Please welcome Erinn Bisping to the investment team at Flare Capital Partners as Director of Marketing and Investor Relations. As we start to invest our most recent fund, we recently have added a few more “healthcare rock stars” to the team and Erinn continues that theme. In addition to an impressive academic career at University of Wisconsin – Madison (BBA, double major in Finance & Investment Banking, and Economics), she has worked closely with many innovative technology companies for well over a decade, most recently at Redesign Health, where she led product, marketing, brand, and growth strategies for nearly a dozen of their new venture healthcare companies.
Successful venture capital firms routinely get an audience with great entrepreneurs and excel in thought leadership and relevance for the sector they invest in. We aspire to have those great entrepreneurs looking for us as hard as we are looking for them. Erinn will evolve many of our existing “go-to-market” initiatives and launch new ones that build a deeper sense of connectivity and community around the firm.
Importantly, she will help to further deepen our relationships with our strategic investors, who represent every corner of the healthcare industry including providers, payors, healthcare retailers, device companies, lab companies, and pharma. Our “Strategic Engagement Model” has been very productive, driving early revenues for our portfolio companies and significant co-investment. Increasingly, we have partnered with our strategic investors to co-create important new companies (see Cohere Health, Inbound Health, etc). Our more traditional financial investors (family offices, sovereign wealth funds, endowments, and foundations, etc) are also a critical constituent as they are active co-investors in many of our portfolio companies.
Quick update on our Flare Scholars program and Flare Scholar Ventures (FSV), two of our more successful initiatives. With 316 Flare Scholars, who are young brilliant passionate emerging healthcare technology entrepreneurs and investors, we launched FSV, which is our commitment to invest a portion of each fund in pre-seed rounds of Flare Scholar sponsored projects. At this point, we now have 16 FSV companies, exceeding our initial goal – and a handful of those companies have already graduated by raising proper seed or Series A rounds (in total our FSV companies have raised over $60 million). The progress of the FSV program is inspirational as we continue to on-board the next generation of great healthcare technology entrepreneurs.
As we look to recruit the Class of 2024 Flare Scholars this fall, we could not be more impressed with the quality of all our Flare Scholars, but particularly the exceptional Class of 2023. Capital will always follow great talent and in this market, it will be great talent that wins.
Has there ever been a more complicated time in the capital markets? The pressures on Chief Financial Officers have never been more acute, the job more challenging, and yet many early-stage companies still struggle to properly staff this critical function. The collapses of Silicon Valley Bank (and the possible cash crises that was about to be triggered for many thousands of companies), Signature Bank, Silvergate Bank, and now First Republic Bank have shined a bright light on this role. And the litany of issues just keeps coming. CFOs are the goalkeepers for the company balance sheets, and they need to be very prepared.
There is a running debate among founders and early-stage investors about when to hire a full-time CFO and how best to staff the finance function of a company. According to Bureau of Labor statistics, there are over 730k “Finance Managers” in the United States. Zippia, an online recruiting platform tracking this job category, tallies 132k CFOs, 14% of whom are in healthcare. Furthermore, 83.3% of people between ages 25-54 were employed or seeking jobs in April, the highest employment level since 2008. The talent pool appears to be deep, but the crosscurrents now at play make these decisions even more complicated.
Last week’s 0.25% interest rate hike and the news on Friday that unemployment ticked down (yet again) to a historic 3.4%, a level not seen since May 1969, have created even more confusion in the capital markets. This is especially so when there is a drumbeat of a looming recession. The 1Q23 GDP growth estimate declined to 1.1% from 2.6% in 4Q22, well below analysts’ consensus of 1.9%. Arguably there is evidence that demand for labor is moderating but the supply of talent is scarce. And there is now the specter of an imminent federal debt crisis, now thought to be in early June 2023 according to Treasury Secretary Yellin.
Effective Federal Funds Rate
Source: Federal Reserve Board, Haver Analytic
This fog of “economic war” is made even more opaque given that the Federal Reserve Board tends to cut rates just prior to the onset of a declared recession as shown above. And no one has yet declared there is a recession. Notwithstanding the ambiguous guidance provided by Chairman Powell last week, a mere 7% of investors expect the Federal Reserve Board to raise rates at its next meeting, according to a recent CME Group survey. The interest rate futures market suggests that there is a 75% chance of a rate cut by September.
One other new phenomenon adding to CFO consternation is the increasing politization of the capital markets. For example, issues concerning Environmental, Social and Government (ESG) matters, which are non-financial factors that investors consider in investment decisions, now is a topic of robust debate. While this mostly impacts public companies and institutional investors (most visibly in the energy sector and important elements of the healthcare sector (see abortion, vaccinations, etc.)), ESG concerns will likely radiate out to touch most corners of the financial markets. A recent University of Pennsylvania study calculated that municipal bond issuers in Texas paid $300 – $500 million more in interest on just the $32 billion borrowed in the first eight months of 2021 after that state instituted “anti-woke” guidelines. Two months ago, 19 Republican governors pledged to oppose investment managers that espoused support of ESG considerations.
According to Oxeon, a leading executive search firm specializing in early-stage recruiting, observed that so far in 2023, over 21% of the firm’s searches are for CFOs, up from 4% in 2021. Across the board, Oxeon data highlighted a 2.5% increase in compensation since 2022, but for CFOs, the increase has been 25% with an average total compensation of ~$413k. A recent analysis from Compensation Advisory Partners showed that CFO salaries actually increased faster than salaries for CEOs for companies reporting in 4Q22 in the S&P1500.
While compensation survey data tend to be all over the board based on stage of company, Carta, a company that specializes in capitalization table management, has a particularly interesting view into executive compensation across 35k companies tracked. A review of the Carta data below shows a wide range of salaries by quartile for start-up companies, from $80k at the bottom quartile to $208k for the highest earners. Looking at those amounts on a monthly basis begins to frame the “fractional CFO” debate as well, particularly in light of the recent SVB scare.
To underscore some of the professional turmoil in the CFO role, Russell Reynolds Associates published research recently which showed elevated levels of S&P500 CFO turnover between 2019 – 2022. Even more informative than the overall turnover is to look at where these executives are heading. Approximately 48% of these departures are due to retirement, with the balance taking on new roles; four out of five times those new roles are not CFO roles but rather other C-suite positions, mostly elevated to CEO jobs. Two-thirds of non-retirement departures see those executives staying with the current organization, suggesting management team depth and a high level of continuity at those companies. Interestingly, 36% of departures occur in 1Q while only 12% occur in 4Q.
Chief Financial Officer Turnover
The commercial banking wake-up call issued in March now has many corporate boards reviewing crisis management strategies. Financial pressures have elongated sales cycles, increased working capital needs, raised concerns about the quality of accounts receivable, increased the incidence of fraud, and challenged bookings pipelines. Economic concerns have pushed customers to demand hard dollar, near-term ROI for purchase decisions, while scrutinizing opportunities for improved workforce productivity. In the absence of liquidity and often shaky follow-on investor interest, many companies will need to navigate financings, tricky private-to-private M&A opportunities, and/or adjust cost structures to get to breakeven on whatever financial resources are on-hand.
All of these dynamics demand a greater level of engagement and experience of the CFO. Interest rates moved nearly 500 basis points in a year and companies needed to respond. There are certainly advantages to the “fractional CFO” model such as possibly lower cost (a Wall Street Journal analysis cited Countsy, an on-demand back-office provider of outsourced CFO services, which suggested costs ~$5k per month), greater operational flexibility, and access to more talented finance skills for very early-stage companies than otherwise might be possible.
