Healthcare Venture Investing Strategic Considerations

Four important strategic questions health system venture investors must address are investment focus, degree of risk, performance expectations, and the potential for revenue diversification.

Investment focus. Because of their mission, most health systems invest in healthcare ventures aimed at achieving Triple Aim goals: improving the patient and caregiver experience, reducing the cost of care, and improving population health. Most health system venture groups steer away from investing in drugs, devices, and therapeutics, because they have less comparative advantage relative to independent investors in these areas.

Many of the interviewed leaders share this perspective. Jeremy Porter, director of business development at Intermountain Healthcare (IHC) in Salt Lake City, says: “As a provider system, we’re not going to add strategic value in these areas. We are focused mostly on innovations in care delivery.”

Sam Brasch, senior managing director of Oakland, Calif.-based Kaiser Permanente (KP) Ventures, agrees, noting that KP Ventures gets greater “value-add” for its parent from innovations in IT and services than from purely clinical ventures such as pharmaceuticals and biomedical devices.

Degree of risk. In addition to deciding which areas to invest in, aligning strategic and investment goals requires thoughtful consideration of leadership’s risk and liquidity preferences. Most mature health system venture groups, for example, avoid investing in early-stage start-ups. For example, according to Brasch, KP Ventures doesn’t make Series A (i.e., first round) investments, preferring to invest in follow-on Series B or C rounds, which generally involve less risk. Although KP Ventures manages several large funds, it limits most investments to less than $10 million to manage its risk exposure.

Summation Health Ventures—a 50/50 joint venture between Los Angeles-based Cedars-Sinai and MemorialCare Health System—has a similar philosophy. Darren Dworkin, CIO of Cedars-Sinai and managing director of Summation, says: “We don’t invest seed capital in early-stage start-up companies. We invest in companies that already have customers and have defined their market position. These companies have traction, are moving along, and want to grow and scale their operations in a manner where we can provide value.”

Performance expectations. Health systems generally expect venture activities to earn a reasonable rate of return on their own, but because they also see strategic value in the companies they invest in, they do not necessarily have as high ROI objectives as independent venture-capital and private-equity firms.

Michelle Conger, senior vice president and chief strategy officer of OSF HealthCare in Peoria, Ill., says that her system expects a 12 to 14 percent long-term ROI long-term on its venture fund. She explains, “These returns are lower than independent venture firms’ [returns], but that’s because we intend to gain strategic value from the technologies we invest in, as these solutions are aimed at solving some of our most difficult problems.”

Although “strategic payback” can certainly augment financial payback, setting ROI expectations lower than financial markets has the potential to protect mediocre ventures and misallocate capital. Older, more established venture organizations like KP Ventures, Ascension Ventures, and Cleveland Clinic Ventures are more likely to expect ventures to earn market rates of returns.

Revenue diversification. Traditionally, health systems did not look to venture investments to diversify their revenue base, mainly because the ventures were not large enough to be material. However, this pattern may be changing. UPMC Enterprises in Pittsburgh, for example, is committed to using ventures for revenue diversification, as exemplified by its development of the population health management (PHM) services company Evolent Health.

Rasu Shrestha, MD, executive vice president of UPMC Enterprises, notes that Evolent Health emerged from UPMC Health Plan as a way to commercialize the plans PHM expertise in by supporting PHM startups for other health systems.

Spinning out operations that are already delivering value is the quickest way to develop scale innovations that can contribute materially to revenue. However, scaling doesn’t happen automatically; it often requires significant investment to reposition internal services for the broader external market. After proving Evolent’s viability as a business, UPMC partnered with the Advisory Board Companies in 2011 to capitalize and help market its services. In 2013, Evolent brought in Texas Pacific Group as a third investor to accelerate growth. The company went public in 2016 at a valuation of $1.2 billion, producing a 10:1 ROI for UPMC—a significant revenue-enhancer.

Another venture organization that is taking revenue enhancement seriously is the Innovation Institute, an LLC jointly owned by six not-for-profit health systems. Larry Stofko, executive vice president, reports that the Institute now has over $200 million in revenue from its shared services companies, and all of them are profitable. 

David G. Anderson, PhD, is a Director, BDC Advisors, San Francisco ([email protected]).

Mary Jo Potter is a Senior Advisor, BDC Advisors, San Francisco ([email protected]).

Dudley E. Morris is a Senior Advisor, BDC Advisors, Los Angeles ([email protected]).