Saturday, February 2, 2013

How Hospitals Can Incentivize Rather than Stifle Innovation through Equity Allocation Policies

(I would like to thank Dr. James Moses and Dr. Dan Imler for contributions to this post)

In the traditional health incubator model, the incubator often gets a small piece of equity for the company’s participation in that incubator. When a hospital becomes the incubator, the question of ownership of the innovation becomes more challenging to answer. This tension boils down to incentivizing innovation. And the problem that arises is that hospitals can deter innovation by claiming complete ownership of innovations. Alternatively, hospitals can spur innovation if the proper incentive is provided in the form of equity, IP ownership, or percentage of revenue. For the sake of this discussion, I will be writing in terms of equity ownership of a company that may be formed as a result of an innovation created through a hospital-based incubator.

Source of the problem
Like many corporations, hospitals want to minimize risk and optimize reward. As such, they often claim an enormous if not the entire stake of ownership over an innovation. Unlike private corporations, hospitals often do not directly reward innovators internally; it is not common for hospitals to pay out an end of the year bonus based on number of IPOs that an innovator has contributed to. (Although an interesting corollary is the value-based payment pilots that are being implemented as part of the healthcare reform legislation. But these performance-based incentives reward clinical outcomes rather than innovation outcomes).

Innovation efforts are often performed on the clinician-innovator’s own time without formal compensation for the copious work that is performed discovering commercial value for a new product or service. Clinician-innovators usually need an incentive to justify the major personal sacrifice and career risk that is taken when pursuing entrepreneurial efforts and value discovery.

The tension of distributing equity
The key is flexibility. Hospitals hold the majority of the power in this construct because the hospital and it’s resources are at the core of the value proposition for a hospital-based incubator: without the hospital’s patients and providers, the ease of identifying problem-solution fit would not exist. Unfortunately, hospitals, being the conservative organizations that they are, often over value their contribution to the innovation equation and demand too much equity in order to optimize their potential upside gain if an innovation has large commercial success. On the other hand, this approach can stifle the incentive to innovate and no commercial successes may ever be realized because clinician-innovators are not incentivized to pursue those ideas.

Proposed approach
The entire process of innovation must be made efficient not for the sake of quickly making people get rich but rather for quickly discovering value that will improve patient health and healthcare. Incentives must be aligned so that the innovator is compelled to pursue the innovation and the hospital is incented to facilitate the innovation. A major lever for catalyzing innovation by the hospital is expediting the legalities of innovation (term sheets, patent applications, etc). Navigating these legalities must be both thoughtful to protect patients and expeditious to prevent innovations from stagnating. Below are some recommendations to optimize the legal logistics and to ensure the clinician-innovator and the hospital feel good about their participation in the creation of a commercially valuable innovation.

1) Better to own part of a something valuable than own all of something that is worthless: A standard policy should exist in which the hospital and the clinician-entrepreneur should share the major portion of equity. The policy may be dynamic to allow for variability in the relative contributions to the innovation at various stages of development. But at it’s core, the clinician-innovator should have a major portion of equity protected.

2) Segmentation of hospital participants: Reward all of the participating elements, such as the host department wherein the innovation was incubated. A systematic approach should be considered when accounting for contributions to the innovation and an institutional policy should exist for allocating an appropriate amount of equity commensurate with contribution to all participating entities. These policies should not blindly reward the entire chain of command based on position of power but rather based on relative contribution. For example, if a department within a school within an academic center has made a major contribution to an innovation, that department should reap the major benefit, with only minor (if any) equity allocated to the school of that department.

3) Separation between clinician-innovator and host hospital: A policy should be established to address ownership if the innovator leaves the hospital. Ideally, the policy defers such decisions to the board of directors of the company that would have been formed during the clinician-innovator’s tenure at the home institution. The board should have appreciable hospital and innovator representation. It should also have a neutral party unaffiliated with the innovator or hospital in order to break ties if they were to arise.

If you know of successful incentive models for innovation at your host institutions, please share them here so that we can aggregate and disseminate a list of best practices. Thank you!

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