In searching for opportunities to invest in healthcare, venture capitalists must consider not only which new technologies and ideas are likely to develop into successful businesses, but which are poised to transform medicine — and which can make a difference in people’s lives.
Having graduated from Yale in 1963 in engineering and applied science, I did my PhD at Yale in 1966. I ended up in McKinsey & Company, where among other things I was one of the founders of the healthcare practice in the early 1980s. I also wrote a couple of books on innovation and capital formation along the way, one called The Attacker’s Advantage, the other called Creative Destruction.
Now, having retired from the firm, I’m doing a variety of things, many of them healthcare-related. I’m on the board of Memorial Sloan-Kettering, where I focus on issues of quality. I’m on the board and a member of the medical committee of the Keck Foundation, where we’re working with the National Academies on a 15-year program on the next interdisciplinary topics between science, engineering, and medicine. I’m on the advisory board of the Yale School of Medicine. And I’m on the board and the chairman of the governance committee of Athena Healthcare, which is a healthcare information technology company, that, I’m happy to say, went public successfully back in the fall.
I graduated from SOM in 1981 and spent 14 years in the investment banking business with a firm called Alex Brown and Sons, working with healthcare growth companies across the country. I then moved to the investing side, and I’m now a partner at HLM Venture Partners in Boston. We invest in healthcare companies of all kinds — private, early stage — across the spectrum of the health industry: healthcare IT, health services, medical devices, and some life sciences as well.
I’m on the board at Johns Hopkins Hospital and Johns Hopkins Medicine, where I chair the Quality Improvement Committee, and I’m a director for a number of healthcare companies, including Masimo, a vital signs monitoring company that went public last year.
I graduated in 1997 — with my wife — from SOM. I was a biomedical engineer before that. I eventually headed new technology ventures for Hewlett Packard in Silicon Valley. I came back east when my wife’s first company was sold, and I joined one of the founders of Bain Capital to do early-stage investment and discovered I enjoyed the challenge of zero-stage company formation. So I looked for something early and ugly in medical technology to cofound. Along with four MIT professors, I founded a company called 3DM, which is in biomaterials for accelerating healing and regeneration. We just sold that in the fall to a Japanese company. And so now I’m out of work and trying to think of what’s new.
I’m taking a significant chunk of time to try to help spur medical innovation in Boston. We’ve established a unique medical track to the MIT entrepreneurship competition, which is one of the best and longest-standing entrepreneurship competitions. Boston is such a great place for medical entrepreneurship. This competition, we hope, will help spur more of that.
Liza Page Nelson
I have, for almost 10 years, been a partner in a venture capital firm that does healthcare and tech. While I am on the investment committee, personally I only lead healthcare deals, which, for us, means primarily small molecule and specialty pharmaceuticals, biologic drugs, and medical devices.
Before that I spent a decade at Pfizer. Among other things, I started and ran Pfizer’s healthcare services business, but I also did drug and other deals and had general management or operating responsibilities in areas like marketing and managed care contracting. Prior to Pfizer and after SOM I was at the Boston Consulting Group in the healthcare practice, where my clients were primarily insurance companies, HMOs, and provider-type businesses, though I did some medical device and core manufacturing work as well.
And before SOM I was at Warburg Pincus, a venture fund, when $100 million was a big fund. I focused there on life science. I have a degree I admit to in economics from Wesleyan, and a degree I don’t admit to in music, just because then people ask you to play.
Guy Fish ’94
My first Yale degree was in 1985 from the Medical School. Then I trained in internal medicine at one of the Case Western hospitals and practiced solo in internal medicine and critical care in rural Delaware.
When managed care came on the scene, I didn’t like it in solo practice, and that’s how I ended up at the Yale School of Management. Following SOM I went to Boston Consulting Group in the Boston office and spent about four or five years there before traveling to New York to try my hand at being an equity analyst at Sanford Bernstein in medical devices.
It didn’t take too long to realize that that was not the end job for me, and a year later I found myself back in Boston in a variety of capacities — an operating role in a tissue engineering firm, some independent consulting — before finding myself at Fletcher Spaght. Fletcher Spaght is a hybrid consulting and venture capital firm. Strategy and management consulting to high-tech and healthcare companies spun out from BCG about 25 years ago, and then five or six years ago we put together a venture fund. I’ve been investing in healthcare and high-tech.
