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Healthcare is quickly going from investment afterthought to the popular kid. It’s a blazing hot sector for private investors, with a record $3.89 billion in venture capital raised in Q1 of 2015 alone. Now consider that all the healthcare startups only raised $1.9 billion in all of 2013!

The influx in capital is not just coming from traditional investors getting in on the action. Corporate venture capitals are now getting into deals, backed by the biggest brands in healthcare. Thanks to the Affordable Care Act, big insurance companies like Blue Cross and Blue Shield and UnitedHealth Group are forming their own venture capital arms, similar to Google and Google Ventures.

The reason why insurance companies are getting involved in startups is thanks to a provision in the Affordable Care Act. The law requires insurers to spend between 80-85% of premiums they collect on “quality and efficiency measures.” Essentially it forces big insurance companies to redeploy capital rather than distribute to shareholders. Early-stage investments appease this legal requirement, while offering companies potential returns on the investments.

Every type of startup has a huge uphill battle. But startups in healthcare have a particularly difficult road ahead of them, with more obstacles than a photo sharing app will run into. Even with all this excess capital being pumped into early-stage companies, will it pay off in the end?

Obstacle #1: Security

Security is an issue that all tech companies deal with, even more so in the wake of the Sony hack, but it’s especially precarious for healthcare startups.

Healthcare data is extremely delicate and must remain confidential. Especially when it comes to mental health, which is seeing a rise in treatment. Particularly with telemedicine becoming more popular. Violating the Health Insurance Portability and Accountability Act (HIPAA) is a real concern. Digitizing records makes them more vulnerable and young startups can’t fake it until the make it with security.

If your company handles protected health data, HIPPA requires physical, network, and process security measures to be in place and followed. Becoming HIPPA compliant increases costs and is time intensive. Both can be a huge strain to a startup’s burn rate.

Obstacle #2: Difficult Customer Acquisition

The direct to consumer model is picking up steam with healthcare startups. Many different services are free to consumers, as the financial model is dependent on business to business relationships.

That said, like any other startup, it’s hard to acquire customers. There are a few different reasons why startups run into customer acquisition problems. First, no one knows about you. Every startup knows what it’s like to be invisible to the potential customers. But that can be resolved with a strong marketing and user acquisition strategy. For healthcare startup, trust is the big obstacle.

Consumers purchase things from people and companies they trust. It’s easier to put blind trust in a project management app that seems interesting than it is with a company that manages your healthcare.  Is the company going to be around 9 months? Or will you have to go through the pain of searching for a new solution again? While big insurance doesn’t offer a great user experience, customers have the peace of mind that it’s not going out of business within a year.

Obstacle #3: Complex Business Models

Health care startups aren’t merely selling a product and a customer is buying it. The business models of healthcare startups are extremely complicated because who uses the end product isn’t necessarily the one paying for it.

For example, what if a patient used wearable technology to track activity that automatically updated digital medical records. The device was given to her by a doctor, who in turn can use the information to track the prescribed physical routine. But it’s the hospital that’s actually buying the wearable technology.

If you’re able to figure out the purchasing maze, you still have to contend with the many stakeholders within the hospital. Sales cycles can be upwards of 12 months once you get the OK from all the directors, vice presidents, and C-Suite executives.

Health care startups have to juggle more balls than other startups. It’s not as easy as hacking together an MVP over the weekend. At every step of the journey, there are added layers that are unique to health care.

What does this mean for investors? It means their early-stage bets are even more high risk. The founding teams have to be larger to account for the needed expertise. At the end of the day, health care startups are going to consolidate like any other hot investment niche. We saw it with social networks, we’re starting to see it with on-demand apps, and it will happen with healthcare. That means that today’s companies are especially under the gun to hit critical mass as quickly as possible.

Image Courtesy of Shawn Campbell 

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