Venture capital and health system investors are bullish on tech startups

The 2010s brought serious reality checks to once-favored technology startups in healthcare. But despite some major blowups, health system and venture-capital leaders say they generally aren’t spooked about the startup scene.

A major reason why is that startups, while often new entrants to a field, have in the past disrupted industries—something healthcare needs—making investors a lot of money in the process. That’s part of the incentive for Partners HealthCare in Boston, which since 2008 has opened multiple investment funds that have attracted millions of dollars. Partners’ most recent effort, launched last October, is a $30 million fund dedicated to artificial intelligence and digital technologies.

“There’s an ability to do more, to accelerate these collaborations and the adoption of this technology, and we believe being able to invest is part of that,” said Chris Coburn, chief innovation officer at Partners, of the new fund.

Partners is in good company, as digital healthcare tech has been a growing area for investment in the past decade. Digital health startups have raised $39.5 billion since 2011, with 40% of that raised in 2018 and 2019 alone, according to a report from Rock Health, an early-stage digital health venture fund that also compiles research on the sector. In 2019, more than 600 investors poured $7.4 billion into 359 digital health startups.

Those dollars can serve as food for thought for innovative health systems. “The flow of those dollars typically represent the recognition by the investment market that there’s opportunity,” Coburn said, noting that Partners’ new fund will be watching patterns of investment into healthcare tech startups to help inform its work, as well as conducting “rigorous” assessments of the startups.

Chasing other people’s money should not be a singular strategy. Seeing interest from venture-capital firms can’t serve as the only cue regarding which startups are worth paying attention to. “It’s always nice if there’s a market signal,” said Dr. Thomas Maddox, executive director of the Healthcare Innovation Lab at BJC HealthCare and Washington University School of Medicine in St. Louis. The lab aims to identify new ways to use data, analytics and technology to improve care delivery, which can involve working with startups.

“But more and more I’ve started to not put a lot of faith in the number of investors or the dollars involved—part of it is just because of some the blowups we’ve seen,” Maddox said.

The most prominent example is Theranos, which raised more than $1 billion as a once-heralded blood-testing startup, but shut down in 2018 after investigations found its devices were flawed and inaccurate. A 2015 exposé in the Wall Street Journal spurred a series of federal investigations into the company, including from the CMS and the Securities and Exchange Commission.

Elizabeth Holmes, founder and former CEO of Theranos, in 2018 agreed to pay the SEC $500,000 to settle charges that she oversaw a “massive fraud.” Holmes and former Theranos Chief Operating Officer Ramesh Balwani are slated to go on trial in a federal court in California this summer.

Another once high-flying tech startup, Outcome Health, has been accused of misleading customers about its advertising network in doctors’ offices after a series of investigations by the Wall Street Journal in 2017. The startup raised $500 million before being acquired by a private-equity firm last year.

Outcome Health’s founders, Rishi Shah and Shradha Agarwal, along with other former executives, were charged in November by a federal grand jury with a fraud scheme to overbill clients and deceive investors.

“Over the past two years Outcome Health has been leading the charge in the Point of Care space, setting rigorous standards and guidelines for reporting, data integrity, service and transparency in an industry that didn’t have any,” Nandini Ramani, Outcome Health’s COO, said in a statement. “The founders have had no involvement in the company for two years, and they no longer have any financial interest in the company.”

Those types of stories haven’t stopped investors, particularly those focused on health and healthcare, from striking new deals.

Alex Frederick, a senior analyst for emerging technology at PitchBook, a firm that analyzes data on venture capital and private equity, noted most of those who invested in Theranos weren’t seasoned healthcare investors. Generally speaking, healthcare investors would “know the right questions to be asking and are making prudent investment decisions,” he said.

Established healthcare investors “won’t be scared off by the Theranos story,” he said.

Startups, arguably more so than incumbents, have the potential to introduce new approaches to old problems, said Dr. Bob Kocher, partner at venture-capital firm Venrock and a former special assistant to the president for healthcare and economic policy during the Obama administration.

