By: Michael Esquivel

Last Friday, Fenwick & West hosted its 2013 Digital Health Investor Summit bringing together investors, entrepreneurs, innovators and thought leaders interested in digital health for a program designed to deepen and accelerate our understanding of this burgeoning industry. Organized in conjunction with our partner Rock Health, the Summit was engaging and thought-provoking and provided us with a glimpse of the many opportunities and potential challenges confronting the digital health sector. Here’s our recap video of the event with special appearances by Christiaan Vorkink of True Ventures, Ann Waldo of Wittie, Letsche & Waldo and Rock Health chief strategy officer Malay Gandhi.

I also recommend checking out Wade Roush's recap of his keynote interview with Chamath Palihapitiya in Xconomy, "Chamath Palihapitiya Wants to Rewire the Crap Out of Healthcare." He includes an edited transcript of that interview.

By: Matthew Rossiter

The need for innovation in healthcare has arguably never been greater.  A range of factors, from aging world populations to rising standards of living in developing countries, are poised to drive long-run demand for innovative drugs, devices and medical technologies that can improve outcomes and reduce costs. 

Ironically, however, funding for healthcare innovation remains in short supply.  As industry participants are keenly aware, life science venture capital financing – which has played a critical role in helping translate research ideas into commercially useful medical technologies – is becoming increasingly scarce. 

Understanding the Capital Crunch

Results from a recent survey of 2012 life science venture capital (VC) activity by Fenwick & West illustrate the magnitude of the situation.  The survey summarizes results from over 350 therapeutic, diagnostic and medical device financings occurring during 2012, and shows that financing valuations continued to trend modestly upward, evidence that companies are continuing to develop promising technologies that justify a step-up in valuation. 

However, fundraising by life sciences VCs has continued to decline.  While overall VC fundraising rebounded modestly during 2011 and 2012, the percentage of fundraising allocable to life science investments declined from 19% in 2009 to 12.5% in 2012.  In absolute dollar terms, we estimate that fundraising by life science VCs was $2.5 billion in 2012, compared to an average of $2.9 billion/year for 2009-11 and an average of $7.8 billion/year for 2007-08. 

Given these fundraising statistics, it should come as no surprise that 2012 saw the fewest first time venture financings of life science companies of any year since 1995, according to the MoneyTree Report.  Venture capitalists typically spend three or four years making new (first time) investments out of a fund, and then reserve the fund’s remaining capital for follow on investments.  So at this point, the 2008 vintage funds have stopped making new investments, and there are fewer new funds to fill the gap.

Navigating the Capital Crunch

In the face of this capital crunch – which appears likely to continue for some time – what is the aspiring life science entrepreneur seeking financing to do?  Plenty of smart people are giving thought to this topic, and the early stage financing ecosystem is evolving.  In the meantime, however, I think it’s helpful for entrepreneurs pursuing venture financing to bear in mind two simple and related points:

• Recognize the timing mismatch: while life science technologies mature slowly, VC investment horizons are limited.  Venture capitalists, no matter how enthusiastic they may be about your technology, are constrained by fund structures that require them to return capital to their investors within ten years.  And practically speaking, VCs are often making investments several years into a fund’s life, and need to show returns to investors in order to raise their next fund as well.  The net result is that VCs are under considerable pressure to seek investments that can exit in five to seven years, ideally sooner.

On the other hand, life science technologies – which invariably must navigate significant R&D and regulatory challenges – can take well longer than five, seven or even ten years to mature and demonstrate their full value. 

Adding to the challenge, today’s public markets are less receptive to development-stage life science companies, meaning that investors can no longer count on the possibility of an IPO to provide an exit opportunity.  Recent years (2011-12) have seen an average of 10 IPOs of venture-backed life science companies per year, in comparison to 25+ per year for 2004-07.  And as noted elsewhere – for example Fenwick’s IPO Survey – more than half of the life science companies that went public in 2011-12 priced below their target range.

