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HealthQuest Capital recently raised a $675 million fund
Venture capital used to be a cottage industry, with very few investing in tomorrow's products and services. Oh, how times have changed! While there are more startups than ever, there's also more money chasing them. In this series, we look at the new (or relatively new) VCs in the early stages: seed and Series A.
But just who are these funds and venture capitalists that run them? What kinds of investments do they like making, and how do they see themselves in the VC landscape?
We're highlighting key members of the community to find out.
Dr. Garheng Kong, Founder and Managing Partner at HealthQuest Capital.
HealthQuest Capital, a private asset firm that currently provides growth capital to transformative companies that are improving value in the healthcare system. A physician, scientist, and engineer by training, Kong has over two decades of experience investing in innovative companies in all areas of healthcare, and has led over 28 companies to successful exits (IPO and M&A).
Prior to founding HealthQuest, he was a partner at Intersouth Partners and Sofinnova Investments, and has also spent time at GlaxoSmithKline and McKinsey, and as a CEO of two early-stage biotech companies.
Kong also serves on boards of LabCorp (LH), Alimera Sciences (ALIM), Xeris (XERS), Be The Match, and the Duke University Medical Center. He is an Aspen Institute Health Innovators Fellow, Kauffman Fellows Mentor, and member of YPO.
He received undergraduate degrees in both Chemical Engineering and Biological Sciences from Stanford, while on an athletic scholarship, and earned MD, PhD and MBA degrees from Duke University.
VatorNews: Give me the overview of HealthQuest Capital. How do you see yourselves in the ecosystem? What's your philosophy about investing?
Garheng Kong: From an overarching mission statement, part of the reason our team came together was really around having the largest impact on patients at scale. We want to pursue innovation, and companies that have a large impact on patients through healthcare innovation. So, from a mission statement point of view, when we thought about it, many of us have been involved with individual patient care, or maybe even advancing research so, for us, it's really about where the rubber meets the road and where can we have the largest impact? I bring that up because you'll hear that we're agnostic to the underlying sector. So, it's not about the modality, it's about the rubber meets the road. Of course, in healthcare, that's really two things: better patient outcomes and better health economics. So, we started a firm with that focus and, as we thought about it, we realized that the opportunities for better patient outcomes are almost unlimited in terms of unmet clinical need. Even with COVID, which everybody's talked about, if you're brutal about it, it's really a very small indication in infectious diseases, and we haven't even talked about oncology, cardiovascular disease, diabetes, neurology, orthopedics, and so forth. So, even that little segment, which was dominating the news, is a really small part of that unmet clinical need. So, lots of room there.
Then there’s the expense of national healthcare, which is tremendous: 18% of GDP, and it's actually lower than energy and IT combined in the United States, so it’s a huge sector and it's not that efficient. Most people would say we probably waste a quarter of that, so call it $4 trillion a year we spend, and we waste $1 trillion dollars a year in healthcare. So, there's a $1 trillion annual market opportunity in the US alone. You'd probably say, “wow, that's really large,” but then I’d tell you, "You don't have to make patients better, you can just get it off the efficiency side.” And so, when we think about it, we're always focused on outcome economics and, from a strategy point of view, what that means is we are agnostic to the underlying modality. We will invest in medical devices, diagnostics, digital health, really anything that is commercial in nature and changing the way that patients either receive care in their outcomes or cost to the health care system.
As we thought about the firm, because of that focus on being flexible in the sub-sectors of healthcare, we built our team that way as well. So, if you look at our team, everybody's an investor, but their backgrounds are quite different. We have physicians, engineers, nurses, and we also have a marketing team, performance CFOs. We do that because that want to have a holistic view on healthcare.
Are you familiar with this anecdote of the blind man and the elephant?
VN: I don’t think I am.
