11

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.

healthcarepizza
 

Click Here to Leave a Comment Below 11 comments
Brent - November 7, 2019

This is really interesting. I had no idea that healthcare startups gave up so much more of their company. I’m not sure, but I can imagine it has huge ramifications on the ability for the founder to control the vision of the startup. Keep coming up with thought-provoking ideas like these and I will keep reading!

Reply
    healthcarepizzablog - November 8, 2019

    Hi Brent,

    Great point. As someone who believes that if a founder can appropriately scale a healthcare company to delivers real clinical results, they should be financially rewarded at the end of the day. I find it very interesting that Jonathan Bush, one of the most successful health tech entrepreneurs of my time, only owned 5.3% of Athenahealth at IPO. Now of course, that was a slightly different time period (back in 2007), but nowadays I don’t see much changing in terms of equity ownership by founding teams. IMO, we need to take a real hard look at this phenomenon and make a fundamental judgement call on how important it is for healthcare investors to attract the best and the brightest to healthcare startups, as opposed to SaaS, social media or e-commerce.

    Best,
    Andy

    Reply
Lauren - November 7, 2019

“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.”

As someone with a loved one who manages multiple conditions, this statement is so true. We need compassionate care that integrates providers and patients better.

Reply
    healthcarepizzablog - November 8, 2019

    Hi Lauren,

    First off, I must commend you for helping your loved one manage their health! It is truly a shame that in today’s society, we don’t support our familial caregivers as much as we should. And to your point about compassion, I sometimes hear entrepreneurs refer to patients as “lives on the platform.” As a business oriented professional, I always reflect on my own experiences and loved ones to find compassion for the patients and their families.

    Best,
    Andy

    Reply
Jeff - November 8, 2019

Great post!

I just started working for a VC-backed healthcare startup and had no idea the cap table was so difficult to maintain.

Is this all healthcare? Or does it matter between biotech, provider services, and digital health?

Reply
    healthcarepizzablog - November 8, 2019

    Hi Jeff,

    Congrats on the new gig. I know that breaking into venture capital is very hard, so I commend you for finding the role. Are you new to the industry or investing?

    Great question around the breakdown of sub-sectors. I did not focus on biotech, although that is probably one of the most prolific areas of healthcare that leverages the public markets for exits. Therefore, I cannot say if biotech is the same, worse, or better. The companies in my analysis were primarily digital health companies. Many of the more recent tech-enabled services companies (One Medical, Cityblock Health) and venture-backed health plans (Bright Health, Oscar, Devoted Health) have yet to go public, so unfortunately I didn’t have that information available as well.

    Best,
    Andy

    Reply
Anthony - November 9, 2019

Unfortunately, healthcare is hard. We should all just start social media apps and custom T-shirt companies. And when the country is bankrupt from health spending, maybe then the VCs will understand what real value creation really is!

Reply
    healthcarepizzablog - November 15, 2019

    Hi Anthony – Although I appreciate your sarcasm, I hope for all our sake’s that the many ingenious and dedicated healthcare entrepreneurs will continue to pave the way.

    Reply
Logan - November 10, 2019

I respectively disagree. Health care startups need to produce better financial returns for investors before they’ve earned the right to keep receiving funding. Looking forward to your response.

– Logan

Reply
    healthcarepizzablog - November 15, 2019

    Hi Logan – First off, thanks for disagreeing! I think we only move forward as a society if we generate discussion and debate about the future of the country and world. I appreciate your concern for the limited partners and VC firms, but fundamentally believe in a zero sum world, we need to tip the scales towards the companies and leaders spending 12+ hours everyday to solve the problems of today and tomorrow, not the ones investing in those companies.

    Reply
N Viswanathan - January 31, 2020

One thing missing is the ROI numbers for investors in these digital health deals vs. tech deals. What did they invest and at IPO, what was the return for them? The % of ownership is not relevant if the pie itself is minuscule.

We should also be asking another question – If investors aren’t making any money from digital health, then how do we keep this industry afloat (IF it is actually improving outcomes) given the issues you point out such as marketplace friction and low margins?

Reply

Leave a Reply:

Never Miss Another Slice Again.