Inbound Health: Make Yourself @ Home…

In 2019, before the pandemic, the U.S. Census Department estimated that 611k people were treated at hospitals every day. In mid-January 2022, at the absolute height of the Omicron surge, there were ~150k daily hospital in-patient admissions recorded due to Covid. As there are 6,093 hospitals in the United States with approximately 921k staffed hospital beds, it is understandable how battered the healthcare delivery system was during that surge. In addition to the pressures to dramatically lower hospital operating costs, it became clear that innovative new care models had to quickly evolve in response.   

While many providers have piloted hospital-at-home (“H@H”) programs, often at sub-scale levels, market forces now make it quite clear that a robust tech-enabled H@H company could be successful. Last month the formation of Inbound Health, a partnership between Allina Health and Flare Capital, was announced with a $20 million Series A. To Allina’s great credit, at the pandemic’s outset its executive team developed a H@H program that has now managed over 4,400 admissions. This program replaced facility-based observation, both for acute and skilled nursing episodes. These cases covered patients across more than 180 diagnosis-related group (“DRG”) codes. In fact, nearly 60% of the episodes since May 2020 are for non-Covid cases. 

Inbound Health provides both the technology infrastructure and analytical capabilities, in addition to the care model, virtual workforce, supply chain, payment models, and a local staff presence as a turnkey solution for other providers to launch H@H programs. The Inbound Health service offers a flexible workforce solution, utilizing employed and contracted labor. Specifically, this program includes physician visits, 24-hour monitoring, nursing services, diagnostics, and drug dispensing, whenever necessary. There are two principal value components to the Inbound Health offering: (i) historic Allina data shows a dramatic reduction in length of stay versus inpatient episodes; and (ii) enables customers to own another dimension of the care continuum.

Inbound Health has developed a fully aligned payment model with its customers, charging a modest fee at the outset to enable the company to start to capture patient data. As the data set is enriched, the reduction in length of stay and significant cost benefits will become readily apparent, facilitating attractive reimbursement models from payers. Ultimately, Inbound Health will be able to identify certain at-risk populations who would be appropriate for H@H offerings in advance.

Over the past 30 years, hospital expenses have increased nearly 5-fold and yet overall in-patient hospital admissions have remained relatively constant at around 35+/- million each year. This is clearly untenable and will require that much of that care must be provided in community-based settings, outside of the hospital’s four walls. The situation is further exacerbated by the acute hospital labor shortage. Long-term care facilities are also struggling to provide adequate staffing, encouraging even more of these cases to be handled in home settings.  

In November 2020, the Centers for Medicare & Medicaid Services (“CMS”) launched the Acute Hospital Care at Home program, which granted waivers to meet certain reimbursement requirements (i.e., 24/7 onsite nursing care, etc) to a total of 114 systems covering 256 hospitals in 37 states. Patients are only to be admitted from emergency rooms or discharged from inpatient beds, often in lieu of being admitted to skilled nursing facilities (“SNF”). In 2019, the national annual average discharge rate was approximately 33 patients per bed, of which 5% were assumed to be H@H eligible per a pre-Covid Milliman analysis. This would imply that ~825k Fee for Service (“FFS”) and Medicare enrollees are appropriate for H@H programs each year.

The benefits of H@H programs are numerous. Outcomes arguably are superior to inpatient stays with many providers reporting approximately 20% reductions in mortality. Patients often prefer to be cared for in their homes and tend to show significant improvement in familiar surroundings. In fact, H@H patients are 3x less likely to be readmitted within 30 days. And patients appear grateful for such care models; Inbound Health has lifetime net promoter scores 86+.

Importantly, the potential cost savings are dramatic: early trial work at Johns Hopkins demonstrated 32% cost savings while an American Hospital Association 2019 study concluded that home hospital patients realized a 38% cost savings when compared to in-hospital care. At a time when rural hospitals are closing and many communities are struggling to provide inpatient care, H@H programs will serve to augment those losses at lower costs.

Against those benefits, there are concerns with H@H programs which must be managed carefully. The implementation can be complex as supplies and staff need to be coordinated very carefully. In-home environments need to be assessed, and whenever necessary, improved to accommodate such clinical services. Patient acquisition can be complicated as demand can be inconsistent given the novelty of such an approach. Certain patients will remain convinced that the highest quality care can only be provided in a hospital (notwithstanding the risk of infection, inconvenience, etc.). H@H providers need to maintain a minimum level of patient volume to ensure that the program can be profitable given the associated overheads required. Additionally, there are possible novel legal exposures to H@H providers associated with non-medical factors involving supply chain issues, logistics, and managing third-party providers.

Arguably the greatest concern involves the enduring payment model. In general, there are two approaches to structuring H@H payment models: top-down versus bottom-up. The top-down approach involves a Medicare payment of approximately $17.5k to the hospital per episode of care based on the acute inpatient prospective payment system. The bottom-up payment approach looks to rates paid to home-based care providers, which are consistently lower, and tend to total approximately $10.5k per episode. Most of this difference is due to larger acute DRG payments in the top-down approach and SNF avoidance.

Given the uncertainty still with the longevity of the waiver program and the somewhat unsettled payment models, the CMS Innovation Center in October 2021 announced efforts to encourage beneficiaries of covered entities to seek care from organizations accountable for quality and cost, providing incentives for such organizations to adopt H@H programs. Specifically, the 2021 stimulus package earmarked an additional $400 billion for reimbursement of home and community-based care. But concerns remain among providers. A recent survey conducted by Hospital at Home User Group concluded that only one-third of respondents were likely to continue with H@H programs even in the absence of the waiver, suggesting a relatively high degree of uncertainty still in the marketplace as to the enduring economics of these programs (27% stated that they would need the waiver to remain in order to continue).

Additionally, it is expected that H@H programs will bundle additional services such as transportation, home modification, and food provision to increase the revenue per episode potential. Interestingly, a recent Modern Healthcare survey concluded that 50% of the time adequate broadband access is lacking and must be deployed. Undoubtedly, this played a role in Best Buy’s $400 million acquisition of Current Health in 2021 to provide more robust remote patient monitoring solutions.

The investment community has also recognized more broadly the compelling market opportunities in senior care revealed by the pandemic. Venture capital investment activity in 2021 spiked to well over $2 billion in nearly 40 deals, while private equity investment also increased significantly last year; both seemed to have returned in 2022 to levels seen in recent prior years, according to Pitchbook and Axios data.

Consistent with the movement to more community-based care, it is not surprising to see that the rate of home births is now at a 30-year high in the U.S. It is estimated that 1.4% of all births in 2021 were in the home, which would be the highest level since 1990. For many of the same reasons that more acute hospital services are moving to the home, rural hospital closures and limited access to obstetric services are encouraging more women to consider in-home delivery options. An analysis from the International Journal of Environmental Research and Public Health concluded that home births cost approximately $4.7k versus in-hospital delivery costs of $19k, an even more dramatic cost savings when compared to traditional H@H savings.

Technology is the great democratizing force in healthcare. World-class care can now more readily be delivered to disenfranchised populations who struggle with access and affordability. The advent of robust H@H programs like what is being delivered by Inbound Health promises superior outcomes at dramatically lower costs.