GK: There's seven blind men, they lived in this remote village, and they hear that this mythical creature called an elephant is going to come to their town. So, they all want to see this animal. They all go touch the elephant: one touches the ear, one touches the tusk, one touches the tail, one touches the leg, and so on. And they all think they know what the elephant looks like but, as we know, none of them actually know, they all just got one part of it. Healthcare is like that: it’s a very large, complex ecosystem and if you only do one aspect of healthcare, whether it's just diagnostics or just devices or just services, whatever it is, it’s just one part of an entire healthcare ecosystem. One area of healthcare can have a butterfly effect and ripple through the rest of healthcare. To put it in a more concrete way: if you're looking at the world's best medical device category, and you missed the fact that there’s a new diagnostic that completely reroutes a person away from that device, it doesn't matter if you’ve got the best medical device. So, we think that it's important to see the whole thing as one piece.
The other part is that we actually think innovation is happening at the intersection of all these systems. So, it's IT, diagnostics, a device, a drug, but it's no different from automobiles which, 30 years ago, were mechanical devices and if something went wrong, we went to the mechanic. Today, if something goes wrong with the car, the first thing they do is plug it into a computer. That's true of healthcare as well, and what we're now seeing now are remote monitoring and connected devices, IT, and hardware. We're seeing AI diagnostics, so software in diagnostics. So, at HealthQuest, our focus is on optimizing value in healthcare, which is outcomes and economics. We have a team with diversified backgrounds, everybody is an operator in healthcare, and then we view it quite holistically, as opposed to sub-sector by sub-sector, partially because we think that's the best way to understand healthcare, but also because that's where the innovation is happening, when you bring all the areas together.
VN: You said you're agnostic to the underlying technology. Do you do both B2B and B2C?
GK: We definitely do B2B in terms of selling to people in the health system, payers, and providers. As healthcare has become more patient-centric, but also consumer oriented, the patient is becoming more of the decision maker in the ecosystem as well, so we partner with companies that have industry components in those situations. So, frequently, they’ll have more than one business model; they might have an offering that is B2C, and also an offering that is B2B. For example, we're involved with a company called Everlywell and they have a platform of diagnostics in the home. You can go to their website and order a test and that's B2C, but the’re a significant enterprise component they have with large payers, large companies, and governments. And so, they’re doing B2B and B2C. We haven’t done a lot of pure play B2C.
VN: Let's talk about your new fund that you just raised. What's the size of that fund? And how many investments do you plan to make out of it, but in a typical year and over the life of the fund?
GK: It’s a $675 million fund. We're grateful for the support, it was over the target cap, and we've been fortunate that all of our funds have been at the hard cap. Especially in this environment, we’re grateful for the support.
Our plan is to make approximately 15 investments from the fund, so you can do math in terms of dollars into each company, but call it the $30 to $50 million range. And we'll probably do five or six new deals a year, and so it will be a two and a half to three year fund cycle. We've been pretty steady; a lot of forms come back really fast but, if you look at our vintages, you'll see we have 2013, 2016, 2019, 2022. So, pretty steady.
VN: What stage is that? Is that Series A or Series B?
GK: We're actually indifferent to the letter of the series; it‘s really the stage of the company. The way I would describe it is, these are commercial stage businesses that have some revenue traction and now they're ramping. Sometimes the company has bootstrapped it, they started it, and maybe got friends and family, and now they're approved, commercial, they have some customers, and they need the next $30, $40, or $50 million. That's where we come in. And then, the other end of the spectrum, is the Series H of some company that's been around for 15 years, and they finally got their device or diagnostic approved, and now they're selling and now they need $30 or $50 million to ramp. So, however they get to our starting line is fine with us, as long as they're at that phase.
The other question we get asked sometimes is if there's a hard revenue minimum or something like that, and what I'll tell you is we're not looking for a specific threshold number, what we're looking for is proof of the business model. And so, again, if I give you two ends of the spectrum: for a pure play service business, you probably need a little more scale because there’s usually not intellectual property, and competition can show up overnight. So, we probably need a little more revenue scale there. On the medical device side, if they’ve just finished running some very significant clinical trial that shows their device is best in class, maybe only in class, we understand the business model of selling a therapeutic medical device. They might have very little revenue, and that's okay with us as well, because in both those situations, we can scale it. But the one thing we don't take is binary risk. So, you won't see pure play development stage opportunities in the portfolio; maybe just to clarify that a little bit more, we, of course, have companies that have development stage assets, but they also have a commercial stage asset. So, if we're investing in a commercial stage company, they have to have a pipeline behind them.
