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Introduction

Necessity drives change in medicine – the need for lower mortality rates, the need for enhanced recovery from procedures, and the need for greater efficiency and value. The urgency for change is further intensified by today’s challenging economic environment; hospitals and, especially academic health systems, are under increasing pressure to generate greater financial returns to sustain their multiple missions. Disruptive innovation holds the promise of rapid improvement in all these metrics. That said, the introduction of innovative therapies and devices must always be weighed against the commitment to provide reliable and well-tested treatments.

By definition, disruptive innovations bypass simple modifications of “tried and true” techniques. As a consequence, disruptive innovations are often produced by outsiders or relative newcomers to the fields, who are unburdened by tradition or long-standing commitment to the “old ways.” [1] The business setting for disruptive innovation is also different from more incremental improvement processes. Healthcare startup companies rely on leading-edge technologies, often too-untested to attract investment from established companies or standard granting agencies. Since most of these nascent companies fail, the environment is extremely competitive and time sensitive.

Given the long odds and intense effort that is required, why should health systems, already burdened by resource intense missions in patient care and research, enter this highly competitive industry? Our hypothesis is that the very survival of academic health systems depends on rapid implementation of fully effective and lower cost care especially for patients with complex illnesses. The irony is that these meaningful advances can only be achieved with close collaboration with individuals not commonly found on medical campuses. In this chapter, we will argue that that a shared investment model is a very effective way to access such entrepreneurs and visionaries. Further, such models allow the cost of investment to be shared with venture capitalists and industry, thereby leveraging the intellectual capital of medical centers and universities.

In a 2016 article, Potter and Wesslund support this argument with three compelling reasons that corporate venture activities are attractive to large health care systems. [2] First, it improves the rapidity of response to market disruption. In today’s market, patients and payors alike demand the most effective treatments. Second, exposure to new and radical ideas fosters a culture of innovation among the highly creative population of staff and faculty who do not face the same quarterly financial measures as those in the for-profit world. Third, it creates leverage for academic medicine overall as it is very common for health care groups to invest in concert. This magnifies the impact of the investment while reducing the financial exposure from failure of any given start-up.

Rationale for Creation of a Venture Capital Fund

Too often, bio-medical product development gets quite far along before there is much input from the healthcare professionals who will actually be using these products. The primary goal of industry-health system partnerships is to remedy this shortcoming and more rapidly and efficiently translate ideas into viable products for clinical use. Partnering with venture capital and/or private equity funds allows health systems to directly drive product evolution such that the technology more perfectly fits their own specific needs and structure. As well, when relevant healthcare professionals are involved in product design and development, the last and most critical step of deployment into clinical practice is greatly facilitated by their sense of ownership. As well stated by Nina Nashif of Healthbox, “introducing change in a healthcare delivery system is 20 percent about the technology and 80 percent about the implementation.” [2] Most importantly, with early access to state-of-the-art technologies, health systems can provide the highest quality care to their patients.

From the perspective of the entrepreneur, partnering with a health system has many benefits. At the minimum, startups can take advantage of a built-in customer base. Above all else, however, startup companies strongly linked to physicians, nurses, staff, administrators and patients have easy access to a wealth of knowledge and mentorship. Entrepreneurs can rigorously test their products working with the very people who will use them. This offers unparalleled development opportunities and allows for rapid iterations toward a final design.

Basic Models of Shared Investment

In the least complicated version of the shared investment model, the academic institution provides funds to assist in product development by inventors who form separate start-up companies. The principals may originate within the institution or come from outside. To encourage engagement and properly incentivise the inventors, the institution gets a modest equity share. If development is promising, the health system can promote commercialization through further direct investments into those companies and products which best align with its mission. These subsequent investments increase the institutions equity share.

This simple investment model is a variation of the first attempts of Universities, nearly 100 years ago, to profit from the technologies developed within their walls. Perhaps the best example of the early “tech transfer” strategies was the Wisconsin Alumni Research Foundation (WARF) at the University of Wisconsin [3]. This entity was formed to protect the patents and intellectual property of University faculty while facilitating the development and commercialization of worthwhile ideas. The principal mechanism of these initial efforts was establishing licensing arrangements with already established companies, rather than creating new companies based on single products or new technologies.

More substantive and collaborative investment models have increased dramatically in the last decade. These involve health systems forming their own separate venture funds with or without formal partnerships with outside venture capitalist groups (VC). The development of these arrangements has been fueled by the involvement of leading academic institutions such as the Mayo Clinic, Cleveland Clinic, and Partners (Boston) along with other large clinical entities such as Ascension Health (St Louis), Inovo Health (Iowa) and Providence Health (Washington). It is estimated that there are currently more than 50 such funds with individual valuations exceeding $100 million in some cases. Since somewhere near 25% of the total venture capital activity is now in health care, this growing interest by the key consumers of these products is not surprising.

