Panel Discussion – Digital Therapeutics – The new drugs? Backed by clinical trials, DTx are proving to be effective therapeutic solutions, used either on their own or coupled with drugs. They can collect large amounts of Real World Data, useful to develop or personalize drugs and treatments. They enable us to serve more patients, at a lower cost, from anywhere, 24/7… which resulted useful in the pandemic and reinforced, even more, the value of DTx for the healthcare systems. Where are we in terms of implementation? What does a successful partnership look like for a DTx company? What can we learn from the German regulation, and how can we make it happen in other countries?
Barcelona Health Hub Summit – Oct 29, 2020
Continuing our discussion with Edward Kliphuis – Venture Capital Behind the Scenes with Amadeus Capital Partners
Maybe to shift the conversation just a little bit, since you’re going to be speaking about digital therapeutics on the above panel – can you help us define digital therapeutics because we’ve seen different definitions?
It’s a tough one. For me, it is a digital intervention that can improve patient outcomes. That’s it, but quantifiably so, and there is a discussion ongoing whether that should be regulated or not. I think that it depends on the business. If there’s no quantifiable improvement in patient outcomes, then I believe the proposition becomes challenging.
What reaction do you have when somebody shows you yet another diabetes app?
It comes back to what I said earlier in the interview; There’s no wrong proposition; if there’s a good business case, then that’s a profitable business for you, But it might not be a profitable business for a VC, and that’s something which you are assessed on. To give you an idea, if you’re investing from a 100 million fund and you’re looking to make anywhere between 10 and 20 investments, then you’re looking for at least one or two of these companies to return the fund.
If as a VC, that means that one of these companies has to be a unicorn. We see many healthcare technology companies trading between eight to 12 times revenues. Let’s take ten times just for easy math; that means you’ve got to have 100 million in revenues. Is that going to be possible in the time frame of six-seven years?
That’s the back of the envelope math that many of my peers will do. The question then is if you slice it by, let’s say, the unit economics of individual users in churn, you’ll probably conclude that it’s not possible. If that’s not possible, you probably look for a dialogue with a different type of investor. Investors with smaller funds require fewer blowout returns, or you’re looking for other financing types.
Again, there’s no wrong answer. It’s just that you know different models see different solutions.
There’s another investor that we’ve chatted with, and their response was if the opportunity doesn’t have a billion in the valuation down the road, it’s just it’s not for us. What do you think what is the most prominent misconception entrepreneurs have when they’re approaching a VC?
I don’t know that we’re an arrogant bunch. I think European venture capital still sits a little bit behind in this perception compared to the US. However, that seems to be catching up now.
I think back in the day, we were seen as old men in cheap suits. Hopefully, that is changing a little bit. We like to see it is as a partnership and as an ability to help each other further but with vastly different responsibilities. I think there is a misconception that we dish out money without any um strings attached.
We also have to pitch for our money, so we know what it is to pitch. We also have to sell, and we also must generate a return on that money. So, we’re kind of in the same position as a startup, but obviously in a different part of the industry.
I have a perception of a European venture capitalist. Want to hear it?
Go for it. I hope it’s good.
It is what it is, and you can tell me why I’m wrong, but my perception is that if you compare them to their US counterparts, they’re just more conservative. They need companies to be much further along and are probably more risk-averse.
And, you want to know why that is so?
So, I’m right
Yeah, but it’s because of a systemic issue. There are two significant issues here, and I don’t know how this will be solved. The first one is called hurdle rate – for historical reasons, European VCs have got a hurdle rate, which means that over money deployed, there is, let’s say, an interest rate that is compounding, and only after that rate is achieved will there be carried interest.
One of the biggest fallacies for European venture capital is that many of these funds are in carry. This is why many of my industry peers will probably rather than optimize for our performance optimize for downside protection. That’s different in the US. In the US, there are hardly any funds that have a hurdle rate.
Now, let me quickly explain what that is. Hurdle rate means if the US fund fundraises 100 million – the moment they raised more than 100 million, that hundred million gets divided into carried and non-carried for the managers. In Europe, often, they put like a six to eight percent hurdle rate on it
that starts compounding from the moment of investing in the fund. If you do the back of the envelope math, you probably have to return 200 million before you ever see the first carry check. That’s one of the drivers of behavior.
The second driver of behavior is that Europe is still a fragmented universe, so a lot of these venture funds take on money from local state-affiliated entities – which the venture scene wouldn’t exist without – but the challenge is that these local backers frequently oblige the managers to invest a proportion of their fund as a consequence into their local market. So, you’ll see many local VCs obliged to back entities in their home market rather than supporting, let’s say, the best potential.
That means that you’re caught in a conundrum of a catch-22 situation where you can’t invest, let’s say in that one great startup that you found in Latvia because sadly enough, you have
to fill your quota of deals in Belgium. And therefore, you’re ending up backing a mediocre entity to fill your quota to be able to go back to your LP’s for raising the next fund.
That also means that you can’t necessarily outperform because of the hurdle rate.
So, yeah, it is true. I think it’s changing now.
My next question would be another perception that I have is and again. Hopefully, I’m wrong. Still, you can tell me. Otherwise, that venture capitalists expect because Europe is such a fragmented market that you have to go to the US to know command the valuation that we talked about earlier. There has to be somewhere in the timeline that the company will have to go to market in the US?
I think it is no longer the case necessarily. I mean, we just analyzed Amadeus, and you’ll see an increased amount of unicorns – companies reaching a point of gravity. That is growing steadily, and my prediction is that that will only increase because of geopolitical tensions in the world. A major driver for this is regulations in the US around foreign investments into the US. They’re nothing short of barring investments from foreign entities, including China, the Middle East, and Europe, into US startups, especially those with security concerns. Grinder was an example of this. Veritas as a genome sequencing play was an example of this, and Tick Tock is now, of course falling apart.
As a result, we’ll see Chinese interest in Europe, a lot of Chinese interests in the UK, and Middle Eastern interests. With an influx of capital, there’s a prediction to be made that the ability to create blowout companies in Europe is only ever-increasing, and we see it as well, by the way, with the US VCs looking to add talent in Europe at this point.
Watch the video – TWIDH with Edward Kliphuis of Amadeus Capital
Part V – Raising European Venture Capital