Unlike web deals, healthcare investing is growing faster outside major hubs

By Sarah Lacy , written on April 15, 2015

From The News Desk

Yesterday, Dennis Keohane wrote a fascinating break down of the biggest findings from CB Insight's first quarter venture capital report. One stat didn't get quite as much attention here or anywhere else: Healthcare deals are retreating from the major tech hubs. According to the report, for the first time since 2013, mega-funding hubs like California and Massachusetts were home to less than 50% of all healthcare deals.

This has been part of a long, slow continental drift going back to the earliest days of the venture industry. In theory, healthcare should be square in a VC's wheelhouse. Big pharma has gotten so big it's stuck with an innovator's dilemma: It'll always be rewarded for continuing to reinvent its main franchise drugs in categories like insomnia, depression, erectile dysfunction and heart disease-- things that plague many many Americans and make for sometimes bizarre/hilarious/ sentimental TV marketing campaigns. Curing horrifically debilitating diseases that affect a narrower swath of the population, however, just don't pay the bills at that scale.

Indeed, most of the early venture capital giants were built with practices in healthcare and IT-- from Kleiner to IVP to Mohr Davidow to NEA-- the list goes on and on. The Internet changed harmony between those partners just as it did nearly everything else in Silicon Valley. In the 1990s, web deals were so outpacing everything else so quickly that several partnerships had acrimonious splits so one group could play by the sexy, lucrative "new economy" rules, while the rest wanted to invest in something way more risky even with clinical trials and government approvals. One of the most famous gave rise to Redpoint Ventures. (Disclosure: Redpoint is an investor in Pando.)

IPOs in a post-SarbOx era where research and banking departments split made things even trickier: Healthcare worked when VCs could rely on a raft of tiny IPOs to fund deeper clinical trials. Those became a lot harder to market and trade. Just as the human genome was finally uncoded, and we thought Amgen and Genentech were a new generation of biotech giants... they weren't. This is not to say healthcare VCs haven't done amazing work, made some good singles, doubles, and triples, and helped back cures and interventions that have saved lives. But that old stat that 95% of venture returns comes from 5% of the deals punishes the sector in sex appeal, investor interest, and returns.

A few years ago on Pando, I wondered why any venture firms still kept both disciplines in house. The games, the tactics, the marketing, the math, the types of people drawn to investing in each category just all seem so foreign from each other at this point. Totally different games -- while both can make money and make the world a better place when done well.

Today's report confirms that this drift isn't just continuing when it comes to some of the industry's most legendary partnerships -- but in geography. This isn't just about entrepreneurship expanding through out the US. According to the study, web deals are actually concentrating around major hubs more than in previous quarters, while healthcare is drifting away.

And notably, this was an up-quarter for healthcare deals. They didn't suffer the same IPO malaise as the tech sector in the first quarter. And VCs invested nearly $2 billion across 131 deals, up 34% from the same quarter a year ago. Six investments raised more than $50 million, but there was no single megadeal skewing the quarter up.

I don't want to overstate this: The report clearly states that like most other categories, the dominant hubs like California and Massachusetts are still the dominant hubs in healthcare investing too. Cambridge in particular had more healthcare deals than South San Francisco, St. Louis, and Durham combined. And all 10 lifesciences IPOs in the first quarter were based in California or Massachusetts.

But it's interesting that the trend is moving in the opposite direction from web deals.

So, who was the beneficiary of the Valley's healthcare "meh"? According to the report, "States outside of the major tech centers took nearly 44% of healthcare deals, with the most deals happening in Missouri, North Carolina, Pennsylvania, and Tennessee."

That last one is no shock to me. We spend a good deal of time in Nashville putting together PandoLand and I recently argued to the Nashville Business Journal that I couldn't imagine the coasts becoming a threat when it comes to Tennessee's strong growth in healthcare deals. It's a different game and while it's one that doesn't work so well with the typical Valley VC mentality, it works incredibly well in other centers in the states mentioned above where sales cycles are more methodical, require real domain expertise, and investors want to see results and revenues and reasonable valuation multiples as they go along. Nashville has been slowly, steadily building expertise, investors, and managers who know how to deal with insurance giants, hospitals, the government, and the rest since long before even I was a business reporter in Tennessee-- and let me tell you, that was a long time ago.

To be fair: Tennessee's national share is still tiny at just 4% in the number of deals. But it's startups are ranking nationally in healthcare at least.

A lot of ecosystems could learn from this: Facebooks and Instagrams sound great but the best way to stay relevant and attract investor dollars is to focus on something the Valley doesn't do well... or is gradually turning it's back on.

[illustration by Brad Jonas]