Damon Ramsey started his company three years ago, a boom time for digital health. His startup, Input Health, uses technology to help physicians better manage their ample workload.
In the past few years, Ramsey received a steady stream of cold calls and emails from venture capitalists. To his surprise, many of them were interested in his startup but demonstrated scant knowledge of health care. Ramsey is a practicing physician in his native Canada, as well as a health-tech entrepreneur.
"They (investors) often had little understanding of the health care delivery space, including the regulation, bureaucracy, and other restrictions," Ramsey tells me via email. "In my opinion, they need to temper their expectations."
But investors' expectations have been anything but tempered in the past five years. According to the San Francisco-based venture firm Rock Health, funding for digital health exceeded $4.5 billion in 2015, which is more than quadruple the total funding in 2011. New startup accelerators have popped up across the country, such as Startup Health and HealthBox, and many top Silicon Valley venture firms launched new digital health funds.
Much of the hype has centered around the health-tech "unicorns," such as Oscar Health, Zenefits, and Theranos. These companies have breathlessly been described by the press as fundamentally "disrupting health care," which only served to bloat their valuations.
"We saw the hype go up," says Tom Rodgers, managing director at McKesson Ventures, and a long-time investor in health care. "But what comes up must come down."
Consider the hype bubble popped. Theranos, the blood-testing startup with a mammoth $9 billion valuation, was called out by federal regulators for "serious deficiencies." Human resources startup Zenefits raised more than $500 million at a $4.5 billion valuation, but publicly replaced its CEO after the press got wind of its "institutionalized cheating." Practice Fusion, the much-hyped electronic medical record startup, laid off a quarter of its workforce and is rumored to be looking for a buyer rather than face the public markets.
You might expect the traditional health care investors to retreat from digital health, and focus their energies elsewhere. But many say they still remain bullish on the space and see potential in a variety of areas.
As Rodgers explained via phone, it can only be a good thing if venture capitalists reset their expectations. As he points out, digital health still lacks a success story of Google or Apple proportions. Instead, many of the first companies to go public have seen their stock crash (the quintessential example is Castlight Health, which bloggers have referred to as an "absolute horror show.") Bessemer Venture Partners' Steve Kraus says digital health companies will struggle like this as long as expectations remains out of control. "On the valuations front, we're seeing a massive disconnect between public and private markets," he says.
Likewise, Rodgers has a positive spin on the string of recent health-tech scandals. "A lot of the distracting noise will dissipate a little bit so we can finally start to get to work," he says. "Frankly, valuations were getting silly."
Some health entrepreneurs tell me they've noticed a subtle shift in the funding environment. Ramsey has received far fewer calls in the past month or two, but he has no idea if that's related to the recent bad press. Others founders describe a new "burden of proof" when they pitch investors, including requests for clinical studies to back up their big claims.
For entrepreneurs, it might seem like the pool of funding is drying up. But health investors say that the companies at the top of the pack will have little trouble getting investment. The best companies might even flourish in a less hype-driven environment.
Rob Coppedge, an investor from Cambia Health, has noticed a recent "misalignment between market expectation and valuation." By that he means that health startups have been pushed to grow too quickly to generate a capital return for their unseasoned investors and board members (In the early days, Theranos famously had only one licensed medical expert on its 12-person board). As one former employee at Zenefits described the expectations: "growth for growth's sake took priority."
But Ambar Bhattacharyya, managing director at health-tech firm Maverick Capital Ventures, warns that some founders might struggle if the firms that provided early financing start to back away from digital health. "What most entrepreneurs are now seeing is a pullback from these valuations and some sources of capital—largely from generalist or tech investors—vanish as quickly as they have come in," he explains.
Bhattacharyya says that future generations of startup founders should ensure they are working with venture capital firms that have ample experience in health care. These investors will understand that it takes time to build a successful and long-lasting company.
"That is where longstanding health care venture investors—and hopefully entrepreneurs—will stand to gain."