The Outlook for Private Equity Activity in Health Care

Despite the possibility of heading into a recessionary-type environment, private equity (“PE”) and venture capital (“VC”) managers that invest in health care remain optimistic, arguing that this sector remains one of the most robust parts of the economy—even in downturns. However, they remain concerned that lower valuations might delay exits and potentially slow dealmaking in some sectors of health care. Finally, despite companies possibly having to pivot from their core competencies to raise capital amid a possible economic downturn, investment managers argue that their due diligence best practices remain the same.

EisnerAmper recently spoke to a few PE and VC managers who shared their outlook on health care (minus the provider side). They included:

• Tommy Martin, CEO, Mammoth Scientific
• Chris Mizer, CEO, Vivaris Capital
• Tadd Wessel, Managing Partner, Petrichor Healthcare Capital Management

Opportunities

PE and VC managers concur that the health care sector presents numerous opportunities because it is an essential service whether people get ill, accidents happen or otherwise.

“Health care has been a stable horse to bet on in periods of economic downturn,” said Tommy. “For the past four decades, public and private spending on health care has consistently outpaced GDP growth.”

Indiana-based Mammoth Scientific manages a Series A through Series C VC fund and invests in life sciences, biotech, late-stage medical devices and health care technology.

According to Chris, specific attractive sub-sectors in health care include items making their way into the clinic including protein chemistry due to artificial intelligence, CRISPR technology (therapeutics), and oncology being more mature.

“We’re getting back to normal in the space,” said Chris, whose San Diego-based firm invests in therapeutics, diagnostics and devices. “COVID-19 absorbed a lot of focus among regulators and researchers; not much happened that wasn’t COVID-19-related.”

Tadd said it’s an opportune time to be in biotech: “Advances in basic science and genomic/proteomic sequencing have generated insights into the fundamental mechanisms of disease and enabled the development of more targeted diagnostics and therapeutics.” 

New York-based Petrichor manages a PE vehicle that partners with health care managers and businesses to provide capital for late-stage development or early commercialization of novel therapeutics, medical technologies and diagnostics. Petrichor also has a biotechnology company formation business, Petrichor Scion Therapeutics, that forms, capitalizes and builds new companies around innovative therapeutics with the potential to meaningfully advance or transform the treatment of serious diseases.

Tadd noted added that advanced computational methods, including machine learning, have brought new and novel insights into many life sciences sub-sectors, including therapeutics, tools and diagnostics.

“The future is bright, and the industry’s collective ability to identify and treat unmet need is accelerating like never before,” added Tadd.  

Valuations

Despite the numerous opportunities that PE and VC managers see in health care, their main concern is that valuations will tighten and exits will be more difficult. 

“In a lower valuation period, it will be much harder to manage meaningful exits,” said Chris, who specified biotech companies were one of the worst performing sectors due to revaluations.

Tommy added: “Companies on the verge of exits or those considering going public might delay that, take a strategic exit or sell to a different company.”

Given low valuations, investors are often pushing for larger financings than companies initially intend as they seek a cash cushion.

“After a quiet four to five months to start the year, the capital markets are re-emerging as companies and investors work through price discovery,” Tadd said. “M&A and business development volumes are beginning to pick up also, though the sector continues to wait for the Merck-Seagen acquisition to formally be announced. Assuming the macro framework holds up, which is far from certain, these ‘green shoots’ should develop into  fully functioning capital markets.” 

Due Diligence

Even within the economic downtown, PE and VC managers said their due diligence process will remain consistent.

“We don’t like to invest in companies that have only two outcomes: either success or failure,” said Tommy. “We want to see a company that has three to four solid pathways to success. So if one isn’t working out, the team can pivot. This doesn’t change, regardless of the economy. What may change is the frequency of companies pivoting depending on capital-raising challenges.”

Tadd added that Petrichor’s due diligence has always incorporated how a company’s technology fits in the future of health care delivery: “Typically, we’ve found early identification of technologies or products that become the standard of care offer the best returns.”

Despite the possibility of entering a recession, PE and VC managers remain bullish on many sectors of health care. However, concerns will remain about valuations and slower exits.

“There’s an ongoing debate in the market,” Tadd said. “One group believes we have passed the point of peak inflation, evidenced by declining interest rates and commodity prices. The other believes we have not seen capitulation or peak pessimism, as valuations currently contemplate an economic deceleration or only mild recession. This is very difficult to know, though we will point out that several macro risk factors that we currently face have never been seen by the newest generation of investors.”     

Our Current Issue: Q3 2022

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