I am on the Board of Registration in Medicine (licensing) for the Commonwealth of Massachusetts; I’m on the board of directors or an observer of several companies in our portfolio.
Stephen Knight ’90
I graduated in 1990 from the Medical School and the School of Management. After graduation, I spent six years working for Arthur D. Little, mostly in Europe, participating in several mergers and acquisitions in the pharmaceutical industry. Then I joined a company called EPIX. I had been told by a venture capitalist I knew that EPIX was going to go public in about six months, and being naïve enough not to know that venture capitalists can’t possibly know that, I thought joining such a startup would be a fun thing to do. In this case, we did go public six months later, when you could go public with real banks at a market cap of about $100 million. As president and COO at EPIX, I was exposed to and hopefully learned some of the ins and outs and trials and tribulations of drug development at a small biotech company. I came over to Fidelity to help found the venture capital group here in biotech a little over four years ago. We’re on our second fund, and the total under management is about $500 million. We invest primarily in therapeutics, but reserve about 30% of our funds for other areas including medical devices and diagnostics.
Richard Foster: Where is the leverage in the system now? Where are the risks? And if you break it down into different parts of the healthcare system, what’s working? What’s not working?
Edward Cahill: My candidate for the key fulcrum in the healthcare industry right now is the whole issue of quality and patient safety. I think that there are a lot of people who find it hard to agree on issues of how the system should be structured, how it should be improved, what the level of access should be, whether it should be privately funded or publicly, etc. But everybody converges on the need for a better system of healthcare delivery that’s more effective, that harms fewer patients, that actually uses the world-class technology and knowledge that we have right now to good effect and doesn’t end up, through a system of medical errors, ignorance, or just poor coordination, killing or harming patients.
Zen Chu: In terms of my answer to where the leverage is in the healthcare system, I think there are a number of challenges with the bad aspects of competition in healthcare. It’s really in need of restructuring, but I don’t know how to do that.
In terms of innovation, one fundamental problem is that when you’re focused on unmet needs, then by definition a new innovation means you’re going to have new spending. Oftentimes we’re taking what’s an acute disease and turning it into a chronic, manageable disease, which means new spending over many years. I don’t know how we’re going to solve that, but innovation is a requirement. You have to rely on inventive doctors to have a more sophisticated business lens through which they view their own clinical practices and their own behavior.
Liza Page Nelson: If by leverage you mean opportunities for efficiency, I hate to admit it, but I believe that after an initial investment, electronic medical records will provide great leverage, because there will be access to useful medical history when a patient presents in an ER or for an office visit. That should provide some better opportunity for integration of care. I think some of the big waste that we have, other than people merely trying to game managed care reimbursement or avoid liability, is because people often don’t know what they’re doing. If you present in an ER in most major cities in America, and you don’t have a health advocate with you, you can’t guarantee that you’re going to have your vitals done, even though fear of liability would make you assume you’re going to. Often people forget to ask basic questions about what medications you’re on, or allergies. And that’s assuming, of course, you’re conscious. I’m not naïve. I recognize the challenges to having electronic medical records. But they would also facilitate quicker diagnosis, so that people don’t have to get imaging done two and three times because people can’t find their records.
On a philosophical level, we don’t provide healthcare; we provide acute care and intervention, when it would be better over time, in terms of expenditure, if our system provided preventative care. Switzerland does something that I like but don’t think would be practical for the U.S.: There is a program where, at the beginning of the year, if you have coverage under the Swiss system, you and your physician negotiate a set of health goals. If you achieve them, you get a tax rebate. So it’s really to motivate you to do things like manage your cholesterol, lose weight, stop smoking.
It’s a little paternalistic and wouldn’t fly here, but the idea of making people conscious of and responsible for maintaining their health and giving them a carrot works.
Guy Fish: From what we do, which is investing in healthcare and the development of innovation, we can see that there is a funding gap: there are lots of innovations that are started in academic settings or garages and go through a very long, dry valley before they become interesting enough for venture capitalists and others to put serious money into them.
