A Big Picture look at Digital Health

At the end of every year, I like to set goals and predictions . I like the chance to look back at my notebook — that’s right, a pen and paper, not GoodNotes, Squid or Bamboo Paper — and see if my theses are becoming true, or if not, what has changed and where I went wrong in my thinking. Typically, it’s a private endeavor, but for this year, I welcome the brutal honesty of publishing them for all those to see. So with that, here are my predictions in the health tech space this year.

When the world sees dolla dolla bills
As a whole, markets have gone insane. The stock market is ignoring the economy. We are seeing record highs in the public markets, while seeing millions unemployed in the US. Yields on government debt are historically low, driving investors to look for returns either via the stock market or through alternative assets.

That capital is being piled in part into venture capital. More specifically, much of that capital is being poured into healthcare VCs. $17B was raised in the US for healthcare VC funds in 2020. That is: the capital that was given to investors focused on healthcare. This will have a massive impact on both the types of companies that are receiving funding as well as the euphoric valuations that SaaS investors are all too familiar with — and healthcare investors are not.

This abundance of capital across healthcare funds (“dry powder,” if you will) places increasing pressure on fund managers to deploy their capital in the era of inflated valuations. Venture capitalists have our own investors. Each fund is set up with different terms, but usually commits to deploying its capital within the first 3–4 years of the initial closing. In order for valuations to remain semi-stable, there needs to be quality companies fundraising for venture capitalists to soundly deploy their capital. How many quality companies can there be? How many applications can the FDA process in a year? How many healthcare companies can big tech companies buy? How many companies can go public? What I am alluding to is that concrete exit opportunities are far fewer in numbers than entrepreneurs.

More money, more players, more problems
What impact has this had so far? The market is saturated with an overabundance of companies trying to solve niche problems as the industry matures and moves towards less fragmented solutions. An example of this is in the remote patient monitoring space, where many companies start with one main indication (i.e. diabetes) and, as part of their product roadmap, build out indications (i.e. first fibromyalgia, then hypertension). What happens when all of these companies converge? It’s a dog-eat-dog world out there. Did the VC evaluating these companies take the concept of this eventual overlap into consideration, or did it focus only on the novelty of its first breakthrough and assume the excellence of the investment based on that? Which do the current valuations reflect? I’m thinking that in the world where cash is a commodity, those valuations are relatively high since they are likely not risk-adjusted.

Another significant shift in the landscape is the amount of generalist funds with significant capital entering the healthcare space. These funds usually don’t want any intense healthcare — something light, easy to understand, and with a recurring business model. These investors will search for companies with proven business models in this new space. This will be, in part, a risk mitigant to an unknown market. This will continue the trend of “mega rounds” (rounds of $100M+) taking place in digital health. In 2020 through Q3, the average deal size was $30.2M, 1.5 times larger than the $19.7M average in 2019.

Besides the implications of valuation inflations in 2021, the IPO/SPAC market is red hot (many opinions on that, but for a different post!) and will cause well-funded growth stage startups to drive M&As as part of the race to the public markets. This past year of digital health IPOs are proof of that: GoodRX acquired Scriptcycle 3 weeks before its IPO and Health Catalyst announced its intention to acquire HIE Technology 2 weeks before its public debut. Already in 2021, Accolade (IPO-ed July 2020) announced its acquisition of 2nd MD. In many cases, these acquisitions are a necessary part of the IPO process; institutional investors need to see minimum revenue thresholds in order to be comfortable with publicly traded startups.

Where is the Opportunity in 2021?

Given the abundance of capital, inflated valuations, and mega rounds, here’s where I’m looking for opportunity this year:

1. Femtech: 50% of the population, 3% of digital health dollars being invested into the space. Femtech is so much more than fertility. This wide market addressing the diversity of womens’ experiences includes general healthcare, pregnancy and nursing and menopausal health.
2. Consumer-focused solutions: It is incredibly difficult to understand the American healthcare system and consumers are starting to retaliate. The pandemic forced innovation within digital health and created a myriad of new virtual, physical, and hybrid solutions. Given these options, consumers will be in charge of their healthcare. Who wants solutions you can’t understand in the age of easily accessible data? Moreover, the profile of consumers has evolved in recent years, and greater emphasis is being placed on convenience as tech-literate boomers age and place a greater emphasis on convenience.
3. Beauty on-demand: As digitized generations get older, the lasting impacts driven by social media will be seen in these fields. Companies that decentralize non-surgical aesthetic treatments including Botox, Coolsculpting, Sculpsure will find a willing market as the societal pressure to have a personal brand increases. 2021 may see the rise of at-home treatments expanding from filters to fillers.
4. Payer-led innovation: While a target market of many digital health companies have historically been hospital systems, 2021 will prove to be a difficult year with provider customers. Most are cash-poor, given the extreme expense of the pandemic to the provider system. However, payers are currently flush with cash due to decreased utilization during the pandemic. This gives payer groups the freedom to explore digital solutions to improve outcomes.

“A climate of fear is your friend when investing; a euphoric world is your enemy” Warren Buffett

It is rare to take value investing concepts and apply them to the world of venture capital — it seems innately paradoxical. The concepts of fear, greed, and euphoria are well known across all financial markets. In these markets, though, I would think it imprudent not to apply a little value investing to the VC ways.

We are already in a euphoric market. 2020 undoubtedly stress tested the healthcare industry and drove faster innovation and adoption than ever before. Ultimately, this should drive better health outcomes. However, the disconnect between the economic state of affairs and the financial markets makes me fearful of what is to come. 2021 will yield more funding, some massive winners and many losers. Unfortunately, the bullish attitude of the market will make it hard to see the immediate impact of the losers. We have seen the upside of IPOs, SPACs, and valuations. The downside will inevitably come — it is just a matter of when. Until then, as a digital health investor I am focusing on using the below current market standard multiple benchmark and the business execution model vs. product and hoping some of OTV’s portfolio companies can take advantage of the market 😋.

Special thanks to Brian Steinberg from Zora Ventures for forcing me out of my comfort zone😀