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Healthtech is a space that is seeing a lot of interest from investors; there was a record $8.1 billion put into the space in 2018, a 42 percent increase over 2017’s $5.7 billion, which was itself a record at the time. This year it looking to be no different: In February of this year alone there was $1.9 billion invested. With that much money being poured in, there's going to be a need for larger and larger funds to invest that kind of capital, and funds dedicated directly to healthtech companies.
On Wednesday, growth capital firm HealthQuest Capital announced the close of its third fund, HealthQuest Capital Fund III, which was oversubscribed at $440 million. With this latest fund raise, the San Francisco-based firm now has more than $785 million in capital under management.
HealthQuest Capital focuses on value optimization in healthcare, Dr. Garheng Kong, Founder and Managing Partner at HealthQuest Capital, told me. Value in is defined in two ways: better patient outcomes and better health economics.
"We pursue innovation that results in much better outcomes. It might cost a little bit more money, but that’s good value. We’re also happy to do new innovation that’s the exact same patient outcome, but which takes five steps out of the healthcare system, saving a lot of money, and that’s good value too. Of course, most of our companies are doing both sides of that equation in terms of patient outcomes and better health economics, but that’s the central thesis," he said.
Part of the reason that these two things matter so much, Kong noted, is all the the unmet clinical need in healthcare right now, in which at least $1 trillion is wasted every year.
"We currently have not cured all the aliments out there, and it’s a very expensive proposition; in the U.S. alone we spent $3.5 trillion on healthcare, 18 percent of GDP, going to 20 percent, and it’s more than energy and IT combined, so there’s a large spend that we can make more efficient," he said. "Depending on who you talk to, most people will say we waste about a third of the dollars we spend in healthcare."
It also has to do with the way medicine is practiced now, as compared to the way it was not all that long ago; as both Kong's father and his wife are both cardiologists, he has seen how medicine has changed over the years, and the shift in what matters.
"When my father was a doctor and he said, ‘I want to do something,' the patient said, ‘Ok,’ and the insurance company said, ‘Tell us how much we have to pay.’ My wife today, before the patient even shows up they’ve already been online and done a big internet search, and they say, ‘This is what I want you to do.’ And then she has to go to the insurance company and get permission. It’s because the days where we get to spend $50,000 to get an extra week of life, you can’t do that anymore. Everybody needs and wants to know about the incremental dollar. What are we getting in terms of reduced hospital days? Did I prevent a hip replacement? Did I get this person back to work faster? Just the fact that it’s cool science is not enough," he said.
"At HealthQuest we think a lot about, not just technology, but about where the rubber meets the road. Does it work? We’re happy to do the Nobel Prizes, but we’re just as happy to do what I call the ‘paper clip of healthcare.’ It’s low tech, but it got you $10 billion last year, and if you make it a little bit better it also really valuable. So, thematically that’s how we invest."
Investing in growth stage companies
HealthQuest Capital calls itself a "growth capital firm," and what that really means is that it is investing in companies that are a bit further along in the cycle, meaning they've achieved some measure of commercialization and have proven their thesis.
"The bright line that we have is that everything we invest in is commercial in nature. There’s not a revenue requirement in the sense that it has to be a certain dollar figure, but it can’t have any binary risk. It’s gone through whatever development it needs to do, it’s got some customers and it’s ramping. These are high growth companies that are addressing the adoption curve for a patient, a physician or a payer," said Kong.
The other reason that the firm doesn't have hard and fast numbers it adheres to for investing, he explained, is that "the nuances depends on the business." For example, one company that HealthQuest invested in is a health analytics company that has a subscription model. It had some customers, and revenue in the low single digit million.
"They had validated their business model. We had comfort that we could really give them the growth equity to scale. In fact, they’ve grown pretty meaningfully, more than 100 percent year-on-year," said Kong.
In contrast, a company might have a business partnership that could be worth $5 or $10 million, but if they only have that one relationship, and they have $5 or $10 million in revenue, that may not even be as enticing to the firm as an investment, as their model hadn't been proven.
"We’ve made investments one day after the approval of a medical device, so there’s zero revenue there, but in that situation we knew that the device worked, it had addressed an unmet clinical need and we felt like we could help them ramp that. So, there’s a spectrum on the services and the software side, where there’s less development investment. There’s different shades of grey," said Kong.
Ultimately, what the firm is really looking for in the companies it invests in is evidence of scalability.
"It’s not so much an absolute number, it’s have they figured out the repeatable recipe or formula so that, when we add growth equity to it, we can stamp out the process? Sometimes you can get that formula locked down for a low revenue number, and other times you need to have a much larger top line before you feel comfortable that you’ve figured it out, because your early revenues are actually not representative of your future value drivers."
When it comes to the which verticals HeathQuest invests in, Kong made it clear that it matters less to the firm what type of company it is, and more around if it fits in thematically with the firm's investing philosophy.