There are other considerations, though, that boards and founders must now confront. The broader landscape is bifurcating between high- and low-quality companies, and that often turns on the completeness of the management teams. Even in challenging financing markets, such as now, great teams can raise capital (admittedly, perhaps at less than hoped for valuations or with less favorable terms). There is a premium for more effective investor relations skills, be it with venture capitalists or commercial bankers, which can be strengthened by full-time continuously engaged CFOs who are “all in.” Many companies now are having to restructure credit facilities, odds of which can be improved by long-standing relationships between borrowers and lenders.
Significant investment in the finance team also improves the level of analytical depth and understanding of the business model, versus simply serving as a reporting function. The increased velocity and cycle time with product development in this hyper-competitive environment puts greater pressure on company balance sheets, necessitating deeper financial analytical capabilities and insights. This commitment to analytics hopefully will pervade into all corners of the organization, creating a collective depth of understanding of the risks and opportunities facing the company.
Adding a strong full-time CFO earlier also signals to investment partners and customers the importance of these capabilities. These executives often develop a deep bench of talent, which is critical as this reduces the single point of failure risk. Continuity is critical in uncertain times.
Highly effective CFOs will drive greater operational efficiencies while lowering the company’s cost of capital. It is clear that an investment in great CFO talent early will generate a hard ROI for all stakeholders.
Now in an environment when capital is relatively scarce and expensive, one should expect a dramatic bifurcation between high- and low-quality companies – the latter will quickly experience a bout of significant consolidation and company closures. The hidden cost of chronically low interest rates has been to forestall the failure of bad businesses. And the warning signs are everywhere.
Obviously, the Silicon Valley Bank (and Signature and Silvergate banks) debacle was the most notable fissure to emerge. Once the immediate shock and realization that many companies had wildly deficient risk management strategies subsided, the fear that in a liquidity crisis many companies now have much shorter cash runways took hold. This is also settling in as the anxiety of an impending recession looms. An analysis by Bank of America and the Federal Reserve shows that tighter lending standards correlate closely with recessions.
Net Percent of Banks Reporting Tighter Lending Standards
Source: Federal Reserve, Haver Analytics, BofA Global Research
Specifically, significant declines in liquidity such as the tightening of bank lending standards have been associated with dramatic economic pain which is now causing industry analysts to speculate about the severity of the impact on the remainder of the year. Typically, there has been a 10-15% decline in capital expenditure over the next six to ten quarters and a 2-4% decrease in employment over the next year and a half following a credit tightening.
Interestingly, this is now playing out while the S&P 500 index remains mired in the twentieth bear market of the last 140 years. While the average decline from the peak to trough is 37.3% and lasts on average 289 days, this bear market which started in January 2022 is now longer than most (although the downdraft has not been as severe). In fact, the S&P 500 rallied in 1Q23 increasing 7.0% but that was a disappointment when compared to orange juice, which was the best performing asset which rallied 30.6% in the quarter. The worst performing asset in 1Q23 was surprisingly the NYMEX Natural Gas index given the relatively mild winter. Notably, the Ukrainian currency (hryvnia) was precisely 0.0% for the quarter. The NASDAQ had a terrific 1Q23 increasing 16.8%.
Systemic financial liquidity will require close monitoring over the balance of the year. In 1Q23, over $508 billion flowed into cash accounts with a staggering $142.9 billion of cash inflows just during the last week of March alone (the most since March 2020 with the onset of the pandemic) as investors sought safety. As economic conditions continue to deteriorate and with companies desperate for investment, this amount of capital on the sidelines may prove to be problematic.
Money Market Funds ($T)
The venture capital industry has not been insulated from these broader economic forces. According to Crunchbase, venture funds invested $76 billion globally in 1Q23, which is a steep decline from the $162 billion in 1Q22. The National Venture Capital Association and Pitchbook just released their flash 1Q23 report which tallied $37 billion invested in 1Q23 as compared to $82.4 billion in 1Q22. In fact, this was the lowest quarterly volume since 4Q19 and well-below the average 2022 quarterly level of $52 billion. The 2,856 companies which raised venture capital in 1Q23 was the fewest number since 4Q17, 21 quarters ago.
Across the board, the decline in activity was most pronounced in the Late-Stage category of financings. There were only 19 “mega rounds” (greater than $100 million raised) in 1Q23. The two other barometers that venture capitalists are willing to take on risk in this new environment are reflected in round size and pre-money valuations. The average early-stage and late-stage round sizes for all of 2022 as compared to 1Q23 were $21.4 million down to $18.7 million (early-stage) and $28.2 million down to $16.4 million (late-stage) – meaningfully smaller financings.
More notably is the compression of pre-money valuations. The average early-stage and late-stage pre-money valuations for all of 2022 as compared to 1Q23 were $131.7 million decreasing to $113.9 million (early-stage) and $286.2 million decreasing to $159.1 million, respectively. In addition to the drop in “mega rounds,” the near-immediate reset in valuations, particularly in the late-stage category, does not portend well for many late-stage investments made in the 2021-2022 timeframe.
In addition to concerns about access to capital on reasonable terms has been the abysmal level of exit activity for venture-backed companies. In 1Q23 there was only $5.8 billion of exits which is less than 1% of all the 2021 exit activity. This past quarter only saw 19 exits of greater than $100 million, which compares very poorly to the pre-money valuations cited above. It is very likely that there will be a significant number of private-to-private M&A transactions with “terms not disclosed” as we grind through the balance of 2023.
Not lost on anyone has been the disappearance of the Initial Public Offering market as institutional investors continue to operate with a “risk-off” mindset. In addition to the traditional IPO activity shown below, there was a frenzy of SPAC (special purchase acquisition company) merger activity over the last two years; just in 1Q21 alone there was $173 billion of SPAC activity as compared to only $8 billion of SPAC mergers in 1Q23 according to Dealogic. This has now come home to roost – and not in a good way. With approximately three-quarters of public companies having now reported 2022 results, the 39 post-SPAC companies reported $11.6 billion of goodwill impairment charges according to analysis by the Wall Street Journal. In 2020 SPAC impairment totaled a mere $4 million, further highlighting the valuation lunacy of the past two years. And the amount of valuation compression likely still to come.
Data: Dealogic; Chart: Axios Visuals
Strong investment returns drive venture capital fundraising. While private equity and venture capital consistently – over long timeframes – generate superior returns over all other asset classes, venture capital funds’ ability to raise capital has been under significant pressure. In 1Q23 there were 99 funds which raised a total of $11.7 billion as compared to the 199 funds in 1Q22 which raised $73.8 billion. There were only two $1.0+ billion funds this past quarter as compared to the 36 raised in 2022, which will likely be seen as the high-water mark for fundraising for some time to come. A recent Pitchbook analysis concluded that mega-funds consistently underperform smaller funds and in fact that “poor performance of billion-dollar funds has caused investors to temporarily stall new commitments to their managers and consider smaller funds that can more effectively deploy capital to venture stages that are more insulated from public market volatility.”
There is a cruel irony now as thousands of venture-backed companies recalibrate operating plans for the remainder of the year with investment partners who are anxious yet are evidently sitting with unprecedented levels of “dry powder.” SVB Leerink recently concluded that there was over $560 billion of venture capital raised but yet to be invested as of December 2022 (Crunchbase tallied $580 billion). If conditions rapidly deteriorate, one expects that valuations (and terms) will become attractive enough to prod venture capitalists out of their hypnopompic state to start investing again. We are not there yet; according to Carta which tracks 30k start-ups, March 2023 investment activity was down 83% from March 2022. Is this now the “new normal” with constrained liquidity and a real cost of capital?
