Healthcare Venture Investing: Part 3 — Evaluating Venture Businesses from a Healthcare Perspective

Originally published here

This article is quite similar to what you’ll see when people talk about evaluating tech businesses. A lot of the concepts and questions we ask ourselves are very similar to our tech friends; what does the team look like, who are their competitors, what are their near-term milestones, etc.

What I hope to add with this section is a lens of how to look at it from a healthcare perspective because although quite similar, there are still minor differences that are important to mention. A lot of a VC’s job is largely based around these concepts and although we do get advice from various experts, this is what individual venture capitalists assess when they’re looking at opportunities.

Team:

Who’s the CEO? Has he had previous experience leading a company?

How experienced is the mgmt team?

Have they worked together before?

What were their roles in the previous companies that they’ve worked for?

From all of my conversations with investors, they mentioned this as one of the biggest reasons why some companies fail and others succeed. They say that team makeup is the most crucial part of building a great company. No matter how cool the science is, if you don’t have trustworthy people running the ship, it’s bound to fail. Having a leader who you believe in and is able to successfully recruit top tier talent is hard to find. Being able to recruit people who have knowledge and experience from a variety of different backgrounds is also vital to sustaining and growing.

As an example, Akili, a leading digital therapeutics company who just recently got approval for their video game to be used as a treatment for ADHD, is a company built with software execs, video game developers, artists, and traditional biotech executives which is perfectly complementary for what they’re trying to accomplish (For interest, their CEO Eddie Martuci talks about this on a great podcast and how this is part of their secret sauce. See here for more)

Has the CEO been a public company CEO before? Has he had exits in the past? Where did he/she used to work? For the executive team, where did they come from? How experienced are they in their respective fields? Has the team worked together before?

I asked this exact question to a premier biotech VC, Sara Nayeem, who’s a partner at NEA, one of the largest biotech venture firms in the world and she gave a great response. For the thread, please see here.

I think there’s an important caveat here though and that’s for first-time CEOs. The big questions we ask ourselves here is do we believe in you to run a company. What other experiences have you had that prove you’re a capable leader? What references can you provide to back up your personality? Have you had trouble working in a team before? Are you able to take criticism and feedback? Are you a micromanager or rather similar to the leader of a cruise ship where you trust everyone to do his or her jobs well? Assessment of first-time CEOs in biopharma can be difficult, but you want to make sure that person understands all the potential challenges they may face as they progress.

Competitors:

What other companies have looked at this target/indication?

What have they done/what stage are they at?

How is this product first-in-class or best-in-class? Is the product sufficiently differentiated from what’s available/being tested on the market?

The key here is to see if the company has done its homework on what their competition is doing. Although every founder generally believes they’ve done something never seen before, chances are that it has been done before and possibly failed. What lessons have you learned from that company? How has it informed you in doing what you’re doing?

For biotech/therapeutic companies specifically, the questions from above are much more relevant. If you’re looking at targets that have been tried before, why do you think your product is first-in-class or best-in-class? How have you de-risked your product enough to show differentiation? If a product is already in phase II or III trials, you’ve lost out on the first-mover advantage so why do you think your product can catch up?

Customers/Payers/pricing:

Similar to tech, who’s the end customer of this product you’re developing. Is it pharma companies, physicians, patients, or insurance providers? This is such a long topic that you could spend months trying to learn about. For the purposes of this post, I’m going to be discussing the US healthcare system and more specifically insurance providers.

Broadly, the US system is not a universally accessible system — it is a publicly and privately-funded patchwork of fragmented systems and programs. Insured Americans are covered by both public and private health insurance, with a majority covered by private insurance through their employers. Government-funded programs, like Medicare and Medicaid, also provide coverage to vulnerable population groups. For more info, please see this summary article. It’s an extremely complicated system; just ask any physician or patient in the US of what it’s like to deal with insurance companies, and they can probably talk your ear off.

Insurance providers in the US are the gatekeepers for access and pricing of medicines so you have to make sure you’re aligned with them. Most early-stage companies won’t have to deal with this aspect, as they usually get bought out by the time they reach commercialization, but this is when you bring in experienced experts who understand the system.

Who’s paying for this (hospitals vs. insurers vs. patients)? Have they had any conversations with payers yet?

What’s the pricing model? How does this compare to what’s available on the market?

Competitors pricing? Peak sales?

How are they going to incentivize doctors to use this product?

