If you have a health care-related business idea that you want to bring to fruition, seeking outside funding is a logical first step in turning your ideas into reality. Startups have several layers of funding available to them in the embryonic stage of their journey as well as their first years in business. The challenge is finding the right investor at the right stage.
This article will cover everything early-stage funding-related and includes input from successful health care startup executives that have received funding through UPMC Enterprises such as:
Aaron Brauser, MBA – Co-Founder and CEO, Realyze Intelligence
Aaron Brauser, MBA, has spent 25 years developing and delivering software for both startups and Fortune 500 businesses. These businesses include 3M, M*Modal, Nokia, CoManage, Idea Integration, and US Steel. Aaron is the former VP of Solutions Management at M*Modal where he was responsible for the commercialization of NLP solutions and helped lead a successful acquisition by 3M for $1 billion. Aaron has extensive expertise in product management, bringing new products to market, and obtaining their ideal product market fit. Aaron received his MBA and BS in Computer Science from the University of Pittsburgh.
Rebecca Jacobson, MD, MS, FACMI – President, Astrata
Dr. Rebecca Jacobson is President of Astrata, a digital health care quality company, created through UPMC Enterprises. Astrata helps Health Plans use NLP and advanced analytics to transform their HEDIS quality measurement programs. Prior to this position, Dr. Jacobson was a Professor of Biomedical Informatics and Chief Information Officer for the Institute for Personalized Medicine. Over the past fifteen years, Dr. Jacobson’s work has focused on extracting meaningful information from electronic medical records to impact population health, precision medicine, and quality improvement, using NLP methods. She is an elected Fellow of the American College of Medical Informatics (since 2010).
Mani Mohindru, PhD – CEO, Novasenta
Dr. Mani Mohindru has served as Novasenta’s Chief Executive Officer and Director since April 2021. Dr. Mohindru also serves as a member of the board of directors of CytomX Therapeutics and Cardiff Oncology. Prior to Novasenta, she has held senior leadership positions in the biotech industry, having served as Chief Executive Officer of CereXis, Inc., Chief Financial Officer and Chief Strategy Officer of Cara Therapeutics, Inc., and many more. Dr. Mohindru is a member of the Executive Advisory Board of the Chemistry of Life Processes Institute of Northwestern University and a member of the Scientific Investment Advisory Committee of the Gates Center of Regenerative Medicine at the University of Colorado.
We hope that after this article you will be able to describe what early-stage funding is, when companies search for it, and why companies need it.
Why Do You Need Funding?
Starting a business, of any kind, takes capital. Even the simplest business requires funding to forecast and establish a runway. Computers, equipment, software, office space, and laboratory equipment all require capital. When you add in all the different components, complexities, and requirements of starting a business in the health care sector, you can easily see your costs climb into the hundreds of thousands if not into tens of millions of dollars.
How Can You Prepare?
If you are serious about growing your business, it is good practice for entrepreneurs to write a full business plan, even if you are a small startup and not really seeking investment. Most likely you will not get time to write the business plan after you start conducting business. Having a business plan ready will clearly prove that you have been thorough when you do start seeking external investments.
Building a strong network can also set you and your business up for success. The more conversations you have with private investors earlier on, the more they will be able to help you when you need them. These conversations with private investors will also clearly show at what stage your business will be investment-ready for them in the future.
“Get a sound business plan and growth model. This usually means you need to have a well-thought-out approach, potentially with some early or pilot results. As you learn new things about the market, your products and services, and pricing – keep that model up to date. It’s your yardstick and map.” – Rebecca Jacobson
“There are a lot of places to look for money if you have a solid team and a great product-market fit. Selecting the right partner can bring added value such as expertise in the space and access to potential prospects. Focus on what your company can gain by partnering with a particular funding source and make sure the investor is committed to helping your company achieve its goals.” – Aaron Brauser
“When searching for investors, consider looking for investors who can provide not only capital but can also act as a long-term partner while you grow the company. Some partners like UPMC Enterprises can also provide the initial operational infrastructure, a network of experts across a variety of disciplines, and potential for collaboration on your science or your product.” – Mani Mohindru
When Should Companies Start Searching for Funds?
