Sunday, February 17, 2013

Risk Faced by a Hospital-based Startup Incubator

Risk is inherent in any activity that involves uncertainty or multiple potential outcomes. More specifically, risk is the potential that an activity will lead to an undesirable outcome. The major role of a startup incubator is to help mitigate the risk for the companies that it is nurturing. Fledgling companies typically face three main types of risk including product risk, customer risk, and market risk. In other words, startups face the challenge of creating the right product that will meet the needs of a specific type of customer, whom there are enough of to make a sustainable business.

Hospital-based startup incubators face several additional risks beyond those incurred by the typical healthcare startup. Below is a brief overview of these risks. The goal of identifying these risks is to create a framework for measuring risk and then ultimately mitigating it.

Culture Risk

On the surface, the culture of academic medical centers is to provide the top level of clinical care and to push the frontiers of scientific discovery. This breeds a culture of ethics, an aversion to conflicts of interest, and a currency of peer-reviewed publications. The outcome is a generally credible, morally driven, and trusted workforce of medical professionals. Under the surface however, academic medicine rewards a “publish or die” culture and an aversion to the words “for-profit” or “private-sector.” What is often overlooked is that commercial value discovery can be a mechanism for social value creation (for more details, please see my recent post). A major risk to hospital-based startups is the potential for slow institutional buy-in to support a profit-driven innovation. Additionally, any academic-innovator that hopes to climb the ranks of promotion will face difficult decisions when faced with the option to work toward more publication of toward starting a company.

Legal Risk

Not only are there cultural challenges, but there is also a substantial legal risk to starting a hospital-based startup incubator. In my recent post on the subject, I pointed out the tension that arises between hospitals trying to retain as much ownership of any innovation that emerges from within its walls. When hospitals become greedy with their equity holdings they can easily strangle any upside for the clinician innovator, which may dysincentivize the clinician innovator and prevent any value creation altogether. Another legal risk is the uncertainty about how hospitals will work with external vendors that hope to refine their technology by collaborating with hospital employees. The legal issues with working with external vendors include accountability as well as equity allocation in return for the opportunity for product testing.

Financing Risk

Restrictive equity allocation policies also have implications for Financing Risk. Financing risk is not unique to hospital-based incubators, but it is exacerbated by the profound equity dilution that can occur to a company before it is even formed. For example, if a clinician-innovator seeks investment from outside of the hospital, the investors may be scared off from a seed or even series A investment; investors may be reluctant to write a check when the founder and driver of the company only hold a small fraction of the company’s ownership at such an early stage in the company life cycle. Although there may be interesting opportunities for leveraging the hospital’s cash equity to invest in the company, hospitals may also cause so many bureaucratic headaches that the option of external fundraising may become obsolete.

Regulatory Risk 

Unlike financing risk, regulatory risk can be very specific to health-related and hospital-based companies. HIPAA compliance and patient privacy protection are of paramount importance these days because of the recently issued final rule on HIPAA enforcement. The final rule added substantial financial penalties to HIPAA violations. Beyond HIPAA compliance, many hospital-based innovations are likely subject to FDA approval. FDA approval may take a very long time and time is the most important and limited resource for a startup that perpetually faces competitive pressures and the aforementioned financing risk.

Patient Protection Risk

The intention of many regulations is to protect patient safety. But beyond mandates from the government or accreditation agencies, there is a very appropriate culture of obligation to protect that patient’s rights. This entails ensuring that care provided to the patient or research performed on or with the patient is moral, ethical, and does not harm the patient. As a result, the risk that arises is analogous to regulatory risk in nature and I will call it patient protection risk. This risk is most palpable when dealing with an IRB. As I noted in a post in January, IRBs can drastically hamper testing for problem-solution fit by requiring exaggerated review of the testing protocols for appropriate patient protections. Also, although well intentioned, the emphasis of academic medical centers on equitable care delivery and serving vulnerable populations may also pose a challenge to quick testing and value discovery. Finally, a conflict of interest that may arise is when a test with a customer needs to occur during the course of care delivery and the doctor conflicting incentives to provide care as well as to test a potentially profit-generating intervention on the same patient.

Education Risk

In a previous post, I described a hospital-based startup incubator as having a clinician-innovator as one of it’s core components. In the post, I described a clinician-innovator with prior experience with entrepreneurship. This situation is likely the exception rather than the rule. The typical clinician that would be available to participate in a hospital-based incubator is a clinician whose entire training consists of research methodology and medical practice with almost no exposure the fundamentals of lean startup methods, customer development, agile development, etc. The lack of internal capacity for entrepreneurial leadership creates a major risk for transforming great ideas into viable businesses. Educating clinicians in entrepreneurship affords very exciting opportunities but the lack of precedent with having external entrepreneurs train clinicians is a risk in itself.

Now that the risks to starting a hospital-based startup incubator have been identified, the next step is to measure the risk and then remove it!

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