Winner Takes All?
Last week I spent some time with Peter Diamandis, founder of the XPRIZE Foundation and Singularity University (among dozens of other initiatives), who quite simply is trying to solve some of the world’s greatest problems. What was most striking about the XPRIZE vision to democratize innovation was how effectively the model corrals entrepreneurs with a very clear “call to action” – where the winner takes all.
The reward incentive competition model crowdfunds solutions – full stop – and does it very efficiently with a clear end point. The Qualcomm Tricorder XPRIZE competition is offering $10 million to the team which can build a handheld diagnostic device (the “Star Trek tricorder”); over 330 groups started to work furiously to build it – 10 are still at it. There are nearly a dozen current XPRIZEs underway with another dozen in development.
The juxtaposition to what we are seeing today in the private capital markets in healthcare technology is striking; winner certainly does not take all but rather will have to share the spoils with many other emerging competitors. There has been an explosion in the number of startups attempting to solve the numerous problems across the entire healthcare ecosystem. Providers and payors have a myriad of important and distinct business issues they are looking to the startup community to help solve. The “call to action” is less clear, certainly not as precisely articulated as the XPRIZE model, which risks leading to too many companies solving more narrow, maybe the wrong, issues. According to Rock Health, over $4.1 billion was invested in nearly 260 startup companies in 2014, which effectively matched the total amount invested for three years from 2011 to 2013.
The forces which conspired to make this so are reasonably well understood. Reform as evidenced by the Affordable Care Act ushered in a wave of innovative approaches such as healthcare insurance exchanges, which brought millions into the healthcare system but also forced consumers to start weighing cost and quality in their healthcare purchasing decisions. The proliferation of technologies around mobility, analytics, and inexpensive IT infrastructure meaningfully reduces the friction to adopt new solutions. The aging population and better understanding of clinical pathways and disease states are driving greater urgency. And my favorite, effectively free money, has made the financing of these new startups relatively straightforward.
Notwithstanding that we are talking about a $2.9 trillion slice of the economy, the question now is one of absorption; that is, can the market make productive all of these new companies? Entrepreneurs salivate about disrupting the incumbents, driving down/out waste and inefficiencies. Many of these new companies are run by people who have successfully built similar solutions in other industry verticals (financial services, commerce, advertising come to mind) over the past 20 years. But like many of those other verticals, there is a natural cycle to how these markets develop – where are we on the curve below?
Maybe contributing to this phenomenon is the short attention span of VCs. My friend, Professor Tom Eisenmann at Harvard Business School, partnered with DocSend (a platform for entrepreneurs to share diligence materials and legal documents with prospective investors) to analyze over 200 investor presentations. The average presentation was reviewed for 3:44 minutes – not hours. Obviously there are a number of meetings involved in the diligence process, but 41 percent of those companies closed their seed round of financing in less than 10 weeks – Series A rounds were even faster. The pace is frenetic right now.
This all can work with robust and predictable liquidity alternatives. A number of analysts are calling for a significant spike in the number of healthcare technology IPOs given the level of private capital now invested in the sector, and in fact we recently saw a handful of exciting IPOs either price or be filed (Evolent traded above $1 billion, and FitBit will break the $3 billion valuation barrier on $750 million of revenues). But today more companies are choosing to stay private much longer (thanks, in part, to the 2012 JOBS Act which increased from 500 to 2,000 the number of shareholders private companies are allowed), which may create a crush at the exits when/if the tide turns.
- Sand Hill Economics estimates that at the end of 2014 the total value of all venture-backed companies was $750 billion or ~2.5 percent of the total value of U.S. public companies (ominously, the last time it hit 2.5 percent was in 2000)
- Across all sectors, IPO activity year-to-date is only $15 billion, which is the lowest amount since 2010
- For venture-backed companies there has been $20 billion of “private IPO” activity year-to-date, as opposed to only $600 million of traditional IPO proceeds for VC portfolio companies
- In 2014 Second Market traded $1.4 billion of secondary shares (the alternative stock exchanges are rapidly maturing), and we are seeing the advent of private derivative contracts trading in unlisted tech companies
- In May 2015 alone, there was nearly $243 billion of M&A activity; interestingly for the 12 months through March 2015, 13 percent of all healthcare companies had received takeover offers
- Year-to-date 2015 there has been ~$100 billion of monthly corporate bond issuances
So capital is plentiful – but traditional IPO activity is meaningfully down. The implication of this is debatable. Are founders and VCs rolling the dice, trying to thread the needle by “going long” given the seduction of the lofty valuations in the private capital markets today (obviously ignoring the complicated terms of these later-stage rounds which may make high valuations illusory). Or has the world fundamentally changed? Didn’t we all say that the last time?