VN: So, you're definitely not investing in anything that's pre-product, so how do you vet the product, especially on the med device side? For a B2C company, I feel like they're easy to vet a company: you use it, you see if it works, but for a B2B company that's probably more difficult. And then for a med device, I'm sure that's even more difficult.
GK: As I mentioned, our team is technical in nature. We have in these MDs, PhDs, biomedical engineers, we actually have former CEOs of medical device companies, as well. And then the other aspect is, we have an advisory board that includes the former CEO of Medtronic and the former CEO of Becton Dickinson, the former CEO of Labcorp. So, we have quite a bit of expertise around the table from our advisors.
Then, in terms of the actual diligence, there is, of course, the technical capability of the device and the result in clinical outcomes. Understanding intellectual property is also really important, and then adoption, because with many medical devices. maybe there’s a physician's choice involved, but how is it reimbursed? Those are all key factors that we think a lot about. In medical device value creation, getting the product to market is really only half the business equation; it's really getting adopted and paid for that matters. I distinguish that, for example, in some other situations where, if you do biotech investing, you can actually create quite a bit of value at phase one, phase two, phase three, prior to being commercial. What we've seen on the device side is there are some exceptional situations where these companies get taken out while they're in development, but a lot of the value creation on the device side, and to be fair on the diagnostic side as well, comes on the commercial and unreimbursed side. And so, we have folks on our team who are commercial experts, we have people who are reimbursement and market access experts, if you will. But, you're right, it does take more expertise to evaluate them.
VN: What's your diligence on the market side to make sure that there is a market for this device for this company? What's the process there?
GK: There's a really high level process of understanding the patient population and what's the incidence and prevalence? There's also understanding specifically where in the patient journey this device will get used. Is it after they try medications? After they try something else? Is this the first line, is it the second line? Is this a device or technology that is a single intervention, so it gets used once? Is it something that people use over and over and over again, because every day they use one and they toss it? If it's chronic therapy, we need to understand the reimbursement because that's essentially the pricing times volume to understand the true total addressable market. And then, of course, the competition. So, we tie all these things together and I would say that, realistically, certainly on the device side, these companies really need to pursue multibillion dollar markets given the effort required to get something approved and commercialized, given what's involved in building these companies.
VN: What I’ve heard people say before is that it's just as hard to go after a big market as a small market, so you might as well go to the big market because there's more money there.
GK: Yeah, that’s right. The risk that anybody takes to commercialize these products is pretty similar, so you should certainly go after market opportunities that are large. Sometimes companies may make the case that their market is lower risk, but it's usually hard to get in a situation where the lower risk makes up for a market that's one-tenth the size.
VN: What are you looking for in terms of the team? At this stage are teams still as important? And what are the things that you want to see from those entrepreneurs and founders?
GK: Team is extremely important in this situation. Ironically, these are real businesses at this point; these are not, “I have an idea and I want to put a business plan together and see how it comes forward.” At this point, there's customers, there’s revenues, there's margins, there's reimbursement, there’s sales and marketing, I mean, there is a real business here. And so, having excellent executives is really important.
Every company is a little different but, if you asked me to stereotype it, we usually partner with a company that has an attractive leader, someone who's quite experienced or has shown to be successful. But, as they're scaling and trying to grow 100% year on year, maybe they have a wonderful VP of Finance but they don't have a very experienced CFO who is strategic in nature, or she or he hasn’t done an IPO or done larger transactions. So, sometimes we will level up the finance function, sometimes we will level up the supply chain, call it QA/QC, because, again, these are companies that are scaling. A lot of times they're using consultants for market access and reimbursement, and we'll help them bring somebody in house. So, we don't usually go into partnering thinking that we don't have the senior leader in hand but, frequently, we go into partnering thinking we will build out the rest of the executive suite because the company is ramping and growing.
