Consider healthcare private equity deals

Canada has cutting-edge healthcare. However, under-investment has left its full potential unrealized. Only three healthcare companies appear on the S&P/TSX Composite index: Valeant Pharmaceuticals International; Extendicare; and ProMetic Life Sciences. It’s different in the U.S., where healthcare accounts for 15.1% of the stocks listed on the S&P 500, with 57 names, as of August 2016.

While the Canadian government does a good job of providing healthcare start-ups with seed money, Scott Kaplanis, partner and portfolio manager at Epic Capital Management in Toronto, says “what we aren’t so good at is the venture capital funding that has been so critical to the success the U.S. has had.”

But that void also creates an opportunity for private equity investors to fund a Canadian sector brimming with talent and, as the population ages, on track for explosive demand.

Baby boomers can expect to live longer than their parents, and there are lots of them. The average life expectancy in North America is now 30 years longer than it was in 1900; and those over age 85 will likely triple by 2040.

That means public and private healthcare spending will increase, and that spending will target:

• prescription drugs;
• long-term care facilities;
• outpatient care and nursing;
• electronic medical records;
• chronic condition reporting and monitoring;
• medical devices;
• hospital workflow software;
• solutions for preventable medical errors; and
• surgical robotics.

But how do you identify future winners?

The first step is assessing a company’s value proposition from a purely medical point of view: Does it have an innovative idea that will improve operations at a hospital, in home care or at some other point in the care continuum?

To make these assessments, Kaplanis relies on an advisory board, as well as a team member who’s a former clinical director of MRI at Sunnybrook Health Sciences Centre in Toronto. His expertise includes extensive entrepreneurial experience in the medical space.

They’ll look at lots of companies and then narrow the field that could be worth investing in to 60. Some of these companies have mature management teams that execute the business efficiently, and don’t need the equity firm’s guidance beyond the initial investment.

Or, they may simply need the equity partner’s capital markets expertise to properly structure a deal. At the other end of the spectrum are companies with good ideas, but need help building an organization and management structure to bring products to market.

In 2014-2015, the firm did detailed due diligence on about 20 companies and invested in five. The focus is on medical technology (medtech) firms, in part because their growth trajectories are strong.

Medtech is more predictable, and still offers potential for outsized returns. They avoid biotech companies, because those products can take up to 10 years to become profitable.

Early stage companies in this space have more upside potential than established names, but also carry greater risk. Weighting adjustments and diversification help reduce that risk. “We give more weight to companies we have more confidence in, and that have more revenue-generating potential,” Kaplanis says.

Who’s right for these investments?

Private equity investment can carry some significant risks. So they’re recommended to investors with at least $1 million in investable assets; and many advisors won’t recommend them to clients with under $2 million to invest.

Generally, it’s best to keep these types of investments within a range of 5% to 20% of a portfolio.

In large part, that’s because the funds are tied up for several years before investors see returns. It’s also smart to work with advisors who believe in these offerings enough to have their own money right in there with you.

Updated August 2016.