When a startup proves its model is successful, not only do “those companies grow, but also they get emulated widely by all the larger players in the healthcare system,” Kocher said. In an ideal world, that “helps make American healthcare better,” driving improvements in challenges like patient experience and healthcare affordability.

And startups can be powerful partners for health systems, said Dr. Richard Zane, chief innovation officer at UCHealth. His work involves speaking with front-line staff at the Aurora, Colo., health system to identify problems they’re facing, and subsequently looking for ways to solve them—such as collaborating with industry partners to build new solutions.

“That’s the main interaction around how we work with startups,” Zane said. Sometimes UCHealth will also invest in startups the system’s working with, he said.

Even if a hospital leader is skeptical of new entrants, it’s worth staying up-to-date on startups and sectors attracting capital—because they’ll be the ones approaching you soon, said Steve Tolle, a partner at HLM Venture Partners. HLM, which focuses on funding health technology and medical device startups, prides itself on being an early investor in companies like Teladoc Health and Phreesia, which have since gone public. “What are you going to do when those vendors start showing up and knocking on the door?” Tolle said. Healthcare executives “should start thinking about how they’re going to respond.”

Three major health technology areas have captured attention from health systems and venture-capital investors alike: digital therapies, patient engagement and genomics.

In 2020, there’s an app for everything—even medical treatment. In the first three quarters of 2019 alone, more than $850 million went to mobile and digital health startups building software that claims to help users improve their health, according to a report from PitchBook. The third quarter was the most recent 2019 data PitchBook had available.

Mobile and digital health is an expansive category, including everything from fitness trackers and wellness tools to prescription digital therapeutics. Notably, digital therapeutics, which use software like apps to help patients prevent, manage or treat diseases, aim to augment—and in some cases, even replace—drugs or standard therapies.

“We’re seeing a lot of interesting activity there,” Frederick said of digital therapeutics. While PitchBook didn’t break out data on the digital therapeutics sector alone, a separate report from CB Insights, another company that analyzes data on venture capital, found that digital therapeutics startups raised a collective $513 million in the first three quarters of 2019.

Frederick said he expects to see startups in this area continue to emerge in 2020.

That’s even though digital therapeutics, unlike more general consumer wellness products, face a significant hurdle: regulation.

“Digital health we think is quite exciting,” said David Blumberg, founder and managing partner at venture-capital firm Blumberg Capital. He sees promise in investing in startups that help users manage health conditions, but for Blumberg Capital—which focuses on enterprise software—startups that require oversight from the Food and Drug Administration pose a challenge.

“We do still stay away from the things that are very FDA-intensive,” he said, though there are some exceptions. “It just takes too long, and it’s too capital-intensive.”

That means digital therapeutics startups are often limited to working with investors that are already active in digital therapeutics—a relatively new and niche space—or tasked with convincing venture-capital firms it’s worth the risk of expanding into a possibly unknown area.

The intersection between healthcare, pharmaceuticals and technology is part of what makes digital therapeutics interesting, but that “convergence tends to make most investors somewhat uncomfortable,” acknowledged Dr. Corey McCann, CEO of Pear Therapeutics, a developer of prescription digital therapeutics.

Pear, which has received FDA clearance for app-based products that help treat substance and opioid use disorders, seeks investments from venture-capital firms across the board—in biotech, medtech, pharma and technology, McCann said. It can be a daunting task: Tech investors are often spooked by regulation, while healthcare investors might not always understand the intricacies of software.

When the company first launched in 2013, it was challenging to find investors with baseline knowledge about both software development and healthcare regulation, said McCann, who previously worked as a venture-capital investor. It’s become easier over time, and Pear has raised $134 million to date.

Even when there’s interest, many investors see digital therapeutics as a more long-term consideration, given that it’s a somewhat nascent field.

“Digital therapeutics is probably a medium- to long-term play, because we still have to see how that market plays out,” said Joshua Mark, a healthcare analyst at CB Insights. Pear one of the first startups in the digital therapeutics arena, received its first FDA clearance in 2017.