Digital Health: The End of the Beginning…

Upon the conclusion of a very tough week for U.S. consumer internet and technology stocks that saw over $550 billion of market value evaporated at Alphabet, Amazon, Apple, Meta and Microsoft (combined market value now sits at $6.64 trillion), coupled with the news of the 70% decline upon the first anniversary of the largest bitcoin ETF (Proshares Bitcoin Strategy fund), it is a good time to take stock of the healthcare technology sector. While there has also been significant volatility with healthcare technology stocks, the resilience of top line revenues has been impressive. Admittedly a rather small sampling, the Flare Capital portfolio saw 12% 3Q22 over 2Q22 aggregate revenue growth and nearly a 60% increase 3Q22 over 3Q21. Overall, revenues are tracking ahead of plan for the year, even in spite of worsening economic conditions.

The pandemic obviously triggered a massive acceleration in technology adoption across the healthcare landscape which in turn let loose a wave of digital health investment activity. The healthcare system was forced to become virtual, real-time, on-demand, predictive, intelligent, distributed, empathetic, even more transparent – all capabilities ultimately enabled by novel healthcare technologies. Secondary issues have emerged such as labor force disruption and productivity which also demand robust solutions. McKinsey & Co. estimates that just the pandemic will burden the healthcare system with an additional $220 billion of costs by 2027, this to a system already struggling to be self-sustaining, much less being profitable.

Coming off a record year in 2021 of $29.2 billion invested in 736 companies according to Rock Health, the 3Q22 data show a continued slowing in the investment pace as the sector confronted more hostile economic conditions and worked to absorb the extraordinary amount invested last year. This past quarter saw $2.2 billion invested in 125 companies, which was the lowest amount invested in the past eleven quarters. This puts 2022 on pace to hit nearly $17 billion invested in over 600 companies, which would still be the second most active year yet. Unfortunately, though, this deceleration suggests that 2023 may be a relatively lean year. Interestingly, $17.6 billion was invested in 1H22 globally in digital health according to CB Insights data.

Importantly, the average deal size dropped from $39.7 million in 2021 to $27.4 million so far in 2022, indicating the relative dearth of large late-stage rounds. Much of the deal size compression occurred in the later stage rounds of financing, particularly with Series C rounds that saw median deal size of $71 million in 2021 drop to $55 million year-to-date in 2022. Rock Health tallied only six Series C financings in 3Q22 and only two rounds that were greater than $100 million.

This past quarter might well have marked the “end of the beginning” of the first phase of healthcare technology sector development. Arguably there will still need to be a few more quarters to recalibrate to this new normal when capital is no longer free and revenue growth is harder. It is informative to compare prior year rounds by series to the next year by the subsequent series (e.g., compare number of Series A rounds in 2019 to number of Series B rounds in 2020/2021) to gauge “graduation rates,” that is the proportion of companies that are able to raise subsequent rounds. One should expect a lower graduation rate as capital becomes scarcer with a concomitant increase in private-to-private combinations (and smaller round sizes as investors limit exposure and/or put struggling companies on tighter leashes). 

A detailed McKinsey & Co. analysis projects that national healthcare expenditures will grow at 7.1% between 2022 – 2027, well ahead of the 4.7% forecasted general economic growth, exacerbating the acute need for greater productivity. The Association of American Medical Colleges recently estimated that there will be a shortage of 200k nurses and 50k doctors in the U.S. in three years.

As tragic as the pandemic has been for literally billions of people, this will likely be looked upon as the inflection point ushering in decades of terrific investment activity. The enormity of the market opportunity, coupled with the deeper appreciation that these value-based models do indeed create significant economic value, will welcome an exciting period of prolonged growth and investment activity when important valuable companies will be created.

McKinsey & Co. estimates that there is $1.0 trillion of improvement to be realized as the healthcare system is rearchitected to optimize limited resources, improve outcomes, and drive enhanced productivity. Bain and KLAS recently released a survey of providers to better understand investment priorities which highlighted the urgency to strengthen both infrastructure and analytics capabilities.

The strategic imperatives of the healthcare system are reflected in which sub-sectors are attracting the most capital. On-Demand Healthcare has consistently been the top funded sector until recently when Non-Clinical Workflow jumped from a distant seventh place to first in 2021. Research and Development investments captured the third slot this year. 

Perhaps not at all surprising, mental health remained the top clinical indication this year with $1.7 billion invested (nearly 15% of all investments) so far this year in 53 companies, which is coming off of $4.8 billion in 2021. According to Grand View Research, the global mental health app market alone is $4.2 billion and is expected to grow at 16.5% annually to 2030. One risk is that arguably too many companies have been funded in some of these sectors, which will likely lead to painful consolidation as the sector rationalizes. The next most popular indications this year are oncology and cardiovascular followed by diabetes and “femtech.”

Notwithstanding the acute and obvious needs, this past quarter also was one of the most challenging quarters to price new investment as companies held on to legacy valuations for financings that closed in 2021. Many investors focused more on seed and early-stage opportunities where pricing was consistently in-line with historic norms and/or they focused on supporting existing portfolio companies.

Public stock market performance provides a difficult benchmark and further exacerbates the valuation debate given how poorly many of the public healthcare technology companies have traded. At the end of 3Q22, the SVB Digital Health and Heath Tech index was down 31.8% year-to-date (in September alone the index dropped 46.5%, underscoring the sector volatility) and was trading at a 3.3x estimated 2023 revenues with a total market valuation of approximately $90 billion. SVB goes on to highlight that since the index peaked in early February 2021, it has declined by 66.8%.

What will need to happen in order to see a significant recovery? In the midst of the madness last year, the SVB Digital Health index traded at 6.9x revenues in 2Q21, a far cry from where it sits now. Clearly, there will need to a be general recovery of investor sentiment and some clarity of the war in Ukraine and China – U.S. relations. Broader capital flows back into risk assets will create a rising tide. Valuation multiples will likely settle somewhere between 3.3x and 6.9x.

One might also expect an increase in “private-to-private” mergers as many companies struggle to get through this knothole. Typically, each round of financing provides 15-18 months of runway implying that many of the companies that raised in 2021 are now thinking about the next round; frankly, not a lot of time given the sales cycles in healthcare. A common critique is that too many companies have built products that are too narrow or solve a small piece of the puzzle. Oftentimes, what is built is a limited point solution, when customers require a broader, deeper set of capabilities. Expect also to see horizontal acquisitions that seek to expand into adjacent customer bases (providers + payers) or bolster distribution capabilities, especially for those companies that may not have sorted out product / market fit.

3Q22 Venture Activity: Third Time Was Not a Charm…

Obviously, 3Q22 was a very difficult quarter in the capital markets. Of the 115 global stock, bond ETFs, currencies, and commodity indices tracked by the Wall Street Journal, only 13 of them showed gains, paced by the not surprising 24.7% gain in the New York Mercantile Exchange Natural Gas index. Sadly, the Ukrainian hryvnia declined by 20.0%, slightly out ahead of the oxymoronic Lean Hogs index which dropped by 18.2%. The S&P 500 Health Care index dropped by “only” 5.6%.

The venture capital industry was not insulated from this turbulence which underscores a general “risk-off” investor sentiment that has settled in as inflation and interest rates both continue to rise. The level of venture investment activity in 3Q22 totaled $43.0 billion invested (a nine-quarter low) in an estimated 4,074 companies (a seven-quarter low) according to Pitchbook. While activity slowed across all stages, it was particularly acute in the later stage rounds as crossover investors walked away. Late-stage investments declined to $24.9 billion in 3Q22 from $64.7 billion in 3Q21.

