SAN FRANCISCO — As many investors predicted, digital health funding took a dive in 2023 with startups bringing in $10.7 billion across 492 deals, representing the lowest amount of capital invested in the digital health sector since 2019.
Funding trends in 2023 continued the downhill trajectory that began in 2022.
The fourth quarter of 2023 was the lowest funding quarter since Q3 2019, with U.S. digital health startups raising $1.9 billion across 122 deals, according to Rock Health's annual year-end funding report, released Monday in conjunction with the J. P. Morgan Healthcare Conference.
By comparison, digital health startups raised $8.1 billion in 2019, by Rock Health's tally, followed by $14.3 billion in 2020 and then a whopping $29.2 billion in 2021, spurred by the investment in health tech during the COVID-19 pandemic. Funding dropped to $15.3 billion in 2022.
Faced with tightening capital availability, startups got creative to stay afloat and looked for lifelines, according to an analysis by Rock Health research analysts Madelyn Knowles and Mihir Somaiya.
"To buy time, startups sought out creative financing measures such as extension rounds, unlabeled raises and 'silent' deals from existing investors. Most companies also made operational adjustments that reduced reliance on outside capital," Knowles and Somaiya wrote in the report.
2023 saw a wave of extension raises and unlabeled funding rounds as startups avoided labeled rounds at adjusted valuations, or down rounds. In a new annual record, 44% of 2023’s fundraising deals were unlabeled, or not designated by a letter, such as “series C”, according to Rock Health.
Follow the Fierce team's coverage of the 2024 J.P. Morgan Healthcare Conference here.
"We previously reported on the rise of unlabeled rounds and noted that they, like series extensions, can serve up new capital to startups that haven’t yet reached the benchmarks expected for their next labeled raise. However, unlabeled funding leaves open questions about startups’ future raise timelines, and these companies may need to raise again soon or risk folding," Knowles and Somaiya wrote.
2023 also saw more than its fair share of unannounced, inside-round financings. But so-called "silent rounds" may merely defer or even compound risks and difficult conversations they’re sometimes intended to avoid, Rock Health research analysts said.
While the low funding numbers weren't a surprise, Rock Health analysts were surprised that other forecasted trends didn't materialize despite the tough market conditions. In 2023, M&A activity did not increase, even though cash-strapped startups were expected to look for buyers, Knowles and Somaiya noted. Despite a sluggish exit market, there wasn’t an alarming spike in startup shutdowns, though there were some notable bankruptcies, such as Babylon Health, as well as asset sales. Olive, once a high-flying "unicorn," for example, sold off its remaining assets and shut down operations.
But, the creative financing measures that startups turned to in 2023 are realistically one-time assists. Startups that aren’t able to leverage funding to reach the requisite standards of their next deal stage will face tough decisions in 2024, Rock Health research analysts said.
Many startups will have to "face the music" by returning to labeled fundraisers but at adjusted valuations, making a public or private exit, possibly with a lower price tag than expected or even winding down operations.
Rock Health analysts expect a return to labeled raises in 2024 as well as an uptick in M&A as deals could be a potential path for cash-strapped companies, even if those sales come at lower-than-once-ideal prices.
"Others may pursue partial M&A, following in the footsteps of companies like Cano Health and divesting parts of the business to focus energy on winning initiatives. Startups working with enterprise customers may find themselves with acquisition offers from those partners. These types of arrangements could mutually benefit both parties, helping founders find a viable path forward and ensuring enterprises can sustain their work with valuable partners," Knowles and Somaiya wrote.
2023 M&A volume was 23% lower than in 2022, with 146 total announced merger and acquisition deals of U.S.-based digital health companies this year, compared to 2022’s 190.
As the public market recalibrates, faltering public companies will likely delist while late-stage players may finally eye public exits after an IPO freeze in the past year. In 2021, 21 digital health companies went public through traditional IPOs or SPAC deals. There was only one public exit in 2022.
BrightSpring Health kicked off 2024 by renewing its plans to go public, signaling a potential end to the dry spell in the healthcare IPO market. Healthcare payment software maker Waystar also signaled plans to go public last year. The company confidentially filed for an IPO in August.
As of December 31, 2023, at least 17% of public digital health companies trading on the NASDAQ or NYSE were noncompliant with listing standards, having traded at or below $1 for over 30 consecutive business days.
Many investors predict that 2024 will continue to be a market reset for digital health.
"The tough reality is that we likely created too many digital health companies over the last 10 to 12 quarters. The capital provided to these companies may have afforded them 15 to 18 months of additional runway. Now, many of them are back in the market, and it’s unlikely that all will receive more funding," said Michael Greeley, co-founder and general partner at Flare Capital Partners said in the report.