If Things Are So Good, Then Why Am I Still Starving?

The Paradox of Today’s Early Stage Health Tech Investing Trend

Is VC health tech investing in a slump? Total capital invested in U.S health tech startups reached a new high in Q3 2018 before retreating in Q4, following a typical seasonal pattern. This trend was mirrored for both early stage (i.e. less than $10 million in financing) and later stage. However, the patterns have clearly diverged between early and later stage when it comes to annualized capital investments and individual deal count.

Later stage health tech deals have tallied a consistent annual rise since 2010, accompanied by step-ups in total capital invested. Early stage health tech deal counts rose through 2016, declined slightly in 2017, and fell materially in 2018. Total early stage capital deployed has been flat since 2015. 

This analysis comes from IPHA’s recently released fourth quarterly snapshot of early stage health tech investing. The 35-page report includes 30 charts/tables and reviews data from 2010-18, with a deep dive into the data for 2017-18. You can download the full report by clicking the link below. 

IPHA Health Tech Early Stage Funding Report

I’m Still Feeling Pain

Early Stage Deal Count Decline Is Slowing Down…A Bit

We initiated the analysis because we were seeing a lot of high quality early stage health tech deals that were struggling to close funding rounds. Our initial hypothesis was that we were simply seeing more deals than in the past and that new capital flows were not adequately accommodating the increase. What we found, however, was that there is more money in health tech overall than ever before, but that money has shifted significantly to later stage deals. Early stage deals are closing larger average round sizes, but, early stage deal count has flattened (i.e. fewer deals are getting done). 

This trend is even more glaring when looking at the ratio of health tech investment capital directed toward early stage investments. It has fallen by more than half from a peak 38% in 2013 to less than 20% today. 

When Will This Pain End?

This situation is clearly frustrating for startup entrepreneurs. The paradox is that those companies capable of waiting longer for financing are closing larger rounds. When they graduate into later rounds, funding is more plentiful and valuations are more generous than ever before.

Later stage health tech investors aren’t feeling the pain, according to the data. Since their earlier pre-seed and seed investments have matured, these ventures are enjoying a favorable funding environment. Also, there is no shortage of new deals, making for a robust deal flow. The sucker punch to early stage med tech entrepreneurs hits when funding fails to materialize because there is not enough capital focused on the early stage.

At IPHA, we have generally viewed this current situation in the U.S. as a buyers-market, to the advantage of early stage investors. 

The Future Is So Bright, I Gotta Wear Shades

At IPHA we have little doubt that health tech investing in early (and later) stages will head higher from existing levels through the rest of 2019 and 2020. Excluding minor cyclical bumps in the investing road, the macro trend is clearly in favor of more money flowing to health tech investing over time. Healthcare costs are rising, the sector is growing as a larger percent of GDP, and the industry is continually looking for new ways to improve patient care, reduce risk, and cut costs. Technology is the surest path to addressing each of these vectors.

The deal count declines in early stage health tech appear to be flattening. The future for early stage med tech investing is good. This recent investment trend may cause a gap in the availability of later stage deal volume in 2-3 years since fewer companies will have accessed capital to reach the later growth stage. At that point, we may continue to see a rise in later stage valuations due to funding scarcity. But, just as likely, we may see some of that later stage funding shift back to early stage deals in search of new opportunities at more attractive pricing. We have been and continue to focus a significant effort on investing in early stage health tech companies now.