This one is a question that doesn’t come up a lot for preclinical companies, but I think it’s important for founders and exec teams to think about this one early on in the process because this could derail your product and go-to-market strategy. In the biotech/therapeutics world, phase II or III assets often get scooped up by pharma in M&A because they have the distribution and marketing departments sufficient enough to really sell the drug. Coinciding with pharmaceutical companies’ recent cuts to R&D and their increased budgets for M&A, they’re much more active now in finding drugs developed by biotech companies that show good clinical trial results.

That being said, it’s still important to think about how you’re going to price the product, especially compared to competitors. If you’re offering a product that is trying to compete with one that is already expensive, how are you going to ensure adequate market penetrance? Can you get your product reimbursed already? Have you talked to insurers/Medicare/Medicaid yet about reimbursement?

The other caveat with this is that from a clinical perspective, doctors are notoriously slow to change their practice. Because they have so many things to think about already and have been doing things the same way for a reasonably long time, they don’t really care about when new drugs come on the market (unless there’s exceptional ground-breaking data). Additionally, new drugs on the market typically mean premium pricing and because they’re trying to save as much money for hospital systems and their patients already, why do you think your drug would be any different?

Timelines/financings:

What’s the Budget/use of proceeds? Does this seem reasonable?

How much money has the company raised to date? Who are the existing investors (tech vs. corporate vs. healthcare VCs)

How much are they currently raising and what would our ownership be?

This is a concept I think most founding teams are already pretty good at presenting but it’s important to investors, especially because VC firms have different timelines of investment depending on what cycle of the fund they’re in. For example, if a VC fund is towards the end of their cycle of the fund, they don’t want to be investing in a company that won’t give them a return till 5–7 years from now.

When looking at the timelines, we also want to see if they’re reasonable? Does the budget seem reasonable? What does their financial model look like? Are the assumptions reasonable? What major milestones can they achieve with this round of financing?

When looking at previous financings, the investor syndicate is very important. The venture world is a very small business and investors talk to each other all the time. If there’s a firm we have a good relationship with that is already an investor, we will talk to them and are more likely to make an investment. The types of investors you’ve been able to get around the table and on the board is also significant because it tells us a little bit about the direction and strategy. Are there corporate VCs who are interested in the product? Do the investors have prior experiences in companies that have done similar things? Have they had significant exits in the past?

Exit strategy:

What are the next value inflection points?

How long till the next milestone? Who’s setting the milestones (company vs. investors)?

Projected cash/runway to get a reasonable exit?

IPO vs. M&A? Potential return (IRR vs. ROC)?

This is basically the bread and butter of our job as investors and something that we pay significant attention to. This coincides with the previous heading as well, but our job is to establish, based on historical data, what the timeline is for a reasonable exit and what evidence you need to show to get big pharma excited. Exits are typically made through M&A or an IPO in the biotech VC world and part of our job is to figure out what results you’d need to generate a significant exit. Whether that be getting a single asset or multiple assets through IND and into clinical trials or if the clinical trial results are sufficient enough to get pharma buyers excited about your product.

We also spend some time doing an evaluation of how much fundraising a company would need to generate significant results, but this does differ depending on the firm you’re dealing with. For example, depending on the size of the fund, an early seed stage fund will only reserve $1-$2M per company whereas the bigger firms like NEA, Orbimed, etc. can invest all the way through from seed to IPO, which typically is on the order of $30-$50M USD per company. That being said, this is not something founders and executive teams should be thinking about, as you want the team to worry about building a great and sustainable company.

Overall:

Does the company tell a compelling story and solve a clear unmet medical need?

Does this make the world a better place?

Does it employ visionaries in the field?

Is it a cool company/hot area of science?

Lastly, our overall impression of the company is something most experienced venture capitalists can speak to right off the bat (and is something I hope to achieve one day). Is it cool and does it get us excited? Is this something that could change the way clinical practice could be done in the future? Is it solving a clear need in the market? Do we like the team, market, and product? Could this be a game-changing therapy down the line?

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Thanks for reading and for those of you who read the entire series, I really appreciate it. Whether you’re an entrepreneur trying to understand how investors think or an academic who’s never even heard of VC, I hope you took something out from this because I know when I was starting out, I didn’t have a clue about any of this. Jumping from the clinical or academic world and trying to find your feet in this industry is definitely a huge learning curve, and something I’m still trying to improve upon every day. That being said, this job puts you at the forefront of medical innovation and I’m glad I get to play a small part in it. Hope this was helpful and feel free to reach out if you have any further questions or any feedback.

Disclosure: I know there’s bound to be some concepts here that I’ve missed but I’ve highlighted as much as possible. Again, I also want to reiterate that every opportunity and start-up is unique and should be evaluated on an individual basis.

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