The best time to approach investors for the purpose of raising external funding is when you can clearly demonstrate that an investment in you will help grow your organization. That sounds easy enough, right? However, the investing process, during any stage, can be long and tedious. When UPMC Enterprises invests in companies, we apply rigorous due diligence to ensure we are making sound investments. Once a part of our portfolio, we assist companies with strategic, long-term growth through a health care economics lens. We also guide our portfolio in locating new opportunities and expanding into new verticals. Often, this takes a fair amount of time.
The diligence process can take at least 6-12 months for some investors. It’s best practice to meet with private investors approximately 12 months before the business actually needs the funding.
How Funding Works
Before diving deeper into early-stage funding, it’s crucial to identify the different participants. First, there are the individuals hoping to gain funding for their company. This is typically a founder or CEO. As the business becomes increasingly mature, it tends to advance through the funding rounds; commonly, a company begins with a seed round and continues with Series A and B funding rounds.
The other participants are potential investors. While investors wish for businesses to succeed because they support entrepreneurship and believe in the causes of those businesses, they also hope to gain something back from their investment. For this reason, nearly every investment made during one or more stages of developmental funding is arranged in a way that the investor or investing company retains partial ownership of the company. If the company grows and earns a profit, the investor will be rewarded commensurate with the investment made.
However, before any round of funding begins, analysts undertake a valuation of the company in question. Valuations are derived from many distinct factors, including management, proven record of accomplishment, market size, and risk. One of the key distinctions between funding rounds has to do with the valuation of the business, as well as its maturity level, prospect for growth, and historical success. In turn, these factors impact the types of investors likely to get involved and the reasons why the company may be seeking new capital.
Differences in Funding
The earliest stage of funding a new company comes so early in the process that it is not included in the traditional rounds of funding at all. Known as “pre-seed” funding, this stage typically refers to the period in which a company’s founders are first getting their operations or ideas off the ground. The most common “pre-seed” funders are the founders themselves, friends, and family. For example, if you have developed or have an idea for a health care payor software and you, your mom, and all your friends invest $10,000, that is pre-seed funding. Depending upon the nature of the company and the initial costs of developing the business idea, this funding stage can happen very quickly or may take a long time. Investors at this unofficial stage oftentimes are not making an investment in exchange for equity in the company.
Seed funding is the first official equity funding stage. Seed funding is funding collected from investors and used to start a business. For example, angel investors (think CNBC’s Shark Tank) may take a liking to your product and help you develop it, market it, and mass produce it. In return for their investments, they own a percentage of your business (equity). Eventually, when the business is running and turning a profit, you can pay them back, or they can sell their stake(s) to others who are looking for investment opportunities.
Seed Funding Vs. Early-Stage Funding
Pre-Seed Funding and Seed funding typically starts with family, friends, and other angel investors who like to work with startup companies. For early-stage funding, venture capital groups, entrepreneurs, and other organizations focus on up-and-coming businesses with products or services they think will sell. If you were turned down in the past, they might be more interested at this point because you have actual collateral and a big stake in the success of the business as well.
What is Early Stage-Funding?
Now that your product (a payor software, as in our earlier example) has been fully developed and is being produced and marketed to hospital systems, you want to expand by adding employees, securing more permanent office space, or expanding your current capabilities. Sometimes, even if you are turning a profit, it is not enough to cover the costs of daily operations and an expansion. Early-stage funding traditionally comes in two parts: Series A and Series B.
Series A Funding
Once your business has developed a track record such as an established user base, client list, consistent revenue figures, sales, or another success indicator, your company may opt for Series A funding in order to further optimize its user base or product offerings. Series A funding always generates more funding than seed funding, but the risks are higher. Venture capital firms are most likely to invest in your business at this stage, and the method of raising funds involves allotting preferred stock.
In a Series A round, it’s important to have a plan for developing a business model that will generate long-term profit as opportunities may be taken to scale the product across different markets. Often, seed startups have great ideas that generate a substantial amount of enthusiasm, but the company doesn’t know how it will monetize the business or sustainably scale. Typically, Series A rounds can raise anywhere from $1 million to $200 million, but this number has increased on average due to high industry valuations.