Notwithstanding a collapse in exit activity in 3Q22 to $14.0 billion (in 2021, exits totaled $781.5 billion), fundraising for U.S. venture capital funds has already set a new record with $150.9 billion raised by only 593 funds through 3Q22. Notably, the average fund size raised in 2022 is $254 million, dramatically larger than the average fund size of $129 million in 2021. And 2021 was the second greatest year for fundraising with $147.2 billion raised by 1,139 funds. Fewer firms are raising larger funds.

How venture capitalists behave over the next few quarters will meaningfully influence the health of the innovation economy over the next three to five years. Undoubtedly much of the decline in venture investment activity over the past quarter was related to funds triaging existing portfolios, determining which companies merit additional financial support, developing action plans to weather the pending economic storm, and a general heightened sense of anxiety – all of which can be quite distracting. In spite of that, 3Q22 investment activity simply returned to the quarterly investment levels experienced in mid-2020, a mere two years ago.

Barron’s recent Big Money poll flagged that 22% of the 107 largest U.S. investors ranked cash as the most attractive asset class today. A sense of malaise seems to have set in with public stock investors now that we have witnessed three straight quarters of negative returns for the S&P 500 index, which has not occurred since 2009.

Data: Yahoo Finance; Chart: Erin Davis/Axios Visuals

Year-to-date the S&P 500 index is down 24.8% while the NASDAQ is down a disquieting 32.4%. Not to be outdone, Bitcoin declined 59.3% and now trades at $19,222 per token, a country mile from the nearly $70,000 reached less than a year ago. The price of a Bored Ape Yacht Club NFT has dropped 25% just this month. Interestingly, a Financial Times analysis of data compiled by Dealogic concluded that nearly 75% of the more than 400 “Covid” IPOs (companies that raised more than $100 million via a public offering between 2019 – 2021) are trading below their IPO prices and that the median return since being public is a negative 44%. Clearly, 2021 will be looked upon not so fondly as an outlier now that capital is harder to come by and no longer free.

Data: Yahoo Finance. Chart: Tory Lysik/Axios

In such an environment one might expect two developments: an increase in M&A activity and/or a spike in “zombie companies” – neither of which has yet to occur. According to Refinitiv, global M&A activity declined by 34% year-to-date to $2.8 trillion, which is the largest decline since 2009, in part exacerbated by an extraordinary level of M&A activity in 2021. According to S&P Global Market Intelligence data, 3Q22 M&A activity in the U.S. was the lowest quarterly amount since 2Q20, with just under 4,700 transactions and a total value of $255.5 billion (average deal size of ~$54 million). Transaction value dropped 58% year-over-year. The lack of robust M&A activity likely reflects increased executive suite anxiety and the dramatic spike in the cost of capital.  

Goldman Sachs defines “zombie companies” as those companies which have not been able to fully service their debts for three consecutive years (interest coverage ratios of less than 1.0) and concludes that approximately 13% of U.S. companies are the walking dead. This has consistently hovered between 12% – 14% over the last decade. Admittedly, this definition includes a swath of exciting high growth technology companies leading Goldman Sachs to focus only on those publicly traded companies with stocks that have underperformed by 5% or more relative to the S&P 500 benchmark for two straight years. Through this lens the number of “zombie companies” drops to below 4%, well below what many might have suspected, but quite foreboding should there be a recession in 2023.  

Speaking of the living dead, the SPAC (special purpose acquisition company) market has been slapped back to reality from a blistering pace set in 2021. In large measure due to the abysmal stock market performance of SPACs, the number of SPACs in all of 2022 may not even equal the 3Q20 level, which was just prior to the explosion of SPAC activity in 2021 when there were 613 SPAC deals. Of course, the broader story is the shuttering of the U.S. IPO market with only 22 “traditional IPOs” year-to-date 2022, according to PwC data. In 3Q22, $2.0 billion was raised by a measly five IPOs, levels not seen in years. So far this year, more than 60% of announced IPOs have been withdrawn due to market conditions. 

How will this landscape impact venture investment over the next few quarters? Many venture-backed CEOs, founders, and boards are grappling with potentially painful re-sets in valuation and many likely now have less than one year of cash. Like navigating various stages of grief, companies will deploy a predictable set of strategic maneuvers: trim costs (often around the edges, often too late), explore venture debt, look to existing investors to extend the last round to preserve a legacy valuation, and maybe then explore financings with terms that optically preserve that legacy valuation. Many of these steps will not be fruitful, at least not until there has been a genuine re-pricing of the company, particularly for late-stage companies. Boards unwilling to re-price will explore M&A alternatives should the company not be able to raise capital on acceptable terms.

Arguably, while we are somewhat early in the cycle of repricing companies which raised capital at high valuations in 2021, there is already evidence of a significant impact on valuations. Late-stage company valuations have declined from close to $700 million in 2021 to $582 million year-to-date 2022. Pitchbook calculated that only 6% of financings in 1H22 were down rounds, suggesting a dramatic acceleration of down rounds in 3Q22.

In any given year, 10% – 15% of all financings are down rounds according to Pitchbook. In fact, more than 3,000 companies have closed down rounds over the past decade. The pressing question before boards now is what the path forward after a down round financing might look like. A retrospective Pitchbook analysis from 2008 – 2014 of over 1,400 companies showed that 70% of those companies went on to raise additional capital while 13% were unable to raise capital or complete an exit; the remaining companies successfully were sold obviating the need to raise more capital. The median decrease in valuation for down round financings across all stages was approximately 35% in 2021.

An increasingly important tool in the tool kit for boards to extend the cash runway is to take on venture debt, even though it may limit degrees of freedom in the future. Against a backdrop when U.S. gross national debt eclipsed $31 trillion for the first time ever earlier this month, venture debt financings have seen significant activity this year with $22.8 billion of loan volume across 1,925 financings. Average annual loan volume for venture debt over the past four years has been greater than $31 billion. In fact, average early-stage and late-stage venture debt rounds have spiked in size from $10.6 million in 2021 to $14.0 million in 2022 year-to-date, and from $17.0 million to $20.8 million, respectively. The decrease from 2019 to 2021 likely reflects the increase in equity investments in lieu of debt.

During this quarter, portfolio companies will look to lock down operating plans for 2023. As management teams and investors stare at this new reality, one would expect more moderate growth plans, anticipating expected difficulties in accessing capital on attractive terms. And while it does not feel good in the moment, scaling a business in such an environment will institute greater discipline and focus on bringing to market only what customers will readily pay for.

Flare Capital Expands the Team – Yet Again…

A critical dimension to the staffing model at Flare Capital is our deep bench of Executive Partners. These people are notable operating executives who have a record a tremendous success in scaling businesses in times of industry transformation. Our Executive Partners are visionary thought leaders, have a depth of industry expertise and insights, can see around corners, and are lightning rods for great talent. Through that lens, I am super excited to share that my great friend, Varsha Rao, has joined as our newest Executive Partner.   

