Flat is the new up
Digital health’s venture funding bubble has officially burst
Investors across sectors have been waiting for the moment when startups’ sky-high valuations at double-digit multiples were going to normalize, and that day has finally come. According to a recent market research report on the digital health venture landscape by Rock Health, Q3 2022 is shaping up to be the smallest funding quarter in the sector this year and the lowest funding quarter by dollars raised in digital health since Q4 2019 ($2.1B).
Interestingly, the number of smaller and earlier-stage digital health deals remained relatively stable with a near-complete absence of late-stage investments in Q3. The analysis further shows that smaller round sizes — rather than fewer deals — pushed down the overall quarterly total.
One hypothesis for this shift is that many late-stage deals that “should have happened” in 2022 happened in 2021 in the form of fast-follow raises, when the economy was performing well. During this time, founders were advised to take advantage of VC’s willingness to pay, which gave their businesses longer runways to extend operations through Q3 ‘22. Rock Health’s data supports this thought: 64 companies raised twice in 2021–36% more than 2020, and 113% more than 2018.
TL;DR: Flat is the new up
VCs who participated in the 2021 “boom rounds” at higher-than-average multiples are more likely to help their portfolio companies with quiet cash infusions or round extensions in 2022, which we are anecdotally seeing taking shape. These “mid-rounds” are allowing businesses to achieve the type of traction needed to fairly rationalize a hefty lettered round step-up in the future that either maintains or improves investors’ share price from the 2021 boom.
Investing through a round extension at a flat (or fairly priced) valuation presents an exciting opportunity to help a business through a growth period and see how a team operates under pressure to perform with strong capital sufficiency. It also allows investors to get comfortable with a business’ founding team and understand its strengths and weaknesses before they raise their next official round of financing.
However, it’s equally important that startups carefully vet investors interested in these rounds, making sure to take capital from funds that are able to add value and help them on their path to hypergrowth before their next official raise. Partnering with smaller, strategic funds with deep industry expertise (e.g., Swiftarc) is one such way to make that possible.
To nerd out further about this trend, share a contrarian take, or chat about digital health deal flow more broadly, feel free to reach out to me at Jess@swiftarcventures.com. I look forward to hearing from you!
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