The digital health fundraising environment has been a roller coaster over the past few years — soaring through the thrilling highs of rapid innovation and abundant capital, followed by the stomach-churning dips of market downturns and investment droughts. Not surprisingly, digital health startups seeking venture capital have been bracing themselves through the highs and lows of the market. In mid-2024, they can now finally take a breath.
The sector’s fundraising numbers for the first half of 2024 show that the investment environment seems to be normalizing for the first time since the Covid-19 pandemic. During the first half of this year, U.S. digital health startups raked in $5.7 billion across 266 deals, according to a recent report from Rock Health. The sector’s year-end venture capital fundraising totals for 2019 and 2023 were $8.2 billion and $10.7 billion, respectively.
That report added that this year’s digital health venture funding dollars are on pace to exceed the totals from 2019 and 2023, which it referred to as “helpful comparators outside of the pandemic-fueled funding cycle from 2020 to 2022.”
“The numbers are beginning to show promise and recovery. The stability we saw particularly in Q1 is beginning to translate into growth. To us, we view this period in time to be the most compelling investment environment we’ve seen in over a decade,” remarked David Kereiakes, managing partner with Windham Venture Partners.
Other digital health investors agree that the market is settling into a steady investment pace and returning to reasonable valuations. Only time will tell if this can bolster the lifeless rate of exit activity in the sector.
Stability at last
Kereiakes pointed out that there are always periods of abundance and scarcity in any investment market. However, in the past couple years, the digital health sector’s pendulum has swung more aggressively and over-corrected for what it believed were excesses of the pandemic period, he said.
The market’s newfound stability is encouraging, along with the fact that investors have begun looking at new assets rather than focusing solely on portfolio management, Kereiakes added.
This trend was reflected in Rock Health’s report. It showed that a large majority of the deals that occurred in the first half of 2024 were early-stage deals, meaning they came during the seed, Series A or Series B rounds. These early-stage transactions accounted for 84% of all deals in the first half of the year.
Ian Wijaya, managing director at Lazard, said the investment activity in the first half of 2024 falls in line with his expectations: more activity than the prior years’ trough and alignment with pre-pandemic investment levels. To him, this makes sense given the passage of time from “pandemic-era, free money exuberance.”
Although each investment in a digital health startup is the result of “a highly situation-specific negotiation,” much of the sector’s fundraising success can be attributed to the increasing clarity in the macroeconomic environment, such as progress in taming inflation, Wijaya stated.
He also noted that he is seeing more providers and payers who are open to allocating a significant portion of their budgets to digital transformation, supported by the broad applicability of AI.
Lower deal volume, greater deal size
Rock Health’s market research also showed that deal volume is decreasing while deal size is growing. As such, the average venture capital deal size increased by 17% to $14.4 million compared to the $12.3 million average deal size from last year.
This is likely because investors are focusing more on quality, Wijaya said. Investors are willing to funnel larger amounts of capital into companies that can demonstrate the efficacy of their clinical model, as well as the ability to produce a quick and needle-moving ROI for customers, he stated.
“The good news is that today there is capital available for the highest quality assets and we are currently living in a renaissance of health tech innovation. It just means that there is a tale of two cities when those investments get done — premium multiples for [high-quality] companies, and materially less interest in B+ assets,” Wijaya declared.
Kereiakes of Windham Venture Partners added that he’s seeing “a bit of herd mentality” among investors, who are collectively allocating their dollars to “safer assets with larger syndicates.”
Another healthcare investor — Michael Greeley, general partner at Flare Capital Partners — said he has noticed this herd mentality as well. Greeley said that he is referring to the current phase of the market as the “anoint the winner” stage.
There is a widening funding gap between the companies that can demonstrate strong unit economics and those that can’t, he noted.
“It’s typical in these markets where you have too many companies. You look for the ones that are going to be viable in the long term, and then they become the ones with funding,” Greeley remarked. “Those winners over the next couple of years go on to be acquirers of the smaller companies.”
In order to be anointed a winner, startups must be able to show investors a clear path to sustained customer adoption and revenue generation, he explained. In this current stage of the market, investors need to have a strong understanding of how many customers a startup can snag, as well as how they plan to deliver ROI to those buyers.
Which categories are hot?
Unsurprisingly, many of the companies emerging as winners are in the ever-hyped AI space, Greeley pointed out.