One could look at this as being fairly Darwinian — maybe ideas that aren’t worthy die out — but there certainly are a number of instances where I’ve seen ideas that are actually pretty interesting but just won’t make the light of day because they don’t meet the criteria for the current funding structure.
Often entrepreneurs who have interesting ideas come to a Fletcher Spaght and we have to help them understand that there are interesting technologies, there are interesting products, and then there are interesting companies. What we do is fund companies — what we believe will be successful companies. Technologies and products, unless you’re willing to put in a lot more than most VCs and other private equity people are typically willing to do, may not get the kind of attention and support that’s necessary. So I think there are opportunities to improve healthcare that go by the wayside because of this funding gap.
On the quality side, I would add that there are other ways of structuring healthcare that we have yet to explore. One interesting thing I’d like to point out is an endeavor that Beth-Israel Deaconess and Blue Cross Blue Shield are starting, or at least starting a conversation about. You have five or so world-class hospitals in Boston. At the end of the day, a payer like Blue Cross is paying the same amount of money, roughly, to every hospital, despite the fact that there may be quality differences. In fact, you could say that any hospital that does not treat the patient as well as they should is going to be paid more money, because the patient comes back into the hospital and the hospital is paid again under the U.S.’s piece-rate system.
What Blue Cross would like to do is reimburse in a way that rewards hospitals for doing a better job keeping patients out of the hospital, avoiding readmission, complications during the hospitalization, line infections, etc., and pays less to a hospital that has these revolving doors and high complication rates. I think that’s one of the bright stars on the horizon.
Foster: That’s a great one.
Stephen Knight: I would key in on what Liza said: the electronic medical record. A longitudinal electronic medical record is something that would add immense efficiency, and probably provide fodder to lots of great PhD theses as people try to figure out what to do with all the data.
I’m someone who back in 1988 lugged a laptop around Yale-New Haven Hospital, just because it seemed incomprehensible that scribbles on paper could possibly lead to anything good in medicine. I then realized it was equally impossible to type all of your notes and get everything done. IT had not caught up with the workflow and work needs of medicine. I would agree that IT in medicine needs to be solved, and the field is now nearing the point, after all these years, at which something can actually happen. And I think a lot of good things will come out of that.
Another issue that is near and dear to my heart is the problem of how we develop drugs. Whether the number really is $1 billion-plus to develop a drug now or not, it’s really expensive, takes a tremendous amount of time, and is really risky. Consequently, there are considerable hurdles among groups like ours in funding very early-stage projects.
There’s a fellow by the name of Gary Pisano at the Harvard Business School who wrote a good book on this subject called Science Business, pointing out that project financing in the movie industry might be a more appropriate model for drug development than more traditional business development plans. Creating entire companies with all of the associated infrastructure might not be as good as creating teams to perform a series of experiments which turn into companies if things work out or disband if they don’t. We’re certainly trying to figure out the biotech early-stage funding conundrum. Developing better therapeutics, and innovative ones, continues to be a challenge. It certainly would lead to a lot of good in the world if we could increase drug development productivity.
Foster: My own leverage points would be ones that you have all talked about already. One is information technology. The impact that can have on the administrative costs and efficiency of hospitals is significant. Few things are more important.
The second theme that you all have picked up, with which I agree, is the efficiency of drug discovery and development. I’m particularly interested in the nexus between the university community, the hospital community, and the drug-development community — sometimes called translational research, sometimes called technology transfer.
The difficulties with that process are huge, including conflicts of interest — you can’t do clinical trials in your own hospital for drugs that you’ve developed, for obvious reasons, but then you have to cooperate with someone else. Many academics view the venture capital community with great skepticism and wonder why the returns to capital should be anyplace near where they are when the genius really resides in the medical community.
The net result of all this is that there’s an awful lot of technology that’s at that interface between academia, finance, and the hospitals which just isn’t getting out for patient benefit. At Memorial, we just started something called a brain tumor center, which is there for the clinicians and the researchers to work together in a common environment. So hopefully something will come out of that. But we’re a long way from getting those problems solved.
Nelson: I’d like to respond to a couple of things that Dick just said about the drug discovery inefficiency. Far be it from me to be an apologist for the pharmaceutical industry, because I think it’s been woefully inefficient. But I personally think one of the big problems in drug discovery coming out of the big pharmas is that we are well past the point of diseconomies of scale on the classic Schumpeterian s-curve. And, unfortunately, the biotech industry and translational research are just not providing the returns for the venture industry that they did in the first two cycles, call it 1978 through 1998.
