Burn Rate Too High, Exit Challenges Persist: 60-90% of Digital Health Startups Fail
Editor’s Note: This article is republished from Health Insight (ID: HealthInsight), translated by Qin Yuyang, and reposted by VCBeat with authorization.
The digital health sector, highly sought after by investors, will see a decline in investment this year. Rock Health’s recently released 2018 Digital Health Investment Report (hereinafter referred to as the “Report”) highlights this trend.
The sector attracted $5.7 billion in investment in 2017, setting a historical industry record. In 2018, this figure surged to $8.1 billion, representing a substantial increase of 42%. Capital exits were as robust as the influx of funding. The report indicates that in 2018, 110 digital health companies exited via acquisitions, while the absence of initial public offerings (IPOs) persisted for over a year.
The report predicts that the growth rate of venture capital investment in digital health will slow down in 2019.
Rock Health is a global venture capital firm focused on internet healthcare, often referred to as the “incubator” of the health and medical industry. The report presents the development status of the digital health sector in the United States. As a single leaf can herald the arrival of autumn, this trend may offer valuable insights for the Chinese market.
The following is a compilation and selection of the report by the author:
The report states that market and regulatory scrutiny of the digital health industry has intensified more than ever before. This harsh reality poses a critical question to the sector: Can its current ability to create value meet capital expectations? It is reported that investors expect a return on investment (ROI) of four times the principal within ten years. “Recently, conversations within the industry have increasingly included the ‘B-word’ (profanity),” the report noted.
“Is Digital Health a Bubble?” The report poses and answers its own question: “Our assessment is that it is not.”
The report suggests that, as in other industries, the development of the digital health sector is inextricably linked to overall economic conditions and risk. “Stock market corrections and shifts in the macroeconomic landscape since 2018 have created a different, more constrained backdrop for 2019,” leading to a contraction in venture capital investment in digital health over the coming years.
Rock Health states that digital health currently accounts for 10% of total venture capital investment. “This trend will continue.”
U.S. Digital Health Sector Accounts for Approximately 10% of Total Venture Capital Investment
In response to market panic, Rock Health analyzed the industry using an investor-validated cognitive framework.
This cognitive framework proposes six focal points for observing industry bubbles:
Has Hype Replaced Fundamental Business?
High Fever Incidence Rate
Is the exit strategy clearly defined?
Surge in Cash from New Investors
High Valuations Detached from Fundamentals
Fraud or Misuse of Funds
The report provides a point-by-point comparison with the current state of digital health investment in the United States, followed by analysis and assessment.
When capital inflows far exceed actual needs, bubbles grow. During the dot-com bubble, investors poured money into new internet companies, “but few had viable business models to justify the investments. This painful lesson is our starting point for identifying signs of a digital health bubble.”
“It’s no secret that the digital healthcare industry is complex,” the report states. Digital health startups must figure out how to navigate long sales cycles, slow reimbursement, complex regulations, and blurred industry boundaries. Amid these constraints, investors and entrepreneurs are actively learning and continuously innovating to demonstrate the value of their services, align with macro trends, and build sustainable business models.
The report states that 61% of startups are shifting from B2C to B2B or B2B2C models.
“From our perspective, today’s digital health investments are driven more by technology advancing the healthcare market than by irrational hype.”
The report quoted Michael Greeley, Co-founder and Partner at Flare Capital: “The U.S. healthcare market exceeds $3 trillion, nearly 15 times the size of the U.S. advertising industry. It took a decade to reach this year’s investment pace of $8 billion. Bubbles in other industries often revolve around uncertain business models and an excessive influx of capital too quickly. Here, we have clear business models capable of serving a massive market.”
The report acknowledges that the digital health industry does indeed have a “moderate bubble” when it comes to “burning cash.”
During the dot-com bubble, companies heavily relied on investor capital and struggled to meet their obligations when funding dried up. Startups in the digital health sector are currently exhibiting similar symptoms.
Many fast-growing startups are raising larger amounts of capital at an accelerated pace. Since 2011, the time between seed and Series A financing rounds has shrunk from over 30 months to approximately 15 months. This compressed fundraising cycle reflects the reality that available capital is insufficient to sustain prolonged cash burn.
Increasingly Frequent Fundraising Cycles
Some investors have highlighted the hybrid nature of digital health: compared with traditional healthcare investments (such as biopharmaceuticals and medical devices), the digital health industry is less capital-intensive, but its sales cycles are more complex and slower than those of conventional technology sectors. Startups must devote more time and capital to securing their market position, reconciling the conflicts between market demands and entrepreneurial innovation.
