Next Things First

A Cold Winter for Start Ups by Rob Coppedge

Our methods are not scientific and I don’t know what you can reliably extrapolate from our results, but you heard it here first: It is already a very cold winter for health care start ups.

In the past week, I have received numerous calls from companies either (1) suspending their fundraising activities and cutting back to bare bones operations or (2) flat out closing up shop.  After nearly 15 years in and around venture capital, I have never seen so many interesting, well positioned companies go through this existential crisis at the same time (not counting the decimation of waves of nonsensical business models in the early 2000’s).

Perhaps it is an effort to clean things up before the end of the year, but I am not so sure that what we are experiencing now isn’t a harbinger of much worse things to come. A few trends worth considering:

1. Waiting it Out. Many early stage companies pulled (or never launched) their fundraising efforts during mid-2008, hoping to relaunch in early 2009.

2. A Dustbowl. By all reports, venture capitalists with “dry powder”  have pulled back and are sitting on their hands waiting to get a handle on the cash needs and time to exit for their current portfolio companies. Not that there has been much venture for early stage health care companies recently anyway, but this is creating a veritable Dustbowl.

3. A Dustbowl, Inside a Chasm? Not only is the industry segment traditionally (and especially now) underventured, but there is little capital for the size of deals needed by early stage health care companies. These companies need $500,000 to $5 million, but few if any are placing this kind of capital in health care start ups (much easier to raise $10-25 million, even in this market). This “Capital Gap” is a big problem, and will be hard to address with the capital and investors in the market now. Larger fund sizes mean larger deals – and most firms with long term health care specialty have been raising much larger fnds. And for funds that have been dabbling in the early stage,  opportunities to move up the risk curve to positive EBITDA deals is very attractive in this market.

4. The Limitations of Angels. The only good news for companies raising capital this fall has come from regional angel networks – but these pools of capital are limited and often regional in their focus.

So, as we move into 2009, we expect to see the companies that have been trying to wait out the market finally launch fundraising efforts out of necessity – and the demand for capital will significantly outstrip the supply. Angel networks won’t be able to keep up and the traditional venture community will remain focused on less risky deals and reserving capital for their existing portfolio companies (which may not see an exit for much longer than originally expected).

While I hope to be proved wrong, we are predicting that these trends will lead to the continued loss of jobs in early stage businesses and potentially the lack of introduction of new innovation into the health care market over the next 12 months. The good news is that well capitalized businesses will have a hey day in this sector, as there is considerable opportunity to build and grow health care services companies in this market (even industry novices can pick up on the increasing clamor for efficiency,  quality and cost effective access – all require new, technology driven solutions). But without the proper capital, there is certain to be a chilling effect on innovation and growth.

Sadly, I expect to be getting more phone calls from entrepreneurs scaling back and shuttering operations during this cold Winter… which might last well into next Fall…

Posted by RobC


1 Comment so far
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Yep, it’s true. “Money’s too hard to mention.” Silver lining? The benefits of undercapitalization are many. You hew closer to the most urgently needed customer value, delivering features and benefits in a very agile way (i.e. monthly and quarterly, not annually), and setting your company up for explosive growth when the alligator arms re-grow. (Alligator arms are what some people get when the bill comes to the table and their wallet suddenly is out of reach). Also, well-capitalized companies often end up overspending, delivering too much complexity, and learning bad habits that are hard to unlearn later. Yes, 2009 may be an endurance test. The companies with the most money are often the most risk-averse. But the risk takers, mavericks, angels, and (just maybe) a select few health industry innovators will reap the rewards in 2-3 years of some huevos today.

Comment by Henry Albrecht

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