This is an exclusive BHB+ story

Venture capital investors inherently take on risk when backing a new behavioral health company. Sometimes, that risk pays off in dividends. Other times, not so much.

Deciding when an investment is no longer worthwhile is a difficult decision, investors told Behavioral Health Business. Investors want to avoid losing their investment and look to several other paths instead of simply walking away and opting not to reinvest.

“Choosing to explore an exit usually isn’t due to a single trigger but instead a confluence of factors,” Marissa Moore, principal at OMERS Ventures, told BHB in an email. “As investors, we’re constantly monitoring for inflection points. For example, where the risk/reward ratio begins to shift and the runway starts to shorten, or pivotal moments when the competitive landscape, regulatory environment or technology itself takes a dramatic turn, or when the data starts to tell a different story than we initially anticipated.”

“When several of these things happen at the same time, that’s usually when we begin to have serious conversations about an exit strategy,” she continued.

Toronto, Ontario-based OMERS is an early-stage venture capital firm with net assets of $133.6 billion. Its portfolio includes behavioral health providers Caraway and HelloSelf.

When businesses fail

Whether or not a company is profitable isn’t necessarily a key indicator of if an investor will sour on an investment. Still, in some circumstances an investor may realize the business they backed will not be successful.

Most failing businesses fail early, Bob Kocher, co-founder of Lyra and partner at venture capital firm Venrock, said, usually within one or two years.

Once a company reaches a certain maturity level, around five years old, they are more likely to survive a while. A few years later, the company will likely achieve profitability or an IPO.

“Take the case of Lyra,” Kocher said. “Lyra is a company that has a small profit and a lot of money on the balance sheet. So it never needs to raise money again, and it can run the business now. Hopefully we use that money to grow and make the thing more valuable. But usually it takes, for a venture business from scratch, seven or eight years to achieve a point where it works, it’s not going to need to raise capital, and it could be profitable if it wants to be, or go public if it chooses.”

Palo Alto, California-based Venrock operates an early-stage technology and health care company program and a later-stage health care program with a long-term approach to investment. The firm’s portfolio includes Lyra and Included Health.

Burlingame, California-based Lyra is a virtual workforce mental health provider. The company has raised about $910 million in funding, according to Crunchbase, and recently signed a deal with Rogers Behavioral Health.

Most startups fail because they cannot raise sufficient funds to get the business off the ground, Kocher said. The next most common time to fail is after the Series A round, usually because they failed to demonstrate that they can acquire patients efficiently and that their service is not theoretically profitable.

Companies may fail after the Series B round because they could not keep growing and their target market is too small, Kocher said. At the Series C round, a provider may fail due to high costs and slow growth.

Still, how much say an investor has in the sale of a business comes down to how much ownership. VCs that get in on the ground floor are likely to have more ownership than those who came in at later stages.

“In many ways, a dollar invested today may not buy you as much ownership as it did years ago given the round sizes, the elevated valuations and the abundance of capital in the system,” Michael Yang, an investor at OMERS, said. There may be a normalization of this phenomenon as some healthcare VCs exit the business on one hand and a new technologies like AI allow new healthcare start-ups to do much more with less so they don’t need as big of a team as they did in the past (and therefore, would raise less capital and suffer far less dilution).

Investors’ options

If investors don’t reinvest, the company will go bankrupt, and investors will lose everything they invested, according to Kocher.

“So you probably try to sell it,” Kocher said. “If you can’t sell it, you try to merge it with another company for stock. “If you can’t do that, then you try to shrink it and cut the cost a bunch to see if you can become profitable as a smaller business. And if you can’t do that, you go bankrupt and close it. That’s sort of the decision tree.”

The exact point at which an investor looks for an exit strategy differs based on the investor, according to Faye Sahai, managing partner of Exbourne Group and founding managing general partner at Telosity Ventures, told Behavioral Health Business.

“As far as exit strategies, there are secondary markets, or if investors are wanting to sell their shares on that and working together with the founder, working together with a founder that might want to buy back the shares from that standpoint.

Redwood City, California-based venture capital firm Telosity invests in pre-seed, Seed and Series A stage mental health and well-being companies. Its portfolio includes the mental health app Wave, text message-based coaching provider MindRight Health and virtual counseling provider Daybreak Health.

The decision to try and exit an investment is a complex one, investors told BHB. It isn’t enough for a company to just not be profitable, Kocher said.

Before making the decision to try and exit a bad investment, one factor investors consider is confidence in the founder and team dynamics, Sahai said.

“In healthcare, and especially behavioral health, policy is the patience really working with that company, understanding that company,” she said. “As an investor, we look at investing as you’re also a strategic advisor, a strategic partner, helping that founder.”