“Due to the long sales cycle, you must invest significant capital to identify your target customers. This is a fundamental and unsettling reality. CEOs who understand how to navigate this will be able to retain greater ownership in their companies and afford themselves more flexibility at exit,” said Liz Rockett, Director at Kaiser Permanente Ventures.
The report suggests that savvy entrepreneurs need to find ways to reduce the need for new capital while achieving growth milestones.
“60% to 90% of startups fail.” The report stated that as long as a sufficient number of companies achieve successful exits, capital institutions will also profit.
In the digital health sector, exit activity has remained sluggish, with few acquirers stepping in. This has raised concerns among investors, who may seek various ways to withdraw their capital, thereby triggering a bubble.
Since iRhythm’s initial public offering (IPO) in 2016, although tech IPO activity rebounded in 2018, there have been no digital health IPOs. Mergers and acquisitions (M&A) remain the primary exit strategy, with 110 acquisitions recorded in 2018, representing a slight decline over the past three years.
Since the beginning of this year, the U.S. market has witnessed a wave of “acqui-hires” and fire-sale acquisitions, while emerging digital health companies have also expanded their product portfolios through M&A. Livongo acquired Retrofit and its DPP (Diabetes Prevention Program) solution to bolster its digital therapeutics offerings. ResMed acquired Propeller Health for $225 million, aiming to become “the global leader in digital health for COPD.”
Some investors have expressed concern that such large-scale healthcare consolidation will limit the number of potential buyers for digital health companies. However, industry insiders argue that this dramatic restructuring among the largest enterprises will inevitably drive demand for digital innovation. The report suggests that opportunities are still emerging amidst the downturn (with reasonable forecasts indicating that mergers are imminent).
Rising bubble prices attract new investors to make speculative bets, with hype and capital flowing in as funds continue to pour in. This could incentivize the more than 200 new investors who have entered the digital health sector annually since 2015. These “novice” investors, who tend to inflate valuations, are also likely to be the first to pull back at the first signs of a downturn.
Rising Proportion of Repeat Investors
The flow of new capital can be a double-edged sword: it facilitates liquidity and exits for the industry, but it may also create bubbles. “And balance is everything.” A survey by Rock Health reveals a balanced landscape: despite a considerable number of new investors entering the market each year, both repeat and new investors have been present in the digital health sector since 2015, with their numbers continuing to grow and the gap between them widening.
Entrepreneurs who have taken root in this field are also sending stable signals and exerting influence on the market—they encourage companies to accelerate their growth pace and formulate long-term fundraising plans, rather than relying on substantial cash inflows every year. These signs allow the bubble to burst on its own.
With larger and more frequent funding rounds, valuations have surged, giving rise to seven digital health “unicorns” (privately held companies valued at over $1 billion) in the U.S. market that have attracted significant investment. Six of these companies raised a round of financing in 2018, with an average deal size of $231 million. Tempus, a platform providing clinical and molecular data for cancer research, closed two funding rounds this year, raising a total of $260 million within 12 months.
The former unicorn Human Longevity lost its momentum in 2018. Its current valuation stands at approximately $310 million, a significant decline from the $1.5 billion valuation it held in 2017.
Steve Klausner of Bessemer Venture Partners warned, “I am not obsessed with unicorn valuations. The focus should be on building a ‘unicorn product’ in the healthcare sector, and the rest will take care of itself.” He expressed disagreement with the practice of some startups inflating their valuations through massive investments, rather than adopting a disciplined approach to conserve cash and avoid selling at low prices.
The report states that market participants may be driven by greed in pursuit of substantial returns before a bubble emerges. During the cryptocurrency bubble of 2017–2018, as many as 80% of initial coin offerings (ICOs) were scams. Such narratives or illicit greed can fuel the market toward a bubble.
In 2017, Outcome Health breached the trust of clients and investors by manipulating data regarding the effectiveness of its pharmaceutical advertising business. The company secured $500 million in growth equity financing within just a few months, thereby achieving unicorn status. By late 2018, Theranos had completely collapsed, offering the market a valuable lesson. “Such stories are notable exceptions in digital health,” the report stated, adding that digital health companies will remain on the path of integrity-driven innovation.
The report states that, as a vital component of venture capital, the digital health sector will become increasingly tied to macroeconomic cycles. In this broader environment, as capital becomes harder to secure, digital health companies must demonstrate their ability to uphold fundamental business strengths.
The report stated, “Healthcare innovation as a whole is facing tremendous opportunities, and we do not anticipate a bubble burst.”
The report suggests that savvy investors and entrepreneurs should prepare for capital flows—including expanding revenue streams, exploring viable exit strategies, and embracing consolidation. When challenges arise, true value creators will stand firm.