Market downturn dampens digital health funding, M&A in 2022. These sectors raked in the most cash

After reaching a fever pitch in 2021, digital health funding cooled down in 2022, raising $10.3 billion across 329 deals in the first six months. 

That's down from the $14.7 billion raised during the same period last year, according to a first-half 2022 funding report from Rock Health, a venture fund dedicated to digital health.

But, it should be noted, $10 billion is still a hefty amount of cash pouring into digital health, and this year's funding is on track to outpace funding in 2020. This year's overall funding is now pacing to land around $21 billion, significantly less than 2021’s total of $29.1 billion and well ahead of 2020's $14.7 billion.

While the first quarter of 2022 funding generally matched the same period in 2021, the second quarter of 2022, with $4.1 billion raised, was the lowest funding quarter since the second quarter of 2020 with $2.9 billion.

Funding isn't the only thing slowing down this year, according to Rock Health's report. And after 23 public market exits in 2021, digital health public exits came to a halt in the first half of 2022  as zero startups went public, and a few publicly listed digital health companies returned to private holdings, including health IT company Cerner.

Digital health had a wild ride in 2021, with startups raising an eye-popping $29.1 billion across 729 deals, according to Rock Health's year-end report.

But there were questions in the market about whether digital health companies would sustain this record level of growth in 2022.

Now the signs are pointing toward funding in 2021 standing out "as an anomaly" rather than the norm, Ashwini Nagappan, research fellow, and Adriana Krasniansky, researcher, wrote in Rock Health's report.

"Venture investors raised record funds last year, meaning they will have capital to deploy for years to come," the researchers wrote. "Meanwhile, startups are using this market moment to reconsider valuations, trim costs, and, in some cases, people, and refine go-to-market strategies. We foresee these startup adjustments activating savvy M&A deal-makers in H2 2022, with pairings between complementary digital health companies likely leading H2 2022 M&A activity."

In early 2022, investor confidence in both public and private markets was shaken by global conflict and inflation concerns. Notable investors Y Combinator and Sequoia Capital published letters to their portfolio companies warning them to prepare for an economic downturn, and venture funds in general battened down their hatches, Rock Health reported.

Non-specialist investors, rather than veteran digital health investors, were most likely to pull back from the sector. In the first half of 2022, approximately 70% of digital health investors were repeat investors in the space, whereas previous years saw more balanced distributions of new and repeat investors.

Investors are now investing more conservatively in growth-stage digital health companies: The first half of 2022’s average check sizes for series C and D+ deals declined by 22% and 12%, respectively, compared to 2021, according to Rock Health. First-half 2022 data also suggest a drop in B-stage digital health funding, with the first half of 2022’s average series B checks 25% smaller compared to 2021. 

Meanwhile, early-stage digital health companies, which are more likely to be free of 2021 valuation baggage, are likely to attract investor attention in today’s market. Digital health companies pursuing their series A rounds raised $18 million on average in the first half of 2022, consistent with 2021, Rock Health reported.

"While things may feel tough in the near term, companies that lean into these belt-tightening measures stand to emerge from 2022 as more resilient businesses, better positioned to navigate market scrutiny when the time comes to make a public exit," wrote Nagappan and Krasniansky.

Where investors put their money 

After a slow first quarter in 2022, funding for digital health startups catalyzing R&D in biopharma and medtech picked up in the second quarter and finished the half at $1.6 billion, with rounds raised by biopharma analytics player Sema4 ($200 million), clinical trial accelerant Verana Health ($150 million) and real-world data solution provider ConcertAI ($150 million).

Digital mental health care also continued to be a hot sector, raising a combined $1.3 billion in the first half of 2022 to again reach the top-funded clinical spot, led by Lyra’s $235 million raise in January. However, of that $1.3 billion, just $300 million closed in the second quarter of 2022—possibly signaling a slowdown.

Funding for digital health solutions monitoring disease brought in $1.4 billion so far in 2022. The category jump was largely driven by raises from Biofourmis ($300 million) and Omada Health ($192 million), which offers remote monitoring companions for its diabetes and hypertension programs. 

With hospital labor costs at an all-time high and staff burnout endemic, investors also are pouring funds into clinical and nonclinical or administrative workflow support. Funding for startups augmenting nonclinical workflow reached $1.3 billion, led by cloud analytics and payments platform Clarify Health ($150 million).