Last year’s digital health investment trends have left some startups feeling uneasy about their ability to raise capital in the new funding environment. Healthcare startups raised $3.4 billion in the fourth quarter of 2022, marking the sector’s lowest quarterly funding total in the past five years. Q4 was also the first quarter with no new unicorn births since 2018.
These low funding totals and changing macroeconomic forces beg the question: which startups will prevail in their fundraising efforts, and which will fall by the wayside? Venture capitalists think companies that have a demonstrable return on investment and serve multiple stakeholders will probably have the easiest time securing capital. Not surprisingly, point solutions and startups in crowded markets will face a tougher environment.
Though digital health startups are raking in less capital than they were in 2020 and 2021, considering healthcare investment trends on a yearly basis is a shortsighted approach, Morgan Cheatham, vice president of Bessemer Ventures, pointed out. Instead, we must look at the overall trend.
Just 10 years ago, only $1.6 billion of total venture capital was invested into digital health companies, Cheatham said. In 2022, the sector raised $15.3 billion. While this is a far cry from the $29 billion raised in 2021, last year’s funding was still 10 times higher than it was a decade ago.
Ambar Bhattacharyya, managing director at Maverick Ventures, agreed that last year’s dip in digital health funding isn’t as foreboding as some may think.
“Perhaps counterintuitively, I expect macroeconomic forces will end up being a positive tailwind for healthcare this year,” he said. “Healthcare has historically been a recession-resilient sector, as much of the demand for healthcare tends to be inelastic. When coupled with the decade-long shift towards a value-based care model, the macro environment will be less of a factor in healthcare than other interest rate or inflation-sensitive parts of the economy.”
In this market, capital efficiency is king. It’s obvious that investors will first and foremost flock toward companies with strong unit economics and ROI, Bhattacharyya said. He also predicted that digital health investors will maintain their interest in the generative AI space, as this industry is in the midst of a technological revolution.
Another venture capitalist — Lu Zhang, founder and managing partner at Fusion Fund — said that her time earlier this month at the JP Morgan Healthcare Conference reminded her that there is still plenty of capital ready to be deployed into digital health.
“Those investing in healthcare are focused on efficiency improvements and want to have the tools to help healthcare solve its ‘triple A’ problem, as I like to call it: addressing issues with affordability, accessibility and accuracy,” she said. “In this current moment, healthcare’s biggest issue is lack of skilled labor, something that could be solved with integrated digital solutions.”
In Zhang’s view, one of the biggest ways the digital health fundraising environment is changing amid economic headwinds is that investors are paying closer attention to the founders with whom they choose to align themselves. Investors want to know how adaptive the founder is and whether they’re experienced in handling downturn and identifying opportunities when in crisis mode.
Separately, founders should not be too dependent on private capital, but also look for investments from alternative sources like the government for non-dilutive funding.
“I like to see that founders aren’t planning to only rely on VC funding to survive as a business. Is the VC capital a catalyst to help them grow or is VC investment their only strategy?” Zhang said.
Zhang and others’ advice not withstanding, many digital health startups are likely to falter given how the ground has shifted. Today, the companies with the strongest ability to raise capital will be those that serve multiple stakeholders, Cheatham declared. Investors find companies more attractive if they can create value for providers, pharma, payers, employers, and consumers, he said.
And serving multiple stakeholders likely means that companies building point solutions will have the most arduous, uphill fundraising climb.
“Executives across the hospital, payer, employer and pharma landscape are reevaluating tech spend across the board and taking a hard look at the long tail of vendors that they signed up for over the past few years,” Bhattacharyya declared, adding that healthcare providers are looking to consolidate vendors.
Cheatham argued that companies that serve providers must demonstrate financial ROI for their clients not only by saving them money, but by actually making them money within a year post-deployment. This nuance will be the difference between companies that are able to scale rapidly and those that are flat or growing slowly, he said.
On the employer side of things, it is becoming difficult for care navigation companies to prove their worth as investors exercise more scrutiny over demonstrable ROI, said Drew Hodgson, national practice leader for health care delivery at Willis Towers Watson.
“I personally don’t think there is necessarily an ROI with a navigation vendor,” he said. “They’re one of those types of vendors that have value with employees — employees really like them. But it’s challenging for them to be able to prove direct ROI under their particular model.”
Hodgson described care navigation companies’ ROI as “indirect.” Companies like Livongo or Carrum Health can end up driving care utilization, but it’s difficult for them to prove that they’re the reason a particular person ended up seeking care, he said.
As venture capitalists continue to speculate about which companies will prevail amid the new fundraising environment, it’s also important to remember that there is some weeding out to do. The patient engagement and clinical documentation spaces are both a bit too crowded, Rebecca Springer, PitchBook’s lead healthcare analyst, pointed out.
Simply put, there’s a lot of startups out there that perform the same task, so the ones that can do it cheaply and efficiently will win out over those who don’t. In the patient engagement space, some big players include Weave and Artera — they could eclipse startups that are less established, Springer said. The same goes for key players in the clinical documentation field, like Iodine and Nuance.
So, expect some failures and consolidation in these markets.
There was one final piece of advice from venture capitalists on how to go about fundraising in this economic environment: be adaptive.
Instead of setting sights on a major round, founders should carefully consider how much capital they really need at any point in time and be flexible when it comes to the funding amount, speed of completing the round and valuation. Funding amounts and valuations will change as the market does, but it doesn’t mean your business is doomed.
Pearl Health CEO Michael Kopko shared similar advice. His company, which helps independent physician practices participate in value-based care models, recently completed a $75 million Series B financing round. Though Pearl’s fundraising efforts were successful, he admitted that this round took longer than the startup’s Series A.
“You can do a lot with a little and that’s kind of always been the promise of startups,” he said. “At the end of the day, you’ll be tested by your mettle and your capabilities and the results you deliver — the dollars don’t really do that. It’s the team and the ability to execute. So I think people get a little bit obsessed with dollars and numbers. And I don’t know if that’s the healthiest thing for the ecosystem.”
Photo: Khosrork, Gatty Images