Varsha and I first met in 1991, a shockingly long time ago, when we both worked on Wall Street at one of the hottest emerging boutique investment banks, Wasserstein Perella. After graduating from Harvard Business School, Varsha spent time at McKinsey & Co. which set her up for a series of leadership positions in start-ups (Eve.com) and high growth companies (Gap/Old Navy, SingTel Digital Media, LivingSocial). Notably, she then served as Head of Global Operations for Airbnb before her role as Chief Operating Officer at Clover Health. Until quite recently, Varsha was the CEO of Nurx, a leading provider of women’s healthcare products and services, having navigated the successful merger of the company to Thirty Madison. She also sits on a few prominent public company boards: Callaway Golf, Viasat. Oh, and she also holds a BA in Math from the University of Pennsylvania and a BS in Economics from The Wharton School.

Not to be lost among all of her successes is that she is also a prominent angel investor with a particular interest in working with female founders and marketplace business models. Insider listed Varsha as one of the country’s top 100 angel investors, having built a broad portfolio across a number of emerging industries. Her network among Silicon Valley investors will clearly be additive to the work we do, to say nothing of the terrific insights she has already contributed with new investment opportunities and for our existing portfolio companies.

In addition to her exceptional insights into the dynamics of marketplaces, Varsha is also keenly aware of the behaviors of consumers. She will be particularly helpful with one of our investment themes involving the “retailization/consumerization” of healthcare.

Join me in welcoming Varsha to the Flare Capital team and the world of early-stage healthcare technology venture investing…

Dentistry: Open Wide and Say Aah…

While over $142 billion is spent annually on dental care in the U.S., many only really think of dentistry when in the exam chair and yet there are many exciting developments to chew on. The last 20 years witnessed a coordinated effort to implement more impactful public policies (expanded Medicaid, Affordable Care Act, more Federally Qualified Health Centers), improve educational programs, develop more effective therapies and powerful diagnostics, and to activate more robust professional societies to better integrate dental care with overall healthcare. Meaningful advances have been made to improve access, and while prevalence of oral diseases remains a persistent challenge, innovative new products and services, coupled with more informative diagnostics, have created more effective treatments.

An adult with relatively good dental health will spend about $1,000 on dental care each year. Over 40% of all dental care costs are covered by private health insurance, while just over 35% is out of pocket. With the onset of the Covid pandemic, there was a marked increase in one-time, non-recurring government support programs covering dental care costs. Notwithstanding that, there remain concerns that lower income and the elderly are not receiving adequate preventative care; in 2019, just 43% of Medicare beneficiaries had a dental exam.

Payment reform and appropriate insurance coverage continues to be a significant issue in dentistry. As of 2020, only 18 states offered extensive dental benefits under Medicaid, with another 10 states only covering dental emergencies and three states not providing any coverage. Despite the overall trend in dentistry to focus more resources on prevention, avoidance, and promoting good dental health, there are significant concerns that the economic burdens many states are confronting now will jeopardize the advances in extending coverage.

Globally, it is believed that there are 1.6 million dentists according to the World Health Organization. While there are 201k active dentists in the U.S. according to the American Dental Association, Health Resources and Services Administration data conclude that there is a shortage of nearly 11k dentists, which arguably undermines care for as many as 60 million Americans (dental coverage shortage areas). In response, a number of new dental schools have opened, which ironically has raised longer term concerns that there may be an oversupply of dentists in 20 years. It takes four years to earn either a Doctor of Dental Surgery (DDS) degree or a Doctor of Medicine in Dentistry or Doctor of Dental Medicine (DMD) degree, so addressing this gap will take some time.

Today there are nearly 61 dentists for every 100k Americans (Alabama has the lowest coverage with 41 dentists/100k, while Massachusetts has 83dentists/100k – D.C., with all of its big mouths, has 104 dentists/100k).

The Bureau of Labor Statistics tallied the national average salary for dentists who practice general dentistry to be $178.3k as of May 2019, which compares poorly to family practice physicians who earn $213.3k. Of the 201k dentists in the U.S., 159k were general dentists while the balance were specialists (orthodontics, dentofacial orthopedics, maxillofacial surgery, etc) that presumably pay substantially higher.

The comparison to PCPs is relevant as dental care becomes better integrated into overall care. The Institute for Health Metrics and Evaluation ranked oral disorders as tenth in terms of “years lived with disability” (“YLD”) disease burden to underscore the extent of the prevalence. It is estimated that globally that over 3.5 billion people live with some type of oral disease and that approximately 300 years of life are lost per 100k people due to issues of oral health. While the National Center for Advancing Translational Sciences track several thousand different diseases, it is estimated that more than 100 of these diseases are systemic and that more than 500 medications have oral manifestations. An emerging area of clinical focus is at the intersection of oral health and behavioral health, and the impact on salivation.

According to the 2016 Global Burden of Disease Study, four of the top 30 most prevalent diseases involved oral health – untreated dental caries (decay of tooth or bone) in adult teeth (#1), severe periodontitis (#11), untreated dental caries in baby teeth (#17), and severe or complete tooth loss (#29). This does not even account for craniofacial birth defects which have an incidence of 1 in 700 births. While the origin of dental medicine was thought to have started around 300 B.C., one of the most famous Greek doctors, Hippocrates, thought the cure to many diseases involved the removal of infected teeth.

While the prevalence of disease has been relatively consistent over many decades at around 20 – 25%, the improvement in access to oral care has had a profound reduction on the amount untreated disease. The chart below only looks at the prevalence of untreated caries among children, which augurs well for future health conditions for many who otherwise would have struggled with diseases related to poor oral health. While more needs to be done, the trend is encouraging.

Payment reform continues to be critical to ensuring better access and adherence to care. Interestingly, utilization of orthodontic procedures pre and post the Great Recession of 2007 – 2009 shows only a modest reduction in necessary services for children, but a significant decline among adults, suggesting that adults are likely to forgo care when economic conditions are more challenging. Analysts today are worried that as the economy heads into another possible recession, many adults will defer necessary oral care, perhaps reversing the improvement in treatment trends highlighted above.    

The ”business of dentistry” is being transformed. There is a debate now playing out among dentists, orthodontists, oral care companies, and regulators as innovative new teeth straightening technologies come to market. Many of these “consumer” treatments from companies such as Invisalign and SmileDirectClub circumvent the traditional dental service providers, which is causing great consternation among certain professional societies. The American Association of Orthodontics is aggressively advocating that orthodontists must provide such teeth straightening services as these procedures “involves the movement of biological material.”

There are a handful of forces at work that promise to reshape dentistry. Patients are pressing for much greater convenience and comfort, which will push practices to be more consumer-centric much like what is happening in primary care. Tele-dentistry and “emotional dentistry” (utilizing virtual and simulation models) are being rapidly adopted. 3-D dentistry and laser printing are two technologies being incorporated into in-office settings. All of these advances are leading to practice consolidation and adoption of more subscription-based models. As with many health-related practices, the movement to true risk-based care models will be challenged by the need to link, with data and attribution, (reasonably) near-term economic value creation to effective oral health.

The amount of innovation in dentistry is exciting and tracks much of what is playing out in the broader healthcare and life sciences sectors, and yet Crunchbase only tracks 208 dental start-ups which have raised approximately $3.0 billion across 483 financing rounds. The amount invested in dental innovation in total is only 0.9% of what venture capitalists invested just in 2021 alone. The significant new market opportunities being created by digitization, consolidation of delivery services, and changing demographics strongly suggests that the amount of capital will increase dramatically. Advances in biomaterials, cellular analysis, regenerative therapies are pointing to an age of more robust personalized treatments in oral care. As professional societies more actively embrace novel risk-based models, innovative new care delivery companies will be started.

