Finding Financial Investors for new 'Open Source' Health IT Companies

This short article is meant to provide a high level overview and guidance about financing for new companies offering products or services in the 'Open Health' arena. This includes companies focused on open source software, open data, open access, and open hardware solutions.

Stages of Company Development & Financing

There are typically six stages of financing that roughly correspond to the stages of a company's development. This includes companies offering 'open source' health IT software and services.

Seed funding: Low level financing needed to prove a new idea, often provided by the founders, family, and possibly angel investors.  Crowd funding is also starting to emerge as a new option for seed funding. [Year 1]
Start-up & Pilot Production: Early stage firms that need funding for expenses associated with initial marketing, development, and production startup. Again, usually provided by the founders, family, and possibly angel investors.  [Year 2]
Initial Operation & Growth: First round of venture capital funding to support early stages of production, sales , manufacturing, and initial growth in exchange for preferred equity. [Year 3]
Working Capital Investment:  Obtaining a second round of additional working funds from venture capital investors for ongoing operations of new companies that are selling product, but not yet turning any significant profit. [Year 4]
Expansion & Continued Growth: Obtaining a third round of additional money needed to continue expansion and growth of a newly profitable company in exchange for secured debt/preferred equity in the company. [Year 5-6]
Going Public: The final round of venture capital funding, also called bridge financing, is intended to finance the process of "going public" with the company. This stage allows founders and venture capital groups to recoup their investment and make a profit. [Year 7]

Angel investors

Angel investors are usually an affluent individual, or group of investors, who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return. These include wanting to keep abreast of current developments in a particular business arena, mentoring another generation of entrepreneurs, and making use of their experience and networks on a less than full-time basis. Thus, in addition to funds, angel investors can often provide valuable management advice and important contacts.

Because there are no public exchanges listing their securities, private companies meet angel investors in several ways, including referrals from the investors' trusted sources and other business contacts; at investor conferences and symposia; and at meetings organized by groups of angels where companies pitch directly to investor in face-to-face meetings.

Angels typically invest their own funds, unlike venture capitalists who manage the pooled money of others in a professionally-managed fund. Angel capital fills the gap in start-up financing between founders, family and friends who provide seed funding and subsequent formal venture capital investors.

There is no “set amount” for angel investors, and the range can go anywhere from a few thousand, to a few million dollars. In recent years, the healthcare arena for the largest share of angel investments, with 30% of total angel investments.

Angel investments bear extremely high risk and thus require a very high return on investment. Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least 10 or more times their original investment within 5 years, through a defined exit strategy, such as plans for an initial public offering or an acquisition by a larger company.

Venture Capital (VC) Investors

Venture capital is financial capital provided to early-stage, high potential/ high risk startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model, especially in high technology industries. The typical venture capital investment occurs after the initial start-up of the company based on seed funding provided by the founders, family, friends and angel investors.

Venture capital is attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a sizable bank loan. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company's ownership.

Venture capital is invested in exchange for an equity stake in the business. As a shareholder, the venture capitalist's return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist "exits" by selling its shareholdings when the business 'goes public' or is sold to another owner.

As a rule of thumb, a venture capital fund may invest in one in four hundred opportunities presented to it, looking for the rare sought after qualities, such as innovative technology, potential for rapid growth, a well-developed business model, and an impressive management team.  Venture capital groups are most interested in new companies with exceptionally high growth potential, capable of providing the financial returns and successful exit event within the required timeframe (typically 3–7 years) that venture capitalists normally expect.

This need for high returns makes venture funding an expensive capital source for companies, and most suitable for businesses having large up-front capital requirements, which cannot be financed by cheaper alternatives such as debt.

Conclusions & Recommendations

A recent article in Healthcare IT News quotes Raj Prabhu, CEO of Mercom Capital Group saying "VC funding in healthcare IT is now on pace to exceed $2 billion in 2013." This also includes companies offering 'Open Health' software and support services.

In a quick review of the literature, some examples of notable angel investors and venture capital groups working in the healthcare arena include Ascension Health Ventures, BlueCross BlueShield Venture Partners, AIB Seed Capital Fund, Bain Capital Ventures, Cardinal Partners, Galen Partners, Foundation Medical Partners, Flybridge Capital Partners, Khosla Ventures, Lemhi Ventures, Milestone Venture Partners, Mid Atlantic Bio Angels, New Enterprise Associates, and Northbridge Venture Partners. There are many other venture groups to approach.

Do the research and be very wary and cautious as you move forward. There are too many stories about venture capital groups taking over control of start-up companies and booting the original founders out of the business. Talk to others who have walked in your shoes and gone through the exciting and arduous process of starting a company, obtaining funding, persevering for years and turning your company into an ongoing, profitable venture.

You need to ask yourself a series of key questions before you go seeking out venture capital investors. For example: What do you want to out of life? What do you want to see happen to your start-up company? When do you want to let go and hand over control of your company? How much of a return on investment do you want for your efforts in taking the risk and moving your company from a start-up to a profitable company? Who can you trust?

Read the collected news clips & information posted on Open Health News (OHN) about Venture Capital Investors in the 'Open Health' arena.