The opportunity to drive cost reduction, simplify administrative burdens and eliminate redundancies in the healthcare system is huge — and startups that are doing a good job of achieving these goals for their customers are receiving large funding rounds. Some examples include Cohere Health, which uses AI to simplify prior authorization, and SmarterDx, an AI startup that provides clinical review and quality audits for medical claims, Greeley noted.
Both companies have closed $50 million funding rounds this year. Greeley’s venture fund participated in both.
Steve Kraus, partner at Bessemer Venture Partners, also highlighted SmarterDx as a prime example of what a successful healthcare AI startup should look like.
The startup developed AI to help hospitals run second reviews of all patient charts — with the promise that this technology can help providers save millions in revenue leakage, as well as ensure that care quality is accurately represented. Revenue leakage often occurs due to small errors or omissions in the clinical documentation and coding process. These errors lead to missed, rejected or unpaid claims, CEO Michael Gao told MedCity News in May.
The startup currently has 15 health system customers, and its pricing model demonstrates its confidence in its ability to deliver value to these providers. SmarterDx operates on a contingency-based business model, meaning the company is paid a percentage of the cost savings achieved or new revenue generated for its customers, Gao said.
The company’s approach is rooted in the idea that AI solutions should complement the expertise of professionals — not replace them. This is another key consideration for today’s funding market, Kraus said.
To him, healthcare AI fits into three buckets: tools that automate back-end processes, tools that accelerate research and drug discovery and tools that help enhance clinical care. Investors are pouring capital into AI startups in the first two categories, but they will likely remain apprehensive about the third category. Some are uneasy about the idea that technology could replace providers, and many are waiting until more regulations are put in place to govern AI tools in clinical care settings, Kraus declared.
While AI is certainly here to stay, it’s not the only digital health category seeing healthy investment.
Startups specializing in behavioral health or chronic conditions management continue to raise sizable rounds, noted Wijaya of Lazard. This is simply due to the massive burden within both of these categories — 90% of the country’s $4.5 trillion annual healthcare expenditure is attributed to patients with chronic and mental health conditions. Some companies in these categories that have raised major rounds this year include Spring Health, Headway, Talkiatry and K Health.
The exit problem remains
While the fundraising environment is more positive, the same cannot be said for exits.
Following a 21-month period with zero public exits in the digital health sector, the second quarter of 2024 saw three digital health companies exit onto the Nasdaq or NYSE. Remote fetal monitoring platform Nuvo exited via a SPAC merger in May, and revenue cycle company Waystar and precision diagnostics firm Tempus AI launched IPOs in June.
“I think a lot of investors are waiting to see that the buyers of these companies are back in a meaningful way,” Greeley of Flare Capital Partners remarked of potential strategic acquirers. “Until we see robust exit activity, I think there will still be some skittishness. This is a more general comment across all venture sectors, but it definitely applies to health tech. Some of these companies have raised a lot of money but are now struggling to find a buyer.”
Kraus of Bessemer Venture Partners isn’t quite sure why exit levels are so low, but he has a hypothesis.
The digital health market is relatively immature and only about 12 years old, he pointed out. To Kraus, the first cohort of digital health companies to go public — including firms like Amwell and Teladoc that have languishing stock prices — haven’t exactly made the sector seem like it’s a great place for public investors to participate in.
“Some of them did well, and some of them really didn’t, and the market just crashed. So there was sort of a conflation between the first cohort of public digital health companies and the rest of the sector. Some of these failed for their own reasons, and some — because of macro-market reasons — were just not good investments for public investors. Adding on the craziness is SPACs, which were just a dumb thing to begin with, it was a perfect storm making for a bad debut of a sector,” he explained.
Kraus also noted that it takes a while for public investors to understand how niche markets work.
While he is confident that they understand the finances of companies like HCA Healthcare, Medtronic or Boston Scientific, he is doubtful that they understand the differences in business models for companies like Teladoc and Maven Clinic, which provides virtual women’s health services.
“Honestly, I think public market investors were learning how the sector worked, and then they said ‘Whoa, this whole thing was mispriced — we lost all our money so we’re going to focus on things that we know.’ That’s my guess,” he declared.
Kraus hopes to see stronger exit activity in the digital health space, but he said he doesn’t know when that will come or what the prices will look like.
Photo: Abscent84, Getty Images