Venture capital funding in the digital health sector continues to be relatively robust. Were one to annualize the 1Q23 pace of $3.4 billion investedaccording to Rock Health, 2023 should be largely in line with 2022 and 2020, excusing for the extraordinary level of activity in 2021 ($29.3 billion invested, arguably due to pressing issues illuminated by the pandemic). While showing signs of resilience, the current economic and financing climate will still drive further bifurcation of high- and low-quality healthcare technologies companies. High quality companies will be able to raise capital. While the annual investment pace may have declined by ~50% from the 2021 level, it is not as if the number of problems to be solved in healthcare were just cut in half.
First and foremost, those companies best able to raise capital this year will have complete and proven executive leadership teams. Full stop. Healthcare is too complicated for inexperienced teams to navigate in good times, to say nothing of the sector headwinds now. Companies will need to bring to market products that drive either near-term client revenues or show cost reductions within one budget cycle. Customers are under significant financial pressure and must show hard ROI right away.
Investors will struggle with value-based care models that only create economic value at scale, when to reach “scale” requires up to several hundred million dollars of private capital. Many companies showed profound member or patient level impact on outcomes but overall were quite unprofitable before reaching “scale;” those companies will sadly struggle to raise significant capital as the sector works to find its footing this year.
Interestingly, healthcare technology investments in 1Q23 accounted for approximately 9.2% of all venture investments in the quarter, which is up sharply from 7.2% in 2022. Notably, though, only six companies in 1Q23 accounted for nearly 40% of the amount invested, perhaps offering a preview that high quality companies will successfully attract capital and that “emerging winners” will be anointed in this period of sector consolidation. The median size for early-stage financings in 1Q23 was consistent with prior years, while there was significant reduction in Series D and later round sizes from $104 million in 2021 to $58 million in 1Q23.
According to SVB Securities, the public companies in the digital health sector had a reasonably strong 1Q23 trading up 10.2%, while unfortunately declining 32.9% over the last twelve months. That cohort is trading at 4.7x and 3.9x 2023 and 2024 revenues, respectively. The overall average revenue growth from 2022 – 2024 is projected to be 17.9%, but with only a 2.5% EBTDA margin expected in 2023.
Last week the Department of Labor released March employment data which showed that the healthcare sector accounted for 51k of the 236k jobs created in the month, just slightly ahead of the 47k government jobs created. Healthcare was the second most active sector behind leisure and hospitality. The Department also reported that there were 1.5 million layoffs in February (most recent month with data), and that there was a 64% increase in jobs lost in the Information sector.
Hopefully some of those displaced tech workers can fulfill the promise of healthcare technology to make the healthcare system more effective, while reducing costs. The system will need to staff up to turn around the drop in life expectancy from 79 years to 76 years since the onset of the pandemic. There is still so much more to be done.
What an enormously complicated time to have been in India, and to have been there alongside the recent G20 Summit made for an even more precarious environment. With a general election a year away, Prime Minister Modi assumed the role of global statesman with gigantic posters festooned throughout Delhi. Notwithstanding that the twenty foreign ministers were unable to agree on a joint Ukrainian statement, Secretary of State Blinken and Russian Foreign Minister Lavrov met in Delhi for the first time since the start of the war.
India must walk a fraught tightrope as the country appears to be pivoting more towards the West, as China becomes a greater adversary. Surprisingly, a series of editorials earlier this month in the Hindustan Times expressed deep sympathy toward Russia (citing NATO encroachment, etc.), hoping to ensure important economic ties, while also extolling Modi to “lead in Ukrainian talks.” Since the start of the war in February 2022, India’s purchase of Russian crude oil has increased a staggering 33-fold, and at a 30% discount to global oil benchmarks. India imports nearly 90% of its oil but has created a vast oil refinery industry, ironically now likely to serve as a potential refinery to European oil needs.
While unemployment spiked last month to 7.5%, up from 7.1% in January, the International Monetary Fund estimates that the Indian economy will grow by 6.1% in 2023 and 6.8% in 2024. According to the Centre for Monitoring the Indian Economy, the workforce is estimated to be 410 million people, 35 million of whom work in the manufacturing sector while only 2 million are in information technology. Much of the economic growth is in corporate jobs (finance, investments, business process outsourcing) which tend to be less labor-intensive given each unit of output, thus the spike in unemployment in the face of strong growth. This also accounts for Modi’s recent initiatives to reform labor laws to frankly look more like China. Under his watch, the major public equity index (Bombay Stock Exchange SENSEX) has responded.
Encouraging multinational migration to India is a critical objective of Modi. At the end of 2022, he announced a $30 billion production-linked subsidy program to relocate manufacturing facilities to India. Foxconn announced a 2024 goal to produce 20 million phones in India. Today, only 3% of all iPhones are made in India; the goal is to take that to 25% by the end of next year.
Major automakers are moving significant production capacity from China to India in response to the 24% increase in local passenger vehicle purchases to 3.8 million units in 2022. India is now the third largest market, tied with Japan; by 2030 it is estimated that 7.5 million vehicles will be sold in India, according to Arthur D. Little. Notably, in 2019 India withdrew from the China-sponsored Regional Comprehensive Economic Partnership of 15 Asian countries to promote free trade in the region. While improving, India still has some of the highest trade tariffs with an average of 18.3% as of 2021.
There were prominent story lines earlier this month that echoed issues we see in the U.S. and that undoubtedly spin up with any society in transition. While there, the Supreme Court was to consider a case to outlaw same-sex marriages, citing it would lead to “complete havoc.” Just in 2018, India decriminalized same-sex relationships, a head-spinning change in direction. Last week the state of Punjab had its entire internet taken off-line for 27 million people as authorities searched for a Sikh separatist. This was topped by the two-year sentencing of the leading opposition figure, Rahul Gandhi, for suggesting in 2019 that Modi was a thief.
There is much, though, for Modi to crow about. Electricity production has increased 66% since he took office in 2014. Just in the last three years there has been a 3-fold increase in homes with running water to 108 million. There are twice as many airports. Corporate tax rates have been lowered from 30% to 22%. The 350 million middle class Indians have clearly seen a marked improvement in quality of life, even with some recent warning signs. GDP in 4Q22 increased by 4.4%, which is slower than the 3Q22 rate of 6.3%, but was 1.5% ahead of China’s 2.9% 4Q22 GDP growth. In fact, 4Q22 manufacturing declined 1.1%, which was the third quarter in a row, and underscores the urgency of many of Modi’s initiatives to entice multinationals to relocate production capacity to India.
The local venture capital industry also saw significant declines in 2022. According to Bain & Company and Pitchbook, overall venture capital investment was $25.7 billion in 1,611 companies in 2022 as compared to $38.5 billion in 1,545 companies in 2021. While the number of investments was modestly higher, the average deal size was markedly lower at $16.0 million as compared to $24.9 million the year before. Aa a point of comparison, the U.S. venture capital activity was $238.3 billion in 17,990 companies in 2022. India now accounts for roughly 20% of all venture capital investments in the Asia Pacific market and ~5% globally.
Consistent with many other markets, the Indian venture capital industry witnessed a surge of activity during Covid, in part due to the greater awareness of new innovative solutions required to navigate this new reality and also given extraordinary liquidity and nominal cost of capital. The eight trailing years heading into Covid saw an average of 610 deals per year in India, which spiked nearly 3x during the pandemic. Much of this investment activity was driven by the arrival of numerous seed funds, which now number more than 80 firms. There are thought to be 200 corporate venture capital funds operating in India today. According to Tracxn, there are 1,654 venture capital firms in India now.
