banker, partnering with entrepreneurs to grow innovative health care and technology businesses.
Prior to McKesson Ventures, he helped build and grow Kaiser Permanente Ventures from $20M to $400M of assets under management. He led an investment team, whose IT and Digital Health investments included Omada Health, Proteus Digital Health, Health Catalyst, KitCheck, Validic, Ingenious Med and MetricStream.
Prior to KP Ventures, Dave was a software and health care investment banker at J.P. Morgan (Hambrecht & Quist), UBS, and Piper Jaffray. Dave is a graduate of St. John’s University and earned a Master of Public Policy degree from Harvard University.
Dave grew up in Minneapolis, where he was an all-state soccer and all-conference basketball player. Now, he is “all backyard” and dreading his children’s first “legitimate” victory.
VatorNews: Tell me a bit about your background. What led you to the venture capital world?
Dave Schulte: My professional background started in investment banking. I graduated from the Kennedy School [at Harvard] with a degree in public policy and was interested in healthcare in particular.
For very pragmatic reasons, I went to New York and Wall Street because I had a bunch of student loans to pay off. But it also turned out to be good training. We all spent three months as a class learning quite a bit about financial modeling, becoming spreadsheet jockeys. And that was great. I don’t particularly want to repeat that experience, but it was great training.
I ended up spending five years in investment banking. Overall, I would say that it was good training in the sense that I learned how to do good due diligence and how to execute transactions. And that set of skills and experience prepared me to move to an investing role.
Then I joined Kaiser Permanente twelve-and-a-half years ago and helped build the investment venture program there from $20 million in commitments when I joined to approximately $400 million when I left middle of last summer and joined the team here at McKesson. Those 12 years at Kaiser focused exclusively on healthcare investing.
VN: What is your investment philosophy or methodology?
DS: McKesson Ventures invests in healthcare IT businesses and technology-enabled services. These are businesses that tend to be in adjacent markets or whitespaces that are relevant to McKesson’s customers and ecosystem.
We are not doing this for tactical purposes, to fill product gaps, or to fill an M&A pipeline for McKesson. Now, that doesn’t mean that some of the businesses in our investment portfolio won’t ultimately be acquired by McKesson. That would be great for both the portfolio companies and McKesson, but that’s not the primary objective.
We’re explicitly looking further and broader than McKesson’s core business. That’s one of the foundational principles when the program was created—that we would be looking for disruptive new business models or markets. We're trying to generate both financial returns and what we’re calling “insight returns.” Those are observations of trends or predictions about markets that we are feeding back to our strategy group and executive team to help inform the long-term strategy of McKesson.
VN: What do you like to invest in? What are your categories of interest?
DS: Within the healthcare industry, we have three categories that we’re focusing on.
One is consumerism and the basic building blocks of a consumer healthcare economy. So, creating better patient experiences, better consumer experiences. Many of the tools and technologies that have been used in other markets like financial services, retail, consumer packaged goods, or other services industries are being applied to healthcare. We believe that will be a long-term trend and will create lots of opportunities to improve health care and improve the patient experience.
The second category would be data-value chain. By data-value chain, we mean the creation of new sources of data that’s being captured, the cleansing of that data, the presentation of that data, the use of that data, the analytics, even basic infrastructure to protect that data. There are lots of areas, themes, and subcategories within data-value chain, but we think that as a category this is going to be increasingly important to health care.
The third category is pharma-value chain which includes not just pharmaceutical companies but also pharmacies and hospitals, and how all those constituents and stakeholders interact in the entire pharma-value chain. There’s similar innovation occurring in analytics, the use of data, and new tools within the pharma-value chain.
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
DS: I would highlight a company called Proteus Digital Health. Proteus fits within the pharma-value chain category. They’ve developed cost-effective sensors that are placed on medication, an individual pill. These sensors are ingestible and they dissolve when they interact with stomach acid. The sensors emit a basic date and time stamp, and that data is captured today by a patch that someone wears on their body. It could potentially be a watch or another form factor, and once that data is captured it’s transmitted to the cloud for analysis and ultimately presentation to the relevant provider, family member or caregiver. You can imagine family members and caregivers would benefit from knowing whether a son or daughter or mother or father is actually taking their medication. And so that becomes a reliable source of actual medication utilization.
The patch is actually capable of capturing activity and physiological data when the patient takes the medication. In other words, how does their body respond when they take a pill? And that data, of course, is highly valuable for the pharmaceutical companies. Pharmaceutical companies have plenty of data they capture from clinical trials, but those are very controlled settings. Proteus would be enabling a new source of data stream which would be real world data in a less controlled setting. This would be for medications that have already been approved, so this would be post-approval types of use cases.
Another business is Omada Health, which is providing online diabetes prevention programs. This is based on years of NIH-funded clinical trials that demonstrate that you can delay and potentially avert the progression toward diabetes if the individual implements behavior changes like weight loss, exercise, and better diet. And that part is not terribly revolutionary but what’s novel or innovative is how do you go about doing that in a way that really engages patients.
