The digital health investment trends of the past year 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 last five years. Q4 was also the first quarter with no new unicorn births since 2018.
These low funding amounts and changing macroeconomic forces beg the question: which startups will dominate their fundraising efforts, and which will fall by the wayside? Venture capitalists think that companies that have a visible 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.
Although digital health startups are raising less capital than in 2020 and 2021, looking at healthcare investment trends on an annual basis is a short-sighted approach, Morgan Cheatham, vice president of Bessemer Venturesdirected. Instead, we should look at the overall trend.
Just 10 years ago, only $1.6 billion of total venture capital was invested in digital health companies, Cheatham said. In 2022, the sector grew 15.3 billion dollars. While this is far from 29 billion dollars raised in 2021, last year’s funding was still 10 times higher than a decade ago.
Ambar Bhattacharya, managing director at Maverick Venturesagreed that last year’s decline in digital health funding is not as foreboding as some might think.
“Perhaps counterintuitively, I expect macroeconomic forces to end up being a headwind for health care this year,” he said. “Health care has historically been a recession-resistant sector, as much of the demand for health care tends to be inelastic. When coupled with the decades-long shift to a value-based care model, the macro environment will be less of a factor in health care than other interest-rate or inflation-sensitive parts of the economy.”
In this market, capital efficiency is king. It is clear that investors will primarily flock to 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 the 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 at the beginning of this month in JP Morgan Healthcare Conference reminded her that there is still plenty of capital ready to be deployed in digital health.
“Those who invest in health care are focused on efficiency improvements and want to have the tools to help health care solve its ‘triple A’ problem, as I like to call it: addressing issues of affordability, access and accuracy, she said. “At this current moment, the biggest health care issue is the lack of a skilled workforce, something that can be solved with integrated digital solutions.”
According to Zhang, one of the biggest ways the digital health fundraising environment is changing amid the economic headwinds is that investors are paying more attention to the founders they choose to connect with. Investors want to know how adaptable the founder is and whether they have experience handling downturns and identifying opportunities when in crisis.
Separately, founders should not be too dependent on private capital, but also seek investment from alternative sources such as the government for non-dilutive financing.
“I like to see that founders are not planning to rely solely on VC funding to survive as a business. Is VC capital a catalyst to help them grow or is VC investing their only strategy?” Zhang said.
Not immune to the advice of Zhang and others, many digital health startups are likely to falter given how the terrain has changed. Today, tCompanies with the strongest ability to raise capital will be those that serve multiple stakeholders, Cheatham said. Investors find companies more attractive if they can create value for providers, pharmacies, payers, employers and consumers, he said.
And serving multiple stakeholders likely means that companies building point solutions will have the most difficult and uphill climb to raise funds.
“Executives across the hospital, payer, employer and pharmacy landscape are reevaluating technology spending across the board and taking a hard look at the long tail of vendors they signed up for over the past few years,” stated Bhattacharyya, adding that health care providers are looking to consolidate vendors.
Cheatham argued that cProvider service companies must demonstrate financial ROI to their customers by not only saving them money, but actually making money within a year of deployment. That nuance will be the difference between companies that are able to scale quickly and those that are flat or growing slowly, he said.
On the employer side, it’s getting harder for care navigation companies to prove their worth as investors exert more scrutiny on demonstrable ROI, said Drew Hodgson, national practice leader for healthcare delivery at Willis Towers Watson.
“I personally don’t think there’s necessarily an ROI with a navigation vendor,” he said. “They’re one of those types of vendors that have value with employees — the employees really like them. But it’s challenging for them to be able to prove direct ROI on their particular model.”
Hodgson described the ROI of care navigation companies as “indirect.” Companies like I’m in love or Car health may end up using care to drive, but it’s hard for them to prove they’re the reason a particular person ended up seeking care, he said.
As venture capitalists continue to speculate about which companies will prevail in the new fundraising environment, it’s also important to remember that there are some takeaways to be made. Patient engagement and clinical documentation spaces are a bit crowded Rebecca Springer, PitchBookThe leading health care analyst noted.
Simply put, there are a lot of startups out there doing the same task, so those who can do it cheaply and efficiently will win out over those who can’t. In the patient engagement space, there are some big players involved weave AND Artery – they can eclipse startups that are less established, Springer said. The same applies to the main players in the field of clinical documentation, such as Iodine AND Gradient.
So expect some failures and consolidation in these markets.
There was one last piece of advice from venture capitalists about how to go about fundraising in this economic environment: be adaptable.
Rather than setting their sights on a big round, founders should consider it carefully how much capital they really need at any given time and be flexible when it comes to funding amount, round completion speed and valuation. Funding amounts and valuations will change as the market changes, but that 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 ENDED a $75 million Series B funding round. Although 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 less, and that’s always been the promise of startups,” he said. “At the end of the day, you’re going to be tested by your skills, your abilities and the results you deliver — dollars don’t do that. It’s the team and the ability to execute. So I think people are a little obsessed with dollars and numbers. And I don’t know if that’s the healthiest thing for the ecosystem.”
Photo: Khosrork, Gatty Images
