In Part I of our series on strategic venture programs we explored some of the reasons behind health systems’ recent interest in venture activities, reasons to create a venture program, and considerations for choosing between internal and external fund management teams. In Part II, we examine two options available should you choose to partner with a third-party fund manager: traditional multi-LP funds and Collaborative Investment Vehicles. Each has a distinct set of benefits and considerations, detailed below, which should be explored as you decide which model best fits your organization.
LP, or limited partner, is a generic term for an investor in a venture capital fund, meaning that a multi-LP fund manages capital on behalf of multiple investors. Multi-LP funds are run by outsourced fund managers who typically define the fund’s strategy and goals based on limited input from each LP. These funds are usually set up with a traditional fund incentive and payment structure. Specifically, they have dedicated fund management teams which hold decision-making authority and have “2 and 20” fee structures (i.e., 2% of the committed capital is used for management fees annually and the fund manager receives 20% of the profits once the initial capital commitment has been returned). These funds typically meet with LPs quarterly but generally do not cultivate deep engagement across their LP base outside of these structured events. A multi-LP fund might be a good option for your organization if you’re looking for a more “hands off” venture approach that can still generate strong financial returns. However, this model can have some significant drawbacks:
- Limited influence on the fund’s investment strategy: In most multi-LP funds, fund managers make decisions on focus areas for sourcing with limited input from each LP because there are so many opinions to satisfy. If your organization has an interest that neither the fund manager nor other LPs share, it’s unlikely that you will see much deal flow in this area.
- Restricted authority on each deal: Because multi-LP funds, by design, include many other parties, most funds are set up such that each LP can offer feedback on deals while the fund manager has final decision making authority. This structure means that your organization might be investing in deals that aren’t of real interest or strategic value to you.
- Potential competition with other LPs: One important reason for making strategic investments is to provide your health system with advantages over competitors by working with innovative technologies. With large multi-LP funds, you may find that some of your fellow LPs have sites that are competitive with some of yours, especially with the recent flurry of mergers and acquisitions in healthcare. This can diminish the strategic advantage a venture investment would have afforded your organization.
Multi-LP funds provide a good option for organizations looking for a more hands-off approach to venture activity. However, if you’re interested in the benefits of working with a fund manager but still prefer the ability to directly impact the investment decisions, a Collaborative Investment Vehicle could be the right option.
Collaborative Investment Vehicle (CIV)
CIVs manage capital on behalf of several LPs, but typically aim for a smaller group than traditional multi-LP funds do in light of the deep relationships they seek to foster with each LP. Using the same economic model as traditional funds, CIV fund managers work with each LP to ensure the fund’s strategy reflects their interests and ensure that their goals remain aligned over time. CIVs limit the time commitment required while still providing LPs with the opportunity to influence sourcing, stay involved in the diligence process, and have final say on all investments. Under this model, there are some unique advantages.
- Limited administrative work: In a CIV, your fund manager takes on all day to day responsibility for running the fund while you and the other LPs provide your subject matter expertise. The resulting fund meets your strategic needs with a relatively modest administrative burden.
- Comprehensive market trend insight: You get access to all deal flow and market trend data, allowing you and your fellow LPs to improve your knowledge base without having to conduct extensive research. You can also rely on your fund manager’s expertise in areas you may be curious about but not yet familiar with.
- Final decision rights: CIVs are structured such that you and your small group of fellow LPs vote on each deal as members of the investment committee. If you’re not excited about an opportunity, you likely have enough sway to guide the group to pass on the investment. Conversely, you have the chance to directly advocate for deals that interest you.
- Shared best practices: Because CIVs foster the sharing of ideas between LPs, the group as a whole is able to learn from each other and improve. The best practices the group adopts are not only shared between LPs, but also with the fund’s portfolio companies due to the deep involvement LPs have with these companies.
Single-LP CIV models also exist. While this model doesn’t allow for strategic conversations to occur between LPs as in the traditional CIV model, this version can allow for (1) a highly personalized market scanning and sourcing funnel, (2) the ability to invest in and develop companies in areas of direct strategic priority, and (3) full control over the decision-making processes.
CIVs are unique investment vehicles which allow LPs to benefit from each other while generating strong strategic and financial returns, and can be a great option for health systems looking to start venture programs. In addition to the strengths of traditional outsourced venture investment activities, CIVs layer in some unique benefits discussed above. They can provide your organization with outstanding value when managed by a group with experience in this area, like Healthbox, which has managed CIVs since 2012. If you’re interested in learning more about provider funds and believe they could be the right fit for your organization, please contact us at email@example.com to learn more about our fund management capabilities at Healthbox.