Investors are understandably cautious this year as the Federal Reserve tightens monetary policies and financial markets erased the gains from the last 12 months. Public company investors in sectors with enticing upside—like digital health—are waiting for headwinds to abate before they jump back in, and investment in venture-backed companies has slowed considerably.
The numbers from the first quarter of 2022 reflect this caution. After a record-breaking 2021 for the white-hot digital health sector, where the number and size of funding rounds reached new heights, the first quarter saw a slowdown in digital health dealmaking and the IPO market quieted significantly.
The downturn, of course, is not confined to digital health. Challenges including inflation, rising interest rates, the war in Ukraine and ongoing supply chain issues have resulted in capital preservation and belt tightening, postponed IPO plans and valuation markdowns across the startup landscape. Public companies in nearly every industry are being similarly impacted, with tech being hit particularly hard.
But the full story of 2022 remains to be written, and for digital health, at least in the private market, it is more of a slowdown than a crash. Deals are still being done, and digital health companies offering products and services that improve patient health and quality of care still have a lot to be optimistic about. But there is no question that for now, the bar for raising private capital or accessing the public markets has been raised across the digital health sector.
Funding Figures Reflect New Reality
Our friends at Rock Health point out that there were 183 venture capital financings for U.S.-based digital health startups in Q1 of this year, with a total value of about $6 billion. This represents a meaningful drop from Q4 of last year, when $7.3 billion was invested. The first quarter of 2021—which was the smallest quarter last year in terms of dollars invested—saw $6.7 billion flow to digital health startups, researchers indicated. Globally, digital health startups saw a 36% drop in funding from the fourth quarter of 2021.
Our analysis of data from PitchBook, which examines not only funding rounds but also leveraged buyouts, grants, acquisitions, IPOs and other transactions, shows that globally there were 390 total transactions in the first quarter, which is a 26% drop from the first quarter of 2021, when 525 transactions were closed.
Investments in early-stage digital health companies have followed the same trajectory that high-valuation growth stocks have charted on Wall Street: downward. While there were 103 funding rounds for early-stage digital health companies in Q1 of 2021, there were 82 over the same period this year, according to Pitchbook. But for later-stage deals, the gap was noticeably smaller. While there were 121 later stage deals in Q1 of 2021, there were 115 in the first quarter of 2022.
This could be a sign that later-stage companies are delaying their entries to a public market that has been extremely volatile so far this year. These companies may also be holding back as they rewrite their roadmaps away from SPAC transactions—which have not fared well in recent market turbulence—and toward the traditional IPO route.
While the number and size of deals dropped in Q1, PitchBook research found that 11 U.S.-based digital health startups—all of them later-stage—raised “mega-rounds” of more than $100 million. Fenwick represented Lyra Health in its $235 million financing, Brightline in its $105 million Series C round and Freenome in its $290 million investment from Roche Diagnostics.
Quieter Exit Markets
Last year saw an average of 23 mergers or acquisitions for digital health startups each month, and a yearly total of 23 debuts on the public markets via SPAC or traditional IPO transactions. Our research shows that there was a single digital health IPO in the first quarter of this year, down from three over the same period last year.
The number of mergers and acquisitions, however, was unchanged between Q1 of last year and the first quarter of this year, at 31 transactions for both time periods. A couple of the transactions Fenwick advised on in Q1 included representing Nurx in its merger with Thirty Madison and Calm in its acquisition of Ripple Health.
In healthcare more broadly, M&A dealmaking is down so far this year. But acquirers are still keen on cloud-based healthcare platforms and new digital tools. Hospitals and healthcare systems—whose bottom lines are under pressure from supply constraints, staffing shortages and a steep decline in elective procedures—need to accomplish more with less during the current downturn, and see digital health solutions as a lifeline.
Hospitals are expected to undergo fundamental changes this year, with consolidations, restructurings and bankruptcies predicted. These trends could mean that the acquisition of digital health tools and platforms will continue full steam this year, as chaos often spells opportunity for newer entrants.
At the same time, significant changes are on the way that will likely have a measurable impact on digital health’s hottest sector of the past two years: telemedicine. While the federal government will be deciding how many Medicare patients are eligible for digital remote care, states will iron out their rules for licensure of healthcare professionals who use these platforms. Major insurers will also be fine-tuning their reimbursement rules for telehealth. If decisions in all of these areas enable the further expansion of telemedicine, it could rev up M&A and funding opportunities for startups in this area.
Signs of Resilience
The economic downturn has battered every asset class, from growth stocks to the bond market to cryptocurrencies to commodities. Analysts disagree on whether the market is nearing its bottom, or whether more volatility and downside is incoming.
The private markets have followed the same path, and investors are advising startups to tighten their belts and make their cash last, as recovery could take time.
Digital health, however, is showing signs of resilience. Six new digital health unicorns—or startups valued at more than $1 billion—emerged in the first quarter of this year, which was a period of historic valuation write-downs across a range of industries.
M&A remains lively, and changes are on the horizon that could help digital health rebound.
As always, it will be interesting to see what the rest of this year has in store. I’m optimistic. As we have seen during prior downturns, times of upheaval and uncertainty will give way to exciting new opportunities for growth, and new companies will be formed and become tomorrow’s leaders.
Questions or thoughts? Drop me a line or reach out on Twitter.