Healthcare startups struggle to navigate a business world that’s set up for them to fail

Digital health startups seem to be struggling to the point of failure. Many insights into why have addressed how technology’s traditional model of quickly putting out a minimum viable product then finding useful applications and business models isn’t working. The model might work in the general technology startup space, but it rarely goes well in the complex world of healthcare. Dr. Paul Yock, a cardiologist and founder of the Byers Center for Biodesign at Stanford University, built his brainchild program on one philosophy to help healthcare startups: need-based innovation.

Need-based innovation is a process in which problems are identified and sorted based on impact and opportunity. Once the top problem has been selected, solutions and commercialization are approached.

While I completely agree with need-based innovation, our healthcare system is set up to discourage all forms of  innovation right now. We also must tackle changing the ecosystem that healthcare startups need to navigate. As a physician-innovator, I have experienced how institutional policies, hierarchical and administrator-driven systems and pilot program dynamics are creating a stunted ecosystem that is not reaching its full potential.

When approaching any stakeholder a health startup usually works with — an advisor, a healthcare system, a pilot site — the wheel often needs to be reinvented. The entrepreneur is faced with a time-consuming and costly disadvantage that frequently forces them to enter deals that hurt them. The deals also counter-intuitively hurt the stakeholder that they are bringing on board because the technologies and companies on which they are counting are set up to fail. There needs to be a clear set of rules for everyone to play by to accelerate growth, with the philosophy that “a rising tide lifts all boats.”

These are the most crushing challenges of the current ecosystem that need a hard look and innovation themselves before healthcare startups can deliver.

Challenge 1: Institutional policies and hierarchical systems stunt innovation

Many healthcare startups are born during a founder’s time at a healthcare or educational institution. The institution promises to foster the innovation and make the nuances of the legal landscape easier. However, institutional innovation policies are not optimized to foster innovation, but rather to maximize ownership and financial returns. Most policies will require all filed patents to run through a “Tech Transfer Office,” which is assumed to provide value by performing Freedom to Operate searches and helping file for provisional patents.

Unfortunately, in today’s world of software, patents are somewhat less valuable and relevant than they once were. If any IP is filed, the institution will claim ownership and will consider licensing it to the inventor for a royalty agreement. Sometimes, if the institution does not believe in the ability of the inventor to carry the IP forward to commercialization, they will even cut them out entirely from the agreement.

An additional approach that is becoming more common within innovation policies is an equity stake in any companies started by an institutional employee, regardless of the existence of IP or whether the institution was interested in it. All of the above scenarios obviously take more from the healthcare startup than they give before an innovator even has time to blink.

Challenge 2: Healthcare doesn’t understand early-stage tech companies

Why are these policies designed this way? Part of the problem stems from stakeholders confusing medical technology with biotechnology (aka pharma). The innovation pathway within biotech is very well-defined, with established business models, established precedent and understandable risk profiles. It is quite common for drug discovery to start in the academic setting. Investors, boards and executive teams are accustomed to this model and can plan accordingly. Licensing patents and collecting a royalty on biotech sales is a market norm.

When it comes to early-stage technology companies, their challenges and early development are drastically different. The two critical resources an early-stage company has are cash and time. The goal is to unlock additional capital with product-market fit, and these companies need maximum flexibility to be able to move quickly to find it. Unfortunately, investors see the healthcare space as complex and high risk, which is true. So these startups face fundraising challenges for the space they are in, as well as unnecessary additional hurdles from the home institutions, increasing the likelihood of scaring away already skittish investors.

Challenge 3: Pilots are set up to hurt more than help

Startups are often completely dependent on partnerships or deals with larger healthcare organizations in order to grow and survive. These deals often start with a pilot. Unfortunately, the dynamic between giant healthcare institutions and tiny idealistic startups for pilots is not actually set up to be mutually beneficial.

In this scenario, healthcare systems have nothing to lose, orders of magnitude more resources and seemingly infinite amounts of time. Their incentive is to differentiate and “own” unique technologies so their competitors cannot get their hands on them. This is where startups often and understandably can make a big mistake — they believe the partner brings more value to the table than they do. For example, just having a pilot, even if it’s unpaid, with a major institution seems like it could help win over investors or additional customers. This leads to a spiral of events that frequently ends in sending startups into a trajectory toward failure (aka death by pilots).

Due to the lack of urgency and the intense bureaucracy, the sales cycle is long, sometimes one to two years, often lasting longer than startups have cash left to burn. Second, as mentioned, the pilot is frequently unpaid, or I have seen situations where an institution will even charge a startup for a pilot, leading to less cash and equity, which is already in short supply. Finally, onerous terms are often instituted, in which companies agree to unnecessary exclusivity or impossible goals. This doesn’t even take into consideration the challenges around deployment with HIPAA, security concerns and data sharing.

The ultimate result is that healthcare institutions that want to add value to their system by improving outcomes and decreasing costs will often doom the very technologies they believe are worthwhile. This dynamic is so well-established that many investors, even those well-versed in healthcare, will refuse to invest in institutional-oriented technology companies. My company, Osso VR, has had representatives of hospital systems approach us saying, “Don’t work with us. It will kill your company.”

Promising opportunities ahead

What if innovation policies were designed so that instead of focusing on what they can take from their spin-out companies, they focus on what value they can add? Stanford’s StartX accelerator program has a model where they commit to investing in 10% of any round a company raises after they leave the program, but it’s up to the company to choose whether or not they want StartX to participate. Unsurprisingly, almost all companies take advantage of the investment offer. These incentives help companies succeed and allow StartX to share in that success.

We need innovators and administrators to come together and agree on common standards and rules to make the process more efficient, fair and effective. One example we might follow is from Y Combinator. Raising money used to be expensive due to the amount of confusing legal documents required and corresponding legal fees. The time and expense could sometimes cause a deal to fall through, or a company would run out of money.

Its SAFE note investment document solves accounting difficulties and challenges around early-stage investment. This document has been validated by founders and investors, allowing entrepreneurs to raise money with little to no legal fees and a turnaround time of a day or two. Organizations like the American Medical Association, AdvaMed and the Consumer Technology Association have the buy-in, validation and potential to start tackling these processes. Standards could be set for protected innovation time, structured innovation positions and fellowships for organizational employees, and deal templates and best practices to shorten sales cycles and avoid onerous terms.

These problems are large, endemic and complex, but I am optimistic we can begin to work together to solve them to maximize our common interest: increasing the value of global healthcare.