Here's why some VC investors say an economic downturn can be good for digital health

TORONTO—In just the past six months, there have been dramatic shifts in the startup environment. For investors and entrepreneurs, the headlines signal choppy waters ahead—venture capital dollars are slowing, startups are raising less money this year as investors remain cautious, valuations are down and public companies have seen their shares drop by double-digits amid market volatility.

Current trends indicate a market correction is underway. But some venture capital investors say they are excited about this market “reset,” as it represents an opportunity for mission-driven founders to thrive.

“I think this is one of the best times to be starting a company and one of the best times to be building responsibly,” said Hemant Taneja, managing partner at digital health venture capital firm General Catalyst said Wednesday at Collision 2022, a tech conference taking place in Toronto this week.

“I think it’s going to be harder but it actually makes you better founders, better investors and better executives. You just have to power through this because the secular trends are strong and tech companies are taking share from industries and creating market leaders across all parts of the economy and that is not going to stop. Capital is there and things will settle down. Digital transformation will continue on aggressively,” he said.

He added, “I think the fact that the market is reorganizing itself is actually good for us to get back to normal behavior. The thing I’m keen on understanding is now we’re going into a high interest rate environment, what’s going to happen when demand softens for a lot of these companies. I think there’s another correction that’s going to come, so I’m keenly watching for that.”

Taneja pointed out that General Catalyst launched in 1999 around the time the dot-com bubble burst and the market crashed.

“We are big believers that downturns lead to great opportunities,” he said. “The reason this is an exciting time is first there is a lot of human capital that’s been unlocked from companies. Second, when capital is not abundant, you build with far greater discipline.”

Digital health and health tech still have significant value going forward, analysts say. Investors point out that digital health companies have stronger fundamentals than companies in the dot-com bubble. And, the market is over-capitalized as the sector experienced a gold rush during the past two years.

Digital health had a breakout year in 2021, with startups raising an eye-popping $29.1 billion across 729 deals, according to Rock Health, a venture fund dedicated to digital health. 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.

The funding slowdown combined with volatile economic trends means the environment is shifting and startups need to learn how to navigate the new landscape.

“The general mantra is we’re going from an era of fast growth, ‘It doesn’t matter what the economics are’ to performance. ‘Are you fundamentally a business that is going to generate great economics and profit?’ That’s a cultural shift companies have to go through,” Taneja said.

And there is still tremendous runway for digital transformation in many industries, especially healthcare.

“So many new industries need to be transformed. We’re doing a lot of work in healthcare and we think there’s 20 years of work to do there. These industry transformations are where great companies are going to start with mission-driven founders in this era,” Taneja said.

Wesley Chan, managing partner at early-stage venture capital firm FPV Ventures, said there are lessons to be learned from the dot-com bust.

“I’m so excited for some of these companies who have been growing profitably to go thrive and survive,” he said.

Chan worked at Google in the company’s early days, founding Google Analytics and Google Voice, and also built Google's early advertising system.

“What I learned at a company, where it’s forged in the first dot-com crash, in a recession, is that you have to be scrappy and you have to be profitable,” he told the audience in Toronto.

He added, “The best companies will come out of this. I saw Google first-hand when there was a downturn in 2000 and I saw the great company you can build when you have access to the best talent and best ideas. I’m pretty sure somebody in this room is going to start the next Google or the next Uber and come out of this financial hurricane and these turbulent waters.”

But Taneja warned that it will be harder for startups to raise money in the next few years.

“The pace overall is going to slow down and you’ve got to be selective about finding investors that are truly passionate about what we’re doing. The bar is going to be higher. It’s going to be about companies that are lean, mean, focused, and doing fewer things better,” he said. “Grandiose ideas that are really capital intense versus being really focused and in general that’s going to get more attention in the next 12, 18 months.”

These sentiments are echoed by other analysts and investors who say startups with strong value propositions and a solid return on investment will fare better than startups just focused on topline growth.

“We’re seeing a shift overall in the environment to making sure that the companies out there are providing discrete value to customers,” Sunny Kumar, M.D., a physician and partner at GSR Ventures, told Fierce Healthcare in an interview. GSR Venture invests in early-stage digital health companies.

“Every single enterprise out there is going to be affected by this macroeconomic trend. Healthcare is more resilient in a period of downturn, but the trends we’re seeing today, whether recession or inflation, is going to affect every single large enterprise, whether health systems, pharma and device companies. All those customers are changing their buying behavior; they are a little more cautious, a little bit more conscientious with purchasing decisions. What we’re seeing with our portfolio companies is that companies who are able to show clear value, clear ROI (return on investment) and clear value proposition are the ones that are able to strongly accelerate today,” he said.

“Companies with a softer value proposition, those are the ones who are going to have a bit tougher time raising in this market,” he added.

The funding slowdown is heavily concentrated in the later-stage deals, Kumar noted. “The seed and the early-stage markets are still relatively robust, but those are starting to see some degree of slowdown as well.”

Taneja advised startups to double down on their priorities and focus on performance rather than rapid growth.

“Some of that might require a down round, some of that might require doing fewer things and growing slower but the team has to get on the mindset on what it’s going to take to be successful in the long run,” he said.