Digital health startups are navigating a tougher funding environment with lower check sizes and more scrutiny on outcomes and value-for-investment in 2024.
In the first quarter, U.S. digital health startups raised $2.7 billion across 133 deals, with an average deal size of $20.6 million, according to an analysis by Rock Health, a venture fund dedicated to digital health.
The first three months of 2024 marked the lowest first-quarter funding since 2019. Funding was down significantly from the $3.6 billion raised in the first quarter of 2023. In the second quarter last year, digital health startups brought in $2.6 billion, followed by $2.7 billion in the third quarter and $1.9 billion in the fourth quarter.
But, deal volume was up. The first quarter of 2024 logged 133 fundraises for digital health companies, beating out each of the past six quarters though just edging out the first quarter of 2023’s 132, Rock Health researchers wrote in the first-quarter funding report.
"In the private markets, creative financing measures were the name of the game, while AI drove investment energy and attention refocused on startups’ abilities to demonstrate outcomes. In the public markets, stock delistings continued to change the makeup of digital health’s publicly-traded cohort, impacting how digital health players and investors think about exit potential," the researchers wrote.
Expectations are resetting for digital health players both private and public, the Rock Health researchers noted, pushing companies to focus on strong outcomes and healthy margins instead of high projected growth rates and also is driving startups to take a different approach to dealmaking.
Several sectors are emerging as bright spots as AI-enabled companies draw investor interest. AI-based digital health startups brought in 40% of the first quarter's funding total, or $1.1 billion across 45 deals, rising from 33% of 2023 digital health funding and 29% of 2022’s funding pot, according to Rock Health's report.
Abridge, which developed AI-enabled clinician scribe software, banked a $150 million series C in February, just four months after raising their series B, and AI precision health company Zephyr AI announced a $111 million series A in March. Other AI digital health startups that raised in the first quarter include Ambience Healthcare ($70 million), Fabric Labs ($60 million), Codametrix ($40 million), Limbic ($14 million) and Milu Health ($5 million).
The trend of creative deal structuring, like unlabeled rounds, continued in the first quarter as digital health startups navigate a tighter funding market. Nearly half (48%) of the fundraising deals in the first quarter were unlabeled rounds, compared to 44% of all digital health funding deals in 2023, according to the Rock Health report.
Medication management player DecisionRx secured $100 million as a debt facility from investment firm Carlyle; as part of the investment, Carlyle received the option to acquire 25% of the outstanding equity of DecisionRx, the researchers noted.
There's also greater scrutiny of digital health clinical outcomes and value-for-investment, with a general acknowledgment that there is still no industrywide standard for evaluating digital health solutions. An analysis from the Peterson Health Technology Institute ruffled some feathers by concluding that digital management tools are not worth the cost. Diabetes monitoring apps "do not deliver meaningful clinical benefits, and result in increased healthcare spending," the analysis found.
Investors, employers and health plans will continue to focus on strong outcomes data, Rock Health researchers noted.
"Crowded digital solution spaces are pushing enterprise buyers to seek out outcomes data as a way to differentiate players in the market and evaluate value-for-investment. As outcomes data becomes a moat and a customer draw-in, investors are seeking out companies that can demonstrate efficacy early. This makes outcomes data more central to fundraising conversations—and at earlier stages," the researchers wrote.
There's also a reset in the public markets as well.
The first quarter of 2024 saw three digital health companies, Science 37, Better Therapeutics and Veradigm, delist from the Nasdaq or NYSE—joining nine companies that did so since 2022 and bringing digital health’s publicly traded cohort to 43, down from its 2021 peak of 54, according to Rock Health.
"With six other digital health stocks ending the quarter at risk of delisting, it’s possible we’ll see the sector’s publicly-traded cohort change even further in the near future," the researchers wrote.
Delistings offer another important value by recalibrating expectations for startups on the path to public exit, Rock Health researchers also noted.
Many startups are shifting from growth-minded forecasting to more conservative market guidance.
“Late-stage digital health companies are evolving from growth-oriented forecast mindsets (what if everything goes right?) to more conservative mindsets (what if some things go wrong?). This shift can strengthen a company’s financial position and increase optionality down the road, including opportunities for a potential exit," noted Sasha Kelemen, director of healthcare investment banking at Leerink Partners, as quoted in the report.
Rock Health researchers noted that the tougher climate for digital health companies, both in terms of financial success and solution performance, can be a positive driver as the sector matures and evolves.