Are Healthcare Startup Founders Doomed By Dilution?

I recently stumbled across a 2013 Business Insider article titled, “Why It’s Better To Sell A Startup for $20 Million Instead of $200 Million” and it got me thinking. In 2011, when Arianna Huffington and her two co-founders sold The Huffington Post, AOL paid a whopping $315 million after only 6 years of operations. I would’ve expected the namesake of the organization to have made a killing in the deal, however given significant equity dilution, Ariana took home only $18 million or 5.7% of the value despite the company using her last name.

This result was striking because digital media, albeit challenging, is not near as complicated as healthcare. My assumption is that founders of healthcare startups will need to raise higher sums of money to properly navigate regulatory and compliance issues, reimbursement challenges, referral patterns, and entrenched incumbent players. I also assume the complexities of the market would result in lower month-over-month increases in membership and revenue relative to their e-commerce or consumer brand peers. Both of these factors could hurt the healthcare startup founder, but I couldn’t quantify until now. Here are the findings. Founders of healthcare or digital health companies who recently have gone public retained less than 10% of their company at IPO, versus 30% of the ownership retained by traditional technology firms like Uber, Linkedin, and Dropbox.

Let’s face it, healthcare is hard. There is no app or magic device to cure an American with 5+ chronic conditions like asthma, anxiety, thyroid disorder, irritable bowel syndrome and fibromyalgia. Managing high-risk populations that account for only 5% of the population but 41% of health care spending is not frictionless with high EBITDA contribution margins. But it is also an industry that needs our best and brightest looking to build successful companies who deliver real clinical and patient benefit.

According to Rock Health, a digital health media organization and seed venture fund, $8.1 billion was invested in digital health startup deals throughout 2018, setting an all-time record. Some of the most well-known VC firms now regularly invest, including Andreessen Horowitz, Kholsa Ventures, New Enterprise Associates, Y Combinator, and GV. It seems that the healthcare industry has piqued the interest of private investors from around the world as it nears 20% of total U.S. GDP. I am generally in favor of this recent trend, because I want legitimate companies to have access to all the capital required to get the job done. I just don’t want those investors to necessarily demand Facebook-level returns, profitability, or growth in doing so.

I know that for many startup founders, the motivations for starting a healthcare company are driven largely by mission to improve the patient journey. However, significantly reduced ownership negatively impacts governance rights and financial upside for the founders who took all the risk. I want founders to be rewarded for tackling the toughest healthcare problems, like dual eligibles, or patients with serious conditions like end-stage renal disease or developmental disabilities. Not be penalized for trying to solve real problems that inherently take more upfront capital or longer time periods to achieve scale. The question remains, will the incredible founders we need choose healthcare, despite the regulatory, scalability, and now, ownership dilution challenges not faced by other more traditional technology industries?

November 5, 2019

Andy Mychkovsky is the creator, writer, and head chef at Healthcare Pizza. In addition to working for a healthcare technology company and advising startups / investors on a variety of digital health topics, he lives in Arlington, VA with his wife and future French Bulldog.