The team is important because, in some situations where you're hoping a device or diagnostic will work in the development stage, you could have the world's best CEO, but if Mother Nature just doesn't agree with you, and your technology doesn't work, it is what it is. In our situation, in some sense, we have more control over it because of the levers are out running the business as opposed hoping the FDA, or hoping Mother Nature, will agree with us, which is why we don't take any binary risks in the portfolio. In fact, an excellent CEO can more easily navigate that because there's no moment where it doesn’t matter if your product doesn’t get approved. So, we think a lot about the team.
VN: Let's talk about valuations, especially in the healthcare sector. COVID had a large impact on the sector, there was a lot of investment that went into this healthtech over the last couple of years. So, have you seen valuations grow in that time? A lot of companies that went public are down quite a bit. So, it seems like the valuations for startups went up and the valuations for public companies went down. Where are we now? When you invest, what numbers are you seeing?
GK: If we start from the beginning of this cycle, you're absolutely right: lots of capital went into the system, there are something around 11,000 digital health companies out there. So, it's a huge, huge number, arguably overfunded in terms of the number of companies out there. And, as you saw during COVID, some companies really benefited, like remote monitoring, telemedicine, virtual care. Now, to be fair, some healthcare businesses also suffered, like a lot of clinics got shut down, but a lot of digital health companies did benefit, and their valuations went up in a multiple range that was previously never seen. So, I would say almost certainly overvalued, and the most obvious is in the public markets where we were seeing multiples that were 10, 20, more than 20 times revenues. That was irrational, but then, as you pointed out, a lot of these companies have traded down 50% or 70% from their highs, ironically, while still growing the businesses. So, fundamentally, from a financial performance, they may still be growing 50%, or even more year on year, but they're trading down meaningfully. That has much more to do with rerating the market in terms of the multiples. Some would probably say it was overdone but I don't think anybody disagrees that it was overvalued at the peak of COVID as well.
And so, where we are today is an interesting moment. By the way, we saw this in 2000 and 2001, and then in 2008 and 2009 as well, but the public markets correct overnight, almost. In the last six months, for sure, peak to trough is 70% for many companies but on the private markets, we're seeing a delay, which we saw previously as well, in terms of valuations and the recognition of the new market environment. So, the question is, how long will that last? Historically, it's always been a situation where the private companies didn't want to fess up to the new market conditions or they did insider rounds or tried to wait for the market conditions to get better. Private companies that have enough capital to get to self-sufficiency, they're actually in a great position because they don't have to go to the market. In fact, we finance all our companies to self sufficiency, so that's an important distinction because of where we come into the company life cycle. But, if you have to go back to the market, at some point, six months, nine months, 12 months from now, then you're going to have to get priced and, once you start seeing that happen more regularly, then the private markets will recalibrate with the public markets. On the tech side, we're hearing about some very large private companies that are raising capital at lower valuations already. On the healthcare side, people are recognizing it, but maybe not as quickly. So, we're in this interesting six to 12 month gap between public private equilibrium, if that makes sense.
VN: Do you feel like companies are putting off their next round? Are they waiting for the market to bounce back a little bit? And for those companies that are raising money, you said they're already taking down rounds, so what is that going to mean for them in the future?
GK: The only companies that are raising money right now need to raise money. There's a small segment of an exception, which is they just raised a pile of money but they don't know how long this market situation is going to last, and they're coming back to the markets saying, “if you want to add on to my most recent round as an extension, we're willing to take more capital.” That's the exception. Almost anybody else who's raising capital right now, it's only because they have to. Anybody who has the option to not raise capital right now is not doing it. And why would you? The market is pretty tough right now and so almost every board of a private company is telling their companies to focus on expenses. This is ironic; we said this exact same thing in March of 2020. We went to all of our companies and said, “COVID is a serious issue. We don't know what the market is going to be like. Hunker down, control expenses, you should not assume that there's going to be a capital market.” Of course, we were totally wrong, because the markets went crazy for the next 18 months but now we really mean it. Actually, it’s a much larger reality here now, so everybody's trying to either hold off for better markets or hold off until their performance warrants it, or until they have to raise.