So we’re in a little bit of a funding nuclear winter. And I think the only thing that’s keeping VCs in the game is that the pharma companies have gone shopping at pre-emptive valuations recently, and since a lot of VCs invest partly by anecdote — because you need to believe there’s the one-in-ten, 10x return to justify the risk — that’s the only thing keeping it alive.
On the translational research front, I’m happy to say that I’ve seen through my nonprofit activities — I’m in a nonprofit advisory group that has as part of its remit sponsoring translational research in neurodegenerative disease — some emerging models that address the funding gap and provide a forum for researchers in different disciplines to share their information without queering their intellectual property.
But those are new models and baby steps, and unfortunately there are so many good organizations going after the same or similar areas of research that would do better by collaborating than by competing for funding with one another.
Foster: Liza, can you give us an example of those new models? That’s very interesting.
Nelson: There’s CHDI, which is an aegis organization for a number of different entities that are engaged from discovery through translational research through repurposing of old drugs, all in Huntington’s disease.
Part of what they’ve done that’s interesting is turn traditional grant making on its head. Anyone who wants a grant submits a short write-up of what they are doing that will advance a cure or therapy for Huntington’s. And they will be held accountable to quarterly or annual performance metrics.
So it’s industrialized to an extent. But unlike a grant to NIH, where you wait for the puff of smoke to tell you if you’ve been qualified or need to resubmit, these guys work with the grant seekers collaboratively to help them get their grant. And one of the requirements of getting their funding is sharing of the information. And they’ve figured out a way to do that without queering intellectual property protection.
Foster: It’s an interesting example of people spontaneously getting together to solve the problems that everybody recognizes are there, in a cross-institutional way.
Nelson: Yes. And you know the Rockefeller University is trying similar interdisciplinary approaches, but that is under the aegis of an academic institution. The Foundation Fighting Blindness, which is sponsored by Gordon Gund, is trying to do similar things. So there are some new models emerging.
Knight: The Cystic Fibrosis Foundation is another example.
Chu: I would add the Gates Foundation. They recently withheld a grant for two years that was a total of over $100 million. They were ready to give it. They told the researchers they were ready to give it. But they were trying to bring in an interdisciplinary team across multiple academic institutions. They said, “The money’s here for you. You need to sort out how you’re going to share your results and your intellectual property. You work that out amongst yourselves.” It took the researchers two years, even with that pressure that there was money waiting. I think that’s an important aspect of venture philanthropy, is to make sure that it helps to overcome some of the cultural barriers to sharing of information among the collaborators.
Foster: It’s not the province of this discussion to suggest ideas, but let me suggest an idea. This topic is big and hairy. I’ve seen a number of sporadic efforts to solve it. Liza and Zen have just provided a number of good examples. But I’m not aware that a cross-section of folks who are trying to do these things have gotten together to talk about the current state of affairs, share expertise, and think about what the next generation of this sort of activity should be.
Nelson: Are you suggesting that someone initiate a forum to share best practices?
Foster: Yes. My guess is that if this was a joint venture between the School of Medicine and the School of Management, it could be quite an interesting meeting, and an important meeting.
Now, the second topic that’s been talked about by several of you folks is healthcare IT and the potential there. Tell us what we should be shooting for in the next five years and how is this going to happen? Is this going to be a matter of GE and IBM doing this? Or is this going to be Athena and Athena-like companies that are coming along? Is Cerner going to do it? Are we going to find new enterprises that are forming? All of the above? None of the above? What’s the key to make it real?
Fish: I want to complete that segue. One of the things that we were talking about is alternative funding mechanisms. But because VCs, as Liza was saying, are not necessarily all that smart in terms of picking the winners...
Nelson: I didn’t say they weren’t smart.
Fish: I believe you said a lot of VCs were investing based on anecdotes, and that translates into not particularly more capable of picking winners with that strategy.
I think that with the price of gold going up again, there’s an analogy to the miner situation. Who made money during the gold rushes? You can think of drugs as being the gold, and the tools in drug discovery as the picks and shovels. The FDA has been saying for some time that they’d like to have biomarkers and surrogates and the like. Imaging is another area where there’s a whole host of opportunities — and that is very IT-intensive.
