Healthcare secondaries: ‘the classic definition of a niche’

Scott Halsted, managing partner of Leerink Partners, discusses steep discounts, regulatory risk and how to deploy in a small and difficult market.

Leerink Revelation Partners, a partnership between West Coast fund managers Leerink Capital Partners and Revelation Partners, recently raised $227 million to invest in healthcare secondaries.

Leerink Revelation Healthcare Fund II can acquire direct positions in healthcare companies, buy stakes in funds, back GP-led processes and provide follow-on capital. Managing partner of Revelation Partners Scott Halsted, who spent 20 years as a direct VC investor at Morgan Stanley, discusses the market with Secondaries Investor.

How large is the healthcare secondaries market?

It’s difficult to get good numbers. What we can do is look back over the last 10-15 years and see how much venture capital money has been invested in healthcare companies. That number is about $20 billion-$25 billion dollars. That excludes other significant groups of investors such as corporate entities like Boston Scientific or Thompson and Johnson, which probably adds another $10 billion to that, and then there are angel investors. Our best estimate for the total available market is $25 billion-$35 billion.

Are healthcare funds more likely to get to the end of their lives and need more time?

Healthcare tends to be one of those areas with the longest holding periods from first investment to exit. The number moves around a little but six to eight years is the typical holding period. But it’s really a bell-shaped curve – there are companies that exit early and others that don’t exit until year 10, 11 or 12.

It’s a regulated industry so not only are there all the development hurdles that you’d expect from developing a new drug or device but you also have to lay on regulatory [requirements], whether the Food and Drug Administration in the US or European regulatory bodies. It’s not unusual for a company to spend two to four years just going through the regulatory process.

Do directs make up a majority of your dealflow?

We’ll do anything – we’ll buy LP interests, do GP recaps, strips of assets – but the biggest chunk of what we do is direct secondaries. The other thing that happens in healthcare is because companies take a long time, existing investors are often not seeking liquidity but additional capital to support their portfolio companies. We won’t actually buy someone’s stake. We come in, give them the capital to protect what they’ve invested over the last five or 10 years.

What sort of pricing do you tend to see?

VC takes a steeper discount [to LBO] and within that healthcare takes a steeper discount. Healthcare stakes are trading at anywhere from a 25-35 percent discount to net asset value.

You need to understand not only the biology but the regulatory [system] and third, reimbursement is very important. These investments tend to have more binary risk, a single point of failure. The technology seems to work great but the FDA may turn them down, which is really bad news.

Are most of your deals proprietary?

Yes. The reason for that is that most of the deals in the space tend to be on the small side, below $50 million or even $20 million. There isn’t enough volume to attract intermediaries into the market. That’s good in the sense that most of the deals we do tend to be non-competitive. The negative is that a huge amount of education [of potential sellers] has to take place.

What’s your investor base?

It tends to be large family offices and ultra-high-net-worth individuals. They tend to like secondaries because you get a pretty quick return on capital relative to traditional venture investing. They see it as getting venture exposure with a little less risk.

Will the market grow?

This is the classic definition of a niche business. It’s too small and difficult to do to attract a lot of players. I certainly would expect to have more competition – you always do. But it’s not a place where one can put billions of dollars or hundreds of millions to work easily. We haven’t seen emerging competition and I don’t think we’re expecting much.

Scott Halsted is a founder of Revelation Partners and managing partner at healthcare secondaries alliance Leerink Revelation Partners.

He was previously a managing member at Morgan Stanley Ventures, where he worked from 1987 to 2007. Prior to his investment career, he held product design and business development roles in the medical technology field.​