• Address the timing mismatch: increase your odds of raising venture financing by planning your business for exit from the outset.  Every thoughtful entrepreneur recognizes that investors need to see a path to “exit” their investment and realize a return.  However, there are key steps that can be taken – from the earliest stages of the business – to enable a quicker exit.  And in today’s capital constrained environment, going the extra mile and enabling a quicker exit is helpful, if not essential, to raising scarce venture funds.

There are various ways to enable a quicker exit, for example:

• Pursue technologies that can reach key value-inflection points sooner.  Resolve Therapeutics did this successfully, pursuing a lupus treatment where proof of mechanism could be established quickly using biomarkers. This helped the company go from research concept to a $255 million partnership and option deal with Takeda in little over two years.

• Consider working with a corporate investor earlier.  Corporate investors are increasingly willing to work with life science companies from the earliest stages (for example, Novartis’ Option Fund), and can provide validation, invaluable feedback on market potential, and a potential path to exit.  As various industry observers have noted, companies with corporate investors involved tend to be more successful.  In some cases, a potential sale to a corporate investor can be built in from the get-go, as done for example by Warp Drive Bio.

• Adopt a business structure that permits tax-efficient sales of assets, prior to a sale of the entire business.  These structures, which typically involve a limited liability company or “brother-sister” corporations under common ownership, have been discussed in the industry for some time.  They are particularly well-suited to drug discovery platform companies, but can work with other business models as well, and have the virtue of allowing an earlier return of investor capital, de-risking the investment and improving overall investor IRR.  The key point for the entrepreneur to recognize, however, is that in order to avoid a potentially insurmountable tax cost, these structures must be implemented early, ideally at company inception.

As supply and demand factors play out, the early stage financing ecosystem will continue to evolve.  Established pharma and device companies, disease foundations and other non-VC investors are playing an increasingly important role.  And perhaps in the not too distant future, big data analytics tools and digital health technologies to support better clinical trials will mature that can help shorten the cycle and reduce the cost of life science R&D.  But for entrepreneurs operating in the here and now, thoughtful early attention to the path to exit remains critical to raising scarce investor capital.

Note: This article, Navigating the Capital Crunch, was originally published by Xconomy in April. 

By: Michael Esquivel

With venture capital funding of digital health up 45 percent in 2012, according to Rock Health, we're hearing a lot about mobile health apps and healthcare IT. You may be asking yourself what is digital health? Hear my take on digital health which I see as the next evolution in personalized medicine. In the video, I describe technologies to get excited about and the hot digital health companies bringing advancements to market.

By: Michael Esquivel

Recently, the Pew Internet & American Life Project (the “Pew Internet Report”) reported that nearly 70% of Americans are monitoring one or more health metrics for themselves or a loved one, but only 21% of those are using a technology tool to help them keep track.

Furthermore, of those who are using technology to track health metrics, only 7% are using apps or other tools on a mobile device. In contrast, half of the respondents indicated that they track health metrics “in their head,” and another 34% said they track health data on paper.

I recently had a conversation with Pam Dolan at American Medical News about the Pew Internet Report. She covered the findings in a story titled, “Has mobile health monitoring hit a wall?” Despite the title’s implication, what I conveyed to her is my strong sense of optimism in looking at these numbers. When you realize that 70% of people in the U.S. are currently tracking data related to their health and that only a small percentage of that group are using technology to help, the potential for growth is both tremendous and clear. What’s surprising is that most commentaries on the report have characterized the findings as proof that the digital health market has plateaued.  

People are buying and using digital health devices and apps in record numbers. The concern is that once the novelty wears off users lose interest and, consequently, engagement wanes. This concern in turn has led to a huge focus on providing actionable and meaningful data that actually improves your health.

As Jack Young of Qualcomm Life Fund has commented, the perfect mobile health device is a bathroom scale that records your weight and transmits the information to your computer where it is tracked over time. It’s passive, usable, actionable, and doesn’t require the user to change their routine.

The take away of the Pew Internet Report is not that Americans’ interest in using digital and mobile tools to track health metrics has plateaued, but rather that we are only beginning to learn how to develop the right technologies that will empower us to more actively engage with our health.