Innovation’s crowning achievement will be to take a bite out of poor oral care.

That’s Italian…

It is remarkable how chill the Italians can be – I was reminded of that yet again a few weeks ago when I was over there. Amidst continued and extraordinary political turmoil and a looming national election on September 25, life simply rolls along. The recent collapse of the Draghi government and bickering among the center and left political parties appear to have created the path for the coalition of right-wing parties led by the far-right Brothers of Italy to secure this upcoming snap election. It is feared that the €200 billion in reform commitments funded by the European Union may be reversed.

And this financial support will be desperately needed as economic conditions rapidly deteriorate. According to S&P Global’s flash composite purchasing manager index, business activity in the eurozone has reached the lowest levels in 18 months. Volatility in the Italian bond market has widened spreads against German bonds to 2.3%, the highest in months, and exacerbated by an unprecedented €39 billion short bet against Italian debt – all signaling a pending financial crisis and whispers of an “Italian Contagion.” The Milano Indice di Borsa (Italian stock market) reflects recent investor anxieties as well as the dramatic downdraft at the outset of Covid (more below).

The most recent International Monetary Fund forecast is calling for a 5% contraction to the four countries most directly impacted by the restriction of Russian gas, which includes Italy. Eni, the large Italian energy company, just announced that Gazprom has reduced natural gas deliveries by 25% to 20 million cubic meters per day. The government launched “Operation Thermostat” dictating building temperatures to limit energy consumption. This past weekend as part of a G-7 initiative, Italy agreed to price caps on Russian oil to limit Russia’s ability to fund its war efforts in Ukraine.

The size of the fiscal support, and frankly the total of the debt short positions, is all the more staggering when one considers that the Italian GDP is $2.1 trillion (at the end of 2021, in current US dollars). The Italian economy, which grew 6.5% in 2021, ranks eighth globally and third in the European Union. Current European Commission forecast is for the economy to grow 2.9% in 2022. Notwithstanding that unemployment in the Eurozone fell to an all-time low of 6.6%, just below 11 million people unemployed, the current unemployment rate in Italy stands at 9.8%. Additionally, Europe is suffering through a significant drought, with 47% of the European Union living under drought warnings, including most of Italy. And yet they continue to be happy and xenial.

Recall at the outset of the pandemic the world watched the Italians which seemed to be the first country to suffer so acutely and publicly. While case counts in the early days were relatively modest as compared to the 60.3 million people who live in Italy today, the Italians suffered through at least three very significant surges over the last nine months (below). Current daily case counts are tracking at about 22k.

Importantly, while mortality rates were staggering at the outset, like much of the world the Italian’s ability to manage Covid over the course of the pandemic was notable. Current daily deaths are running around 90, which suggests mortality rate below 0.5%. Again, the absence of masks and social distancing (not unique to the Italians) underscores how happy they are.

Thankfully, the Italian healthcare system is among the top ten in the world according to the World Health Organization, stressing equality of access for all. In 2020, Italy spent 9.7% of GDP on healthcare as compared to 19.7% in the U.S. per Centers for Medicare & Medicaid Services data. As of 2021, the life expectancy was forecasted to be 83.7 years, according to United Nations data, as compared to 79.5 years in the U.S. (although recent Centers for Disease Control and Prevention analysis pegged it at 76.1 years given the impact of Covid). Shockingly, even with all of the pasta, Italian obesity rate is 19.9% (47^th least obese), precisely average for all countries; the United States weighs in at 36.2%. Sadly, 23.4% of Italians smoke which is slightly ahead of the global average of 22.0%.

Even considering all the turmoil, the Italian venture capital industry enjoyed quite a renaissance in 2021 with over €2.9 billion invested in 534 deals according to ScaleUp Italy. Twenty deals accounted for €2.05 billion of that activity, while there were 173 deals between €1 – €20 million, suggesting a deepening ecosystem is emerging. According to Crowdfund Buzz data, €171.9 million was sourced via crowdfunding platforms in 2021.

As a point of comparison, €780.5 million was invested in 306 companies in 2020 and €605.6 million was invested in 244 companies in 2019, respectively. Crunchbase lists 147 venture capital and private equity firms, accelerators, and family offices in Italy. Clearly, the groundwork for an exciting innovation economy is being created, but there is some distance to travel. Total venture capital investment as a percent of GDP was 0.14% in 2021; in the United States it was 1.4%.

Italy ranked #25 of all countries (up from #28 between 2017-2019) in terms of “happiness” according to the 2021 World Happiness Report commissioned by the United Nations. Let’s just hope that the political, economic, environmental and health dynamics do not get in the way. Don’t worry…be happy.

Psychedelics: What a Long Strange Trip It’s Been…

The numbers are staggering. An estimated twelve million Americans suffer from post-traumatic stress disorder (PTSD) according to data from the U.S. Department of Veterans Affairs, approximately 37% of whom are considered to have severe symptoms. At some point in our lives, six in ten men and five in ten women will experience meaningful trauma; approximately 6% of the population will go onto to suffer with PTSD. While the causes of PTSD are relatively easy to identify (combat, accidents, assault, etc), the symptoms can reveal themselves in confounding ways and the treatment modalities can be frustratingly ineffective for many. Data from the National Institute of Mental Health show greater prevalence of PTSD among women and with older Americans.

The healthcare industry has had a complicated history with developing proper therapeutic treatments for PTSD. Given the extraordinary urgency and overwhelming need, in part due to the trauma in war zones in Iraq/Afghanistan/Ukraine/Middle East, severely limited behavioral and mental health resources, and issues associated with the pandemic, there has been a renewed interest in psychedelics. Recent estimates from the Substance Abuse and Mental Health Services Administration showed that over $280 billion is spent annually on treatment services for mental health and substance use disorders, and this is barely adequate. While the most effective treatment for many is “talk therapy,” the healthcare system today simply does not have enough providers.

In response, the biotech industry has started to embrace a class of mind-altering compounds such as psilocybin, lysergic acid diethylamide (LSD), and 3,4-methylenedioxymethamphetamine (MDMA or Ecstasy or Molly). According to Psychedelic Alpha, there are now 49 public companies and 39 private companies that are developing products utilizing psychedelic compounds; there are even four ETFs facilitating investor trading in baskets of these stocks. And all of this without FDA approvals or legalization. The Wall Street Journal recently profiled Empath Ventures, which is raising a $10 million venture fund focused exculsively on hallucinogens.

The Multidisciplinary Association for Psychedelic Studies (MAPS) was created in 1986 to advance the medical, legal, and cultural appreciation for the role of psychedelics in treatment of PTSD and other intractable behavioral conditions. Supported by over 130 scientists and $44 million of funding, MAPS research has shown that these compounds are not addictive and do not cause organ damage. Much of its advocacy work has been to pressure the FDA to accept that these psychoactive compounds, when properly administered in micro-doses, can be highly efficacious as part of mainstream psychiatric approaches. A recent study in Nature showed that when administered to PTSD patients, 67% no longer showed signs of PTSD symptoms as compared to 32% in the placebo arm.

