Digital health’s consistent funding expansion hit a roadblock in the beginning of 2019, with Rock Health, Startup Health and others pegging the year’s first quarter investment below that of 2018.

But that’s not to say that confidence in the sector is also down. A BIO 2019 panel of digital health investors hosted by tech-focused law firm Cooley LLP said that interest among their peers and healthcare’s other major stakeholders is just as strong as ever — it’s just taking a new form as the industry continues to mature.

"I don’t think it’s going to be a bubble in the same way you saw the dotcom bubble,” Wainright Fishburn, Jr., founding partner at Cooley, said Tuesday in Philadelphia. “We’ve [seen] a lot of money go in, we’ve seen a lot of exits, and there’s a lot of duplication in sectors, but I think it’s just a natural tapering off. … This is a sector that is still very hungry for solutions and there’s so much money flowing through.”

During their time at the show, representatives from three venture capital firms provided perspectives on the current state of the digital health sector, what they look for in an investment and how the entry of big tech firms is influencing their behaviors.

A maturing market

“In general, [in] that first wave of companies [from roughly 2012], there were a lot of what we would call ‘cute point solutions,’” Fishburn said while introducing the panel. “Someone who maybe was a nurse in the ER that saw a real problem, or someone who was working with an insurance company, somebody who had a psychiatric practice and saw a problem with scheduling. You’d end up with an interesting company and a point solution that sometimes got enough traction to become a real company. Many times they got enough interest to raise money and become a company, and then the question is 'Did they become a successful exit?' But I think what we’re seeing today is a next generation of companies that’s able to have a much deeper and broader impact into whichever point in the ecosystem.”

As a result of this shift, early-stage digital health investment is no longer the sole domain of venture capital, explained Dr. Dan Gebremedhin, a partner at Flare Capital. Corporate entities ranging from payers to providers to employers are bankrolling the startups that can prove they’ll drive outcomes, or in many cases growing these entities in-house.   

“They’re serving as these anchor customer relationships, and they’ll also invest, but you’ll actually see some of these large entities actually starting companies,” he said during the panel. “You’re starting to see how some of these large corporations … [are] actually attempting to create new entities based on their perspective on the market. You’re seeing it on the provider side, and ultimately when we think about corporate entities entering into this market space, it’s really about connection to the patients: understanding who owns the patient, who has access to the patient data, who is touching the patient along their patient journey. Because ultimately, it’s about activation. You can sell technology, you can sell content, but ultimately if it’s not leading to an outcome, it’s going to be hard to build a big business around that.”

Speaking broadly, the panel agreed that digital therapeutics, system-level platforms, patient-centric approaches and technologies that extend an existing care model (such as telemedicine) will be at the forefront of the industry in the coming years. As for the dip in funding, its the natural result of thoughtful backers prioritizing fleshed-out platforms over a flood of point solutions.

“I think what you’re seeing now is more of the industry reaching equillibrium in terms of funding,” Brett Cook, senior associate at F-Prime Capital, said.

Products need to address stakeholders’ needs

Healthcare is a difficult area in which to introduce a new product, largely due to the inherent disconnect between what payers, providers and patients are seeking, Kapila Ratnam, general partner at NewSpring Healthcare, said. Because of this, it’s important that startups who are seeking backers are aware of what each stakeholder wants, and how each may benefit from the product.

“The vast majority of businesses that we invest in are B2B, and so when we do that we’re always looking to make sure that all the stakeholders are aligned,” Cook said. “And even when you have all the stars align, you’re still looking at 6-, 12-, 18-month sales cycles, and you sell to payers and providers. So it’s really important from the outset that you understand all the incentives and you understand the way the purchasing and use of these products unfolds.”

Complicating matters is the industry’s aversion to major change, Gebremedhin said. The products investors are most interested in are those that clearly address problems severe enough to justify the cost of purchasing a solution, he said, as well as those valuable enough to inspire behavioral change among the people who will use it.

“There’s a lot of problems in our healthcare system, but there’s not a lot of problems where there’s a willingness to pay for a solution, right? So I think that when you think about a product, there’s nice to have, and then must have,” he said. “I used to work at a payer before I was at Flare Capital, and a lot of these large healthcare enterprises, payers, providers, there’s actually an incentive to do nothing because you may disrupt your existing business lines. … So when we look at potential investments in the health tech space, we’re looking for kind of 10x improvement in the overall workflow that they’re touching. A great example of that is our business Aetion … you’re taking analyses that would take three months and they take three days. That’s at least 10x improvement.”

That being said, the form of the solution will also go a long way toward its appeal to backers and customers alike. A robust, multicomponent product is more likely to make a splash than something simple.

“My experience — not just with our portfolio company, but companies trying to sell into payers and providers — [is] that you absolutely need to marry both services and technology,” Ratnam said. “It’s generally hard [to succeed] anyway, but it’s particularly hard to sell pure software. When you wrap software around services or services around software it’s a much easier sell because you’re selling a more comprehensive solution.”

Big tech a small concern

There is one more straightforward reason why investors might be most interested in solutions that combine health services and tech — the threat of tech giants stepping in and handling the latter component more gracefully.

“I think we don’t invest in hardware [because of] the ability of those entities. Once they define a market focus that they want to go after, that they can definitely achieve, they have the money to lose in order to get there,” Gebremedhin said. “But there’s another frame that we think about, and it’s this concept of consumerism. Historically, large healthcare enterprises, consumerism has not been their strong suit, whereas these large tech giants, that’s really where I think they shine, understanding the needs of the consumer.”

Still, Gebremedhin said that he didn’t see big tech stepping into “the guts of healthcare,” as chronic condition management or care delivery would be outside of their area of expertise. It was a sentiment generally shared by the rest of the panel, who said that, barring certain exceptions, they don’t fear the impact of big tech on their specific investments.

“Where we need to watch out for the Amazons and the Googles of the world is not so much the impact that they have on healthcare tech, but more along the lines of what they’re doing with their own employee population and as self-insured employers,” Ratnam said. “They’re trying to manage their own costs. … But in terms of general investing in digital health, I see some interesting things coming out, but I don’t see that affecting our investing thesis very much.”