Healthcare Venture Capital Driving Mergers and Acquisitions

December 09, 2019 - Healthcare venture capital investments continue to drive mergers and acquisitions (M&A) in the industry despite a shortage of common ground between CEOs and investors, a new survey finds.  

The US healthcare market saw a 14.4 percent increase in mergers and acquisition activity from 2017 to 2018, data from PricewaterhouseCoopers revealed. In total, there were 1,182 M&A deals in 2018, and M&A activity has remained firm in 2019, with deal volume exceeding 250 deals in the first three quarters.

A significant portion of those deals were conducted by healthcare venture capitalists, the survey conducted by Sage Growth Partners (SGP) stated. Across all industries, $130.9 billion was invested in US-based startups in 2018, surpassing the previous high established in the dot-com era. About $713 billion was also in private equity investment. 

“Business opportunities in healthcare today are driven by two key factors – the industry’s widespread waste and inefficiencies, and public and private sector mandates to reduce costs while increasing health outcomes,” Dan D’Orazio, SGP’s CEO, stated in a press release. “As a result, there is an abundance of potential partners and investment capital.”

However, investors and CEOs are not always on the same page with their healthcare M&A goals, which might lead to troubles realizing efficiencies and reducing costs, D’Orazio highlighted.

READ MORE: Mega Mergers Behind Recent Hospital Merger and Acquisition Activity

“It's not surprising that investors and CEOs don't completely see eye to eye on the perceived benefits of venture capital investment,” he stated. “However, they will have to find a way to successfully overlap their needs to benefit from the most valuable resource in their arsenal – the people."

To determine the differences between investors and healthcare CEOs, SGP engaged 30 investors who provided capital to healthcare companies at stages ranging from seed to buy out, as well as 30 CEOs of healthcare companies, of which half received funding in the past 12 months. It gauged the attitudes of these investors and CEOs and intended to understand why M&A deals were rising year over year if perspectives varied so greatly. 

When asked about business partnerships, both CEOs and investors agreed that driving revenue growth, possessing expertise that is relevant to the business, and getting ready access to customers and subject matter experts are vital to a productive and long-term partnership.

But they disagreed about top variables that are integral to the success of a business. While board leadership topped the list for investors, it fell to seventh place for CEOs. And recruiting senior management sat as the fourth most crucial benefit for investors, while CEOS didn’t find this quite as important, ranking it last.

Overall, CEOs sought healthcare venture capital to bring credibility to the market, make connections with customers and subject matter experts, and accelerate growth and scale. While not as important, healthcare CEOs also valued an investor’s expertise related to the market or company, capital, and reputation.

READ MORE: What is the Future of Healthcare Mergers and Acquisitions?

On the other hand, the top benefits of healthcare venture capital besides board leadership and senior management recruitment according to investors included connections to customers and subject matter experts, acceleration of growth and scale, and capital.

“Both CEOs and investors want to see value creation. Many CEOs are seeking investors’ contracts, but may see less value in leadership on the board,” said Mason Beard, co-founder of Wellcentive. “Investors may feel that they can play a more central role in sharing their firms’ expertise, especially to earlier stage companies.”

Healthcare CEOs and investors also disagreed about the delivery of bad news. CEOs reported that they deliver bad news early with some detail, but the investors disagreed. They reported that CEOs deliver bad news early, but with minimal to no context.

The survey also uncovered some of the reasons why venture capitalists invest in healthcare the way that they do. Investors are looking to mitigate risk, and 63 percent reported that they would rather invest in a top ten company in a fragmented market over a top three company in a consolidated market. 

A majority of investors (83 percent) also said they prefer investing in healthcare companies that face threats posed by competing businesses versus those resulting from legislation (17 percent). By a 2:1 margin, they also said they would invest in a healthcare company with a proven team and an average product over a company with a differentiated product and an average team.

READ MORE: Hospital CEOs Share 3 Ways to Ensure Value-Based Care Success

“Investors lean toward risk mitigation. When you get a team that can sell and adapt, the flavor of the ice cream they sell matters less,” said Mason Beard, co-founder of Wellcentive, which was acquired by Philips in 2016. “If I were an investor, I wouldn’t care whether you had a whizz-bang product if I felt the people running the company might drive it into a ditch. The sweet spot would be a differentiated product and a killer team.”

While investors are looking for the right team, healthcare CEOs want proven investment firms to prioritize their company, the survey found. About 80 percent of CEOs said they prefer being a first tier investment with a firm that is respected rather than being a second tier investment with a renowned firm.

More than half of the CEOs (60 percent) also said that an excellent track record of success is more important than the financial terms of a given deal.

“There’s no reason to pay a premium for a premium investment partner name if you’re not going to get any benefits. I would much rather get the full attention of a solid firm than the partial attention of one of the top names,” Kurt Skifstad CEO of ArborMetrix, said in the survey.

They agreed that people come first, and both reported proven team success as significantly more important. 

For example, investors unanimously preferred a differentiated product in a $1 billion market over an average product in a $5 billion market, and by a 2:1 margin, investors indicated that they would invest in a company with a proven team and an average product over a company with a differentiated product and an average team.

Similarly, more than half of CEOs (60 percent) prefer an “excellent track record of success over the financial terms of a given deal.” 

“If I were an investor, I wouldn’t care whether you had a whizz-bang product if I felt the people running the company might drive it into a ditch. The sweet spot would be a differentiated product and a killer team,” said Mason Beard, co-founder of Wellcentive.

While healthcare CEOs and investors had many differences, both groups agreed that business to business and to consumer is the biggest opportunity in healthcare, and business to consumer is the least effective opportunity. 

The report concludes that it is vital for investors and CEOs’ perspectives to be aligned as it is integral to the success of a healthcare company. But the varying perspectives of investors and CEOs is a net positive for healthcare businesses. “Each possess overlapping, but largely distinct, experiences and skill sets that diversify a company’s most valuable resources-namely their individual know-how and can-do spirit. The key to optimizing these resources is to align and deploy them,” the report stressed.