VN: What is your firm's differentiation? Starting with the LP base, a lot of firms go after the same LPs, so what’s your pitch to them?
GK: There's a few things. One, of course, is the strategy; I've talked to you about our strategy of being open minded about the modality, in part because we have this very holistic multi-angle view on health care. Most firms distinguish themselves by saying, “we invest in digital health or devices, or biotech, or whatnot.” So, it's a different approach, holistic and focused on value optimization. Two, is the team. And if you look at our team, lots of operating experience, which matters for the companies; lots of investing experience, but very complementary in nature. So, if you look at our teammates, you'll see everybody has a slightly different background by design, as opposed to everybody looks the same. I mentioned that we have a world class group of advisors and it's the former CEOs of Humana, Optum, Aon Hewitt, Procter and Gamble, Medtronic, Labcorp, and so forth. So, that's also important, as well. Third, and ultimately, its performance and returns. I've done this for 23 years now and our team has been together for a long time and we've consistently generated attractive returns, cycle over cycle. And it's not well, “this time, it just didn't work out, sorry,” it's very steady. Our pacing is also very steady, as well. So, strategy, team, and performance.
You asked about what we tell our LPs; our LP base is actually also an important differentiator in the sense that we have large hospital systems as investors, we have medical product manufacturers, whether they're diagnostics or devices, as investors. We have other health care organizations, as well. So, we also have some really strategic LPs in our fund. So, those are some of the differentiators that we shared with our LPs and we're certainly grateful for the support because, at the end of the day, the proof is in the pudding in the sense that they did decide to partner with us.
VN: Talk to me about the entrepreneur side, because obviously the best companies can take money from basically any firm. They have options. So what's your pitch to the companies?
GK: One is what we call the HealthQuest ecosystem, and that ecosystem is the set of relationships, many formal, sometimes informal, where if you want to talk to any payer, Humana, Aetna, United, Blue Cross Blue Shield, Anthem, Cigna, we’ll get you there. If you want to talk to any health system, whether it's Ascension or Mercy Health or Kaiser or New York Presbyterian, we'll get you there. If you want to talk to any large medical manufacturer, whether it's Labcorp or Medtronic or Baxter or Cardinal Health or Medline, we’ll get you there too. And so, the ability to access most, if not all, of the healthcare ecosystem, is something that we can do with our partner companies.
Two, our team all comes from healthcare. We don't invest in anything else; we understand healthcare and, as I mentioned, our investment team comes from operating roles, so we can go to the entrepreneurs and say, “We've actually sat in your seat and we have that perspective as well.” From a capital point of view, obviously, we have capital invested, and we also have a lot of relationships such that, when we put these deals together, the ability to draw follow-on capital is quite strong, as well as our LPs have quite a bit of interest in co-investing. So, from a capital capability, we're also very steady.
Perhaps most importantly, we have a pretty large family alumni network and a lot of times people say, “Can you give us references?” We don't give references, we just say, “just pick a company on our website, we won't curate it for you, we're happy to connect you to any CEO we work with, because our hope is that they would have had a good experience.” Maybe just as an add-on to that, we work together as a team and so when you partner with us at HealthQuest, you don't happen to get the one partner who's on your board, you actually get the whole firm. That's true, because the way we ended up partnering is that everybody got involved on the diligence side. So, on the way in, our team has already gotten familiar with the company, multiple people on our team that met multiple people on their team and, in fact, one of the things I love about our group is the number of times somebody will say, “I met someone at this conference, and they would be great for this company." But this company is not the one that he or she's on the board of, it's just a company that's in the HealthQuest portfolio, but they think and know about it because they were involved on the way in. So, those are some of the some of the things that we would share with potential CEOs that we work with.
VN: Highlight a couple of companies for me that you invested in, maybe one or two of them. What was it about those companies when you sat across from them that made you want to invest?