To improve success and further “deal flow,” the entities often form some type of associated business development programs which can be configured as short term “accelerators” or more long-term “incubators.” In these programs, start-up companies are funded for variable periods of time, 3 months in accelerators and up to 2 years in incubators. To facilitate informal interactions with mentors within the medical center, they are usually housed in proximity to the sponsoring institution. Each sponsor brings their unique strengths to the effort; the healthcare entity provides expertise in patient or physician needs while the VC’s support marketing and business plan development and provide counsel regarding long term financing options.

Investment and Return

Since any form of shared investment model requires a substantial capital outlay by the health system, it is essential that leadership sees the value of these partnerships and commits to both the initial investment as well as the follow-on investments invariably needed to take the products to market. Development of new technology from initial discovery to commercialization is obviously high risk and mandates that investors are both patient and accepting of setbacks and, even failure. The rewards of successful investments are considerable and include returns from royalty income or favorable “exits” from the acquisition or public offering of the supported companies.

The passing of the Bayh-Dole Act in 1980 allowed universities, non-profit institutions, and small businesses to maintain ownership of their federally-funded intellectual property. The ensuing financial returns with licensing income and royalties have been remarkable. The annual Association of University Technology Managers (AUTM) Licensing Activity Survey found that between 2012 and 2016, while federal, industrial, and other research funding remained stable, licensing income increased considerably by 13% to almost $3 billion in 2016 [4]. Royalties, cashed-in-equity, lump sums and license fees have also risen exponentially. Overall, research institutions received meaningful equity from almost half of all of the start-ups formed in 2016. In an era of declining reimbursement per unit for clinical work, these alternate activities can provide much needed unrestricted funds for academic support and re-investment.

While non-monetary benefits are less easily quantitated, they are equally important. In our experience as well as that of others, the excitement of these business ventures allows the spirit of innovation to become ingrained in the institution, making very real contributions to the missions of education and research. Contrary to common wisdom, entrepreneurial activity and industry partnerships do not promote a movement away from academic careers and do not adversely effect more fundamental research. A recent study of 6840 science and engineering doctoral students at 39 U.S. universities demonstrated that basic science research activity, the number of publications, and interest in an academic career were not significantly different between labs that encouraged entrepreneurship and labs that did not [5] In addition, labs that encouraged entrepreneurship were more likely to report invention disclosures. Seen this way, it can be argued that a focus on innovation nurtures discovery at all levels, including basic and translational work [6].

Medical innovation also leads directly to numerous other avenues for research funding. The Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs of the National Institutes of Health and the National Science Foundation provide additional federal sources of funding for academic departments [7]. Under these programs, small businesses may apply for grants dedicated to technology commercialization. Although universities and other research institutions may not apply for these grants directly, they may be subcontractors to either home-grown or external small businesses who are funded by these grants. Other options for research funding include the numerous federal and private agencies that back technology transfer activities and translational research. The opportunities for industry-based research financing are also substantively enhanced by increased exposure. Finally, the positive publicity from such discoveries can also help attract philanthropic funds to the institution.

Cedars-Sinai Experience

Our experience in venture investment began with the formation of Summation Health Ventures (SHV) in 2014. This $80 million fund included equal capital commitments from Cedars-Sinai and Memorial Care Health Systems. Collectively both non-profits have seven hospitals with >2500 licensed beds and nearly 5000 affiliated doctors.

Our investment strategy was focused on companies that met two requirements: (1) that the two health systems could add value during product development and (2) that we would plan to use the finished product in our operations. Thus our personnel became both contributors and customers. The final rationale for investments is that if it added value for Cedars-Sinai and Memorial Care, it would be attractive to many other hospitals. Hence, the valuation of the companies we invest in would be increased.

SHV largely avoids very early stage companies, concentrating on products that have achieved or will soon achieve FDA approval. Primary areas of interest are new medical devices, non-invasive surgical techniques, and especially information technology to help monitor patients and connect them to their caregivers. The focus is not to hold majority investment positions in the start-ups and we directly encourage other health system funds and major VC’s to join in. The investments are generally made during Series A raises rather than seed rounds although we do provide small seed investments, with options to convert to stock, in companies that may develop into more attractive investments.

