VC Experts: Funding Healthcare Deals Remains Complicated
A recent report by leaders at the New York City-based Deloitte, entitled “Road to Next: Exit avenues: the era of inside and down rounds,” focuses on current trends around venture capital, and a current “liquidity squeeze” that is impacting what kinds of profits can be made on dealmaking across industries.
In their opening summary, the report’s authors write that “Bottlenecked exits are starting to flow again, liquidity is still top of mind.”
Key findings of the report:
Ø Exit activity has always been a critical metric for private markets, but the unique confluence of factors that has emerged over the past 18 months is increasing attention on the recent liquidity squeeze and, perhaps more importantly, the path back to stronger dealmaking.
Ø The liquidity spigot has begun to trickle again, and growing sentiment assumes that the worst of the dealmaking slump may be over. Markets are pricing in interest rate cuts before the end of this year, with early signs of economic cooling after a prolonged battle against inflation. Public market rallies in the first half of 2024 provided encouragement for companies waiting in the wings for their listing debuts.
Ø In the meantime, however, most companies are finding it necessary to consider alternative liquidity options. A growing number of inside rounds and down rounds are closing as expansion-stage companies seek out more efficient financing. Post-initial public offering (IPO) secondary transactions, referred to in the report as “liquidity events,” also grew in popularity as some investors approached liquidity and portfolio management more creatively.
Ø The software-as-a-service (SaaS) and life sciences verticals drove the majority of expansion-stage exit value in the first half of the year, while the health tech and AI and machine learning (ML) verticals experienced the strongest gains. Several transactions worth more than $1 billion each closed, representing growing interest in areas including glucagon-like peptide-1 (GLP-1) obesity treatments and AI-enabled software platforms. AI maintains its grip on several industries, with no signs of pulling back in the next few quarters.
The report also notes this: “Compared with 2023, expansion-stage exit activity has demonstrated greater momentum in 2024, with Q2 notching the highest quarterly exit value since Q4 2021. Total exit value for the first half of the year nearly doubled compared with the same period last year, suggesting that the market may be on track for its first year of growth after two years of declines. The ‘wait-and-see’ approach that many companies took in response to the market correction has been stretched to its limits by the Federal Reserve’s (the Fed’s) “higher-for-longer” interest rate strategy. The result has been a tepid reentry into exits for the expansion stage for two primary groupings: stronger companies seizing what they see as a window of opportunity despite headwinds, and undercapitalized companies that move forward with transactions out of necessity.”
Per all this, Professor Patrick Vernon, a clinical professor of strategy and entrepreneurship and director of Venture Capital Investment Competition at the UNC Kenan-Flager Business School at the University of North Carolina-Chapel Hill, explains in a recent article that “Another word for exit is a liquidity event, referring to the conversion from an illiquid asset (equity in a startup) into a liquid asset (cash), required by our LPs. Ultimately, for VCs this means our investments must be sold, and there are effectively only two options for a successful exit: be acquired by another company for cash and/or publicly traded stock that can easily be traded for into cash; or go public via IPO, initial public offering, thus turning illiquid private stock into a publicly traded stock.”
In the context of all that dealmaking, Editor-in-Chief Mark Hagland spoke shortly after the report’s publication with two Deloitte leaders who have expertise in healthcare and understand how these dealmaking trends are playing out inside the healthcare industry: Heather Gates, national emerging growth company leader, and Peter Micca, partner and national health tech leader in Deloitte’s Life Sciences and Healthcare division. Below are excerpts from their recent interview.
The report discusses the “liquidity squeeze” and its impact on dealmaking. Let’s start at 40,000 feet up: most broadly, how do you see the landscape for dealmaking in healthcare right now?
Heather Gates: There’s no industry that’s free from being impacted by the overall squeeze. I refer to this year as the year of the bottoming-out of valuations. Companies that raised crazy valuations in 2021-2022, can’t do that any longer. So you either raise a new round, and it will likely be flat; “flat is the new up” in most cases. There are also inside rounds, where they can’t get a new investor. So VCs have to double down on certain investors and let go of others. Healthcare is like all sectors in that regard. That’s really the first half of the year. I’m seeing an uptick in M&A activity, and more companies preparing to go public. I’m optimistic for the future.
