Diligencing Healthcare Companies, Part I: Pitch Deck Screening and Initial Call

Introduction

What is the true purpose of due diligence, anyway? Pose this question to a thousand investors, and you're likely to receive a thousand different responses, especially in the early stages where hard numbers are scarce. The most coherent answer I've encountered—an amalgamation of insights from numerous individuals—is that due diligence in investing is essentially the process of transitioning from a skeptic to an advocate for the company.

No matter how you get to a “Yes” or “No”, what most experienced investors will tell you is to have a consistent methodology towards gathering information, so you can develop a repeatable process as you look at thousands of companies in your investing journey.

So, how do we at The Healthcare Syndicate approach our due diligence? In this series, I aim not to prescribe a rigid framework but to outline the overarching goals of each phase of our diligence process, including some specific questions we pose to healthcare-oriented companies. Our goal is to enrich investors' healthcare diligence frameworks and offer a glimpse into our operations for healthcare founders.

Without further ado, lets jump in!

Pitch Deck Screening

Our typical engagement with prospective companies starts with their pitch deck. If you’re looking for some amazing insight here, prepare to be disappointed. Most pitch decks we receive are usually well structured, presenting information that typically make the basic cut for a venture opportunity. For the uninitiated, this can broadly be summarized in a few bullet points:

• A big problem with a large ($1B+) market opportunity

• A novel, defensible solution

• Led by a capable team that has the potential to grow the company value by at least 10X.

Assuming the founder has checked the above boxes, and beyond screening for other types of investment risk criteria (revenue stage, fundraising progress, etc), further quantitative analysis probably won’t help too much in screening companies quickly.

So what should we look for instead?

I believe that looking for something unique or different in the company is the most important exercise in the screening phase. Why?

Building early stage companies is truly an exercise in going from 0 to 1, and as early stage investors, the most important risk we are underwriting is existential risk, or the risk of going out of business. Given that early-stage ventures typically don't generate sufficient cash flow to be self-sustaining, their capacity to distinguish themselves amidst a sea of competitors is critical for survival. Some examples of uniqueness I look for related to healthcare are:

• Unique take on the clinical problem (ex: Key to successful chronic pain management is the acceptance of pain, not the just reduction of the causes of pain itself.)

• Differentiated solution compared to typical approaches (GoodRx secures low-cost drugs through negotiations with PBMs, unlike direct discounts from drug manufacturers or pharmacies.)

• Unique distribution channel or target customer (ex: Warby Parker selling prescription glasses online vs traditional physical store.)

• Unique founder background that is relevant to the problem being solved. (MeCo Diagnostics founder Adam Watson saw the financial devastation of recurring breast cancer in his extended family)

Another reason to find some unique aspect that piques your interest? On a personal level, you are about to spend alot of time on better understanding the company and the founders, so it’s a good idea to find a company that will keep you interested throughout the diligence process.

If you find the company sufficiently unique and interesting, it’s time to set up a call!

The initial interview: The Who and The Why

Whether by Zoom, phone, or in person interview, the initial call is an important way for us to get a feel for who the founder is, and get to the heart of why they’re in this venture at all.

You’ll notice below while the answers we expect are typically healthcare specific, we don’t ask any healthcare specific questions. That’s because we believe the founder qualities are best understood with open ended questions, and really speaks to who this person is inside and outside of their venture.

Two questions I always lead the discussion with are:

Why did you pick this venture?

Healthcare ventures aren’t for the faint of heart, and I’ve rarely encountered a founder that wasn’t in the top 1% in some aspect. Given entrepreneurship is an exercise in extreme focus, it’s important for us to understand the rationale behind why they chose this particular topic when there are clearly many other opportunities they could have pursued.

While different investors resonate with different background stories, we find that compassion is an important aspect of the story we like to hear. While passion is an oft-cited success factor in entrepreneurs and securing funding, passion alone can be self-serving.

Compassion, however, motivates the founder to light the way for others to do better. Healthcare is fundamentally a business servicing patients, and founders who are motivated personally to solve someone else’s problem will develop the most relevant solutions for patients.

Why do you want to venture scale this company?

Part of achieving venture outcomes is a relentless march towards scale. The market tailwinds might be there, and the company might have top-notch technology, but none of those factors matter if the founders don’t have the desire to achieve venture outcomes. While I’m not a big fan of growth at all costs, the founders do need to at least be aligned with investors on the expected financial outcome for the company.

Beyond these two key questions around the who and the why, we also like to ask questions around defensibility of the product and go to market strategy to get a sense of how confident the company is in their competitiveness, and how much awareness they have of the competitive landscape:

If competitors were to have the same exact underlying technology, what other ways can you differentiate from them?

Technology advances alone are rarely enough to have a long and durable advantage in the market. Chances are someone has already worked on something similar, and once the company’s product hits the market, competitors will be racing to see how they can access the same market opportunity. Knowing why their product is unique, and why their customer will stay loyal to them is critical to understanding how the founder plans on being a market winner for many years to come.

For example, failure to collect on patient responsibilities are a large contributor to hospital bad debt, and companies are springing up to improve the dismal collection rates through innovation in pricing estimates, consumer-like payment interfaces, and alternative financing. While healthcare payments can use alot of improvements on the frontend, the root cause of poor collection rates lies in providers attempting to collect payment after the patient has left the provider premises.

Clear Health understood that challenge, and while their solution leverages similar algorithms and pricing techniques, they’ve adapted these underlying methods in a non-intuitive way to instead create a white-labeled prepayment portal, which reduces sticker shock, improves patient satisfaction, and increases collection rates. Such positioning requires intimate knowledge of the real underlying problem and isn’t easily replicated.

If someone were to replicate your product, what obstacles would they face that would prevent them from providing the same offering?

Unfortunately for technically oriented founders, patents really don’t matter too much, and are only useful if you’re ready to spend a fortune defending patent infringement. However, even if the market advantage isn’t there, there are still some cases to be made for a defensible product where the founder had some non-intuitive or unique insight into the technology, and it is not a straightforward process for competitors to copy. In this case, the unique development path of the technology alone might give the company additional time in the market to build additional defenses against competitors.

For example, MeCo Diagnostics has developed a diagnostic test to guide breast cancer recurrence treatment with generic antifibrotic drug. This novel use of a low cost treatment was possible because of their exclusive agreement with the Spanish Cancer Consortium (CNIO) to leverage a previous one of a kind phase II study on the efficacy of antifibrotics against breast cancer recurrence, which puts them at least 2 years ahead of any competitors who would want to develop a similar diagnostic+therapeutic combo.

Conclusion: Thinking Fast

In Daniel Kahneman book “Thinking, Fast and Slow”, he defined “Thinking Fast” as the mind's rapid-fire method of arriving at judgments, making quick decisions, and processing information on the fly, without the painstaking effort of detailed analysis.

In this initial screening phase, where aligning values and identifying resilient leaders is key, embracing intuition becomes not just beneficial but essential. The ability to discern which founders possess the unique blend of vision, grit, and adaptability required to cross the finish line cannot always be reduced to numbers or metrics.

This approach, though seemingly less tangible, is crucial in the art and science of venture assessment, where the future potential often lies hidden within the unquantifiable, so don’t be afraid to use your intuition when evaluating the founder’s response to your questions!

Now that we’ve covered how to screen companies, follow us over the next few weeks as we cover how we do a deep dive on companies that pass our screening to eventually create a compelling deal memo. Stay tuned!

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