Omada’s program is available online, which makes it far more convenient for patients, more cost effective for employers and payors and more scaleable to large populations. Omada has also layered on a social cohort which helps to encourage and hold each other accountable. So you go through 16 weeks of specific content but while you’re going through that you're going through it with people that Omada has carefully selected that may have similar characteristics. And that cohort holds each other accountable and answers questions for each other, and that social component is monitored by a coach. That contributes to the element of expertise or experience to the group setting in a way that can scale to reach much larger populations.
One of the constraints is if you build classes for the population of pre-diabetics, there are tens of millions of patients who would all be eligible and would benefit from these programs. So if you really want to make a difference in improving the condition of patients with pre-diabetes, you have to find a way to do it in a scalable and cost-effective way. That’s what Omada is trying to do.
VN: What do you look for in companies that you put money in? What are the most important qualities?
DS: The first thing that I look for is a really driven, smart, passionate--but also humble--entrepreneur. I think high-quality entrepreneurs is where you start. Then I tend to gravitate to big ideas, big markets, and novel approaches. And then, they have to be solving a real problem, and a problem that customers are willing to pay for.
I tend to prefer to invest in things that are meeting the needs of enterprises as opposed to consumers because I think the direct to consumer market is still relatively nascent in healthcare. That’s not to say it won’t become a real opportunity for small companies and startup companies but today, the vast majority of dollars spent in healthcare tend to flow through enterprises—through Medicare and through commercial insurance.
Understanding how these business will get paid and how they go to market is where a lot of startup businesses fall down, because they under-appreciate how complicated, difficult, and challenging it is to sell solutions in the healthcare market. In general, building wonderful technology is not the hardest part. Actually, it’s building a value proposition you can sell in a sustainable, repeatable way over a time horizon that lends itself to a small, venture-backed company that usually has a high burn rate.
In other words, sales cycles are long and everybody talks about that in healthcare. The problem is once you accept that sales cycles are long, you have to find a way to exist for a long enough period of time where you can get the fruits of your labor..
VN: What kind of traction do you look for in your startups?
DS: We don’t have any hard and fast rules.
Typically, more customers is better. In healthcare, the distinction between a paying customer and a pilot is important. Pilots have been confused by investors and entrepreneurs as commercial adoption when, in fact, actually paying, implementing, and committing to doing things like integrating a small startup company’s solution with a health system [results in] much bigger decisions and far greater commitment when they make those decisions than simply piloting a solution in one hospital or a small subset of patients.
So I would say the quality of customers and the type of customer engagement is far more important than the actual number. There’s no magical number but we want to be able to pick up the phone, call a paying customer, and understand what motivated them to adopt a solution and pay for it. That’s how we would delineate when a startup company is far enough along commercially. Clearly, ten paying customers is significantly better than two but we don’t have black and white answers on that particular question.
One more qualification: When we talk to a customer, what we want to hear is that the startup company is solving a significant problem. Lots of customer references provide affirmation that the health system, the provider, or the payer likes the company, they’re doing good work, they’re easy to work with. There’s lots of affirming flattery, but what we’re trying to validate is that these startups are actually solving a real, significant need and they couldn’t imagine not having the solution now that they’ve had it for awhile. That’s the type of validation or answer we’re looking for when we talk to customers.
We’ve gone through a phase of lots of piloting and I think the buyers of technology will become more selective about how and whom they pilot with, which is a good thing for startup companies. It might be harder to get pilot experience but the commitments startups are likely to receive will be firmer commitments. At least that’s my hope.
VN: Given that these days a Seed round is yesterday's Series A, meaning today a company raises a $3M Seed and no one blinks. But 10 years ago, $3M was a Series A. So what are the attributes to get that Seed round versus a Series A?
DS: As a general rule, we don’t imagine we will be building a portfolio with a lot of seed-stage investments. Our target area is Series A and later. This is in part because businesses at that stage of financing tend to have the type of commercial progress that is the best fit for our approach to investing.
For us, in a Series A investment, you have to have a credible founder and CEO and the beginnings of a credible team. In other words, the founder and CEO needs to have attracted a couple other key hires to the concept, to the vision, to the business. And, specifically in healthcare IT, you have to have a working product. And I would always love to see some customers at the Series A stage. That’s a general answer to your question, but at that early stage, you’re largely betting on a founder and the founder’s ability to execute and attract other great talent and early customers.
The concept needs to make sense. In a Series A stage, it’s far less of a commercial success and more of a founder and concept and whether they’re pursuing a big problem and big market.
VN: Given all the money moving into the private sector, I believe there's more money going into late-stage deals in 2015 than there was during the heyday, back in 2000, do you think we're in a bubble?
DS: I do. There’s a nuance: are you talking specifically about healthcare IT, digital health, or are you talking more broadly about venture-stage companies and tech? I would say the bubble’s bigger in the tech world than it is in the healthcare IT or digital health world. The amount of money is significantly greater just going into tech than health care in general.
But the dynamics in what I call digital health or healthcare IT have contributed to a bubble. Some of that bubble has been produced by new entrants into this category. In other words, traditional tech investors who are not healthcare investors all of a sudden interested in the opportunity to apply technology and software to healthcare, which has lots of inefficiency, challenges, and problems.