The history of psychedelics is complicated. More than 60 years ago, these compounds were both legal and yet on the fringes of therapeutic use. As the 1960s counterculture took hold and embraced the abuse of this class of drugs, the legislative response was to crack-down and criminalize them. Their acceptance was further undermined in the 1980s, and still is today, as Ecstasy and Molly swept the club scene with very disturbing incidents of “date rape” abuse. Further complicating a broader medical community acceptance is the patchwork regulatory framework. While illegal on a federal basis, the use of psychedelics is legal only in certain states and cities.

Further complicating the situation is the conflation of psychedelics with other drugs such as narcotics, tetrahydrocannabinol (THC, most commonly associated with cannabis), opioids, and other performance-enhancing drugs. While obviously distinct from psychedelics, the real societal issues created by those drugs often overshadows the potential and for many, the necessary, therapeutic applications of psychedelics. The massive opioid settlements roiling the pharmaceutical and drug distribution industries further clouds the discussion; just last month Teva settled all pending opioid cases for $4.25 billion. The Centers for Disease Control and Prevention (CDC) recently released a study showing that 3.7 million Americans injected themselves with drugs in 2018, which was a five-fold increase over 2011 and led to a spike in HIV and hepatitis C cases.

A recent New York Times study found that 13% of all U.S. veterans suffer from PTSD; for those returning from Iraq and Afghanistan, it is believed that could be as high as 20% – 25%. Studies have also shown that on average 17 veterans commit suicide every day. Between 2010 – 2019, 42k veterans died from a drug overdose. The need for more effective treatment is acute, obvious, and urgent.

The level of drugs prescribed is overwhelming yet still so many suffer, highlighting how inadequate current treatments still are. Over 8.9 million Americans were prescribed drugs last year for major depressive disorders, and yet, it is believed that 30% of those prescriptions had no effect. IQVIA prescription data in 2021 showed that there were 337.1 million scripts written for antidepressants. Covid has also had a significant impact. Per Express Scripts data, there was an 8.7% increase in antidepressants prescribed between 2019 – 2021, as compared to 7.9% increase between 2017 – 2019. CDC data revealed that 15.8% of all prescriptions in 2019 were for mental health conditions; undoubtedly, that will be quite a bit higher today.

The course of psychedelic treatment typically involves up to four monitored micro-dosed “trips” that can last anywhere from 90 minutes to several hours. A micro-dose is usually 5% – 10% of a normal dose which can create a therapeutic impact without the debilitating hallucinogenic high. Such an approach is believed to induce significant neuroplasticity which facilitates a “re-wiring” of the brain, although the precise mechanism of action is still not fully understood. While the actual drug may be relatively inexpensive, the overall supervised experience requires trained staff and facilities.

The need is not lost on the digital health industry, which is also looking to develop more cost-effective and scalable solutions to better manage and treat the PTSD population. While not only focused on PTSD solutions, since the beginning of 2018 approximately $11.2 billion has been invested in digital mental health companies according to Rock Health, causing it to be the consistently highest ranked clinical indication to attract funding. Interestingly, Innerwell recently raised a seed round to build a psychedelic telehealth platform to connect patients and therapists. In April 2022, Nue Life raised a large Series A round to launch a tele-psychedelic platform. A recent Grand View Research analysis concluded that the global mental health apps market was $4.2 billion in 2021 ($1.4 billion of which is in the U.S.) and will grow by 16.5% annually through 2030.

Much of this investor enthusiasm is based on the potential to dramatically improve provider productivity and address acute gaps in care. Adoption of these tools is consistent with greater appreciation of the power of virtual care models and demonstrated improved outcomes. As the healthcare system is moving to a more “meet the patients where they are” mentality, digital health solutions promise to play a greater (and complimentary) role in treating PTSD. Of course, the severity of many of these conditions will require more intensive traditional therapeutic interventions as many of the digital mental health apps are geared toward less acute conditions with a focus on meditation and wellness.  

The tragedy here is that trauma can happen in an instant, but the treatment may take a lifetime. With traditional resources so constrained and offering uncertain outcomes, the role of psychedelics is at a minimum intriguing, and at best, could be a powerful approach to providing relief to those most acutely impacted.  

Flare Capital Team Updates…

It is always nice to ring the bell when a great person joins our investment team – this time we get to ring the bell twice.

Venture capital firms simply do not need to hire a lot of people. While we will make at least several dozen investment decisions together over the course of a fund, we might only make a handful of hiring decisions. Each addition to the team is important and well-considered with an extensive interview process and a long courtship. Notwithstanding that, recruiting Uma Veerappan and Kelly Scherrer were easy decisions and are two more important pieces to the puzzle.

Uma is well-known to the Flare Capital team. While earning her MBA from the University of Chicago Booth School of Business last year, she was a Flare Scholar in the great Class of 2021. She did terrific work on a number of projects, including the closing of our investment in Elektra Health. As soon as we first met Uma, we knew she was special. Her passion for healthcare and deep understanding of this sector’s many complexities and nuances were immediately evident. While in business school, Uma both worked with a few healthcare technology start-ups and held roles at two venture firms.

Earlier in Uma’s career, she was a Strategy Consultant at EY with a particular focus on launching next-generation products at the intersection of healthcare and technology. Specific areas of interest included applications of artificial intelligence and surgical skills assessment. Prior to her time at EY, she was a Fulbright Teaching Grantee in South Korea. She is not just steeped in the healthcare technology sector and worldly but is whip smart having been recognized as a Woodruff Dean’s Achievement Scholar at Emory University, where she earned her BA in Economics and Educational Studies. I am certain we have a lot to learn from Uma.

And we may have hit the lottery twice this summer when Kelly Scherrer joined the firm as Controller, further strengthening the “back of house.” Given the volatility and general decline in economic conditions, coupled with having raised our third fund, it is even more important now that we double down on our ability to carefully monitor and support our portfolio companies. Kelly’s impact has been immediate and profound, leveraging her work both at RSM and PwC where she focused primarily on tax compliance for hedge funds, venture capital, and private equity firms. In an environment where financings will be harder and close attention to underlying financial and operating performance of our portfolio companies is critical, Kelly meaningfully advances the cause for the firm. And she is also super smart, having earned her B.S.B.A. with concentrations in Finance and Accounting from Northeastern University’s D’Amore McKim School of Business.

Quick update on our Flare Scholars program and Flare Scholar Ventures (FSV), which is our commitment to invest a portion of our new fund in the pre-seed rounds of Flare Scholar sponsored projects. With 254 Flare Scholars, who are young brilliant passionate emerging healthcare technology entrepreneurs, we now have 13 FSV companies, exceeding our initial goal – and a handful of those companies have already graduated by raising proper seed or Series A rounds. We could not be more impressed with the quality of all our Flare Scholars, but particularly the exceptional Class of 2022. The progress of the FSV program is inspirational as we continue to on-board the next generation of great healthcare technology entrepreneurs.

We will look to recruit the Class of 2023 Flare Scholars this fall and remain committed to the FSV program as we begin to invest out of the new fund shortly. Capital will always follow great talent and in this market, it will be great talent that wins.

And please join us for our next quarterly Expert Roundtable Series webinar on September 27, 2022 at noon EST. The topic is “Fundraising in a Turbulent Capital Market.”