In Series A funding, investors are not just looking for great ideas. They are looking for companies with great ideas as well as a strong strategy for turning that idea into a successful, money-making business. The investors involved in the Series A round usually come from more traditional venture capital firms such as UPMC Enterprises, which provides funding and shared services for all companies we invest in.
During this stage, it’s common for a few venture capital firms to lead the pack. In fact, a single investor may serve as an “anchor” investor. Once a company has secured a first investor, it may find that it’s easier to attract more investors.
It is increasingly common for companies to use equity crowdfunding (Kickstarter, GoFundMe, etc.) to generate capital as part of a Series A funding round. The reality is that many companies, even those which have successfully generated seed funding, do not develop interest among investors as part of a Series A funding effort. In fact, fewer than half of seed-funded companies will go on to raise Series A funds.
“Be prepared to articulate your value proposition well. What is it about your company that a potential investor would be interested in? Is it your platform? Your assets? Both? Or is it something else? Think about why your business is unique and how it differs from others in the same space. An equally important point is to spend time preparing to talk about who will ultimately benefit from the product or services you intend to build.” – Mani Mohindru
“Investors want to build a relationship and follow your company over time. Be prepared to make an investment in time and energy to get to know them, their other investments, and why you would fit into their portfolio. During any stage of funding, but especially during early-stage funding, be ready with an “ask” – what are you seeking, with what timeline, what are the milestones?” – Rebecca Jacobson
“I think you want to cast a relatively wide net with potential investors during early-stage fundraising because these are people you will work with very closely through good times and bad. You want to really understand and do your research prior to talking to each investor. What types of companies do they typically work with? How do they view early-stage companies? Are they longer cycle? Are they looking to grow rapidly? Do they fit with the company culture you’re trying to establish? Make sure your objectives are aligned.” – Aaron Brauser
Series B Funding
Following Series A is Series B. Series B rounds are all about scaling past the development stage. Series B funding is used to increase production, execute marketing plans, and compete head-on with competitors. During this stage, the criteria for funding is evaluating the profit forecasts, how your company stacks up against its main competition, and whether intellectual property is involved, and if so, its value in the marketplace. The funding limits are higher than Series A, but the risks are lower.
Investors help startups get there by expanding their market reach. Companies that have gone through seed and Series A funding rounds have already developed substantial user bases, products, or services, and have proven to investors that they are prepared for success on a large scale. Series B funding is used to grow the company so that it can meet these levels of demand.
Building a winning product and growing a team requires quality talent acquisition, substantial marketing, and other resources from numerous business disciplines. Bulking up on business development, sales, advertising, tech, support, and employees can be very expensive. By partnering with an organization like UPMC Enterprises, startups can reap the benefits of utilizing the shared services such as Legal, HR, Talent Acquisition, Marketing, and Finance that we offer to all of our portfolio companies. Companies undergoing a Series B funding round are well-established, and their valuations tend to reflect that; Series B companies have valuations significantly higher than their Series A valuations.
Series B is similar to Series A in terms of processes and key players. Series B is often led by many of the same characters as the earlier round, including a key anchor investor that helps to draw in other investors. The difference with Series B is the addition of a new wave of other venture capital firms and other investors.
The Bottom Line from the Experts
“Really focus on getting the right team together and then look for an investor who will complement your team and bring real value. Having the right team and the right people around you will make all the difference. Also, get out there. You will learn so much just from talking to current and potential customers as well as investors.” – Aaron Bauser
“Get feedback from everyone, your co-founders, potential investors, and anyone else that is willing to listen. A big advantage of an incubator is that there are a lot of people who can listen and help you improve. Be able to articulate your value propositions, target customers, competitive landscape and the products and services you intend to offer. Finally, don’t skimp on marketing. Take the time to develop the basic marketing you need to look serious – some simple branding, a website.” – Rebecca Jacobson
“Do not underestimate the importance of the right team. Ideas are relatively easy to generate but effective execution of those ideas can only happen with the right team. Also, you need to be specific and realistic about the milestones you and your team can achieve in the next 1-2 years. Tie them tightly together with the timelines and focus on how you will get there. In the end, a successful company is built with the right combination of assets, the right team, and the right amount of money.” – Mani Mohindru