THE MATH FOR HEALTHCARE VENTURE CAPITAL INVESTMENTS MAY NOT ADD UP
The famous economist John Maynard Keynes believed that the animal spirits in finance depend on spontaneous optimism rather than a mathematical expectation, and those financial affairs have an instability due to the characteristics of human nature. If you combine the animal spirit with the felicitous nexus of venture capital, universities and the obsession about consumer first, it is no wonder that VCs continue to invest in start ups with the hope of transforming industries.
Since 2010, venture capitalists have poured $60B into digital health. We are now at a $10B clip in annual investments. Assuming that healthcare VC deals have the same average fail rate of 25% as the broader sector, over $45B of these investments will hypothetically bear fruit. Assigning a conservative 5–6x return to these investments, the current healthcare VC investing should create over $220–270B of value. That means the entire value of our $3.8T healthcare industry should churn in 20–25 years. Notwithstanding the simplicity of our analysis regarding success rates or returns, we believe our reasoning is consistent with the correlation between value creation and industry size. So how do we divine financial fortunes from these investments without massively increasing the size/spending of the industry? The answer is in Keynes’ view on the psychology of markets.
Looking at the facts, the good news is that both federal as well as state governments are increasingly inclined to outsource Medicare and Medicaid services to the private sector. This, in turn, significantly increases the TAM for healthcare companies. Additionally, as care moves to prevention, early diagnostics and hospital at home, we predict that a whole host of healthcare categories will be replaced, reduced in size, reassembled or disbanded altogether. This will open brand new markets for many of our start ups. We put most hospitals, specialty care and old-line software/services businesses on our list of endangered species.
The confluence of technological advances and the industry’s readiness for change will undoubtedly create paradigmatic businesses in healthcare. The Goldilocks zone is of course the psychology of putting the consumer squarely at the center. But don’t look for short-term reduction in healthcare costs. Many of these companies are additive, and actually increase the size of healthcare spend in the short run. But we are certain that they will eventually bend the cost curve. Let’s join Keynes and hope that this optimism will not fail us!
