Why do you invest in the growth sector of healthcare, and why did you select these three sectors on which to focus (medical technology, healthcare services and specialty pharmaceuticals)?

We strongly believe that the growth sector has the most attractive risk/reward ratio. Growth equity can be defined in many different ways. For us, it’s generally revenues of $10-50 million – and growing fast. Companies may not be cashflow positive or profitable, but they are what we consider real businesses with great teams. From a portfolio perspective, you’re protecting your downside because the company has revenue and is demonstrating repeat purchase patterns and traction in the market, and you’re hopefully last or second-to-last money in. And on the upside, you’ve invested early enough in the corporate cycle that you can get venture-like returns, 3-6x, maybe even 10x.

For a growth equity shop, we are somewhat unique in that we invest in healthcare services, but are also pretty heavily-invested in the life sciences. We’re looking at niche markets within these three subsectors [medical technologies, healthcare services and specialty pharmaceuticals]. All three sectors have a high degree of protectability; whether that’s through IP, know-how, or stickiness of revenues (such as in tech-enabled services). At our investment size, $10-30 million, we need to back companies that scale rapidly and efficiently. This is why we avoid sectors like biotech, which requires significant capital to push a product through the pipeline, or traditional provider-based roll-ups where it’s not as capital efficient to add locations.

This year’s conference theme is “Challenging the status quo in healthcare.” How do you feel your investments or investment strategy attempts to tackle this goal?

I find the conference inspirational in that it is run by students and is very – “where is healthcare headed over the next 10-20 years?” I tend to gravitate towards investing in companies that are a bit more “bread and butter” healthcare and less aspirational than some of the start-ups you’ll probably see at the conference. Our primary job is to make money for our LPs, requiring us to assess the risk and reward of big, exciting endeavors that entrepreneurs often tackle, versus more simple, execution-based opportunities. Having said that, healthcare is evolving rapidly, and everything we look at has to be able to do things better and more capital efficiently. We’re no longer interested in incrementalism. The companies that we get involved with provide basic and critical products and services that patients and organizations need. The kinds of investments we do generally tend to play well, regardless of the political or economic climate.

There’s been a lot of talk about “healthy” valuations in healthcare PE. How has this played out in your experience?

I remember in 2004, I was involved in a deal that we really stretched to try to win. We bid 8x EBITDA. At the time, the firm that I was with had never bid that high, and there was a lot of angst. You’re seeing multiples now, for those same businesses, that very routinely are trading for 12-14x, which in my view is not sustainable. There’s also more money on the sidelines than ever before. All the talk I’m hearing is that we are probably going to go through a recession in 2019 or 2020, but ironically, with all the capital on the sidelines, it probably won’t affect PE valuations as much as it has in past recessions.

In our experience, we try to do proprietary deals, where there are no bankers, we can take our time and there is not a lot of competition. In our first fund, 8 of 11 companies in the portfolio were completely proprietary. But whether its proprietary or more of a process, in this environment, you have to play aggressively to win. If you’re on the fence, hesitating, or aren’t prepared to pay a fair value, you’re just not going to win.

That’s a lot of proprietary deals. How do you go about sourcing?

We emphasize networks and relationships. We want everybody at our firm – from the associate to the partners – sourcing deals. We invest very heavily in our employees and are proud that a lot of our opportunities are often being sourced by the younger generation. Our associates’ and VPs’ efforts to build their networks now, will result in very powerful networks 5-10 years later.

We’re also always talking with management teams and trying to be the firm of choice when different teams are looking for their financial partners. Through our past investments, we have maintained strong relationships with management, so that when they are looking for their next thing, they come back to us. We’re proud of the fact that 8 of 11 teams in our first portfolio are repeat teams, and we’re hopeful to continue this trend. This is atypical with most other private equity firms!

What are some investment themes you’re interested in?

We are highly opportunistic – it’s the nature of our business – but there are several themes we look at each year, and also some ongoing themes.

A clear theme over the last 10-15 years is the move from physician preference to payors retaining more control, and we like themes that follow that trend. Ongoing themes for us include cost containment and cash pay – such as in aesthetics and nutraceuticals. In addition, healthcare is so massive, that I’m still amazed at the new niches that we continue to discover. For example, our last transaction was in the medical coatings space which has turned out to be an incredibly interesting, growing market with stable recurring revenues. We like small, niche areas in specialty medical devices or diagnostics because of the capital efficiency of scaling these businesses.

What potential challenges do you see on the horizon for healthcare investing?

First of all, I think it’s a great time to be investing in healthcare. There’s a lot of change in the not-too distant-future and, with change presents fantastic opportunity. From a challenges perspective, we’re always looking to invest in new and better products and services, but we have to be much more conscious of access and the healthcare systems’ ability to pay.