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Who will pay for digital health apps?

Price Transparency and Active Wellness

Has Digital Health Found a Home at SXSW?

Overview | Pew Internet & American Life Project

70 percent of Americans track their health, but most go low-tech [GigaOM]

By: Michael Esquivel

The New York Times’ health and science blog, Well, recently published a post discussing the results of an informal quest to find the price of a hip transplant. The post received widespread attention and commentary because of its unfortunate results: it was nearly impossible to get a price quote, and the price quotes that were obtained varied by a factor of 10 and bore no relationship to either the reputational quality of the healthcare provider or the quality of the surgical services to be provided. Some of the most well-regarded hospitals quoted some of the most reasonable prices, while some less highly regarded hospitals quoted very high prices. The bottom line: there is currently little price transparency or rationality in the healthcare system. As a result, there is no 'market' in healthcare, yet.

Fortunately there are startups that are seeking to address this lack of transparency. Castlight Health, a Fenwick & West client, is a leader in this emerging space. Some insurers, moreover, are also trying to cut through the pricing opacity. The Arizona Republic recently reported that some insurers, as well as the federal government, are beginning to provide pricing information through web-based tools.

Irrespective of how we get there, price transparency—leading to price rationality—has the potential to jumpstart the transformation of healthcare. Price transparency, in addition to potentially lowering cost, also has the potential to spur behavioral change. Once individual consumers understand the true cost of healthcare, and that they are—one way or another—paying for it, they may become more active in their pursuit of wellness.

And it is becoming easier to pursue active wellness today than ever before. Hundreds of new devices and apps allow individuals to monitor various aspects of their health condition, which has in turn powered the quantified self movement. For now, quantified self is mostly about understanding one's activity level (or lack thereof) and basic biosigns such as heart rate, blood pressure, blood glucose and so forth. But eventually it has the potential to lead to individual empowerment on a molecular level. Spotting a dangerous biomarker before physical symptoms manifest could potentially lead to early detection of serious illnesses, and consequently early intervention. Early detection and intervention leads to better outcomes, which further reduces cost—a beneficial loop for individuals and healthcare as a whole.

By: Michael Esquivel

The question of whether or not smartphone apps can play an important role in the delivery of healthcare services has been more or less answered with a resounding yes. From weight loss to diabetes monitoring to diagnosing ear infections, successful digital health models and pilot programs have provided compelling proof of concept that there is potential to improve users’ well being and health through the use of these apps.

The remaining questions are: who will pay for these apps, and how will the developers make money? For now, the partial answer is that individual patients and consumers are the buyers of these mobile health apps. In today’s healthcare market, consumers do not typically pay directly for products or services; nor do they usually pay for 100% of the actual cost. Those expenses are borne by payers, a combination of private insurance providers, public insurers (e.g., Medicare and Medicaid), and employers who either pay a significant portion of the cost of private healthcare insurance for their employees or are self-insured.

Developers often assume that insurance companies will be their ultimate customers. But insurers require proof of effectiveness before they are willing to extend coverage to a new class of products. The insurance industry is also large, relatively slow moving, and tends to follow the lead of large public insurers when it comes to granting a product a reimbursement code.

That fact that many mobile health apps are aimed at wellness or prevention may also be viewed as an obstacle. Most private insurance in the U.S. is tied to employment, and patients move from one insurance carrier to another on average every seven years. This creates a potential disincentive for insurers to invest in prevention as they likely will not reap the long-term benefits of any investment in wellness, including prevention apps and related technology.

This historic disincentive, fortunately, is beginning to wane. The Affordable Care Act is shifting the payment paradigm from a fee-for-service model to payment for outcomes, and it is this fundamental shift that will put more of an emphasis on prevention and disease management, which is exactly where digital health apps have been initially successful.

So what does all of this mean for developers looking for revenue? In the short-term there are three key customers:

• Individual consumers/ patients who will pay out-of-pocket for apps that demonstrate value to them in terms of quality of life;
• Employers who want to reduce or manage healthcare costs by improving the health of their employees; and
• Integrated payer/ providers (e.g., HMOs) who have a long-term stake in their members’ health.

