Four Red Flags for Digital Health Investors

10/30/13Follow @johnsungkim

It’s been a banner year for startups raising money to start digital and mobile health businesses—enough to spark a recent Time magazine article called “The Obamacare Start-Up Boom.” Here in San Francisco, it seems the number of job applicants my own digital heatlh company receives, as well as the number of attendees at health technology meetups, keeps swelling each month.

It’s hard to say whether the investment dollars flowing into digital health startups have reached “bubble” levels, but what’s clear to me is that many angels, and even experienced venture capitalists, fail to appreciate the significant growth challenges these companies face.

Having taken two SaaS companies from garage to profitability—including my current company, DoctorBase—I’ve learned that there are four red flags that investors should watch out for when learning about new startups in this space.

1. The wrong ratio of hustlers to engineers.

I have the privilege of mentoring other startups at the UCSF Entrepreneurship Center as well as judging startups in hackathons like Pre-Backed, whose teams compete for a contract with large provider entities like Wellmark Blue Cross and Blue Shield.

Unlike many other early stage technology startups, these companies usually have three business people for every one engineer. That’s not sustainable. Healthcare applications and services often require integrations into legacy systems, and that takes database engineers, competent network and systems administrators, and seasoned user interface designers who know enough about coding to be familiar with the “front end stack.”

While one brilliant engineer can surround him or herself with three business-minded folks who land that promising pilot, getting beyond the pilot to a full blown repeatable deployment requires another set of resources entirely. Medium- to large-sized customers in B2B healthcare will ask for integrations into legacy systems, change their mind and ask for “critical” features at the last minute, and require startups to navigate a maze of legal, regulatory, due diligence and budget cycle hurdles.

When investing in other digital health startups or evaluating potential early-stage partners, I look for a 3:1 ratio of engineers to business people if the startup has 4 or less employees, a 2:1 ratio if they have 5 to 12 employees, and a 1:1 ratio at 13 to 25 employees.

2. Completely unrealistic assumptions about user acquisition costs.

At a recent digital health startup presentation by a brilliant Stanford student turned health-tech entrepreneur, someone in the audience asked, “How are you going to get doctors to actually use this?”

Her reply was, “Because patients are going to demand it and they [doctors] are going to have to cave in to this demand.”

Wrong answer. Not only does it cost about $2,000 to get a doctor to become an active user of any software or mobile application (just ask anyone who has advertised to doctors in Google or LinkedIn), but healthcare professionals hate being “forced” to do anything, especially in these sensitive economic times where they feel they are the victims of a rapidly changing system.

A founding team whose attitude toward doctors, nurses, and staff is basically, “they’re technophobic idiots who we’re going to teach a modern lesson to,” is in for a rude awakening. They may be able to create some noise by grinding away at a few dozen customers, but healthcare providers by and large will find a way to give the proverbial finger to such startups as they try and scale. After all, there are only about 600,000 physicians and 200,000 dentists in this country, most of whom belong to professional organizations where they routinely share clinical knowledge and vendor reviews.

Startups whose strategy is to obtain patient consumers first should know that it costs more than $22 per click to be in the #1 position in Google Adwords for the keywords “Physician San Francisco.” Oftentimes when I tell that to startups focused on B2C, their spreadsheets and expectations change wildly.

Teams whose business plans call for Internet marketing and social media campaigns to obtain users will need to … Next Page »

John Sung Kim is the founder of the cloud software company Five9 and founder and CEO of the digital health company DoctorBase. Follow @johnsungkim

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  • http://www.doctorbase.com/ Zach Landman, MD

    Great insight into the complex world of healthcare innovation. To add to what you said, everyday there is another savvy MD and their cunning nephew engineer throwing another promising product into the mix. They sound great, they address a certain problem, and some even have scalable potential and market size.

    However, as you touched upon, we’re in an age where there is a surplus of great ideas and MVPs (minimally viable products) and a dearth of companies able to navigate the complex healthcare environment. Hospitals, IPAs, ACOs, HMOs, MSOs, healthcare systems, individual practitioners, group practices, multi-specialty organizations, medical societies, payors, and vendors all have differing and complex needs. If the company doesn’t understand how vastly different (in terms of culture, complexity, costs, revenues, sales cycles, etc.) each niche is, then they’re likely in for a rude awakening.

    • http://www.hitconsultant.net/ Fred Pennic

      Zach, your closing sentence sums it up perfectly. Great article John!

  • Tom

    Definitely forwarding this article to anyone I hear say “I think I have a great idea and I am going to get in the start-up game.” Not to crush their dreams, just too give them a realistic look into what it takes to do it right.

  • Mike

    Although the doctor/office manager usually makes the decisions, at the end of the day, the office staff are often the front end users. If the service doesn’t fit into their work flow, problems ensue. Emgerging health-tech start ups must take this into account… an amazing product is useless without users… better make sure yours is office staff friendly!

  • Jamien

    Successful startups, no matter the industry, learn very quickly that success is heavily dependent on sales, marketing and user experience. When you have as fragmented an industry as healthcare, this is even more relevant.

  • http://www.vongehrconsulting.com/ Erroin Martin

    Excellent article. Each point you made, especially the first and the third, I have seen violated numerous times. (I do believe the fourth gets violated by most start-ups no matter what the market is because they love their idea and cannot see the reality of the market.) On my own journey in a couple of healthcare start-ups, I will refer to this post repeatedly. Thank you.

  • http://www.wellnessfx.com/ jim kean

    Great article John! I think the other aspect of the current seed stage scene is that the current capital structure of Silicon Valley has vast stage gaps. A decent enough seed stage idea can land funding. If you can get to cashflow breakeven there is also Series D expansion capital (lots of funds in fact). The problem is expansionary capital for the arid capital desert from early expansion (Series A) to late stage but pre breakeven (Series C) is sparse. Most healthcare VCs that are left in that portion of the capital structure are either relics of the 90s (can’t spell IT), biotech or med-device investors (barely know what a computer is), or are inexperienced VCs from the consumer tech side (unknowledgeable about Healthcare). On top of that, the number of hungry mouths (e.g. the graduating seed stage companies) are all competing in this limited environment.

  • Keith Streckenbach

    Spot on John! As a veteran with successful HIT exits, I’ve the scars to prove you’re 100% correct. Thanks for succinctly sharing the wisdom.

    Keith Streckenbach