There was a dramatic rotation to earlier and mid-stage investment rounds, with a rather dramatic pullback in late-stage rounds in 2022. There were only 48 “mega rounds” (greater than $100 million) in 2022, compared to 92 in 2021; most of the decline occurred in 2H22. Notwithstanding that, there were 23 unicorns created in 2022, eclipsing 100 in total – a strong barometer as to the strength of the Indian market. In light of that, though, there is growing anxiety about the exit environment; there were only eight IPOs in 2H22 and analysts note that at least 10 pending technology IPOs have been recently pulled. Total exit level in 2022 was approximately $3.9 billion, well below the $14.3 billion in 2021.
There was a significant deceleration of investments in the healthcare technology sector, as highlighted below, to $700 million in 35 companies, which is somewhat surprising given India ranked 66 out of 195 countries for overall global healthcare security index. According to a recent World Bank study, India spends 2.2% of GDP on healthcare, suggesting an extraordinary market opportunity for healthcare technology to improve access to affordable care.
A World Health Organization (WHO) analysis concluded that Indian life expectancy today is 70.8 years, which is nearly half a year longer than just in 2021, but sadly ranked only 117 in the world. The WHO calculated 44.7 million Covid cases with 531k deaths. India ranks third in the world for the incidence of lung disease, in part due to the extraordinary level of air pollution. A headline in the Hindustan Times earlier this month featured a leading Indian actress (Saiyami Kher) complaining that she still coughs after running the Mumbai Marathon in January. There was chaos surrounding each hospital I saw in Delhi.
There was one other dimension to good public health which one is often reminded of: whatever you do, do not stare at the monkeys…which are everywhere. And certainly, do not tease them – they can be very sensitive.
Go to the end of the earth, and when you get there, turn left and go another few hundred miles and you will be at the Maldives, an independent Muslim country of ~550k people nearly 500 miles off the southern coast of India. Straddling the equator and comprised of 26 atolls covering 35k square miles, the Maldives is the smallest of all Asian countries and is considered the world’s most geographically dispersed. And it faces a host of profound existential threats.
Being so remote does not insulate the Maldives from global issues. The two most obvious and troubling today involve the Covid pandemic and global warming – both issues exported from the rest of the world. Most immediate are public health risks, exacerbated by an inadequate healthcare infrastructure and caused by diseases brought in by tourists.
Early on in the pandemic, the Maldives was considered one of the world’s most active “Covid hot spots” registering the highest number of infections per million people, according to an analysis by Bloomberg. Fortunately, the total number of fatalities was quite modest with just over 300 to date, but it underscores the ever-present exposure to global health crises, especially for a country so dependent on tourism.
Perhaps reflecting a cultural ambivalence or concerns with raising anxiety among tourists, the public health messaging around Covid risks was effectively invisible. Tucked into the corner of the airport terminal was one lonely sign extolling the merits of responsible behavior. Vaccination requirements were waived years ago.
Notwithstanding that, the country has made meaningful progress on other key healthcare benchmarks. Average life expectancy now stands at 72 years, up from 46 years in 1978. Infant mortality is at 1.2%, a marked improvement from 12.7% in 1977.
Far more disturbing are the implications of global warming and rising sea levels. While some may argue over the intensity or cause or solutions to global warming (or even if it exists at all), for a country with average elevation of 4 feet, 11 inches above sea level those debates are secondary. The highest point in the country is 7 feet, 10 inches.
Anxiety spiked recently with the news that the Thwaites Glacier, affectionately known as the Doomsday Glacier, was facing collapse which would increase global sea levels by an estimated two feet. The Thwaites is 75 miles wide and sits as a dam to “upstream” water flows from the Antarctic; its collapse risks unleashing a cascade of other glacier collapses. Sadly, what happens in the Antarctic, does not stay in the Antarctic.
Even geopolitical issues risk intruding on this idyllic place. While remote and not easily reached, the large number of Russian tourists was notable, notwithstanding a sad and lonely Aeroflot check-in desk. It is hard given what the world is witnessing with Russian aggression toward its neighbors to contemplate what those travelers think while on vacation. But even in such moments, there were examples of exceptional grace. Svetlana, the Maître d’ at one of the finer restaurants, greeted each guest with elegance undoubtedly while thinking of family members left behind in the now destroyed Ukrainian city of Kherson…
Yesterday just over 25k people died of starvation. The causes that contribute to that tragedy are numerous, and while the problems are often intractable, possible solutions to address this calamity are being developed in disparate settings such as the laboratory, in the capital markets, in restructuring the supply chains, and with fiscal and tax policies.
Many of our pedestrian concerns have likely been eclipsed by the ongoing devastation in Ukraine and the catastrophic earthquakes in Turkey and Syria. Hunger and issues of access to adequate food supplies stare us in the face constantly now. A recent United Nations report titled “State of Food Security and Nutrition in the World” concluded that 2.3 billion people in 2021 faced moderate or severe difficulty in obtaining food, well before these two emerging crises. It is believed that nearly 830 million people struggle with hunger today.
Obviously, the Ukrainian war drove dramatic food price inflation starting a year ago. In addition to supply chain disruptions, there was the dramatic spike in fertilizer prices given that Russia and Belarus account for 35% of global potash and nitrogen production, a critical component of fertilizer. Up until this year, the global agricultural sector experienced dramatic increases in productivity over the last several decades due to the abundance of hydrocarbons used for fuels and fertilizers. That is at risk of reversing.
As impactful, the spike in food export restrictions has significantly reduced the amount of food trade, which in addition to limiting food availability, also exacerbates food price inflation in countries facing scarcity. The world’s poorest countries tend to be net importers of food products and are most directly exposed to food price inflation. This dynamic has also led to food hoarding in certain countries as a way to moderate domestic inflation and limit social unrest. Globally, the stock-to-use ratio for wheat and corn is estimated to be 29% according to the United Nations Food and Agriculture Organization. China is holding 50% of the world’s wheat stockpile, significantly increasing wheat import at the outset of the pandemic; the U.S. only holds 6%.
It is estimated that 60% of all food production is accounted for by five countries: China, the U.S., India, Brazil, and Argentina. While Ukraine is only the seventh largest wheat producer, it still represents approximately 10% of all annual production, which is not reliably available to the rest of the world. Together with Russia, both countries together account for 28% of all wheat produced, according to an analysis by McKinsey.
These issues have conspired to create an estimated wheat and corn deficit of 15 – 20 million metric tons in 2022, which may increase to 23 – 40 million in 2023 per McKinsey. The high end of this range would be enough food for 250 million people.
Setting aside the scourge of starvation, the urgency to develop alternative sources of food production is also linked to broader issues of national security and social unrest in malnourished hot spots around the world. The Defense Advanced Research Projects Agency (DARPA) has launched the “Cornucopia” initiative to develop a new framework for future food production systems that are more equitable, accessible, and lower cost. At the core of this effort is the goal of utilizing microbes which could create secondary food production systems thereby reducing geopolitical risks. It is estimated that the U.S. military is deployed in 80% of global crises, much of them related to food security.
Particularly disturbing was a recent Bank of America analysis which concluded that humans are utilizing natural resources 1.7x faster than the earth can recover; this is expected to reach 2.0x by 2030. Only 29% of the earth’s surface is land, of which 71% is considered habitable or just under 41 million square miles. It is estimated that 46% of all habitable land is used for agriculture, and 77% of that is for livestock, implying that livestock occupy 14.3 million square miles. According to the United Nations Food and Agriculture Organization, one-third of the earth’s soil has already been compromised, underscoring the urgency for innovative approaches to food production.
Further challenging the world’s ability to produce food is the burden pests impose in critical regions of the world. A recent study by the Center for Agriculture and Bioscience calculated the total financial costs in Africa due to invasive pests and plants to be $3.5 trillion. Many of these losses are due to the labor required to weed fields to ensure that appropriate crops can survive.