In the longer term, a combination of payers and providers will likely become the primary buyers for mobile health technologies through Accountable Care Organizations (ACOs). These organizations will have greater financial incentives to maximize their members’ long-term health. Even so, developers should anticipate that these organizations will, as noted above, require proof of effectiveness that their digital and mobile health apps and technologies are improving patients and consumers’ health and well being before they should expect their apps to be purchased and integrated into ACOs’ preventative and wellness platforms.

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Big Data Could Save Healthcare System $300+ Billion Annually

By: Michael Esquivel

According to a recent report released by Rock Health, Big Data has the potential to save the healthcare system more than $300 billion per year by improving poorly coordinated care, reducing fraud and abuse, and improving administrative and clinical efficiency. Big Data refers to the insights that organizations—in this case providers, payers, and drug and device development companies—can gain from analysis of growing sources of structured and unstructured data from electronic medical records, sensors, and smart phones. Collecting and analyzing the vast amount of data currently available provides the opportunity to identify trends or patterns to improve quality and lower the cost of care. Big Data applications (apps), for example, could identify leading causes of hospital-acquired infections or readmissions, which could lead to better preventative measures while lowering the cost of care.

Harnessing the power of the tremendous amount of data available also has the potential to improve drug research and development by managing and analyzing the growing pool of public and private genomic information. By leveraging Big Data, companies hope to improve drug development by better identifying drug candidates for targeted therapies and reducing the risk of clinical trial failure. Scientists are already using genomic data to improve their understanding of several different types of cancer.  

Big Data also faces some important adoption challenges and legal concerns. Consumer concerns about privacy and security of personal information remain key issues. Companies using healthcare data to develop apps often need to balance access to relevant information with consumer privacy concerns. Leaders in cancer research have already expressed concerns about how barriers to disclosure of medical information could limit future advances. Federal laws also regulate collection and use of a consumer’s medical data. The Federal Trade Commission (FTC) requires businesses to obtain a consumer’s affirmative consent before collecting and sharing medical information. Furthermore, the Privacy Rule under the Health Insurance Portability and Accountability Act (HIPAA) contains extensive regulations on the use and disclosure of individually identifiable health information. 

The HIPAA Privacy Rule defines individually identifiable health information broadly. The definition includes information that relates to an individual’s past, present or future physical or mental health condition and for which there exists a reasonable basis to believe that the information can be used to identify the individual. A key challenge for data driven apps in healthcare will be distinguishing between identified health information that is tightly regulated and de-identified information, which the Privacy Rule does not restrict. The Privacy Rule, moreover, defines de-identified health information as information that neither identifies nor provides a reasonable basis to identify an individual. Information can be de-identified for the purposes of the Privacy Rule by a safe harbor approach, which requires removing 18 different identifying markers from the information. On top of the expansive definitions, the rule contains several restrictions, as well as exceptions, on how covered entities—defined as health plans, providers and healthcare clearinghouses—use health information.

Congress has also recently enhanced security protections for personal health information. The Health Information Technology for Economic and Clinical Health (HITECH) Act, passed as part of American Recovery and Reinvestment Act of 2009 (ARRA), provides breach notification regulations. Under the HITECH Act, HIPAA-covered entities must promptly notify affected individuals of a breach, as well as the Department of Health and Human Services (HHS) Secretary in certain instances. The HITECH Act contains strict penalties for data breaches, even for breaches caused by third parties.

The insights potentially discoverable through Big Data represent a significant opportunity to transform the delivery of healthcare services and the development of new treatments for serious diseases like cancer. Successfully implementing these solutions will require diligent management of consumer privacy and security concerns. Perhaps most importantly, any app that uses medical data will need to consider privacy and security law compliance issues.

