Now that the economy is in a medically induced coma, venture capital firms are scrambling through their versions of “three stages of grief”
• What is the status of each portfolio company? Which ones need to raise capital? What cost reduction steps must reluctantly be taken? Are the current reserve assumptions appropriate?
• How do we feel about all of the in-process investments that have been diligenced for the last few months?
• When do we begin to consider new investment opportunities? And how can we do that if we are not even able to meet the team? Or visit the company?
Naturally, the first two items can be assessed quite quickly, and remedial action plans are likely already being deployed. The third item is a bit trickier to predict. When the Flare Capital team members were surveyed as to when we would all be back in the office, the answers spanned from early May to mid-July.
So it was with great interest to review the 1Q20 Rock Health data released today which registered nearly $3.1 billion of new digital health investments in 107 companies. This was the second largest quarter ever, behind 3Q18. Interestingly, the average size of investment was approximately $29 million, in part reflecting that there were six financings greater than $100 million (there were more than 100 such financings across all sectors in 1Q20). Later stage investments accounted for 31% of the financings, further underscoring the maturation of this sector. Rock Health also points out that 63% of all companies financed in the quarter sell into the provider segment, which as we painfully know, is solely focused on the Covid-19 crisis now.
There is a nuance buried in the monthly data this past quarter that may inform what the next few quarters might look like. The January 2020 activity was very robust: 41 companies raised $1.4 billion – but the pace started to markedly slow as the quarter unfolded. February saw 33 companies raise $898 million while March saw a further moderation with 32 companies raising $603 million, just 40% of the investment activity two months earlier. As the volume of new commitments comes down over the next few months, it certainly appears that 2020 will look more like 2016 or 2017 than 2018 or 2019 in terms of overall investment activity.
Arguably, healthcare technology and services investment opportunities are even more of a priority today given all of the shortcomings that have been exposed over the last few months. The profound need for innovative new clinical care models, remote management, predictive analytics to identify and manage high-risk members of our society, solutions to accelerate drug discovery and regulatory approval, novel approaches to population health management, and solutions for patient financial responsibility have never been more important. And importantly, many of the onerous regulatory frameworks that slowed adoption of novel care models have been reformed, particularly for virtual care.
Thus, the dichotomy – enormous and painfully evident market needs staring at a deeply impaired capital markets. Entrepreneurs should expect a dramatically lower level of investment activity and with that, dramatically lower valuations (a review of trailing valuation multiples shows that 2H19 may well have been a highwater mark). Round sizes are likely to be considerably smaller, often tranched to value-creating milestones as investors scramble to manage liquidity and portfolio reserves. Terms are likely to be more investor friendly, reflecting the new risk environment. In times of dislocation, many corporate venture funds significantly pull back or leave the market altogether. Obviously, prospects of near-term compelling exits just evaporated. Management teams will be pushed to extend operating runways with the cash on-hand, as syndicate members nervously look around the board table to assess which funds will struggle to support the company.
And the cruel irony is that the healthcare needs are overwhelming. Axios recently reported that quarantined Americans are reverting back to many bad health habits:
• Nielsen data for the week ending March 21 showed alcohol sales spiked 55%; online alcohol sales jumped 243%
• Evidation Health data from 68k fitness trackers shows over the course of March activity dropped 39%
• Marijuana sales are increasing dramatically – up 56% on California alone
With some epidemiologists estimating that the death total could ultimately be as high as 500k, a second order concern may well be acute malaise that sets in over the next few quarters as we collectively process such a catastrophe. Nearly 7,700 Americans pass away every day in this country which starts to put daily death tolls of a few thousand into some context. Inevitably, many of us will be personally touched by this virus, either will get sick or know someone who was sick or even died from this. There will also be third and fourth order effects as delayed attention to other chronic diseases catches up or a resurgence of Covid-19 returns.
While of little solace in this moment, the healthcare system is quite resilient and there are great entrepreneurs who already envisioning solutions to address many of the systemic issues we now are confronting.
Stay healthy…six feet apart.