GK: I mentioned Everlywell, for example. So this is the home diagnostic company and a few things that resonated with us: one, we have quite a bit of diagnostic expertise, so it's an area that we follow. Two, it was investing in a trend that we subscribe to, which is moving medicine away from the hospital. The most expensive place to do anything in healthcare per unit time per square foot is in the hospital. So, if you can do that exact same thing in the doctor's office, or the home, for sure the patient's happier, and it's also a lower cost to the healthcare system. What Everly was doing was taking something that's typically either done at a hospital or doctor's office and then moving it to the home. So, it was already along the lines of a trend that we were interested in. So, an area we have expertise in, a trend that we were already following, the management team was very strong. I mean, the founder and CEO, Julia Cheek, has built something from scratch that is now the category leader. So, a high quality leader in a space that we already follow and understand. And then the ability to help the company; we don't want to invest and be super passive where we’re not able to participate. In this situation, we felt like we could help partner with the company: we joined the board, we're actively involved there. In fact, in this one situation, one of our advisors, Dr. Regina Benjamin, who is the former Surgeon General of the United States, also joined the board as well. So, we were able to participate in helping in that manner.
Maybe our most recent investment has become called Lunit, which is an AI diagnostic company. In this situation, they have technology to look at images, such as chest X-rays, screening mammography, digital slides, and help identify if something is cancer, or if something is not cancer, to help the radiologist, or to help the pathologist. Again, this is already along a theme that we're already interested in, which is augmenting the provider. We don't have enough providers, whether it's doctors or nurses or technicians, and how can you use technology to help them? You can read a lot more films if the AI calls out, “look here for the cancer or look here for the infection,” and this company was best in class. I mean, we've seen a lot of these different types, but they're best in class. They've partnered with GE and Philips and Siemens and so forth, as well. It's the future of medicine, ultimately, in terms of having technology augment what we do already as physicians.
VN: What are some of the lessons that you've learned in your investing career? What are some of the things that if somebody was joining a venture now that you’d want to pass on to them?
GK: One of the things I learned, and we joke about this, is that I happen to have six degrees but the one degree that I don't have is a PhD in psychology. Even though we have this extremely technical business of investing in healthcare and innovation and so forth, it does come down to people, and how do management teams think, how do boards think, and do your co-investors think? And how do you harmonize all of these people to go in the same direction? One of the things that I would advise anybody who's considering this career is that you have to understand spreadsheets, you have to understand technology, but really, at the end of the day, you have to understand people, and what motivates them, what drives them, how to get people to work together. And so maybe that's both a piece of advice and a lesson learned along the way.
VN: What's the part of the job that you really love the most? When you go to work every day as a venture capitalist, what's the thing that really motivates you to do this?
GK: It's impact. Everybody in my family is a physician; I'm the only non-practicing doctor and what I would tell you is that if you're a practicing physician, you might impact 50,000 people in your life during your career, because you see them one at a time. You know all their names, their family members' names, and so forth, so it's a really wonderful relationship. What drove me to get into what I do is I wanted to impact people at scale. In fact, the first thing is you invent something, which I was fortunate to do, and you realize that if you invent something you could help 100,000 or one million people. And then what you realize is that nothing you invent will see a patient unless you commercialize it, so then you get in the business, then you do one company, then you have a second company, and then you think, “Well, I should do 50 companies.” At this point, the scale is large, I mean you definitely don't know the name of the patient at this point, but the number of people whose lives that you can impact positively is lots more zeros. In fact, at our annual meeting, for example, we put up the financial performance of the funds and all that stuff, but one of the things we do is the patient impact. We will actually have the underlying patients of the companies that we partner with, and those who have been positively affected, they also share their stories at our annual meeting as well. So, that's the part that's the most exciting.
VN: Is there anything else you want people to know about you or the firm or the space or anything?
GK: At the end of the day, our goal is to be the capital partner of choice for healthcare innovation, and our hope is that if a company or an entrepreneur is changing the way healthcare is delivered, that they'll think of us.
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