News

Health Consumers Become Focus

April 25, 2007 - The Wall Street Journal

By BRIAN GORMLEY

Health-care venture capitalists are taking aim at a new customer.

These investors traditionally have targeted doctors by financing companies with new drugs and medical devices. But increasingly, they are bankrolling start-ups with products aimed at consumers, such as treatments for wrinkled skin or online health-information portals.

Though health-care investors still put most of their dollars into disease treatments, two trends are compelling them to consider consumer products. As the success of Botox shows, baby boomers can spend freely on products to make themselves look and feel young. And as corporations offload more of the responsibility and cost of health care onto workers, demand is rising for services to help consumers make informed choices about managing their care.

A few consumer bets are already paying off. In October, eHealth Inc., which sells health insurance online, went public after raising capital from Kleiner Perkins Caufield & Byers and Sprout Group, among others, while Thermage Inc., a wrinkle-treatment provider whose backers included Morgenthaler Ventures and Delphi Ventures, went public in November.

Companies are luring entrepreneurs as well as venture firms. In the cosmetic sector alone, 18 U.S. drug and device makers raised venture backing last year, compared with 10 in 2005, according to VentureOne, a market tracker owned by Dow Jones & Co.

Since consumer health care is relatively new, however, there are only a few corporate acquirers for venture-backed concerns. One of them figures to be publicly traded Allergan Inc., which sells Botox. But going public will be the primary exit strategy for many -- which may be challenging for companies in competitive sectors like cosmetics.

But several investors counter that the opportunity for consumer-directed health, wellness and information services has barely been realized, and there's room for many more entrants. "This is going to be a giant field," says Robert T. Nelsen, managing director of ARCH Venture Partners, a backer of several consumer-oriented companies, including Kythera Biopharmaceuticals Inc., whose products include a treatment for unwanted fat deposits.

Consumer investing doesn't come naturally to most health-care venture capitalists, who are more likely to be schooled in the biology of cancer than in the psychology of shoppers. Until recently, most kept to conventional pharmaceutical and medical-device investments.

That changed last decade as health-care costs soared. In 1999 two start-ups, Lumenos Inc. and Definity Health Corp., formed to offer relief through defined-contribution health plans, in which employers make set contributions to savings accounts that workers use for routine care. A traditional insurance plan protects against major expenses.

The service appeals to small and midsize companies, which struggle the most with rising costs, said Zubeen Shroff, a managing director of Galen Partners, which backed Lumenos. Many slowed or even halted the growth of health expenses through the defined contribution plan, he said.

Large insurers noticed: UnitedHealth Group Inc. snapped up Definity for $300 million in 2004, followed the next year by WellPoint Inc.'s $185 million acquisition of Lumenos.

While smaller businesses are the earliest adopters, some say more big corporations also will use defined-contribution plans before long. This shift spurred investors at Highland Capital Partners Inc. about four years ago to begin hunting for companies that could help consumers improve their health and manage their health-care dollars, said partner Bijan Salehizadeh.

That led them early this decade to invest in yoga studio operator Yoga Works Inc. Since then, they have funded many more start-ups with products for this new era, including RedBrick Health, which raised a $15 million first round in November from Highland and Versant Ventures. According to the company, it provides personalized incentive programs that create cost savings and reward positive lifestyle changes.

While the defined-contribution trend is encouraging, the performance of Botox has supplied hard evidence of consumer products' potential. Though used for conditions like excessive underarm sweating, injectable Botox is better known for smoothing frown lines. Sales crossed $1 billion in 2006, up from $239 million in 2000, and cosmetic sales now account for almost half of the total.

One consequence of Botox mania: a glut of start-ups are now looking for funding for skin-tightening devices, venture capitalists report. That is leading some to search for less-crowded fields.

Sutter Hill Ventures and Alloy Ventures, for example, have invested in the first and second rounds raised in 2005 and 2006, respectively, by Restoration Robotics Inc., which is testing a robotic device that performs hair transplants. Transplant-surgery outcomes vary according to the surgeon's skill. Restoration's robot -- which is surgeon-controlled -- produces uniform results in half the time, says CEO Jim McCollum. Investors hope this pushes hair transplants into the mainstream. Today, "people think of late-night commercials when they think of hair restoration," says Sutter Hill Managing Director Jeffrey W. Bird.

Part of cosmetic devices' appeal is that patients pay out of pocket, and so there's no haggling over insurance coverage. But the price of cosmetic and other health treatments can differ by where they are performed. Bessemer Venture Partners and Trinity Ventures since May 2005 have invested about $9 million in Vimo Inc., whose Web site enables patients to compare the price of a hip replacement or an angioplasty from hospital to hospital. They also can rate their doctors and even request that Vimo negotiate the price of their procedure.

While consumer health is a niche today, some see it nudging into everyday medicine. Orthopedics companies devising less invasive but more expensive hip and knee replacements, for example, could discover that the Centers for Medicare and Medicaid Services, or CMS, won't pay the higher price because the old devices work fine, says Guy P. Nohra, managing director of Alta Partners. That could lead to a system in which those who can afford it pay the difference for less-invasive procedures.

Such a scheme already exists for replacement lenses used to treat cataracts. In mid-2005 CMS said patients could pay the price difference for new lenses that, unlike the old ones, free patients with presbyopia of the need for reading glasses. Before, those wanting the new lenses had to pay the entire price themselves.

This won't become the norm in orthopedics or other areas overnight, but in five or 10 years more companies could find themselves in such an environment, Mr. Nohra says.