Shamefully, it is believed that upwards of 30% of all food production is wasted, either during the production process or “downstream” at the point of consumption, according to a McKinsey Sustainability study. This equates to 1.3 billion tons of food; some analysts conclude that amount would satisfy nearly 2 billion people annually. Over a third of this wastage is perfectly fit for consumption.
Americans alone waste 119 billion pounds of food according to Feeding America, which is 40% of all food. This is equivalent to 130 billion meals and costs $408 billion. The American Journal of Agricultural Economics concluded that each family in the U.S. spends $1,900 on wasted food each year. The non-profit ReFED, which studies food waste issues, estimates that 7% of all wasted food is simply due to confusion over expiration dates on labels.
Feeding America estimates that there are 50 million people in the U.S. who struggle with food security. To address this, the Biden Administration recently announced a goal to eliminate hunger in the country by 2030. In addition to $8 billion in private charitable contributions, the Supplemental Nutrition Assistance Program provided $119 billion in food stamps to 41 million Americans last year.
Solutions to hunger are complex, expensive, and inherently co-dependent on each other. Obviously, a more progressive tax framework on the production of foods that damage the environment or are not productive sources of protein may shift resources to more efficient sources. It is estimated that there is a 10x factor between the most and least efficient sources of protein, which accounts for much of the innovation in lessening the dependency on livestock.
Conversely, incentives and subsidies can be introduced that shift resources to novel more effective means of protein production. In mid-2022 the World Bank announced plans for $30 billion in assistance for programs linked to food and nutrition security. The Inflation Reduction Act earmarked $22 billion for Agriculture Department programs in regenerative or climate-friendly agricultural techniques.
Arguably and cruelly ironic, the U.S. food production industry has contributed to a domestic health crisis. It is estimated that 58% of all calories consumed now are from ultra-processed foods with modest nutritional value. Furthermore, nearly 100 million Americans have diabetes (11% of the population) or are pre-diabetic. Sadly, the Center for Disease Control and Prevention recently published a study of children in the U.S., highlighting that 50% consume only one vegetable each day. This is to say nothing of the knock-on environmental impacts given that 37% of all greenhouse gases emanate from the farming industry and that excess nitrogen from fertilizer is devasting to many inland waterways.
Issues surrounding food production and distribution have not gone unnoticed by the venture capital community. According to Pitchbook, $10.6 billion was invested in 988 companies in 2022, and while down 13.2% and 10.2% from 2021, respectively, last year was the second strongest year on record and represents relatively healthy activity given overall market volatility. Median pre-money valuation in the “agtech” sector was an attractive $15.3 million while median round size was a modest $3.3 million. Notably, exit activity was only $2.2 billion across 38 deals, perhaps suggesting the category is still quite immature. In light of that, $2.5 billion was committed to launch the Food, Nutrition and Health Investor Coalition in September 2022 to support private investment to address issues of hunger. Crunchbase estimated that $2.5 billion was invested in 2022 in start-ups to address just food waste issues.
These investments point to longer-term innovations that might be expected to have an impact over the next few decades. Introduced with much fanfare and investor enthusiasm, the synthetic biology sector brought to market a range of plant-based meat products. Many of the fast-food chains rolled out meals based on products from Beyond Meat and Impossible Foods, causing the stock prices to soar. This past year saw dramatic declines in share prices for companies in the alternative meat category (Beyond Meat has declined 65% over past twelve months) as supermarket sales of these products declined by ~15% in 2022, according to Information Resources Inc.
Upside Foods, formerly known as Memphis Meats, uses synthetic biology to produce chicken; it is chicken cells but just not from poultry. These lab-grown meats sidestep ethical issues around the treatment of live animals and are considered more environmentally friendly. While today’s price per pound is not yet competitive with real chicken (in 2022 the price per pound was $7.70 as compared to $4.30 for real chicken), it is expected that vat-grown meats at scale should be more in line with real chicken. Certainly hope so as we race toward 100 pounds per person consumed in the U.S.
In addition to products that provide more efficient sources of protein, there are solutions which take on the supply chain waste issues and utilize existing foods that may not be palatable or “ugly.” Misfits Market uses misshaped foods that would otherwise be disposed of. Novel technologies are being developed to make fresh foods last longer, allowing them to travel greater distances in the supply chain, which tend to be distinct and separate from general supply chains. Shorter supply chains for food tend to create less waste but that is often not practical. The producers of beef, pork and poultry are highly consolidated (and centralized and industrialized), with the top four in each category controlling 85%, 70%, and 54% market shares, respectively. It is believed that 60% of all mammals are now livestock.
Alternatives to traditional farming will require time and patient capital to develop, and quite likely substantial government support, if not outright intervention. The advisory firm Green Street calculated that average annual return for U.S. farmland to be 11.2% over the past 25-years through 3Q21 (likely only more valuable over the past year) as compared to just 9.6% return from the S&P 500 Index over the same period – and without the volatility of the public markets. In 2021, the average acre of U.S. farmland was valued at $3,380. Traditional approaches continue to be good long-term investments.
The phenomenon of vertical farming may effectively shorten supply chains as fruits and vegetables are grown in indoor controlled conditions, utilizing automation and AI to optimize production yields. Bowery Farming is an emerging leader in this category, which according to Grand View Research saw $4.3 billion in sales in 2021, growing at nearly 26% per year through 2030. Of the more than 400k plant varieties, 30k are thought to be edible, even though humans only consume roughly 200 plant types. Plenty to work with.
Interestingly, insects represent another source of plentiful protein and while most of the investment so far has focused on insects as food for livestock and pets, there is a growing appetite to feed insects to humans. Notably, Ynsect has already raised $370 million to develop food ingredients made from insects, claiming that such an approach requires 100x less land and 25% less water for equivalent meat production. Rabobank estimates that by 2030 10-20k tons of insects will be processed for human consumption.
According to the Proceedings of the National Academy of Sciences, there are 2.5 million ants for each human, implying that there are 20 quadrillion ants on the earth. Almost enough to lose your appetite…
Just over three months ago, along with our terrific partners at the Hospital for Special Surgery (HSS), we announced the formation of a new company called RightMove Health, which has as its goal to make high quality, patient-focused virtual musculoskeletal (MSK) physical therapy (PT) available to all Americans. HSS is hands down the preeminent leading academic medical center specializing in MSK health.
And like at the Academy Awards there simply are too many people at HSS to acknowledge but clearly a few need to be recognized for having built an extraordinary collection of physical therapy assets and for visionary thinking to partner to build a leading independent company serving the nearly 12 million people who annually utilize physical therapists: Lou Shapiro (CEO @ HSS), Bryan Kelly (incoming CEO @ HSS), Amy Fahrenkopf (President, HSS Health and SVP @ HSS), and David King (Interim Executive and Founding Team member @ RightMove).
Perhaps even more exciting, last week we announced the addition of a rock star CEO, my good friend Marcus Osborne, who is known to many from his extraordinary work for over 14 years at Walmart, most recently serving as SVP Walmart Health. There is not a corner of healthcare or an innovative solution that Marcus has not considered or purchased. And a tip of the hat to the team at Oxeon, led by Patrick Sullivan, who ran an exceptional recruiting process. Importantly, Marcus joins Employee #1, David Lim, who is an exceptional founding Chief Clinical and Medical Operations Officer, having among many accomplishments been on the founding team at Quartet Health. This is a band of rock stars…
There are a few powerful industry trends facing the over 590k professionals in the PT field in the United States (Bureau of Labor Statistics counts ~225k actual physical therapists), and like many other recent developments in healthcare, these trends are framed by the pandemic. Obviously, the explosion in telehealth services has been transformative in the PT industry and is a significant tailwind for RightMove. It is estimated that telehealth visits increased 38x in the immediate aftermath of the pandemic. According to a recent McKinsey study, 55% of patients expressed greater satisfaction with virtual versus in-person visits.
