We are ingrained to believe financial markets work in cycles. Sometimes they boom and sometimes they bust. And when they boom, people love to predict when they will burst.
So it comes as no surprise that many predict the healthcare venture capital boom will burst sometime in 2022. This is not likely, even if we see federal interest rates rising at some point in the year.
Healthcare venture capital is unique from other industry verticals in venture capital. As a whole, the venture capital industry is perceived to be risky. But healthcare venture capital is unique because it is a form of risk mitigation.
Risk is an abstract concept. We think we understand it. But like most abstract concepts, we struggle to define it. Risk in healthcare comes from patient behavior. A compliant patient who actively communicates with his or her physician is deemed a low cost patient. A noncompliant patient who routinely frequents the emergency room is deemed a high cost patient. Or, to use insurance jargon, the former is a low risk patient and the latter is a high risk patient.
We struggle to identify any one action or decision that leads a patient to be high or low risk. This is because risk is the aggregate of all patient behavior and therefore difficult to quantify exactly.
Now with insurance companies integrating patient outcomes into the reimbursement models, the healthcare industry faces an unprecedented level of risk. Before, when a patient would be seen, regardless of the outcome of the care received, hospitals would be reimbursed at the same rate. Now it is not so simple.
Insurance companies are aggressively pushing reimbursement models that place a fixed cap on reimbursements or benchmark individual compensation to a specific clinical metrics. They are adding risk to the healthcare system.
Ironically, in the face of this new risk, the entities exposed can use venture capital to mitigate against it. Venture capital is high risk capital because it allocates money towards new innovations. Commercializing innovation is hard and has a high failure rate.
But healthcare is willing to embrace venture capital because the risk of innovation offsets the risk of benchmarking clinical reimbursements to patient outcomes. In the face of changing reimbursements, healthcare has no choice but to innovate. The best way to innovate is to risk mitigate – and this is exactly what healthcare venture capital can do.
We already see healthcare systems building venture capital firms to invest in innovations that they will pilot on their patients. The ten largest healthcare systems in the United States all have their own internal venture capital firms. Some are called mission funds, but they all have the same purpose of allocating capital towards new innovations or promising clinical research.
The largest Medicaid provider in California, SCAN Health, operates like a private equity conglomerate, unveiling different clinical services like portfolio firms within a holding company.
This is on top of the growing list of healthcare venture capital firms – which are funded by insurance companies with exposure to healthcare and led by prominent physicians who in previous decades served as hospital executives.
Of course they would look at venture capital the same way large healthcare systems do. It is all about using one form of risk to mitigate against another form of risk.
So there is little reason to believe this boom in the healthcare venture capital market will subside anytime soon. Unlike other venture capital industry verticals, healthcare venture capital is not creating risk, it is counteracting the growing risk of outcomes driven reimbursement models.
This critical difference predicts the future of venture capital in healthcare. As long as healthcare continues to expose itself to reimbursement risk, it will continue to mitigate against it.
And the best diversification strategy is venture capital.
