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Staring into the abyss

Edison Partners’ Chris Sugden opens up about the venture capital space

It takes a lot of guts to be a player in the venture capital space. After all, you’re committing serious sums to a company — often without any personal collateral or other guarantee from the owner — hoping for a good return. But for people like Chris Sugden, managing partner of Princeton-based venture capital firm Edison Partners, it’s the only game in town.

Part of the reason is the potential for returns: at a time when banks are paying less than 1 percent interest on most deposits — and likely to skid lower, given the Fed’s recent rate cuts — a successful deal can mean a return thousands of times higher. But VC investors aren’t the only ones rewarded, since the funding and advice they offer can be a lifeline for a company’s growth.

That’s what happened with a Bedminster-based health care information technology company called Zelis, where Edison Partners initially pumped in $4 million and ended up with a return approximately 40 times higher than that.

Concept of business and money growth

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“We invested in Zelis, which was then called Premier Healthcare Exchange, or PHX, about 10 years ago, when its annual revenue was $10 million,” said Sugden. “We sold a significant portion of our interest in 2016 but we continued to maintain a stake in the company as it evolved.” The company was bought by private equity firm Parthenon Partners and combined with other businesses to form Zelis, which generated about $375 million in revenue in 2019, according to Inc. Magazine.

Besides offering electronic payment services to doctors, hospitals and other medical providers, Zelis provides claims analysis and management, using data mining to identify miscoding and other errors that could result in insurance companies paying more than they should. “A simple example would be if you check into an emergency room for the flu, and they issue a bill that erroneously includes a charge code for a cast for a broken leg, PHX’s software would flag it,” added Sugden.

It was a long road, he recalled. Edison Partners found out about PHX when the VC’s seven-person “deal sourcing” team spotted the company on a proprietary Edison database. “Then-analyst Lenard Marcus, who is now a general partner at Edison, alerted us to the opportunity. He spent about a year speaking with PHX Chief Executive Officer and founder Todd Roberti,” said Sugden.

A cliff-hanger

But at that point, Roberti was considering selling the company, Sugden noted. “His investment banker weighed in against our investment.”

Chris Sugden, Edison Partners

Sugden

Fortunately Roberti, who ended up getting a lot more money for his stake by staying in for the long run, decided he wasn’t ready to exit his creation. “With our initial investment, Todd was able to continue to grow PHX,” Sugden said. “Typically, in addition to cash we offer entrepreneurs our own experience and advice, as well as networking opportunities.”

But before VC firms like Edison Partners put their cash on the line, they want to see if a potential portfolio company really has legs. “We’re in the risk business, but we still engage in due diligence,” he added. “We consider the market for the company’s products or services, its model and the management team. The people at the helm of the company are particularly important, since they’re the ones managing the business during its ups and downs.”

The Edison team liked PHX because “the business model hit the trifecta,” according to Sugden. “Health care is a huge market; it’s growing and continues to do so because of the aging population; and there’s plenty of waste, which the Zelis platform addresses. PHX, now Zelis, actually saves money for its customers, and shares a portion of the savings with them.”

Choices to consider

For a business owner, particularly a startup, VC funding may be more attractive then bank financing, added Sugden. “Bank financing can be onerous for an entrepreneur, since the lending institution will often ask for a personal guarantee from the owner. We allow them to escape the personal guarantee, as well as restrictive loan covenants that may require minimum levels of on-hand cash and limit their ability to grow, due to limited access to working capital. Also, we can lend the startup valuable expertise and industry contacts.”

The crisis changes everything

“Since the Great Recession of 2008, no one has thought about the world going to hell like now,” said Chris Sugden, managing partner of the Princeton-based venture capital firm Edison Partners. “For the most part, people have focused on what can go right, not what could go wrong.”

But this pandemic, and the resulting economic shocks won’t derail VC outfits like Edison, he added. “The past 10 years have been like a feast, with reduced interest rates and a rising economy. Now it’s time for a bit of indigestion. The last week or so we’ve been on a lot of phone calls as portfolio company CEOs engage in triage to shore up their balance sheet.”

Sugden and his crew are also offering a shoulder to lean on. “Who can the CEO talk to about their own nervous feelings?” he asked. “It’s like being a coach or parent — you have to be a rock for our portfolio company leadership teams who have to be a rock for their employees. In my experience, the really great entrepreneurs open up to us about their concerns. We function as a sounding board.”

Part of the problem was that “in the past few years, valuations went through the roof,” lamented Sugden. “The market was like an open spigot for capital, so fast-rising companies like Uber, DoorDash and WeWork, which have all since stumbled, were funded at incredibly high valuations despite the fact that their business models still required proof that they could scale profitably.”

Sugden said his organization avoided that bandwagon, but predicts that the broader VC community will go back to basics following the virus-induced meltdown. “Something needed to happen, and this hastened it,” he said. “Investors will return to considering how companies have to pay to acquire, retain, and service their customers, and whether they can charge more than what it takes to cover those costs. It’s simple, fundamental unit economics will be important again.”

If a cure is quickly found, Sugden thinks the VC and broader markets could bounce back in a few months. “If it takes longer though, startups may have to wait some time before they can secure funding. Right now, for example, we’re mainly focusing on getting our existing investments through this, but we are still evaluating new investments and will put money to work in new investments this year.”

But one big risk for VC funders is that “your capital is locked up,” he warned. “Because the company is private, you may not lose investment value quickly like in a stock market crash, but on the other hand you can’t cash out quickly, either. We usually plan a three-to-five-year exit, but we will ride winners as long as we can.”

Edison Partners found a great match in Roberti, said Sugden. “He had a vision and knew how to follow through on it. We didn’t have to handhold Todd. He is a great entrepreneur and leaned on us more as a sounding board than anything else.”

The VC firm continues to partner with the serial entrepreneur. In January, Edison Partners announced it was leading a $5 million investment in Ringmaster Technologies, another Roberti health care technology venture. Among its services, Ringmaster’s cloud-based platform uses advanced data analytics to improve quoting and administration processes for brokers, agencies, third-party administrators and others.

“We saw an opportunity to explore new technology and create automated solutions to drive greater value and growth across the entire health care industry’s business chain,” Roberti said. “I returned to Edison Partners based on our previous success together and, more specifically, the specialized expertise they provide at the board level and with their operating acumen. I’m excited to partner with the firm and again become a critical component of the complex health care ecosystem.”

PHX and Zelis created many millionaires, “including non-executive team members who joined PHX in the early days and were a key part of the success,” said Sugden. “The bottom line is firms like ours don’t win unless the entrepreneur and management team wins.”

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