By: Michael Esquivel

The Federal Trade Commission (FTC or Commission) recently published a guide, Marketing your Mobile App: Get it Right From the Start, to help mobile app developers understand FTC advertising and privacy rules. The publication follows agency actions against two mobile app developers regarding information collection and product claims. In one such agency action, an app developer paid $50,000 to settle FTC charges that it failed to require parental notice and consent before collecting and disclosing children’s personal information.  A second developer settled with the Commission after claiming without proper substantiation that its mobile app treated acne. Advertising claims and privacy issues both have special importance for digital health and mobile health developers because of heightened advertising and privacy concerns for products that make health or safety claims or collect medical information.

For marketing and advertising, the FTC focuses on the truthfulness of claims and proper disclosure of the information. Specifically, in advertising their product, app developers should have solid proof of objective claims about what the app can do. The FTC advises additional caution when marketing apps that have health or safety benefits. Such claims may require what the FTC calls competent and reliable scientific evidence. Precisely what constitutes competent and reliable scientific evidence has been subject to some interpretation. In the past, the FTC defined acceptable scientific evidence as "tests, analyses, research, studies, or other evidence based upon the expertise of professionals in the relevant area, that has been conducted and evaluated in an objective manner by persons qualified to do so, using procedures generally accepted in the profession to yield accurate and reliable results” [Brakeguard Products, Inc., 125 F.T.C. 138 (1998)]. For most companies, including app developers, this may mean referencing existing scientific data or studies to substantiate claims about health or safety benefits of a product.

In addition to the content of claims, the FTC established a “clear and conspicuous” standard that seeks to ensure key information is plainly disclosed. While the law does not generally dictate font size or text type, the FTC has taken action against companies who have put key terms behind vague hyperlinks or in long blocks of legal text. Generally the FTC recommends disclosures that are big enough for consumers to read, presented in a way that is easy to understand, and placed close to the claim that the disclosure qualifies.

For privacy issues, the FTC recommends mobile products incorporate privacy by design, provide transparency about data practices and offer choices about data collection that is easy for the consumer to find and use. Privacy by design means securely storing user data, limiting the information collected and disposing of unneeded information. Transparency means explaining what information is collected, how it will be used and if the information will be shared with others. Developers frequently disclose such information through a privacy policy link in the application.

In addition existing law provides special protections for health or financial data or information provided by children. Under the Children’s Online Privacy Act (COPA), apps directed at children under age 13 or with actual knowledge that a user is under age 13 must explain their information practices and get parental consent before collecting such information. Additionally, the FTC advises getting consumer’s affirmative approval before collecting sensitive information like medical data or financial information. Digital health and mobile health app developers who collect medical information should also be aware of existing state and other federal laws regarding the collection and sharing of users’ data.

The recent settlements by two app developers and the FTC’s publication of these guidelines signal that the Commission will enforce advertising and privacy regulations on app developers regardless of size or level of development. They also represent an increased interest in mobile applications from national policymakers. Given the more rigorous standards for healthcare advertising and medical privacy, digital health and mobile health companies should pay close attention to these guidelines while developing and marketing their products.

By: Michael Shuster

On October 5, the United States Supreme Court agreed to review the case Bowman v. Monsanto Co., Docket No. 11-796 (USSC 2012). The high court will be taking on the question of patent exhaustion in seeds, specifically Monsanto's "Roundup Ready" seeds. Monsanto sells the seeds, which grow into plants resistant to the herbicide glyphosate, aka Roundup. Bloomberg coverage of the case highlights the legal issues surrounding the conditional sale exemption, a doctrine adopted by the Federal Circuit, allowing patent holders to enforce their rights against buyers downstream.

We don't have the briefs yet, or for that matter the amici briefs which will no doubt be plentiful and fascinating, but we can gather from the questions presented by the parties in favor of and opposition to the writ that this could well be a seminal patent case (apologies for the pun). Law professor, Dennis Crouch, covers the latest developments in the case on the Patently-O blog.