One Medical Acquisition: The Path Forward…

Last week’s $3.9 billion acquisition of One Medical (NASDAQ: ONEM) by Amazon triggered significant hyperventilating about the transformative and immediate impact of this transaction on the healthcare industry. Interestingly, Amazon’s market capitalization increased 1.4% or $18.3 billion on the day of the announcement, paying for the purchase a few times over. Undoubtedly there could be exciting near-term benefits for the 750k ONEM members as their Amazon Prime accounts are linked to their ONEM memberships, facilitating targeted Whole Food and Amazon Pharmacy coupons. But what might we expect to see over time is a provocative debate with powerful implications for how each of us manage the arch of our healthcare journeys.

Important Disclosure: Flare Capital was a significant investor in Iora Health and had a board seat. Iora Health was acquired by ONEM in September 2021 for approximately $2.1 billion and is an important part of the ONEM story going forward. Amazon now has an important foothold in the Medicare market. This is not meant to be a victory lap as the stars of the Iora Health story were squarely the management team, particularly the founding CEO, Rushika Fernandopulle. And while Rushika may have been the lead actor, the supporting cast numbering in the several dozens and too many to list here played a critical role in that company’s extraordinary success (raised nearly $350 million, sold for $2.1 billion).  

Indeed, it does appear that Amazon is methodically stitching together a series of assets that over the next few years will better reveal the scope of its healthcare strategy. With significant fanfare, the January 2018 the formation of the healthcare consortium Haven with Berkshire Hathaway and J.P. Morgan was one of the first markers placed by Amazon in healthcare. While ultimately unsuccessful, this was followed up quickly with the June 2018 acquisition of PillPack for $750 million, which became the cornerstone of Amazon Pharmacy. The enthusiastic press coverage earlier this year about the expansion of Amazon Care to 20 cities was particularly notable. Easily overlooked were all of the important healthcare hires made by Amazon over the last five years, each one received with a quizzical look at the time but now look prescient and coming into better focus. 

And running in the background are the numerous other Amazon initiatives such as Alexa and Ring doorbells which have rapidly proliferated robust, intelligent, and all-seeing (all-knowing) sensors in and around millions of homes and other healthcare settings.  

The industrial logic of this transaction looks very compelling – at least in the abstract. In the ongoing effort to improve outcomes while lowering costs, the healthcare industry is shifting sites of care from high-cost acute settings to lower cost post-acute settings (i.e., the home).  Overlay the “consumerization of healthcare” trend, greater awareness of the role that social determinants play in one’s health, the move to value-based care models, and the heavier cost burdens placed on employers further amplifying their voice in healthcare purchase decisions, Amazon’s decision to acquire a leading, branded primary care platform with 188 practices in 25 major markets with a particular focus on the employer customer (ONEM has more than 8k corporate clients) is fairly straight forward. The creation of Haven, while considered a failed experiment by many, tipped Amazon’s hand years ago.

Now let’s dream a little. According to U.S. Department of Health and Human Service estimates, the total per capita lifetime health spending (in 2016 dollars) is $414k; if healthcare spend increases 3% greater than overall inflation (quite likely), that number would be $2.3 million. Much of the arm wrestling in the market today is over who will manage that spend on behalf of patients/members/consumers. Through that lens, Amazon’s desire to determine how those dollars are spent is quite obvious. Given all of its assets – purchase and behavior data, sensors, analytics, cloud infrastructure, etc – Amazon’s understanding of each of us is unrivaled. The company’s ability to engage, activate, communicate, inform, incentivize, and provide products and services is staggering. Amazon’s potential to change behaviors, overtly and subtly, is enormous. It is not hard to see this collection of assets being a platform for a risk-based, value-based care model at some point. Amazon Health Insurance?

So, what can go wrong? Plenty. First, healthcare is hard and expensive. One can easily envision consumers being anxious with the aggregation of all these data within one entity. Notwithstanding the guardrails provided by HIPAA, Amazon has raised numerous privacy concerns in the past. Just last week it was revealed that Amazon shared Ring doorbell surveillance data to eleven law enforcement agencies without prior consent. That same day Amazon offered concessions to European Union regulators in an antitrust case alleging that the company was using non-public information from retailers on the platform to compete against them.   

One dimension not getting as much attention in all of the excitement with this transaction is the specifics of the deal. Clearly, as the economy has turned, valuations have been compressed over the last six months. While the $18 per share price is a ~75% premium to the prior day share price, it is nearly 40% below the 52-week high of $30.18 per share and well below the all-time high of ~$60 per share hit in February 2021 when ONEM’s market value was approximately $12 billion. Analysts peg the purchase price to be 3.6x and 2.8x 2022 and 2023 projected revenues, respectively. Pretty sobering multiples given the investor euphoria of the last two years.

Notwithstanding that this transaction may fundamentally reset valuation multiples, this likely will trigger a wave of additional M&A activity, particularly among smaller private healthcare companies. As liquidity is leaving the system making follow-on financings harder and more expensive, many companies will simply choose to merge or sell. And as is so often the case, the premium multiple tends to go to the companies that transact early in the correction cycle.

Having said all that, this is terrifically validating for the thesis that technology will transform the business of healthcare. It is exciting to contemplate the potential role “Big Tech” can play in this sector. Over the last 24 months, there have been nearly 1,500 digital health financings; many of those companies have built interesting but narrow point solutions with arguably muted impacts on cost, quality, and outcomes. Amazon’s healthcare strategy points to the profound implications of a broader integrated consumer-centric model.

Interestingly, McKinsey’s “profit pool” analysis continues to rank the healthcare services and technology sector as one of the most attractive in all of healthcare. The firm estimated that this sector generated $50 billion of EBITDA in 2019 and that it will increase to $68 billion by 2025. Specifically, McKinsey argues that this 8.2% CAGR is powered by advances in data and analytics, as more effective population health management, revenue cycle management, patient engagement, and virtual care models proliferate. Through this lens, it certainly appears that Amazon is targeting a compelling entry point into healthcare.

The scale of Amazon is astounding. Last year the company generated $469.8 billion in revenues. It has over two million small and medium-sized businesses on the platform. Given concerns over regulatory exposure, the company recently took steps to reduce its private label operations, which while only about 1% of total sales, includes a staggering 243k SKUs across 45 house brands. Here’s to hoping that the ONEM members do not get lost in this maze and that Amazon can actually have a meaningful impact on their well-being.

Digital Health – 3Q22: What is the Diagnosis?

You know it is bad out there when the best performing financial asset in 2Q22 was the Russian ruble which appreciated 48.6% – the next closest investment was orange juice which was up 18.2%. Even the Kazakhstani tenge far outpaced the S&P 500 and Nasdaq Composite indices, generating a return of 0.1% versus –16.5% and -22.5%, respectively. On real terms, this has been one of the worst starts of any year for the S&P 500 since 1872. With a myriad of issues swirling around us – inflation, war in Ukraine, China geo-economic tensions, domestic political paralysis, climate concerns, racial inequities – it is a wonder that the U.S. equity markets have not suffered more greatly. J.P. Morgan is even teasing at perhaps a strong 2H22 in the capital markets.

Not to diminish at all the numerous problems confronting policy makers, the inflation concerns are real (obviously) and insidious, compromising basic economic decision making. When looked at historically below, just how extraordinary this new investment climate is becoming is starkly apparent. There is an entire generation (maybe two) of investors who have never experienced this before, much less a public market correction of this magnitude. To confuse matters further, June’s strong jobs report with 372k new jobs created (well ahead of analyst expectations) is hard to reconcile with the 1Q22 GDP decline of 1.6% heightened concerns that the U.S. economy may be stumbling to the feared “two-quarter GDP decline” definition for recession.  

