What's behind digital health’s funding freefall

Funding of digital health startups is on the decline. 

In 2021, venture capital investors poured a record $29.1 billion into digital health companies. Last year started off nearly as hot, but the market began to drop in the second quarter. Halfway through 2023, the industry has seen only $6.1 billion invested across 244 digital health companies, according to data from Rock Health, a digital health research firm. This is the lowest amount since 2020. The average deal size in the first half of 2023 was $24.8 million, a $1.7 million decrease from 2022.

Here’s what experts say is behind digital health’s funding dip.  

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Reason 1: Investors fail to see successful commercialization 

Digital health investors are recalibrating how they view potential portfolio companies and their long-term valuation. The nascent nature of digital health and uncertainty over of how companies will be valued long term is to blame. During the 2021 funding boom, many emerging companies were given ‘unicorn’ valuations of more than $1 billion. However, many of those same companies have struggled to achieve profitability, had to lay off employees, sell lagging businesses and even file for bankruptcy. 

Many digital health companies haven’t been able to  successfully commercialize their products and sell them to health systems and insurers, said Peter Micca, national health tech leader in Deloitte’s audit practice.

“Investors are pickier in terms of the solutions they see in the market,” Micca said in April. “They want to see a track record. They want to see the size of the [total market demand]."

As a result of this changing dynamic, some companies that are getting funding deals are doing so without valuations and funding round labels. According to Rock Health’s data, 41% of the deals so far in 2023 were not publicly classified with a series or round label, which is up from 22% in 2022.  

Unlabeled rounds often signify valuation shortfalls or declines in investments from prior rounds. Companies unable to meet investor growth expectations have few choices but to accept less money, experts said.

“It is far more common [in the current funding environment] to see digital health companies with slower growth than expected,” said Dr. Justin Norden, a partner at venture capital firm GSR Ventures.

The rise of unlabeled rounds also means that companies could have limited cash on hand to stay solvent, experts say. Adriana Krasniansky, Rock Health’s head of research, said that even two years ago companies were moving around some of their fundraising timelines in order to make the most of the cash on the table.  

Reason 2: Macroeconomic challenges

Beyond investor hesitation, macroeconomic challenges have played a role in digital health’s funding decline. The Federal Reserve’s steady increase of interest rates has slowed the economy and had a negative effect on investing at large. 

“We had a prolonged period of very low interest rates, essentially free money, and we're unlikely to return to that type of environment,” said Matt Wolf, a director and senior healthcare analyst at consulting firm RSM, in March. “This is the environment that digital health operators need to be accustomed to.”

Reason 3: Silicon Valley Bank collapses 

If larger economic challanges were not enough, the failure of Silicon Valley Bank in March further hurt the digital health funding landscape. The bank was taken over by the Federal Deposit Insurance Corporation after a run on deposits. First Citizens Bank eventually acquired a portion of SVB.

Silicon Valley Bank was the bank for many digital health startups and venture capital firms. The bank was used by 76% of venture capital-back initial public offerings in healthcare since 2020, according to data cited on its website.

Experts say it is unlikely another bank will invest as heavily into the digital health startup space. Some venture funds that did business with Silicon Valley Bank are having to partner with newer banks, which could be less willing to invest in an emerging industry like digital health.

Reason 4: Outside investor interest is waning

Low interest rates and the COVID-19 pandemic brought outside investors into telehealth and digital health more broadly. As telehealth utilization dipped after the COVID-19 pandemic's peak, many general investors have left the space.

"It doesn't necessarily mean that they were wrong to come into the sector," said Steve Brotman, managing partner at venture capital firm Alpha Partners. "But they're on to the next hot thing. They're chasing private credit [and artifical intelligence]. At one point, it was telemedicine."

Companies previously able to take advantage of the extra capital flowing into the space from non-healthcare investors now must prove results to the smaller supply of industry-specific investors that  remain. According to Rock Health, fewer than one in three deals in 2023 have come from investors new to digital health.

Reason 5: Digital health buyers face their own economic challenges 

Digital health companies face more scrutiny and increasing competition for their customers’ time. Health systems, employers and health insurance companies face shrinking operating margins and their own economic challenges. At the same time, they are receiving more pitches from digital health companies than ever before.

Health systems that are buying digital health solutions are pickier and expect an immediate return on investment from any solution they’re going to implement.

"It doesn't necessarily mean that they were wrong to come into the sector," said Steve Brotman, managing partner at venture capital firm Alpha Partners. "But they're on to the next hot thing. They're chasing private credit [and artifical intelligence]. At one point, it was telemedicine."

Related: Salesforce, OpenAI CEOs invest in diagnostics company

Looking ahead: Big checks, AI fuel optimism 

Despite some of the headwinds, many experts say digital health’s fundamentals remain appealing.

“There are a fair number of companies right now in the space doing very well,” Micca said. “Raising new capital, accepting the higher valuation points, knowing they can cap the public markets in two years when the market turns because they have a revenue stream and a cash flow.”

Experts agree opportunities remain for some companies. The first six months of 2023 saw 12 deals valued at more than $100 million each, mostly in the areas of non-clinical workflow and practice management, value-based care enablement and at-home care. Those dozen deals made up 37% of the year's total funding so far, according to Rock Health’s data.

Solutions prioritizing artificial intelligence have also proven to be an exception to the broader funding dip. Many vendors have sought to implement varying degrees of technology in their offerings. 

Interest in generative AI remains high following the November 2022 release of OpenAI’s AI-enabled chatbot ChatGPT. In May, venture capital firms General Catalyst and Andreessen Horowitz announced they were backing Hippocratic AI, which says it will build a large language generative AI model specific to healthcare. In July, the company nabbed another $15 million from a series of healthcare partners including Scottsdale, Arizona-based health system HonorHealth and Cincinnati Children’s Hospital.