One of the most critical concerns of any fledgling venture fund, is receiving sufficient leads and contacts to allow a sufficiently rich “deal flow.” Over the last 4 years, we have performed initial review of more than 500 potential investments of which about 50 have had some level of due diligence carried out. We assume this high level of activity reflects both the strategic value of our institutions and their personnel, and their potential sales base. A meaningful advantage of our engagement is introductions to our network of partnering VCs and other academic medical centers who can both aide in technology development and become customers.

To date, three of our original investments have returned value much greater than our investment upon their acquisition by larger companies; another 4–5 are poised for sale, Most importantly, a number of these products are adding value right now to our operational efficiency.

Given our positive early experience with Summation Health Ventures, we formed our own accelerator partnering with Techstars, a US-based venture firm that hosts mentorship-driven business development programs in many sectors beyond health care. Techstars mentored companies have enjoyed an enviable record of viability; about 90% of companies who go through their programs are still in business 2 years later, as compared to the base success rate of similar enterprises of 10%.

Every 6 months, a competitive call for interested start-up companies attracts about 500 applications from all over the world. We select 10–12 companies and host them for 90 days on our campus, providing $40,000 per month of support for each. During this intense period of time, Cedars-Sinai clinical and academic personnel mentor the companies, helping to further develop the innovative technologies and integrate them into established care delivery systems. All of the companies in the first two cohorts signed research or commercial contracts with Cedars-Sinai or other academic medical centers. In collaboration with Cedars-Sinai physicians, multiple start-ups performed and published well-controlled studies of their products. Most importantly, the engagement of over 250 physicians, residents, nurses, executives, and other staff in over 1000 h of meetings with the start-ups in this program demonstrates the innovative spirit stimulated by this program. Numerous other programs, including Stanford Biodesign, the University of Michigan, Cleveland Clinic Innovations, and the Johns Hopkins Sibley Innovation Hub, have similar highly successful multi-disciplinary medical innovation programs. [8, 9]

Challenges to Health Care Venture Efforts

As well described by Atkinson in 1994, success in any type of venture fund demands creativity, expertise, and experience [3]. These are, in fact, the key attributes of academic medical centers. Success in investing also requires a fourth attribute - singularity of purpose; many of the investments require 5–10 years to mature. Unfortunately, this long-term focus is often difficult to maintain in large health systems and research universities. A number of factors contribute to this problem including complicated relationships between medical schools and “parent” universities, the capital needs of new affiliated hospitals in rapidly expanding systems and the disruptions associated with too frequent academic leadership changes. These challenges are further intensified by the fundamental tension between “doing good” by helping patients versus generating the highest financial returns.

This tension is invariably present in health care venture efforts because both financial and strategic goals are always in play. While attractive returns are undoubtedly a lure of such investments, most health care funds greatly value the ability to gain a market advantage over competitors through early adoption of disruptive innovations.

Three additional ingredients for success cannot be overlooked. [3]

  1. 1.

    Funds must have capital sufficient to match the aspirations. Without enough money to make prudent “follow-on” investments in later stage financing rounds, health care venture funds can be progressively diluted in equity, greatly lowering their return when the products they helped develop are acquired by large companies or receive substantial funding through an initial public offering (IPO). For this reason most venture funds now exceed $80 million of initial assets. Even this size barely provides a sufficient operating margin for enough analytic personnel to handle the due diligence involved in assessing investment opportunities.

  2. 2.

    Academic aspirations should be largely discounted in investment decisions. This is much harder to do than it appears since the intrinsic value of publication and basic discovery are so deeply ingrained in most of the sponsoring organizations. To succeed in venture investment, support of academic laboratories cannot short change the more mundane but essential tasks undertaken to improve product design and more rapidly commercialize innovations.

  3. 3.

    Collaborations are essential on many levels. Obviously, the process of product development will necessarily involve the entire spectrum of staff and faculty as well as institutional infrastructure such as information technology and laboratory facilities. Equally important, hospital-based venture funds must foster positive relationships with outside, often much larger, venture groups. These connections will greatly advantage later stage funding rounds and enable worthwhile products to be developed well beyond the funding capacity of a single investor.

Conclusion

Creating or partnering with a venture capital fund offers many positives for health systems and academic medical centers. It can speed introduction of new and powerful technologies that enhance the care of patients. It offers the potential for substantial financial returns, adding a new revenue stream that can support academic activities. Finally, it stimulates a passion for discovery and commercialization among employees and faculty. All that said, it is a serious business requiring skill sets and experience not normally within the perview of medical enterprises. Recruitment and retention of personnel with these skills is an absolute requirement for success.