Digital health investments shift to disease treatment, workflow solutions and VBC in Q3: Rock Health

Digital health founders and investors continue to face a tighter funding cycle with fewer deals and lower check sizes. However, several sectors are emerging as bright spots as investors show an interest in startups exploring new treatment pathways and tackling nonclinical workflow solutions.

In the third quarter of 2023, U.S. digital health startups raised $2.5 billion across 119 deals, the second-lowest quarter by funding total since the fourth quarter of 2019, according to an analysis by Rock Health, a venture fund dedicated to digital health. This brings 2023’s totals to date to $8.6 billion raised across 365 deals.

Digital health startups brought in $2.5 billion across 113 deals in the second quarter of 2023, following $3.5 billion raised over 131 deals in the first quarter.

This past quarter is the fourth of the five past quarters to log funding in the $2 billion range, joined by the third quarter of 2022, the fourth quarter of 2022, and the second quarter of 2023, Rock Health reported. Digital health funding in the third quarter was actually up from $2.2 billion raised in the third quarter of 2022 but down 63% from $6.8 billion raised in the third quarter of 2021 and down 40% from the $4.2 billion raised during the same quarter in 2020.

In the first half of 2022, digital health startups raked in $10.4 billion, and an eye-popping $15.1 billion was raised in the first six months of 2021.

Investment in digital health startups began to cool off in 2022 after hitting record highs in 2021 fueled by the shift to telehealth and digital technology during the COVID-19 pandemic. If funding keeps at this pace, digital health is on track for the lowest funding year since 2019, Rock Health projected earlier this year.

"While the digital health sector experienced significant reductions in funding and deal volume, quarterly trends are stabilizing within a new investment cycle," Rock Health researchers Adriana Krasniansky and Uday Suresh wrote in the report. The digital health fundraising market settles down, it bring a "new market equilibrium" and "a stabilized funding cadence" compared to the wild ride in 2021 and 2022, they wrote.

"Anticipation of a slower economy and the arrival of high interest rates impacted venture funds’ ability to raise capital, reducing funding for startup investment. Lower startup valuations and limited IPO activity reduced funds’ portfolio valuations and delayed distributions to limited partners (LPs), fundamentally reducing capital available for new investments," Krasniansky and Suresh wrote.

There's a more conservative mindset among investors, who are now doing fewer deals and negotiating harder on deal terms—further feeding a lower funding cycle, they noted.

Down rounds remain a concern, and there's been a marked uptick in startup founders raising extensions and unlabeled rounds. This has likely contributed to 2023’s sparse midstage series announcements, with only 34 series B raises so far this year, compared to last year’s 82, and only 11 series C raises so far this year, compared to last year’s 35. That's the lowest number we have on record since Rock Health began tracking digital health venture funding in 2011, according to the report.

"As digital health companies transition between the old equilibrium and new, founders and investors will need to continue navigating difficult conversations around valuation adjustment and ownership dilution," Krasniansky and Suresh wrote.

In 2023, digital health funding is shifting away from pandemic-era focuses of on-demand healthcare and life science R&D catalysts toward digital health products and services that support disease treatment, nonclinical workflow and management of complex conditions such as kidney disease. 

Treatment of disease nabbed the top funding spot by digital health value proposition, raising $1.64 billion from the first quarter of 2023 to the third quarter of 2023. Digital digestive health company Vivante Health banked $31 million to scale its platform that combines integrated telemedicine, nutrition coaching and self-guided modules for digestive health.

Nonclinical workflow solutions bagged $1.59 billion in fresh funding from the first quarter of 2023 to the third quarter of 2023. Players in this space are tackling tasks ranging from durable medical equipment management (Synapse Health, $25 million) to revenue cycle management (Collectly, $29 million), to patient scheduling and communication (Keona Health, $7 million), Rock Health researchers noted.

Mental health remained the top-funded clinical indication among digital health startups, bringing in $900 million year-to-date, and startups in the nephrology space raised $700 million this year.

Investors also are showing a strong interest in value-based care enablement. Better Life Partners, a startup that offers virtual mental health, addiction treatment and care coordination, raised $26.5 million, and Healthmap Solutions brought in $100 million to expand its business. The company serves payers and at-risk providers seeking VBC solutions for chronic kidney disease.

"If a startup can drive down the total cost of care in a risk-based arrangement, that’s a huge value for payers and other customer organizations. Until recently, most digital health investors have focused on VBC enablement for primary care. Now investors are pursuing the white space of VBC enablement for specialty care needs," Marissa Moore, investor at OMERS Ventures, said in a statement in the report.

As related policy initiatives gain momentum and large healthcare enterprises dig deeper into VBC models, VBC enablement will become an important component of startups’ commercial road maps and will drive enterprise partnerships, Krasniansky and Suresh wrote.

"This will be particularly true in high-cost therapeutic areas like mental health, kidney care, cardiovascular care, and oncology," they wrote.

Rock Health researchers also contend there's reason for optimism for digital health's public market performance, despite some notable downfalls of former IPO darlings.

Pear Therapeutics and Babylon Health both filed for bankruptcy this year. Pear’s closure reflected the company’s difficulty securing payer reimbursement for its prescription digital therapeutics, Krasniansky and Suresh noted, while Babylon folded after losing major contracts, in part due to operational scrutiny. 

Despite these negative headlines, from the opening of the first quarter to the close of the third quarter of 2023, the Rock Health Digital Health Index, which averages the stock performance of digital health companies trading on the Nasdaq and NYSE1, underperformed the S&P 500 but beat out the S&P 500 Health Care and the Nasdaq Biotechnology Index, according to Rock Health. This performance was buoyed by strong performances from publicly traded players Teladoc, Hims & Hers and Augmedix.

"Q3 2023 delivered a steady stream of small(er) wins for the digital health sector: a stabilized funding cadence, investment shifts toward high-priority needs of workflow support and value-based care enablement, and signals of budding confidence from the public market," Krasniansky and Suresh wrote.