Bowman argues that he is entitled to the patent exhaustion doctrine. That is to say that after the original authorized sale of the seeds Monsanto's patent rights are extinguished, which is how the patent exhaustion works in most other products. Of course as a practical matter this means that a farmer needs to buy Monsanto's seeds only once, because every subsequent generation of seeds germinated from the plants sprouting from the originals are free and unencumbered by the patent rights that belong to the original generation. Bowman asks the Supreme Court to find that the Federal Circuit erred when it created, in Bowman's view, "an exception to the doctrine of patent exhaustion for self-replicating technologies."

Monsanto argues that it owns patent rights in a genetically modified plant, and the fact that it is a self-replicating living organism is irrelevant because the patent rights "are independently applicable to each generation of soybeans embodying the invention, such that a grower who, without authorization from Monsanto, creates a new generation of genetically modified soybeans infringes Monsanto's patents."

It is never a good idea to attempt to predict a Supreme Court outcome, especially before the briefs have even been filed, but given the Court's recent track record on life science patents this may not yield a good outcome for Monsanto.

By: Matthew Rossiter

Times are tough in the life science financing environment, as underscored by numerous recent news stories as well as quarterly statistics from Dow Jones VentureSource and The MoneyTree Report.   

However, Fenwick’s First Half 2012 Life Science Venture Capital Survey highlights a few potential bright spots as well.  In particular, while the number of life science financings declined significantly during the first half of 2012, our survey indicates that valuations have improved modestly, and we also see evidence that large biopharma and medical device companies are increasing their support of startup ventures.

Fenwick’s latest survey analyzes venture financings for 186 U.S.-based life science companies over the first half of 2012. One metric used to assess the health of the life science funding environment is to look at the change in share price from one round of funding to the next.  In 2012, the trend has been positive, with average price increases of 19% and 26% for Q1 and Q2, in comparison to average price increases of 4% and 11% for Q1 and Q2 of 2011.

Another way to look at the data is to measure how many funding rounds occurred where the price per share increased (up rounds) or decreased (down rounds) from the previous round.  For the first half of 2012, up rounds outpaced down rounds 53% to 19%, with 28% flat. This is a modest improvement over results from 2011, which averaged 47% up rounds and 25% down rounds, with 28% flat.

It is important to put these valuation trends in context: fewer life science financings are occurring, and the life science valuation figures trail those of other industries covered by our Silicon Valley Venture Capital Survey.  However, the upward trend in valuations is an indication that startups are continuing to develop promising technologies that can justify a step up in valuation – in other words, there is a healthy supply of promising new ideas.

Likewise demand for new ideas with demonstrated potential, in the form of acquisitions of life science startups by large life science companies, also continues to be strong.  A recent report from Silicon Valley Bank, as well as blog posts by Bruce Booth (Atlas Ventures) and Bijan Salehizadeh (NaviMed Capital), highlight the continuing strength of the current life science M&A market.

But while these supply and demand factors continue to be strong, there is currently less funding available to life science startups that seek to develop and advance new ideas.  So it is perhaps unsurprising that we also see large biopharma and medical device companies – who continue to rely on acquisitions of startups to help refill their product pipelines – becoming more involved in providing funding to the life science startup sector, and more creative in the means by which they do so. For example:

• The venture arms of larger corporations have always played a role in the life science sector, but participation has been increasing recently, with the National Venture Capital Association and Thompson Reuters reporting that corporate venture capitalists participated in 17.5% of all life science financings during the 2011 through 1H 2012 period, up from 15.3% of all financings during the 2010 through 2011 period.
• In addition, some large corporations are partnering with established venture capital firms, both by making direct investments into venture capital funds and by forming innovative collaborations that combine corporate and venture capitalist resources and expertise, to identify and develop promising early stage technologies. Recent examples of this trend include collaborations between Merck and Flagship Ventures (2012), Johnson & Johnson, GlaxoSmithKline and Index Ventures (2012), and Shire Pharmaceuticals and Atlas Ventures (2011).
• And in some cases, large corporations are providing funding and resources directly to early stage companies, such as Johnson & Johnson’s recent announcement that it would establish “innovation centers” in San Francisco and three other cities.