Foster: Intuitive Surgical too. They do robotic-assisted, minimally invasive surgery.
Fish: Yes. Another tool which is actually very IT-intensive is the whole genomics aspect and looking at population-wide studies; finally having the ability, with an Affymetrix-type chip or a BioTrove-type chip to look at thousands and thousands of SNPs (single nucleotide polymorphisms) across large populations. Dr. Chakravarti did a study like this at Hopkins, looking at sudden cardiac death and markers across a very large population. We finally have the technology platform and the power to be able to do these types of studies. A company which we think is very exciting, in which we actually have an investment, is Interactive SuperComputing, which is enabling really interesting healthcare IT mining, by knitting together lots of PCs into a supercomputing cluster at a fraction of the cost, and getting results in a fraction of the time.
Foster: So you’re talking about healthcare IT for the purposes of discovery.
Fish: That’s right.
Knight: Richard, Athena Health started purely on the billing side of healthcare IT, if I’m correct.
Foster: That’s correct. And that’s still largely where the activity is. However, we’ve moved on to the clinical side, now.
Knight: Healtheon (now WebMD) started with the grand scheme, and then figured out that billing was, at least, a tractable solution. Is there a perspective that you have on what will happen in terms of opportunities for smaller companies? Or do you think that, because of the requirement to sell broadly and have interconnectivity, healthcare IT will be dominated by larger companies?
Foster: A couple of comments. I started with a bias, having done a lot of work on the economics of technological change. If I were to summarize that, it would be that the biggest problem for the incumbents, of course, is legacy costs. It’s unbelievably difficult for incumbents to get over legacy costs. So if they happen to be caught in a technological discontinuity, it’s very difficult for them to leave the old and move into the new.
And I expect that to be the case in healthcare IT now. Not that there can never be exceptions, because there are always exceptions. So, for example, Athena started out with an ASP [Application Service Provider] model way before anybody talked about “software as a service.” Now everybody accepts it. And it brings information and intelligence to the system in ways that were unanticipated.
So while Athena is in the physician’s office — and whether it’s a two-doc office or it’s a 700-doc practice at Yale — getting rid of that administrative trivia, which has never been the center of most physicians’ passion, is not only terribly important, but also allows Athena’s ASP service to have more knowledge of the algorithms used by the payers than anybody on the planet, including the payers. And now they’re in a position to help the payers rationalize and streamline some of their decision-making criteria, and that information itself has enormous value.
So it’s generative. It builds on itself. There will undoubtedly be other competitors in that business. And we’re only talking about the U.S. And we’re talking here about the physician’s office — we haven’t talked about the hospital. Clearly, similar things are possible in the hospital.
We think that about 10% of the cost of the U.S. healthcare system could be consolidated, not only with no negative consequences, but with positive productivity consequences. That’s an enormous number. And if we could get that over the next 10 or 15 years, that would, in and of itself, moderate the growth of the healthcare system.
You might be able to tell that I’m not entirely objective about this. I actually think it’s a great, great opportunity and I don’t know a bigger single opportunity. You guys, I’m sure, do know of bigger opportunities, but I think this is a huge one for impacting the cost and efficiency and humanity of our healthcare system.
Nelson: When I was starting to look at this as a business opportunity more than a decade ago, there was no HIPAA. There were no comparable standards for protecting the privacy of patient information. And the thought of doing anything over the internet was anathema. And now that’s routine, so that does enable quite a bit.
I’m going to use a dirty word in healthcare or in information technology integration, and that is “standards.” We still don’t have a common nomenclature, other than DRGs, CPT codes, and J-codes, for what goes on during an episode of care. So if someone is trying to enter something in as “heart failure,” it can be “heart failure,” “congestive heart failure,” “cardiomyopathy.” There will need to be some kind of standards established.
And unfortunately, nobody makes money doing that. So it’s difficult to see what the catalyst for that will be. It’s nomenclature, but it’s also connectivity standards to ameliorate some of the legacy problems that hospitals and payers have. If someone could figure out the universal middleware that made all of that field mapping and translation of all that different nomenclature work, that would be, to use a very bubble term, the “killer app” of healthcare IT.
