NO. 03

What Makes Companies Grow?
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Where are the Opportunities for Investment in Healthcare?

Dr. Stephen Knight ’90, president and managing partner of the healthcare-focused venture capital firm F-Prime Capital Partners, talks to Yale Insights about how the company evaluates startups—and why launching a company yourself is sometimes the most profitable route.

In 2015, venture capital firms invested a record $16.1 billion in U.S. healthcare companies, up from about $12 billion the year before. More than half of that investment ($8.95 billion) went to biotechnology firms, another record.

What is the impact of all that investment? According to a 2007 study commissioned by the National Venture Capital Association, more than half of revenue in the life sciences in 2006 came from venture-backed companies, and one in three Americans benefited from advances made by venture-backed life sciences in the previous two decades.

Yale Insights talked to Dr. Stephen Knight ’90, president and managing partner of the healthcare-focused venture capital firm F-Prime Capital Partners—a venture capital wing of Fidelity Investments—about how the company evaluates opportunities to fund healthcare innovation.

Q: What are you looking for when you decide to invest in a company?

We’re looking for companies that are most likely to be transformative in some way. In biotherapeutics, that’s usually addressing some great, unmet medical need. For example, an area that we’re investing a lot in right now is gene therapy. There are diseases that affect very few people like a disease called SCID, which people old enough will remember as the Bubble Boy Disease. A company that we’re starting is working on a gene therapy—it is nearing approval, actually—to completely correct the gene so that you would be able to get a reconstituted immune system for those patients.

Sometimes we invest in technology platforms. Gene editing, which is very topical right now, is something that we’ve been investing in, both in existing companies and in future companies. On the healthcare services and healthcare IT side, again, the idea is companies that are trying to address big changes and big unmet medical needs. I think most people think that there’s significant room for improvement in the healthcare system here in the United States. We’re looking at both healthcare technology and services that are doing that. One of the companies we have, Iora, is a company that is dramatically changing the primary care model of how healthcare is delivered.

Q: What do you look for in the company itself—the personnel, the structure?

The normal checklist includes terrific management and great investor syndicate. Those are certainly aspects of both company formation and existing companies that we invest in that we try to address. Sometimes you’re willing to try to figure out how you can fix those two boxes if they aren’t completely checked.

We invest in existing companies, but we also will pull together companies with academic founders, sometimes putting in some of our team members as original management to pull the company together. We’re doing one right now that involves universities from the UK, the east coast of the United States, and Harvard. That management team is distributed across both Europe and both coasts of the U.S. Eventually, it will probably consolidate somewhere, but we’re pulling together the management and building the company from scratch.

That’s something that increasingly we’ve done in the last five years. And if we look back, I think that some of our greatest returns were made in companies we invested in early. You can’t start any earlier than company formation, so that’s kind of the limit case of that particular algorithm. I also think that sometimes for competitive reasons it makes sense to start the company yourself—by the time you make the investment in an existing company, the opportunity is already gone.

Q: You were part of a discussion we had about innovation in healthcare in 2008, and you cited electronic medical records as something that could have a big impact. How has that area evolved?

We have yet to make a pure investment in electronic medical records, but at the risk of being somewhat provocative, we do have an effort right now that we call the Epic-buster. As you may know, Epic is a large healthcare records company that has a pretty good market share of the largest academic medical centers in the country. We think that there might be an opportunity to intermediate that. One of the areas that we’re looking into is having a patient-focused medical record.

I think if you compare records in, let’s say, the financial services industry with healthcare—in terms of transaction costs, ease of use… Not to pick on Epic but go and sit with a physician who is trying to use that product and learning it, and there is quite a large gap in both usability and portability for patients and physicians.

Q: Back in 2008, you also mentioned drug development as an area where increased productivity was needed. Do we have a structure that allows for investment in the drugs we really need?

I think if you go back to 2008, the venture-backed biotech industry was in the doldrums. People were wringing their hands and saying, “There’s really no way to make money in this industry.” You fast forward to 2012 up to 2016, although a lot of errors come out of the market, it’s still the largest bull market in my professional memory. During that time, I think a lot of capital has gone into drug development. I think that there are a large number of exciting therapeutics that are being developed right now from startups. I mentioned some in gene therapy because that’s a particular focus of ours right now, but also in small molecules and in biotherapeutics. We’ve certainly been involved in a number of immuno-oncology companies. Those are small companies that have been backed by venture firms and are leading the therapeutics that will transform medical care.

Q: What about new antibiotics? Is investment getting where it needs to go to deal with drug resistance?

Antibiotics represents a tricky area. One of the reasons we focused on rare diseases early on is, one, it was where we thought we could have an impact, but I think it was also that we thought of ourselves as primarily people with technical backgrounds who would be comfortable taking technical risks. We’d be comfortable taking financial risks. Regulatory risks were not ones that we felt comfortable taking. We wanted to go into those areas where the FDA was encouraging and being helpful in getting new therapeutics to patients.

I think the FDA has done a wonderful job. The problem is that in areas in medicine where large trials are required and where there’s no very clear and present danger for a specific disease, it’s harder to create the financing system whereby you have confidence that you can hit the endpoint in a clinical trial and then get approval. I think that just provides a lot more uncertainty and I don’t have a great answer to that particular question. I think that that is a very good example where there is clearly systemic risk and public health risk, and probably a lot more great science that could address the issue if we could figure out ways to develop drugs and come up with clear answers in a less expensive way.

Q: How important are teams for your company?

One of the approaches that we’ve taken as a venture firm that’s a little bit different is that often VC firms will exist as individuals doing their own deals and resting on the success or failure of those deals. It becomes a collection of people who occasionally work together. I think for better or worse, and I think it’s for the better, we’ve really tried as hard as we can to create a team-based approach to investing. We have an eclectic team with individuals with various talents.

That in some ways mirrors what you need in starting a company. With, let’s say, a biotherapeutic company, you need brilliant scientists. Without that, you’re not going to create the kind of companies that we want to create. At the same time, you need the structure and discipline that comes with organized management. Then you need people sometimes who are just great utility players, who get stuff done. Trying to get that type of team that has a rapport, has ineffable things like a sense of humor, and really just get along together—I think some of those less tangible aspects of a successful company really do make a difference over the long term.

President and Managing Partner, F-Prime Capital Partners