Last year’s trends in digital healthcare investments 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 five years. Q4 was also the first quarter with no new unicorn births since 2018.
These low funding amounts and shifting macroeconomic forces raise the question: which startups will prevail in their fundraising efforts, and which will fall by the wayside? Venture capitalists believe that companies that have a visible return on investment and serve multiple stakeholders are likely to 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 health investment trends on a year-over-year basis is a short-sighted approach, Morgan Cheetham, vice president of Bessemer Venturesindicated. Instead, we should look at the general 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 rose 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 of Maverick Venturesagreed that last year’s decline in digital healthcare financing was not as foreboding as some might think.
“Perhaps counterintuitively, I expect macroeconomic forces to prove a positive tailwind for healthcare this year,” he said. “Health care has historically been a recession-proof sector because much of the demand for health care tends to be inelastic. Coupled with the decade-long shift to a value-based care model, the macro environment will be less of a factor in health care than other parts of the economy sensitive to interest rates or inflation.”
In this market, capital efficiency is king. It is clear that investors will primarily target companies with strong unit economics and ROI, Bhattacharya said. He also predicts 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 her time earlier this month at JP Morgan Healthcare Conference reminded her that there is still plenty of capital ready to be deployed in digital health.
“Those investing in healthcare are focused on improving efficiency and want to have the tools to help healthcare solve its ‘triple A’ problem, as I like to call it: solving affordability, affordability and accuracy “, she said. “Right now, the biggest challenge facing healthcare is the lack of a skilled workforce, something that can be addressed with integrated digital solutions.”
According to Zhang, one of the biggest ways the digital health fundraising landscape is changing amid the economic headwinds is that investors are paying more attention to the founders they choose to partner with. Investors want to know how adaptable the founder is and whether they have experience handling crisis and identifying opportunities when in crisis mode.
Separately, founders should not be overly dependent on private capital, but also seek investment from alternative sources such as the government for non-dilutive funding.
“I like to see that the founders are not planning to rely solely on VC funding to survive as business. Is VC capital a catalyst to help them grow, or is VC investment their only strategy?” Zhang said.
Regardless of Zhang’s advice and others, many digital health startups are likely to fail given how the landscape has changed. Today, i.eCompanies 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, pharma, payers, employers and consumers, he said.
And serving multiple stakeholders likely means companies that build point solutions will have the hardest, toughest climb to raise funds.
“Executives in the hospital, payer, employer and pharma landscape are reassessing technology spending across the board and paying close attention to the long queue of providers they’ve signed up for over the past few years,” Bhattacharya said, adding that healthcare providers are looking to consolidate suppliers.
Cheatham claims that ccompanies that serve providers must demonstrate a financial return on investment for their customers, not only by saving them money, but also by making them money within a year of implementation. That nuance will be the difference between companies that are able to grow quickly and those that are stable or grow slowly, he said.
On the employer side, it’s becoming increasingly difficult for healthcare navigation companies to prove their value as investors exert more control over demonstrable ROI, said Drew Hodgson, national healthcare delivery practice leader at Willis Towers Watson.
“I personally don’t think there’s necessarily an ROI with a navigation provider,” he said. “They’re one of those types of providers that have value among employees—employees really like them. But it’s a challenge for them to be able to demonstrate direct ROI on their particular model.”
Hodgson described the return on investment of navigation companies as “indirect”. Companies like Livongo or Carrum Health can lead to care utilization, but it’s hard for them to prove they’re the reason a person sought 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 is work to be done. Patient Engagement and Clinical Documentation Spaces Too Crowded Rebecca Springer, PitchBookthe leading health analyst pointed out.
Simply put, there are many startups doing the same task, so those who can do it cheaply and efficiently will win over those who can’t. Some big players are getting involved in the patient engagement space Weaving and Artery — they could overshadow startups that are less established, Springer said. The same goes for key players in the field of clinical documentation, such as iodine and Nuance.
So expect some failures and consolidation in these markets.
There was one final piece of advice from venture capitalists about how to raise funds in this economic environment: be adaptable.
Rather than targeting a large round, founders should think carefully how much capital they really need at any given time and be flexible when it comes to the amount of funding, round completion speed and valuation. Funding amounts and valuations will change as the market does, but that doesn’t mean your business is doomed.
Pearly health CEO Michael Kopko shared similar advice. His company, which helps independent physician practices participate in value-based care models, recently completed $75 million Series B funding round. While 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 always been the promise of startups,” he said. “At the end of the day, you’re going to be tested by your courage and your ability and the results you deliver — dollars don’t really do that. It’s the team and the ability to execute. So I think people get 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