Peter Micca: The macro-trends certainly apply to healthcare as well as other industries. Healthcare is different, though, because there is a third-party payer. But the demand for innovation in healthcare far exceeds the supply, because HC has been a very late adopter of technology, and most of it has been in device-based technology until recently. So it behaves differently, at the most granular of subsectors. Take telehealth as an example: during the early stages of COVID, there were hundreds of telehealth companies. Most industry sectors converge and consolidate over a multi-year period. The telehealth sector consolidated in six months to four major players, and valuations dropped precipitously.
And we see a movement away from point solutions; there were literally thousands of point solutions emerging during the COVID pandemic. The payers and providers who buy those services got very confused and didn’t know where to start. The market leaders did their own transactions and made acquisitions. So those emerging companies had to deal with some level of provider burnout, and had to develop a more succinct, valid return on investment for the buyers of the technologies and services, and had to merge with other companies. Right now, if you’re a point solution, it’s a really tough market, you’re not going to be able to raise adequate capital and get to a B or C round. So tremendous interest in previously underserved markets like women’s health and mental health and early-stage diagnostic capabilities that align with the mega-trends in HC, around value-based care. The reality is that you can’t really move to VB arrangements without the data and analytics.
Have we seen a peak of for-profit companies coming in from outside the core bricks-and-mortar provider sector in healthcare?
Micca: It gets back to my opening comment, that healthcare doesn’t behave like other industries. How much healthcare do you want, and who’s going to pay for it? Every single day, new therapies, dugs, diagnostics, are created. And thus, the unit cost keeps going up. The only way to bend the cost curve is to deny or regulate access, or use technology to manage costs. The disruptors vastly underestimated the costs of delivering primary care and overlooked many of the challenges. The reality is that healthcare is a very local business, and the Medicaid regulations differ in every single state. Will there be a movement away from primary care? No, but there will need to be better alignment o the physicians; that’s the challenge. You can’t regulate physicians, only nudge them.
What about the consolidation of primary care provider entities?
Micca: We think it’s going to continue; we see larger health plans getting further involved in consolidating the primary care practices. The consumer is thirsty for trust. And when you look at the surveys around whom consumers trust, health plans, insurance companies, like cable companies, are at the bottom of the list. But they still trust their physician. Ironically, the large retail primary care organizations engendered trust. None of those companies knew how to manage the cost of care. So we see consolidation continuing, but perhaps in different forms.
How different is healthcare from other industries, in all this?
Gates: The multi-party interdependencies between insurers, doctors, etc., make it very different from other industries. We did a report on the financial services industry. It was a similar discussion around disruption and adding capabilities or acquiring them. It’s also a highly regulated industry, but if as a consumer, I have a bad banking experience one day, that’s one thing; but if I have a bad healthcare experience, there will be hell to pay. So as Pete noted, it’s very complicated. There’s passion in a lot of industries, but this one gets down to really personal needs, and of course, there’s regulation.
Micca: If you took Bill Gates when he was creating Microsoft, he acknowledges that he made thousands of mistakes in creating platforms and technologies. There’s no room for that in HC; and it’s considered as close to a person entitlement as possible. There’s an inherent belief that everyone deserves it. And really, someone’s got to pay for it. With an iPhone, you can say, I don’t want the bells and whistles; you can’t do that in healthcare as a consumer; though there are sectors—pet health; that’s not an insured product. Consumers do have to make tradeoff decisions. But they’re not qualified to make a tradeoff decision when it comes to their health.
How fast can these shifts take place in healthcare?
Micca: On the Ozempic costs, the total cost per year of providing insurance for the new class of weight-loss drugs has been estimated to be potentially as high as $1 trillion per year; that’s not sustainable. The vast bulk of that is a cosmetic consumer product. It’s just too big a price tag. And so that part, to get to that kind of scale, we’ll never get there. But speed-to-market?
I’ll distinguish between logistics and distribution and true care delivery. Amazon has Pill-Pack, for example. Those kinds of processes will go forward, but if you look just at the care delivery component, it’s not going to be as fast as the consumer wants it to be. It will always take longer. The validation process to ensure quality in care delivery, takes longer than what people want. The distribution and logistics work always happens faster.
Gates: When COVID happened and we saw this massive shift in a short period of time that hadn’t happened in the prior 20-30 years, it was automation of things that we hadn’t perceived as being able to automate, and those things happened fast. But everything else will be a slower haul. It’s much more complicated.
Micca: Think about the impact of the global markets, the impact of global innovation that will get exported to the US. And typical global markets have single-payer systems. Ironically, that will drive the costs up short term, that and AI. AI short term, will actually increase the cost of care, because it will create more supply and therefore more demand, though over time.