It’s no secret that millennials and members of Generation Z, dissatisfied with traditional healthcare, have been pushing health systems to revamp how they engage patients in their care. But to more actively involve patients, health systems need new tools. That potential market opportunity has driven a growing startup segment designed to help health systems attract new patients and keep existing ones engaged, according to PitchBook’s third-quarter report.

Startups in that marketing and communications segment—which raised a collective $1.1 billion in the first three quarters of last year—provide services related to hospital marketing, patient engagement and patient scheduling, among other areas that health systems are looking toward to improve the patient experience.

That includes ventures like U.K. chatbot and telemedicine provider Babylon, online appointment scheduling startups like Kyruus and Zocdoc, and companies like Evariant, recently acquired by Healthgrades, that help with patient acquisition and retention, according to PitchBook.

The healthcare industry has been increasingly prioritizing the “importance of the voice of the consumer in healthcare decisionmaking,” said Bill Evans, CEO of the venture fund Rock Health. He called investing in “opportunities that are created by a rise of consumerism in healthcare” among the company’s top funding interests.

Growth in that consumerism segment is indicative of healthcare “moving toward a more proactive model, requiring healthcare systems to reach out to patients and needing to have a strong brand,” said PitchBook’s Frederick. That’s a theme health systems have expressed interest in independent of startups.

Just last month, Partners HealthCare unveiled plans to commit roughly $100 million toward the first phase of a new digital health initiative, a five-year effort centered on using technology to make care more accessible for its patients. That includes deploying tools like online appointment scheduling, text messaging with patients and other services to support patient engagement.

Partners isn’t alone: Nearly 70% of top healthcare CEOs said they’ve made recent changes to the structure of their organizations to be more patient-centered, according to a Power Panel survey Modern Healthcare conducted last year, and most said they were using tools like apps and electronic health records to improve patient care.

“Point of proximity is going to be the greatest area of growth in 2020,” Coburn said. He cited American Well, which has raised $517 million to date in funding, and Phreesia, which went public last year, as examples of strong investor interest in products that help providers meet patients where they are.

Exploring the intricacies of the human genome is shaping up to be an area within health technology that’s losing investment steam—despite the fact investors still see potential.

Some of the most-funded startups to date are focused on genomics. 23andMe has racked up nearly $800 million in funding, ranking it among the most well-funded health technology startups of last year. Another startup in that cohort is Tempus, a precision oncology company, which has raised a total of $520 million.

Yet despite individual startups bringing in millions, funding for the genomics field as a whole slowed in 2019.

While genomics startups were “really hot” in 2018, they didn’t scoop up much venture capital last year, Frederick said. Startups that interpret users’ genomic and microbiome data, and personalized medicine startups, raised roughly $157 million in the first three quarters of 2019.

Compare that to 2018, when those startups collectively raised more than $1 billion, according to PitchBook. That spike was in part driven by recent technological advancements that had lowered the price of genetic testing, mixed with consumer excitement over the potential for personalized health and ancestry information, according to the report.

Freenome, a startup that uses genomics and AI to detect early-stage cancer, has raised $237.6 million to date from investors like Kaiser Permanente Ventures, Roche Venture Fund and Alphabet’s life-sciences research arm Verily. And Helix, the genomics startup providing sequencing services for Mayo Clinic’s new library of patient genetic data, has raised $300 million from investors including Mayo Clinic and Illumina, another genetic-sequencing company.

“I think we’ll continue to see investment there, but it probably won’t meet the massive capital infusion” seen in 2018, Frederick said. While investors continue to see genomics as an area with “huge potential,” they’ve realized it’s “going to take a lot of time and careful research to unlock” insights related to personalized medicine that these startups are hoping to glean, he added.

The possibility of using genetic data to inform healthcare decisions is exciting, but complicated, noted Maddox from BJC’s Healthcare Innovation Lab.

“The more that we have dug into genomics, the more we realize that it is even more complicated than we ever imagined,” he said. “It’s dizzyingly complex.” That said, there’s “power” in what genomics represents: “When it’s fully realized, it will fundamentally change medicine,” Coburn said.