Early-stage health tech funding grew in 2022 even as overall investment dropped, according to Silicon Valley Bank's Healthcare Investments and Exits report.

The analysis found companies raised $3.2 billion in seed and Series A rounds across 485 deals in the U.S., UK and the European Union, just inching above the $3.1 billion raised across 503 transactions in 2021. 

Though 2021's funding totals broke records, it was certainly an outlier, said Jonathan Norris, managing director for business development in SVB's healthcare practice and one of the report's authors. 

But he said there's still plenty of investor interest in health tech. Norris sat down with MobiHealthNews to discuss why early-stage dealmaking held steady last year and how startups should approach funding in 2023.

MobiHealthNews: Looking at the health tech segment, what are some of the main conclusions and takeaways you drew from funding in 2022?

Jonathan Norris: One is that the seed, Series A side of health tech continues to see really healthy amounts of investment. In fact, if you put it as a full-year number, it's actually the highest it's ever been. You're seeing a lot of these early-stage investors hiding out in seed, Series A because it allows them to not have to worry about these 2021 valuations that we saw in the market that we have to deal with at some point. But it allows them to do early-stage, reasonable valuations. It also allows them to finance 12 to 24 months out and potentially think about that next round being on a little bit of an upswing outside of a down market.

I think the second one is when you do look at overall investment in the sector, it's down pretty significantly from 2021. But really, 2021 should be seen as an outlier year, and that's across all the different healthcare sectors. Every single sector saw records set in the number of companies, dollars invested. We had records set in venture fundraising, we had records set in number of IPOs and M&A. It's an outlier year. 

How do you balance that versus what you saw in 2020? You can see the first half of the year was pretty strong. The second half was a little bit lower, but still kind of in that 2020 pace. So I think you were seeing, one, it's going back to a reasonable pace of 2020, which was sort of the record before 2021 happened. So it's still a very healthy pace. Two, I think the reduction is a sort of a right-sizing away from 2021. 

But it also has to do with investor time and focus. Because what was happening in 2022 was investors really taking a look at their existing portfolio companies. What companies need funding? What companies can raise outside funding? And if they can't raise outside funding, what does an insider round look like? Do we need to think about a change in the business plan? Do we need to think about a change in cash burn? Do we need to think about a full pivot? And so those really took the time away from considering new investments. 

And then frankly, just because we saw the public market change so much in terms of comps, it was really hard to think about a late-stage valuation, even if you did want to do a late-stage deal. So that all equaled a less active, less dollar-laden 2022 versus 2021. But still a fairly good year in terms of dollars being deployed. And it just belies the fact that there's so much capital out there, and there is a ton of interest in the sector.

MHN: You noted the shift to those earlier-stage companies and investments. What do those companies need to do in 2023 to keep momentum, especially if the later-stage deals stay stagnant?

Norris: That's been an interesting focus for us, not just on the companies that did receive investment in 2022, but also the companies that raised in 2021 and late 2020 that had to figure out what Series B was going to look like for them. A lot of times, they ended up doing insider rounds and pushing out that Series B fundraise. 

What we saw here — and I think it's similar in biopharma as well — is that the milestones that enable that next round have shifted. New investors can push these companies to do more. [For example,] we need to show conversion from the pilots to commercial contracts. We need to have a backup plan to profitability, which seems like a crazy thing to talk about for a Series B, but still. We want to see revenue. And we want to see what it looks like when you step on the gas and go really, really fast and grow revenue. And what does it look like if you're going to cut the burn a little bit and just focus on growing it at a slightly reduced pace?

There's really a lot more focus on, what's that revenue plan? What's the benefit that you're really providing your customer? And can you quantify it? Because that's really going to be where the rubber hits the road for health tech. You really have to focus on performance, but you also have to focus on reducing costs and showing real outcomes. To me, that's really the story of what unlocks that Series B in terms of the health tech sector, and that's really going to need to be the focus for these companies.

MHN: You said it seems a little crazy for a Series B company to have a backup plan for profitability. Do you think that's going to be hard for a lot of them to show that they're really reducing costs or they have good health outcomes or they have a plan to profitability at that stage?

Norris: Yeah, it's going to be a challenge for sure. I think it really builds into the question of, has this sector been overfunded? And the answer is yes, but I don't think that's any different than any other healthcare sector. But health tech is overfunded, and it was overfunded at what you would say were aggressive valuations in 2021. Now you would look at them and say, frothy [valuations] because you're looking at what companies are valued at today. 

I think it's going to be a challenge. I think folks can meet it, but I also wouldn't be surprised to see some consolidation in the sector, even on the private/private side. Two companies that have interesting technologies that are in more of a niche market coming together to maybe build into a platform technology. Some of these really large, highly valued private companies that do have a lot of cash and are looking to expand their platform, either with new technologies or adjacencies, or even acqui-hires [purchasing a company mainly to acquire its employees].

It's really because there's only so many spots for new investments out there. Even though venture investors are flush with a new fund under management, they've been told by their LPs [limited partners] to slow the pace down, and we've definitely seen a slower pace. 

So there are dollars available for great companies. The questions are, how much available capital is there for good companies that are showing progress? And the answer is, it depends. It depends on the space that you're in, what milestones you've hit and what your plan is going forward. 

It's not possible to sustain the level of investment that we had in 2021. So it naturally comes down to, how do you create the best company you can? And sometimes that's going to be through consolidation.