For example, HealthQuest invested in a medical device company called Spirox, which developed an innovative solution for sleep apnea and nasal airway obstruction. The device can take a five hour surgical procedure, which would require six week recovery, and instead perform the whole thing in 10 minutes, with only a day of recovery necessary.
"That’s an important theme that I’d highlight, which is moving medicine away from the hospital. The most expensive place to do anything per square foot is a hospital, and if you can move it from a hospital to a doctor’s office, or a doctor’s office to the home, it’s way better for the patient because they won’t get a hospital acquired infection or any other complication, and it’s way cheaper for the healthcare system. We frequently will pursue innovation that moves something from the hospital to the doctor’s office to the home. This happens to be a medical device, but the theme really is what’s important," said Kong.
Another company the firm invested in is Avizia, a telemedicine company, provide software and hardware that allows physicians to see patients remotely. What intrigued the firm this time was the promise of more efficient healthcare.
"The 10 minutes you get with the doctor should be basically the same, but taking out the 45 minutes to get there and the 45 minutes get back is obviously more efficient. Then, of course, the doctors need fewer nurses to put you in the room, and check you in, and do all those other things. So, that’s a really interesting example of much more efficient healthcare delivery. We certainly invest across that theme," Kong explained.
Finally, HealthQuest also invested in precision medicine company Castle Biosciences, which can tell patients you whether or not their melanoma is likely to spread or not. If it is not likely to spread, they basically take a skin biopsy out, and the patient is done, but if it’s likely to spread then, they will plan for a much more aggressive treatment. Knowing if a treatment is necessary or not can save patients unnecessary procedures, and save the system unnecessary costs.
"Precision medicine is the concept of telling and treating an individual as opposed to be a patient population. It’s important for the patient, it’s important for the physician, but it’s also really important for the system because they know who to spend money on and who not to spend money on. That’s a concept around treating the individual as opposed to the average person so we’ll treat everybody the same," said Kong.
With each of these investments, the reason HealthQuest invested was less about the category, whether is be a diagnostic, a digital health or a medical device company, but instead because of the value optimization they offered.
"Better patient outcomes, better health economics. The underlying modality and technology, we’re quite agnostic to," said Kong.
There are a lot of venture firms out there, and entrepreneurs will often have a choice about who to take money from. HealthQuest differentiates itself from other firms in a couple of different ways. In part, its value add comes from its reach and network.
"If you want to talk to a health system, there’s a good chance that we can get you in the door. If you want to talk to an insurance company, there’s a chance we can get you in the door. If you need a partner that’s a diagnostic company to help you, you need a partner that’s a medical device company to help you, if you want to talk to a pharmaceutical company, we can frequently help you do all those things in terms of expanding and growing your business. If you need to recruit executives that are experts in commercialization or reimbursement, or pick whatever category you’d like, we can help you there as well," Kong said.
More importantly, though, is approach when it comes to its team, in which every company HealthQuest invests in is managed by everyone at the firm, rather than just dealing with the one partner who led the deal.
"We have actually built our team to be very complementary to each other and, when we partner with a company, they get the entire firm. If you look at our team, you’ll see individuals who are experienced across the things that we think matter: investing, operating and healthcare," Kong explained.
For example, Kong is a physician and scientist by training, who has been investing for 20 plus years at this point, so he has strong clinical strengths. Another member of the firm has been a CEO multiple times, so he’s good with sales and marketing, while another has been a CFO and COO four times over and is strong financially and operationally. Another has been a CEO three times and he’s been strong on the product development side. Another member of the firm was a 30 year executive recruiter who is good at building management teams and evaluating management teams.
"We built our team so that all of us engage with our partner companies, not just through the one partner who happened to have led the deal, so that allows us to apply financial clinical, operations, product development, human capital resources, expertise to each of our companies," said Kong.
"The full resources, everybody is going to be thinking about you. When we go out and we’re talking to corporate partners, the entire team is thinking about our portfolio companies; it’s not the partner is only thinking about the three deals that he or she happens to be involved with. So that’s quite a different dynamic than many other firms.
The downside to this approach, he admitted, is that it can limit the number of investments a fund of this size can make; while a typical $440 million fund might make 30 or 40 investments, HealthQuest will make 15.
That being said, the firm's limited partners like this approach because they believe that applying multiple smart perspectives and experiences that it makes for better investment decisions, and, also, they can manage those investments better. Also, the number of investments also fits in with the stage of company HealthQuest is going after, said Kong.
"Given the stage we invest in, which is already commercial, so we know there’s no binary, technical or clinical regulatory risk, we feel very comfortable that 15 company is enough for our portfolio. To be fair, if you’re doing seed stage investing, you would probably want more than 15 in your portfolio, so it really has to match up with the stage as well."
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