Second, advances in healthcare technology have improved patient engagement and facilitated more personalized care plans. This development has directly informed the third significant trend in PT, which is the drive to provide more in-home services, in part due to the rapidly aging population.
Staff burn-out and pressures to provide more flexible, accommodative work environments for providers coupled with profound improvements in virtual reality and AI have recast the patient-provider experience and account for the other two industry trends. Against this backdrop, the market forces seem to have converged to marry the field’s highest regarded, most effective, and clinically validate PT protocols developed at HSS with outstanding entrepreneurial talent to scale a disruptive approach to address what has been an often poorly managed care pathway, rife with underwhelming outcomes and significant waste.
It is thought that Hippocrates may have been one of the first practitioners of PT as far back as 460 BC. Much has changed since then. IBIS World estimates the PT market to be nearly $47 billion in size, serviced by nearly 38k clinics. Across all professionals in the PT field, average earnings total $75k annually, although sadly, there is quite a wide disparity by gender and geography. Bureau of Labor Statistics data show the mean salary specifically for physical therapists is ~$93k.
Notwithstanding those issues, the PT field has developed a deeply committed and talented labor force, which is fortunate given MSK issues are estimated to account for one-sixth of all healthcare spend annually, costing approximately $600 billion per year. Physical therapists are the first line of care for MSK issues, and when handled properly, PT can reduce the incidence of certain unnecessary and frightfully expensive MSK surgical procedures. This is exacerbated in a fee-for-service framework, so more effective PT triage solutions facilitate the move to value-based care MSK clinical models.
The RightMove offering is centered around “expert physical therapists” who will provide live triage and virtual PT covering 90+ MSK conditions. The company will build upon HSS’s vast PT experience and data collected over decades; annually HSS conducts ~330k in-person and ~100k virtual PT visits. The product offering is anchored in three modules: virtual triage (45-minute live comprehensive exam); virtual PT sessions; and “digital engagement” with curated expert content, personalized dashboard, and asynchronous chat capabilities.
Over time, it is expected, like many virtual care providers, that RightMove will develop into a “hybrid” model that likely will include an expert network of in-person physical therapists (“powered by HSS”), which will be particularly impactful for larger risk-bearing provider and employer clients. All of these capabilities have RightMove on the path to becoming a value-based PT platform to take on risk in pay-for-performance, pay-for-quality arrangements.
The power of the co-creation model that our firm, Flare Capital Partners, has utilized successfully is to co-invest with a leading strategic partner at the outset, often times one of our investors, to stand up a novel offering that while solving an immediate need of our strategic partner, can develop into a wider industry utility. This model requires that the new company be able to quickly recruit world class executive talent – RightMove just checked that box – and importantly, that other great co-investors join the ride once the company has launched. RightMove recently received additional capital from two outstanding firms: Frist Cressy Ventures and Greycroft. Another box checked.
It is not a “stretch” to say that Marcus and David made the right moves to join. I am only hoping that they create an offering that makes it easier for me to touch my toes. Oh, and I still want to finish a marathon in under four hours – is there anything for that?
Obviously, the problems addressed by healthcare technology did not just get cut in half. So, what accounts for the rather dramatic decline in venture investment in digital health from $29.3 billion in 2021 to $15.3 billion in 2022, according to recently published Rock Health data. There has likely never been a more complicated and confounding time to be investing in healthcare than now. Against a backdrop of daunting macroeconomic issues, the problems confronting the healthcare industry requiring innovative solutions continue unabated.
This past week we learned that the U.S. has hit the debt ceiling of $31.4 trillion. The Wall Street Journal’s year-end survey of leading economists peg the likelihood of a recession in 2023 at 61% with a meager 0.2% annual GDP growth rate; fortunately, inflation is expected drop to 3.1% by the end of 2023. GDP growth over the past 12 months was only 1.4% while employment has increased by 3.0%, strongly indicating a rather dramatic decline in worker productivity, which is a leading indicator of recessions. Bank of America now forecasts a 1.1% decrease in GDP in 2023, which would be one of the mildest recessions in decades. Ominously, though, Deutsche Bank expects default rates on high yield bonds to be 5.6% in 2023 and a frightening 11.3% in 2024 – near historic highs.
Paramount to all of this is liquidity and fund flows to determine whether investors are seeking exposure to risk-based assets. Sharp declines in monetary growth inevitably lead to dramatic declines in asset values. Data from the Investment Company Institute over the past few years show significant equity mutual funds outflows, largely accounting for the dramatic reset in equity prices.
As healthcare technology investors gameplan for 2023, it is informative to look at prior sector corrections, none more notable than the bursting of the Dot Com bubble over 20 years ago. According to an analysis by SVB Securities, its Digital Health Index declined by just under 70% since peaking in February 2020 (nearly 700 days ago) tracking very closely to the trading activity of the NASDAQ Index from March 2000 to Spring 2002. The NASDAQ Index touched bottom almost 950 days after peaking in March 2002 suggesting, if the trend holds, that the digital health sector will mostly trade sideways through 2023. Underscoring the reset in valuations, the median twelve month forward revenue multiple for the SVB Digital Health Index declined from 15.0x to approximately 3.0x during this timeframe.
Public markets were not the only markets impacted. With an increase in relative liquidity and sophistication of the secondary markets, a more robust trading environment for securities in private companies has emerged. An analysis by Forge Global highlights the dramatic correction in valuations just over the past year, with median pricing declining by ~50% of the prior round of financing. With the shock of the pandemic in early 2020, this discount was only about 20%, recovering to be ~10% premium in 2021.
Interestingly, an early readout of overall venture capital investment activity from Pitchbook for 2022 totaled $238.3 billion as compared to $344.7 billion in 2021, a rather dramatic pullback of new investment activity undoubtedly impacting follow-on rounds for venture-backed companies. Analysts estimated that there are now 2.5 sellers for every buyer for private shares, a modest improvement from 4:1 six months ago but nowhere near the balanced 1:1 in 2021. Fortunately, the healthcare sector has been relatively resilient in the secondary markets.
Other barometers as to the health of the financing markets are the IPO market and M&A activity. Overall, exit activity of venture-backed companies was nothing short of abysmal in 2022. According to Pitchbook data, there was $71.4 billion of exit activity across 1,208 transactions in 2022 versus a staggering $753.2 billion and 1,925 transactions in 2021 (average deal sizes of $59 million and $391 million, respectively). This past year looks to be the weakest IPO year since 1990, according to Axios, with a mere $8 billion in proceeds across 74 IPOs.
Data: Dealogic; Chart: Axios Visuals
Indicative of the general lack of liquidity in the market, 70 special purpose acquisition companies (“SPAC”) have shut down just since last month, more than the total number of shutdowns in the market’s history, according to SPAC Research. These 70 SPAC sponsors are estimated to have lost $600 million. In total, there are still approximately 400 SPACs holding about $100 billion still sitting on the sidelines. Notably, Chinese companies that went public in the U.S. in 2021 only raised $536 million, which is down 96% from 2021.
Notwithstanding the many financing headwinds, the resilience of the healthcare technology sector should be supported by the continued migration of patients/members into value-based, digital-first solutions. As the pandemic morphs into an endemic, there is an expectation of increased hospital utilization, an increase in previously deferred elective procedures, and a relatively supportive reimbursement environment including for telehealth and other virtual services. Telehealth visits seemed to have settled at 14% – 17% of all visits, up from ~1% pre-Covid. The role of the consumer will continue to be important, underscoring the need for better, more effective engagement and care management platforms.