An interesting corner of the market to look for signals of this recalibration is the venture capital investment activity. Pitchbook and the National Venture Capital Association recently published a flash 1H22 analysis which showed a significant decline in investment activity in 2Q22 but a marked increase in the number of deals. In 1H22 there was $144.2 billion invested in 9,421 deals which implies an annual rate of $288.4 billion and 18,842 deals, as compared to $341.5 billion and 17,637 deals in 2021. This would be a 15.6% reduction in the annual amount invested yet a 6.8% increase in the number of companies.

A deeper review of the 2Q22 data highlights the dramatic reduction in average round size: in 2021 average round size was $19.4 million; in 1Q22 it was $19.0 million; but in 2Q22 it collapsed to $12.9 million. A critical question is the mix between new investment activity versus follow-on investments in existing portfolio companies. While Pitchbook estimated that only 5% of 1Q22 financings were “down rounds,” the expectation is that it spiked in 2Q22 and is likely to eclipse the 10-15% levels seen over the past decade or so.

Very clearly venture investors have tightened the reins. While there continued to be strong interest in early-stage private companies, investors appear to be providing shorter runways, likely focusing more intently on near-term milestones. And while averages can easily mask other trends, there is no doubt that late-stage crossover funds have dramatically pulled back, perhaps given the relative attractiveness of fallen public stocks or yet again with the realization that they may have strayed into a part of the market which is not their strength. A small sampling of what just occurred can be found when looking at the crushing rise and fall in the fintech sector, as valuation multiples collapsed by well more than 50%.

By definition everything that priced over the last two years was overvalued when looked at through today’s lens. The Chief Investment Officer of Bridgewater, a leading global hedge fund, recently observed that more than 40% of all public companies are reliant on raising additional capital which will be very tricky in this environment when liquidity is being taken out of system. Coincidentally, 43% of S&P 500 companies provided negative guidance in 2Q22 with FactSet reducing EPS estimates for the index by 1.1%, the greatest decline since 2Q20. According to Renaissance Capital, only 21 U.S. companies completed an IPO in 2Q22, raising a paltry $2.1 billion, a level not seen since the depths of Great Recession in 2Q09; the median IPO raised only $22 million. Furthermore, 2Q22 IPO performance has been abysmal – the worst quarter in history in fact – with the Renaissance IPO ETF down 32.5%.

The secondary market may offer another avenue for investor liquidity – and there are some fascinating signals emerging there. Forge Global, which operates a private stock marketplace, has seen a reversal in Indications of Interest (“IOI”) between buyers and sellers over the last six months which is putting pressure on valuations. In 4Q21, 58% of all companies traded at a premium to their last round’s valuation yet in 1Q22 that declined to 24%.

Interestingly, this is against a backdrop of a significant decline in M&A activity. Globally through 1H22 M&A activity decreased by 21% with a 28% decline in U.S. activity alone. The decline appears to be even more pronounced for venture-backed companies. Through 1H22, the M&A volume was $48.8 billion with 831 exits, which when annualized ($97.6 billion, 1,662 deals) compares poorly to the staggering $777.4 billion and 1,880 exits in 2021. This would be the lowest annual M&A volume since 2016.

One possible silver lining that may provide lifelines to many private companies is the amount of capital being raised by venture capital firms. Year-to-date U.S. venture firms raised $121.5 billion across 415 funds, which is an unrivaled pace unseen in any year prior. According to Preqin, the venture capital industry added $43.1 billion in dry powder in 2Q22 on top of the $478.5 billion already amassed, suggesting many venture partnerships will be having the ever-present “sunk cost” debate to either continue supporting existing, possibly struggling companies, or look for new opportunities.

One resilient bright spot on the venture landscape had been the healthcare technology sector but even that may be changing. Rock Health, the leading research firm that covers the digital health sector, just published its 2Q22 investment activity report showing a marked decline in both dollars invested and number of companies ($4.1 billion and 141 companies). Through 1H22, there has been $10.3 billion invested in 329 companies suggesting the sector is now on pace to see between $16 – $20 billion invested in approximately 600 companies, which while below 2021, would place this year comfortably in second place well ahead of any year prior. Investment activity in June 2022 was $1.45 billion suggesting a $17.4 billion pace. Notably, the average deal size in 2Q22 was $28.1 million which likely indicates increased caution as round sizes decline.

The average round size is directly influenced by the size of the later stage rounds, which is where there has been a significant pullback. For instance, Series C average round size in 2021 was $90 million; it was $81 million in 1Q22 and is now $70 million through 1H22, suggesting that the 2Q22 average round size was considerably smaller than that. This is a critical metric to monitor as many successful digital health companies require a few hundred million dollars of invested capital to achieve scale and/or liquidity.   

The mix by stage of financing is informative as well. Over the last five years, Series A financings accounted for ~25% of all financings, Series B was 15-17%, Series C was 8-10%, and Series D or later was another 8-10% (the balance included seeds, bridge rounds, and other equity financings). While this has remained relatively consistent, the “graduation rate” (the ability to raise a subsequent round) will be closely watched as capital becomes scarcer and more expensive. Notwithstanding the decline in 1H22 M&A activity to 16 transactions per month (versus 23 per month in 2021), one would expect to see a significant increase in private-to-private M&A activity in 2H22 as companies fail to hit value-creating milestones, perhaps implying a lower prevalence of later stage rounds.

Rock Health has also analyzed investor type concluding that 70% of investors in digital health companies in 1H22 are repeat (presumably more expert) investors, which had been consistently 55-60% in prior years. If this trend holds, one might expect to see relatively less capital available to healthcare technology companies as more casual, generalist investors focus elsewhere. Notably, the number of investors by round per company in 1H22 was 2.3 as compared to 1.7-1.8 in prior years, suggesting that entrepreneurs are building larger investor syndicates with greater financial capacity.

The atmospherics around this sector is somewhat confounding. The promise of healthcare technology solutions has never been more evident, yet the public markets have been unforgiving over the last handful of months. The median revenue valuation multiples for the SVB Leerink Digital Health index (21 companies) for 2022 and 2023 are 2.9x and 2.4x, respectively (the average multiples are greater at 5.5x and 4.4x), yet the companies in the index in aggregate are projecting a relatively robust 25.3% revenue growth (2021-2023) with an average 2022 projected gross margin of 61.0%. Since the index’s peak in mid-February 2021, it has declined 64%.

The regulatory situation is also running at crosscurrents. There is significant support for greater data liquidity, interoperability, and transparency, yet in a post-Roe world, there has never been greater anxiety about the misuse (abuse) of intensely private information around reproductive rights.

One issue that has concerned healthcare technology entrepreneurs over the last three years has been access to great talent. In light of an historically low unemployment rate of 3.6%, there does seem to be an emerging group of available and talented labor. The website layoffs.fyi has been tracking the number of laid off start-up employees, and with the implosion of the crypto, fintech, and “proptech” (real estate) sectors, there has been a spike in the number of people suddenly available to join other hot start-ups. According to the Bureau of Labor Statistics, the unemployment rate in the healthcare and social assistance sector is 2.4%, so this may actually be a silver lining for digital health companies.

Data: Layoffs.fyi; Chart: Axios Visuals