The appeal of that as an investment opportunity has attracted lots of non-traditional healthcare investors. I don’t believe they will remain interested in this sector forever because some of them will discover how hard it is due to the long sales cycle and how complex the healthcare industry is. So I think some of the dynamics that have contributed to this bubble will correct themselves over time.
But I also think there was a real wave of enthusiasm among investors, entrepreneurs, health systems, and participants in the healthcare industry for the possibility and promise of technology being applied to healthcare. I think the long term trends are absolutely real and sustainable, but I think the expectations and hype got way ahead of the reality. So I think that’s the other reason for a bubble in healthcare.
Again, I think over the next two decades this will be one of the most promising periods of healthcare that I’ll see in my lifetime, but it’s going to take decades not years. The magnet that was attracting a lot of investor interest will not be nearly as strong, so the bubble will dissipate over time. The core, fundamental reasons are sound, viable, and completely rational. It’s just that the expectations over the last couple years were irrational.
VN: If we're in a bubble, how does that affect your investing?
DS: The short answer is it doesn’t change our fundamental point of view on what makes an attractive business, attractive market, or compelling entrepreneur. That has remained consistent and will remain consistent.
We begin to pay more attention, of course, to valuations. We begin to think harder about financing risk or syndicate risk. In other words, when things are good it’s easier to raise money. If we’re investing in Series B or Series C companies, are these businesses that are likely to raise their next level of financing, and at what valuation? We look harder at who our investment partners are and what the investing history has been to date. In good markets, of course, investor fatigue is not nearly as prominent. But as markets correct, lots of funds are not able to continue to support their portfolio companies, so that becomes a much more significant risk.
The core investment criteria we apply and our core beliefs about market trends and the attractiveness of IT and digital health in the long run actually don’t change at all. In the current environment we add a few more criteria to evaluate investment opportunities, and those are largely focused on valuations and burn rates. We also pay more attention to path to profitability, the composition of the investor syndicate, and the reserves that are available among our co-investment partners.
Below: Schulte (far right) speaks at Vator Splash Health 2016. See key takeaways from the panel here.
VN: What do you like best about being a VC? What makes you excited?
DS: I love it. I love the job. I genuinely think it’s a privilege to work with entrepreneurs who are bright, passionate, creative, resilient, taking risk, and innovating. Intellectually, it’s really interesting work. We’re constantly learning. I’m often the dumbest person in the room. I think it’s a wonderful job and a wonderful career. I genuinely feel lucky to be doing this work. It’s a privilege to work with people who are so committed to what they’re doing. It’s a lot of fun.
VN: What is the size of your current fund?
DS: It’s a $250 million allocation. And McKesson is the sole LP/funder. We’re in the first year of that fund so, going back to the question about investing in a bubble, the good news is that we have plenty of reserves for our current portfolio because we’re at the very early stage of investing this fund.
VN: What is the investment range? How much do you put into each startup?
DS: We like to target $8-15 million total in a successful company. But we’re willing to make smaller investments in the initial round.
VN: Is there a typical percent that you want of a round? For instance, do you need to get 20% or 30% of a round?
DS: There isn’t. I’m happy about that because it gives us greater flexibility to get into the highest quality investment opportunities. In other words, we’re willing to lead and price a round, we’re willing to co-lead a round, we’re willing to be a co-investor and a smaller investor in the round. That flexibility allows us to become easy to work with for the entrepreneur but also for our co-investment partners.
There’s one caveat which is that we’re not willing to invest such a small amount of money that it isn’t worth the investment of our time and our team’s time. If I go back to the purpose of the investment, one thing that is unique about McKesson Ventures is that we have a dedicated effort and team focused on portfolio development. That means helping these businesses be successful by virtue of seeking out expertise and potential commercial relationships within McKesson, our customer base, and our ecosystem.
So there’s a lot of effort and time invested on behalf of our team to try to deliver that value to our portfolio companies. We want to make sure we have at least a few million dollars in these companies in order to justify that effort. Overall, I think our flexibility is an advantage for us at the moment.
VN: What series do you typically invest in—Seed, Post Seed, or Series A?
DS: We’ve made one seed-stage investment, but we’re typically doing Series A or later.
VN: In a typical year how many startups do you invest in?
DS: We made seven new investments in 2015. We’re trying to invest in 5-10 companies a year, but there isn’t a magical number. If we don’t see any compelling investment opportunities, we may make zero investments.
VN: Is there anything else you think we should know about you or the firm?
DS: One topic that’s interesting is corporate venture. I was in a corporate venture fund previously. My colleague, Tom Rodgers, was in both a corporate venture fund and a traditional venture fund previously. we’re trying to be very deliberate about improving the corporate venture model.
In healthcare, in particular, corporate venture funds have the possibility of playing a very important role in terms of accelerating customer adoption, validating technology solutions and helping to scale these businesses.
Last year, MedCity conducted a survey with their readers and McKesson Ventures was deemed to be the most trusted corporate venture fund in digital health. We take that very seriously, that we’re trying to deliver on the promise of corporate venture in healthcare. Time will tell, but so far I think we’re off to a good start.
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