While the 2022 downdraft in digital health funding mirrors investor concerns more broadly, given the enormous market opportunity to transform the business of healthcare, this past year still recorded the second most active year ever. In fact, the 4Q22 investment pace of $2.7 billion was more than 20% ahead of 3Q22 activity of $2.2 billion, pointing to continued sector strength, but also that the “new normal” will likely be annual investment activity between $10 – $15 billion. Entrepreneurs will need to recalibrate to this new reality – capital will be less plentiful and likely more expensive.
What does that practically mean? Average round size collapsed to $26.7 million down from $39.7 million in 2021. Of course, averages can be misleading. According to Rock Health, there were only 35 financings greater than $100 million (“mega rounds”) while there were 88 and 43 in 2021 and 2020, respectively. Those 88 companies in 2021 consumed 56% of all invested capital that year, while mega rounds represented only 39% in 2022. In addition to fewer mega rounds, there was significant compression in round size for both Series B and C financings according to analysis prepared by my firm, Flare Capital (my thanks to my colleague, Parth Desai). The implications of smaller round sizes will require companies to operate with greater capital efficiency and/or focus on more modest milestones with each financing given the shorter runways.
There was a dramatic spike in valuations at the outset of the pandemic as investors embraced novel technologies as the healthcare system was forced to be virtual, intelligent, predictive, and real-time nearly overnight. Interestingly, pre-money valuations held up remarkably well in light of recent volatility in the public markets. There was evidence of softness in Series B rounds but valuations for most stages were either flat or up slightly over prior years, with notable strength in the Seed stage rounds.
While admittedly somewhat nonsensical, adding the average round sizes from Seed through Series C rounds in 2022 (total of $104.6 million) compares favorably to the average Series C pre-money valuation of $421.6 million (or 5x post-money valuation to capital raised). In 2019, prior to the onset of digital health investor euphoria, on average $77.4 million was raised to reach Series C stage (or 2.2x post-money valuation to capital raised). One should expect a more measured capital appreciation dynamic going forward with less liquidity sloshing through the market.
As a cohort, healthcare technology unicorns (Flare Capital tracks 86 of them) saw significant valuation compression in 2022, consistent with the overall public equity markets, declining in aggregate value to $281 billion from $416 billion in 2021. While valuations of privately held unicorn shares tend to reset slower than comparable public stocks (that might be changing – slowly – with greater liquidity in the secondary markets – see above), one should expect further reduction in valuations in 2023 as those companies come back to market to raise additional capital. This will be great theater as many of those companies still require significant capital to reach breakeven and will find capital availability much more limited and with potentially onerous terms. Also expect extensions of prior rounds with significant existing investor support to be quite prevalent.
According to analysis by Refinitiv, overall healthcare and life science M&A declined from $505 billion in 2021 to $329 billion in 2022. Arguably, a few hundred healthcare companies will be coming to market to raise capital in 2023; not all of them will be successful. This will undoubtedly generate a spike in private-to-private M&A activity which may reverse the trend in 2022. Specifically, exit activity in the healthcare technology sector saw a dramatic reduction in 2022 to a miniscule $2.2 billion according to SVB Securities. It is a safe bet that this will increase meaningfully in 2023.
But no need to be so dour. A reading of the Center for Medicare and Medicaid Innovation (“CMMI”) 2022 Report to Congress (someone had to) is energizing as a healthcare technology investor. There is no shortage of innovative models and solutions demanded by the market, coupled with a sophisticated and talented entrepreneurial community set on transforming healthcare. Over the past two years, CMMI has tested 32 novel payment and service delivery models that touch 41.5 million lives and 314k providers; eight models have already shown significant cost savings or meaningfully improved quality of care.
As more of these initiatives and the few hundred digital health companies launched in the past five years show impact with data and can claim attribution, there should be adequate capital available to fund future growth. And maybe even tap into the nearly $300 billion of venture capital raised (according to Pitchbook) but yet to be invested sitting on the sidelines waiting to jump in.
Me: “Describe the most powerful, potentially disruptive technology to transform the business of healthcare.”
What to many may look like a typo, ChatGPT is one of the most rapidly adopted technologies to capture the imaginations of the “Technorati.” It took a mere five days for ChatGPT to reach one million users. Three days ago, the Wall Street Journal broke news of talks that OpenAI, the non-profit artificial intelligence research laboratory which developed ChatGPT, is considering a secondary share tender offer for at least $300 million at a $29 billion valuation. This would nearly double the vauation from a financing completed in 2021. Microsoft invested $1 billion in 2019 and is a cornerstone strategic partner with OpenAI, which was founded by Sam Altman and Elon Musk in 2015.
So, what is it? The GPT stands for Generative Pre-trained Transformer and is a natural language processor model. Most chatbots are considered “stateless;” that is, each session starts from the beginning, there is no inherent continuity in the engagement. Not Generative AI which puts forth the “best guess” on what word comes next in the sequence based on the training and is not deterministic. In a sense, it has an ability to “remember” and can pick up where it left off creating a more persistent persona. ChatGPT is not overtly a search engine but can indirectly and powerfully inform and teach. Natural language tools such as ChatGPT inevitably will replace awkward existing graphical user interfaces (GUIs) to create more effective human – computer interactions.
These foundation models are trained on extraordinarily large data sets. ChatGPT was trained on GPT-3.5, which is one of the largest training sets of data available yet only reflects content up to the end of 2021. Generative AI tools are considered relatively easy to create as they are built on existing foundation models, which analysts suspect will become somewhat commoditized over time. Recognizing the logarithmic scale of the chart below underscores the dramatic and recent explosion in the size of these models. Megatron-Turing NLG has 530 billion parameters and is the largest monolithic transformer in the English language.
There are important implications to this approach, which is very compute power intensive and requires an extraordinary amount of training data. Analysts estimate that ChatGPT is burning up to $4 million per day and that each interaction costs between $0.01-$0.02. Setting aside the myriad of eristic issues involving plagiarism, mistakes (“hallucinations”), biases, etc – more on that shortly – one of the most immediate implications is a profound disruption to Google’s search business. The New York Times recently reported that ChatGPT is “Code Red” within Google, which has enjoyed a near-20-year hammerlock as the internet’s front door. Expect to see ChatGPT be front and center in Microsoft’s Bing search engine.
Google made waves last summer with its LaMDA (Language Model for Dialogue Applications) when a Google engineer claimed it to be sentient. While later shown to be somewhat hyperbolic, it clearly showed that significant progress had been made in developing more robust chatbot solutions. Not to be left behind, Meta developed Galactica, its version of a chatbot, but unfortunately was quickly removed due to issues around accuracy and biases (seems to be a chronic Meta condition).
These initiatives are important for the healthcare industry to monitor. It is expected that quite quickly a platform will emerge that will be robust enough, accurate enough to reliably transform healthcare applications. The irony is that this novel technology is about to disrupt a whole set of recently deployed novel healthcare technologies. The generative AI category has certainly attracted enough investor attention. Venture capitalists have invested over $1.37 billion in approximately 78 companies in 2022, according to Pitchbook. A recent New York Times analysis estimated that there are already more than 450 generative AI start-ups.
Healthcare investors have backed literally hundreds of virtual care models with a provider at the center – doesn’t this platform go right to the heart of those business models? There will be a litany of obvious use cases: training, content for patients, symptom checkers, second opinions, etc that lend themselves readily to these generative models. Translating medical jargon to plain language will improve patients’ understanding and likely adherence to courses of treatment. In addition to the tremendous time savings, the reduction in friction for the patient will be immeasurable.
