Digital health funding boom slows in Q1. Was 2021 the high watermark for investment?

Coming out of 2021’s breakthrough year, digital health funding slowed in the first quarter, signaling potentially choppy waters ahead for investors in 2022.

Digital health startups banked $6 billion in the first quarter of 2022—an eye-popping number compared to just three years ago—but investment fell significantly behind the $7.3 billion raised in the fourth quarter of 2021 and the trailing twelve month quarterly average of $7.1 billion, according to Rock Health, a venture fund dedicated to digital health.

"While Q1 isn’t usually a standout quarter for funding overall, in three of the five past years, Q1’s funding beat its preceding quarter—but that isn’t the case this time around," Rock Health's Adriana Krasniansky and Pavan Shah wrote in the company's first-quarter funding report.

Digital health had a breakout year in 2021, with startups raising an eye-popping $29.1 billion across 729 deals.

Compared to a year ago, at the height of the digital health funding boom, startups raised $6.7 billion in the first quarter of 2021. That grew to $8.3 billion in the second quarter followed by $6.8 billion in the third quarter last year.

Digital health startups inked 183 deals in the first quarter of 2022, with an average deal size of $32.8 million. 

Krasniansky and Shah noted in the report that the first quarter of 2022 also experienced some month-to-month volatility: In January, 2022 companies raised $3 billion, while February only saw $1.4 billion and March, $1.6 billion.

"Again, this could be related to seasonality—February is a shorter month, and late-stage deals can skew monthly patterns—but this quarter’s monthly funding numbers may be early indicators of a digital health venture funding correction," they wrote.

But the digital health sector isn't alone in its funding slump. Global venture funding reached $160 billion in the first quarter of 2022, down 13% from $184 billion raised in the fourth quarter of 2021, according to Crunchbase. North American startup investment fell 11% in the first quarter of 2022, the first quarterly decline in nearly two years, Crunchbase also reported.

The more restrained digital health funding numbers in the first quarter may reflect investor caution, according to the report, with the rise and fall of COVID variants, energy shocks, market volatility, the dismal performance of public digital health companies and inflation numbers signaling choppy waters for digital health investors.

Rock Health's composite of publicly traded digital health securities, called the Rock Health Digital Health Index, tumbled 38% between the beginning of the third quarter of 2021 (July) and the close of the first quarter of 2022 (March 2022), far below the S&P 500’s 5% dip over that same time period. 

"We observed that, at least in part, recent exits sunk Rock Health Digital Health Index performance overall. Digital health companies that exited onto the public markets before 2020 saw, on average, a 17% drop in stock price from Q3 2021 open to Q1 2022 close, while digital health’s 2020 and 2021 exit cohort saw a 55% drop in share value over the same timeframe," the report authors wrote.

Startups that went public via special purpose acquisition companies led a surge in 2021 healthcare IPOs. But those SPACs are now stumbling.

"While SPAC popularity boomed over the past two years—17 of digital health’s 31 public market exits from 2020-2021 were SPAC mergers—digital health’s SPAC exits’ average stock price fell 57% from Q3 2021 open to Q1 2022 close, while IPO exits’ average stock price fell 29% during the same time period. This suggests that digital health’s SPAC class exerted downward pressure on overall Rock Health Digital Health Index performance," Krasniansky and Shah wrote.

Contributing to this turmoil, in the first quarter of 2022, there were a number of digital health SPAC deals canceled, SPAC exits taken private and SPAC targets sued for misleading funders, the report noted.

Digital health unicorn Alto Pharmacy reportedly scrapped SPAC plans.

"Multiple factors may be contributing to SPAC turmoil, including that SPAC targets are, on average, three years younger than their IPO counterparts, suggesting that some SPAC targets may not have been ready for the public markets, and that incentives may be misaligned between SPAC sponsors and other investors, suggesting that stock price may be compromised at time of deal close," Krasniansky and Shah wrote.

There are 53 healthcare-focused SPAC shells still looking for target. Time will tell whether these companies continue forward with M&A moves or if they follow other blank-check companies and call it quits before acquiring targets.

In the private markets, a crop of digital health unicorns raked in mega late-stage deals in the first quarter of 2022, including TigerConnect ($300 million), Lyra Health ($235 million), Alto Pharmacy ($200 million), Omada Health ($192 million) and Ro ($150 million). This reflects an overall upward trend in late-stage check size: While series D+ raises averaged $80 million in 2020, the past 15 months are tracking average D+ check sizes of more than $130 million, according to Rock Health.

One interesting trend seen in the first quarter of 2022 is digital health funding flowing to different sectors of digital health than tracked in previous quarters.

Funding for digital health startups catalyzing R&D in biopharma and medtech ($1 billion) dropped slightly to second place this quarter, while funding for startups augmenting clinical workflow ($888 million) rose eight spots to third place, according to Rock Health's data. This category includes several players that reduce or offload clinician tasks—medical transcription (DeepScribe, $30 million), complex care workflow (Memora Health, $40 million) or clinical surveillance (Decisio, $18.5 million).

Mental health care continues to be a hot spot within digital health, with startups in this sector raising $1 billion in the first quarter of 2022 bolstered by employer-focused Lyra Health’s series F ($235 million) and Omada Health’s series E ($192 million), announced as Omada integrates behavioral health into all of its virtual care programs.

Investment in startups supporting reproductive and maternal health, which totaled $424 million during the quarter, reentered the top six for the first time since 2019. Within this market, Ro, which now owns Modern Fertility and recently acquired male fertility startup Dadi, raised $150 million, and new entrants like specialty maternal care marketplace Zaya Care banked $7.6 million. Virtual fertility clinic Turtle Health snagged $2.7 million.

With next nine months in digital health investment will be difficult to predict, Krasniansky and Shah noted, as factors like supply chain and energy disruptions, market corrections and the Russian invasion of Ukraine are new variables entering public and venture funding equations—changing the calculus for startups and investors in 2022.