Caveat Emptor, Caveat Venditor. That is my official blog post foreshadowing.
The digital health rocket seems to have gotten supercharged lately, at least when it comes to fundraising. Depending on who you ask, either $1.62 billion (Rock Health’s count) or $2.5 billion (Mercom) or $2.8 billion (Startup Health’s count) was plowed into digital health companies in just the first three months of 2018. By any measure Q1 2018 was the most significant quarter yet for digital health funding. This headline has been everywhere. Digital health: to infinity and beyond! But what is the significance of this? Should investors and customers of these companies be excited or worried? It’s a little hard to tell.
But if you dig a little deeper, there are some interesting things to notice.
First of all, the definition of “digital health” is gets murkier and murkier. Some sweep in things that others might consider life sciences or genomics. Others include things that may generally be considered health services, in that they are more people than technology. Rock Health excludes companies that are primarily health services, such as One Medical or primarily insurance companies, such as Oscar, including only “health companies that build and sell technologies—sometimes paired with a service, but only when the technology is, in and of itself, the service.” In contrast, Startup Health and Mercom Capital clearly have more expansive views though I couldn’t find precise definitions. My solutions is this: stop using the term “digital health”. Frankly, it’s all healthcare and if I were in charge of the world I would use the following four categories and ditch the new school monikers: 1) drugs/therapeutics 2) diagnostics in vivo, in vitro, digital or otherwise; 3) medical devices with and without sensors; and 4) everything else. But I’m not in charge of the world and it isn’t looking likely anytime soon, so the number and nomenclature games continue. My kingdom for a common ontology!
Another thing to notice: some deals are way more equal than others, to misquote a book almost everyone was forced to read in junior high. Megadeals have come to digital health (whatever that is), defined as companies getting more than $100 million dropped on them in a single deal. For instance, according to Mercom Capital, just five deals together accounted for approximately $936 million, or more than a third of the entire quarter’s funding (assuming you’re using the Mercom numbers) If you use the Rock Health numbers, which include only three of the mega deals, we are talking $550 million for the best in class (bank account wise, anyway). Among the various megadeal high fliers are Heartflow ($240 million raised), Helix ($200 million raised), SomaLogic ($200 million raised), PointClickCare ($186 million raised), and Collective Health ($110 million raised); three others raised $100 million each.
It used to be conventional wisdom that the reason healthcare IT deals were appealing, at least compared to medical devices and biotech, is because they needed far less capital to get to the promised land. Well, property values in the digital health promised land have risen faster than those in downtown San Francisco, so conventional wisdom be damned. These technology-focused enterprises are giving biotech deal a run for their money, literally.
Another note on this topic: the gap between the haves and have not’s is widening dramatically. Mercom reports that the total number of deals for Q1 2018 was 187, which is the lowest total number of digital health deals for 5 quarters. Rock Health claims there were 77 deals in the quarter; Startup Health, always the most enthusiastic, claims there were 191 deals in the digital health category. I don’t know who has the “right” definition of digital health; what I do know is that either way, this is a lot of companies.
But here’s what it really means: if you take out the top 10 deals in Rock Health’s count, which take up 55% of the first quarter’s capital, the remainder are averaging about $10.8 incoming capital per deal. If you use the Mercom numbers, the average non mega deal got $8.6 million. This is a far more “normalish” amount of capital for any type of Series A or Series B venture deal, so somewhere in the universe, there is the capacity to reason.
I think that the phenomenon of companies proliferating like bunnies on Valentine’s Day has another implication: too many damn companies. Perhaps it’s only me, but it’s getting harder and harder to tell the difference between the myriad of entrants in a variety of categories. Medication adherence deals seem to be proliferating faster than I can log them. Companies claiming to improve consumer engagement, whatever that is, are outnumbering articles about AI, and that’s saying something. Companies claiming to use AI to make everything better, whether it’s care delivery or drug development or French Fries are so numerous that it’s making me artificially stupider. I think that this excess of entrepreneurship is actually bad for everyone in that it makes it much harder for any investor to pick the winner(s) and makes it nearly impossible for customers to figure out the best dance partner. It’s a lot easier for customers to simply say no than to take a chance and pick the wrong flavor of the month. It’s just become too darn easy to start a company.
One way that investors and buyers are distinguishing the good from the not-so-much is by looking for those who have made the effort to get an FDA approval and who have made an investment in serious clinical trials to prove value. Mercom Capital reports that there were over 100 FDA approvals of digital health products in 2017. Considering that there were at least 345 digital health deals in 2017 (taking the low end Rock Health numbers) and that only a fraction raised money in that year, it is interesting to think that a minority of companies are bothering to take the FDA route. Now this is a SWAG at best, but it feels about right to me. I often hear digital health entrepreneurs talking about the lengths they are going to in order to avoid needing FDA approval and I almost always respond by saying that I disagree with the approach. Yes, there are clearly companies that don’t ever need the FDA’s imprimatur (e.g., administrative products with no clinical component), but if you have a clinically-oriented product and hope to claim that it makes a difference, the FDA could be your best friend. Having an FDA approval certainly conveys a sense of value and legitimacy to many in the buyer and investor community.
And with respect to well-constructed clinical studies to demonstrate efficacy, nothing could be more important for companies trying to stand out from the crowd. We keep seeing articles like this one, that talks about how digital health products often fail to deliver on the promise of better, faster, cheaper or any part thereof. And there’s this one by a disappointed Dr. Eric Topol, a physician who has committed a significant amount of his professional life to the pursuit of high quality digital health initiatives – a true believer, as it were, but one who has seen his share of disappointment when it comes to the claims of digital health products. I’m definitely of the belief that there are some seriously meaningful products out there that make a difference. But there is so much chaff around the wheat that it’s hard to find the good stuff. Digital health has become the world’s biggest Oreo with the world’s thinnest cream center. But well-constructed two arm studies can make one Oreo stand out in a crowd of would be Newman-Os.
And a last thought: somewhere between 412 investors (Mercom) and 187 investors (Rock Health) participated in these Q1 2018 deals. That’s a pretty big spread, but still a hell of a lot of investors. 2017 was the first year that more than 500 unique investors put their money down on a digital health bet. One half of those were first time investors in the genre. If you’re an entrepreneur looking for money, the good news is you have lots of targets. The bad news is that you have lots of targets who aren’t going to be particularly useful to you. Caveat Venditor: Seller beware is all I have to say about that.
It will be interesting to see if the gravity-defying digital health activity will continue ad infinitem or whether the sector will come into contact with the third of Newton’s Laws. Investors are, by definition, in it for the money. If you can’t exit you shouldn’t enter. In 2017 there were exactly zero digital health IPOs. This year there has, so far, been one IPO: Chinese fitness tracker and smartwatch maker, Huami, which raised $110 million and is now listed on the New York Stock Exchange, per Mercom Capital. In 2017 there were about 119 exits via merger or acquisition, which was down from the prior year. This year has started off with a faster M&A run rate (about 37 companies acquired in Q1 2018), but what we don’t know is whether the majority of these company exits will look more like Flatiron (woo hoo!) or Practice Fusion (yikes!). Caveat Emptor: Buyer beware is all I have to say about that.