Notwithstanding the promise, there still remain significant concerns. Most troublesome are the incidents of “hallucinations” whereby ChatGPT with great confidence may provide an answer that is simply wrong, manufactured, or lacks appropriate nuance. The apparent fluency and ease of ChatGPT obfuscates the lines between fact and fiction. ChatGPT is not allowed at the Q&A website, Slack Overflow, which is used by software developers given concerns about accuracy.
Perhaps understandable given how nascent the technology is, there are other concerns involving unintended biases. Today there is no obvious revenue model for ChatGPT so under an onslaught of investor pressure, should we brace ourselves for a world of sponsored medical content and/or disinformation? Absolutely. Will we see “brought to you by…” embedded in much of the generated content? Should there be concerns that ChatGPT may amplify the loudest, most boorish voices? Of course. Like with Google and Meta, until the underlying algorithms are fully revealed, how the content is created may amuse but the implications will not be fully understood. The temptation to misuse such a powerful platform is real and imminent.
Arguably, academic and medical societies need to mobilize. While the clinical adoption at the bedside may be either generational or limited initially, patients will certainly reach for ChatGPT much like they have for Dr. Google for the past 20 years. A number of Flare Capital portfolio companies which operate in and around the AI sector have seen significant market interest but more limited near-term commercial traction, underscoring that broad scale adoption has been more challenging (selling technology in healthcare is hard – plan accordingly). That may well be about to change. One of our more recent early-stage portfolio companies building that future is BirchAI, which envisions documentation consistently better than the average human by 2025 (graphic credit to BirchAI, Sequoia Capital).
Outstanding healthcare is ultimately a human-to-human interaction, the more complicated the condition, the more skilled the provider needs to be. But what are the implications if the care for more mild or chronic conditions can be augmented (or even replaced) with a platform as empathetic, as informed as a human and yet available 24/7? Arguably many behavioral health conditions could be managed by a platform that freely communicates with patients and learns over time how best to inform, engage, activate. Does this not start to meaningful address issues of access? Is this one of the onramps to more personalized care? Just saying…I mean, just chatting.
None of this was written by ChatGPT…or was it?
Me: “Write one paragraph that describes the healthcare technology sector in 2023”
ChatGPT: “It is difficult for me to accurately predict the state of the healthcare technology sector in 2023, as my knowledge was cut off in 2021 and I do not have access to updated information. However, based on trends and developments in the field up until 2021, it is likely that the healthcare technology sector will continue to grow and evolve rapidly in the coming years. This may include the development and adoption of new technologies such as artificial intelligence, virtual reality, and telemedicine, which can help improve the efficiency and effectiveness of healthcare delivery. There may also be an increased focus on the use of data and analytics to drive decision making and improve patient outcomes. Additionally, there may be ongoing efforts to integrate technology into various aspects of the healthcare system, such as electronic health records and medical devices, in order to streamline processes and improve communication between healthcare providers.”
Having spent three energizing yet exhausting days in Israel this past week, one struggles to neatly put the experience in a simple elegant context. Like many countries today, there is extraordinary and somewhat confounding political confusion. There are significant anxieties due to volatile economic conditions. And all of this against a public healthcare crisis that simply will not abate. Maybe one word to capture the zeitgeist of the moment is unrelenting.
Undoubtedly, Israel resides in a neighborhood fraught with conflict, although there are encouraging signs of geopolitical advancements anchored by the Abraham Accords. This framework seeks to (more) normalize relations with the United Arab Emirates (UAE), Bahrain, Morocco and Sudan, with other Arab countries expected to join the fold over the next few years. Since the initial signing, over 500k Israelis have traveled to the UAE in the past two years and there has been an estimated $192 million in trade deals according to an analysis by The Jewish Chronicle. The Israeli Minister of Defense can already point to $791 million in defense exports to the participating countries. Even with this progress, it was fascinating to watch the Morocco – France FIFA World Cup semi-final match at Ben Gurion Airport with several hundred highly partisan Israeli fans on Wednesday night.
But the current political discourse is solely locked now on the rise of the ultranationalist party in the emerging Netanyahu-led Likud party’s coalition, which won the national elections held last month to form the 37th government of Israel, and just this past week secured a 10-day extension to form the new government. Many of my conversations centered on this phenomenon which will likely see the further expansion of settlements, stiffened resistance to Palestinian statehood, and the possible dismantling of judicial oversight. The Knesset, which is the legislature of Israel, has 120 seats and will likely be made up of 12 political parties, each of which secured enough votes to be included – there are another 43 parties which will not have a seat in the Knesset). Unrelenting political chaos.
Interestingly, the public health response to Covid has been nothing short of impressive. When most other countries struggled to manage variant surges (see below at the challenged U.S. responses), Israelis deftly managed to limit the spread of the disease and suffered a modest, yet still tragic, loss of just under 12k lives with a total of 4.75 million cases. By comparison, the U.S. to date has experienced an estimated 1.1 million deaths and 99.6 million reported cases, effectively 3x the fatality rate seen in Israel.
The entrepreneurs I met in the healthcare technology sector were remarkable and unrelentingly enthusiastic and determined. According to Tracxn, there are 867 healthcare technology start-ups in Israel now, underscoring the well-deserved reputation as the “Start-Up Nation,” which was first coined in 2009 to account for the extraordinary Israeli entrepreneurial culture. According to Calcalist, there are 9,484 start-ups in Israel now and approximately half of them have revenues below $10 million. Just under 10% of all Israeli start-ups are in the healthcare technology sector.
One of the wonderful hallmarks, among many, of Israeli healthcare technology entrepreneurs that I witnessed on each of my prior visits (March 2011, June 2014, December 2016) is the unrelenting obsession to solve intractable healthcare problems, often with a very disciplined product-first approach. Obviously, their engineering bona fides are beyond dispute, which colors how many founders view the market opportunities. Given much of the risk healthcare technology investors take is around product / market fit, the promise of deeper collaboration with Israeli founders is to help refine the specific near-term commercial opportunities that have real budgets.
As is the case in most venture capital markets around the world, the Israeli venture investment activity cooled significantly in 2022, tracking to be an estimated $15 billion, well below the 2021 highwater mark of nearly $26 billion. Notwithstanding that, the Israeli venture investment per capita ranks #2 globally as of mid-2022, behind only Singapore, with $506/person invested as compared to Singapore and the U.S. (#3) with $695 and $357, respectively.
The relatively strong exit environment in 2021 with close to $24 billion of exits across 262 deals continues to drive exciting venture capital fund formation. According to the Tel Aviv Stock Exchange, there were 94 IPOs in 2021 which raised nearly $13 billion. While many markets struggled to see new venture funds raised, Israeli-based funds saw a 71% increase over 2021 in the amount of capital raised, reaching €2.9 billion across 28 funds through November 2022. Tracxn estimates that there are 126 accelerators and incubators in Israel to complement the local venture capital industry.
The level of activity is remarkable when one considers the relatively short and challenged history of the capital markets in Israel. It was not much more than 40 years ago when the Israeli economy was in the midst of an absolute desperate financial crisis, triggering a massive Economic Stabilization Plan in 1983 (the 1984 inflation rate was over 370%).
Structural reform and privatization initiatives over the past twenty years have created one of the most robust regional economies with benign inflation and a GDP per capita in 2021 of $51.4k (compared to $69.3k in the U.S. and $23.6k in Saudi Arabia). Israeli unemployment rate as of October 2022 was 4.1%. The total market capitalization of the 549 publicly traded Israeli companies is $216 billion. It is estimated that now 25% of all European IPOs are in Israel and there are significant capital inflows into the market. The push for dual listings has further diversified the investor base of many companies and afforded greater liquidity. Unrelenting capital market successes.