Foster: The hospitals that I’m aware of are working very hard on exactly those issues, all in their own idiosyncratic ways.
Knight: That’s traditionally been a problem in medicine. Because of the way hospitals are funded and incented, and because of the management structure, it’s very difficult for them to overcome, as you were pointing out, Dick, the weight of legacy and to have the ability to invest money to improve productivity.
Foster: One wonders what the implications of the web will be on all of this. On the physician practice side, I never would have been able to imagine any of the synergies that Athena is, in fact, being able to achieve for its docs. And the docs, now, have started benchmarking themselves against other practices. They never would have thought of that 10 years ago, because there were no numbers that were credible numbers.
Now, moving into the hospital is a totally different business and a totally different set of economics, so we don’t have any aspirations to do that. But if enough hospitals get on the network, then the network provider all of a sudden has an opportunity to do some of these things that would help bring some of these standards that Liza has been talking about.
Cahill: It’s been a fascinating conversation to listen to, especially with regard to what Dick was saying earlier about the incumbents’ disadvantage when it comes to dealing with new and paradigm-shifting technologies. It’s interesting to look at this from the point of view of a healthcare investor, because in the hospital, I’d say, there’s been a tremendous incumbent advantage over the last 20 years. There’s been a tremendous amount of resistance to change, resulting in an amazing advantage for incumbents, at least incremental advantages.
In fact, Cerner, which is now always cited as one of the leading incumbents, is the last innovator company that I can recall that actually broke through the oligopoly, back when all the oligopoly dealt with was financial systems and financial information. Cerner was the first to offer a new paradigm or a new vision which called for clinical information management as well. It wasn’t anywhere near the sophistication of what we would think of now.
But it took Cerner literally decades to break through. And at any one point in time, by making the wrong decision or not getting the right financing, they probably would have failed. So it’s a funny situation: incremental change and advancement in healthcare IT is very difficult, because of the advantage the incumbents have, right now, and the resistance to change on the part of the hospitals and even the physicians.
I’d also like to give you a little anecdote about the huge difficulties of not only investing in healthcare information technology but seeing it get adopted and gain traction. A couple of years ago, we at HLM came across a technology that could instantaneously provide any physician, say, in the emergency room, with all the drugs, both inpatient and outpatient, that a given patient had been prescribed and filled within the last six months — auto-matically, instantaneously, accurately, and very inexpensively. We were working in the worst way to bring out this technology.
We saw this as a key part of the information deficit in the emergency room or in the hospital. As Liza said before, a lot of the patients, when they come into the emergency room, just don’t know, or don’t remember, all of the drugs that they might be on. And they’re on,
in some cases, well over a dozen if they’re over 65 or have chronic disease.
It was amazing how much difficulty we had. The large pharmacy benefit managers had the technology and even had a vehicle to commercialize it, but they had no incentive to commercialize it. We worked for over a year and a half to get that technology into a position where it could be widely adopted and widely used. It would have saved a lot of lives. Every doctor and hospital administrator we talked to was enthusiastic beyond belief about this.
And at the end it just died from inertia. And we see a lot of that in healthcare information technology. The system is so fragmented and it’s so unclear who is paying for what, who is making what decision, who stands to benefit, who may not, who has to do the work, who gets the reward. It’s going to be very hard to bring earthshaking changes to the healthcare information technology field.
Despite that negative, we still actively invest in the field and are very excited and enthusiastic about it. But you have to be very sure that not only is the idea good, but the technology has to be there, the time has to be right, and the incentives all have to be aligned. And if a healthcare information technology fails, it’s usually not because it’s not a good idea. It’s because of all the rest behind it.
Foster: Ed, do you see any connection between this and some of the early points that you made about the need for patient quality and ending physician errors in the hospital?
Cahill: I think they’re very closely related. I think information technology has enormous potential to improve drug development, to improve the financial capability and the efficiency of doctors and hospitals. But also I think it has just as much potential to improve the care we’re given and reduce medical errors and increase quality.
Foster: I do too.
Cahill: And in fact, if healthcare IT is not adopted in a widespread way, I don’t think we have a chance of addressing those problems.
Photographs by Tony Rinaldo