For the better part of the last two-plus years, my colleagues and I at 7wireVentures have been asked as investors if health care — and especially digital health — is in a “bubble.” Though these conversations rarely reach a satisfying conclusion, the attention given to investing bubbles is understandable.
As a sector, digital health has witnessed a litany of record-shattering milestones over the past two years, with tailwinds from the pandemic ushering in an influx of interest that has been long overdue. The sheer number of investors participating in the digital health market grew by 43%. Increased investor focus on digital health led to a monumental $30.7 billion in venture capital funding being deployed in 2021, representing a whopping 107% uptick from 2020 levels. In the last two years alone, average valuations have tripled to $73 million and helped grow digital health unicorns to a cohort of 85 companies. To say the sector is “hot” is an understatement.
The latest funding numbers, however, indicate that a market correction may be underway. Geopolitical unrest, energy shocks, and rising inflation, among other extrinsic factors, have recently fueled investor restraint and caution. Following 2021’s blockbuster year for digital health, Q1 funding in 2022 fell to $6.0 billion, 18% lower than the preceding quarter and the first time in a while when Q1 funding did not exceed the preceding Q4.
Is this a harbinger of a bubble about to burst? A reflection of public market volatility? A sign of exuberance coming to an end? Or simply a representation of investor discipline?
Digital health just had a record year. But is a day of reckoning ahead?
I and other industry watchers will be able to answer those questions in a few years. Right now, with the myriad of possibilities and probabilities, attempting to understand whether the digital health market is aflush with too much capital or the market is finally having its moment in the sun, only time will tell.
A short history of bubbles
Famously, Yale economist and Nobel laureate Robert Shiller accurately predicted both the dot-com bubble in the early 2000s and, 10 years later, the housing crisis. Few of us, though, are Nobel laureates in economics. Studies show that, on average, prognosticators and self-described “market gurus” are right less than 50% of the time — slightly worse than a coin toss. Though made in jest, physicist Niels Bohr’s often-quoted comment, “Prediction is very difficult, especially if it’s about the future,” seems to ring true here.
Simply put, an economic bubble is characterized by a rapid rise in market value that is disconnected from an asset’s fundamental or intrinsic worth. As the metaphor suggests, this precipitous rise is often followed by a steep decline in value. While the benefit of hindsight may describe a spectacular “pop,” the bubble bursting is typically more akin to a slowly deflating balloon.
Financial bubbles are typically considered a common feature of free-market economies. American economist Bill Janeway goes as far as to note that the first law of financial bubbles is, “that they are ubiquitous and therefore they are banal.” Wherever markets and assets exist, he continues, “there we will find herding behavior, momentum investing, and prices decoupling from any relationship to cashflow past, present, or prospective.” In other words, the very nature of investment will often expand and constrict economic bubbles.
The “bubble” phenomenon is far from uncommon. From the Dutch tulip bubble of the 1630s, aptly coined “Tulip Mania”, to the more modern Dot-com bubble of the 1990s and U.S. housing bubble of the mid-2000s, history has been peppered with a series of market speculations and crashes. Since the first century, there have been no fewer than 80 economic crises globally, including 26 in the 21st century alone.
As an industry, health care has generally been resilient in the face of economic downturns and has typically been viewed as a defensive sector relative to the broader market. During the Great Recession, from December 2007 to June 2009, for example, while national employment decreased by 6.9%, employment in health care actually expanded, increasing by over 850,000 jobs, or nearly 7%.
Health care companies play in a fundamentally unique market, one that has presented innovators with decades worth of problems to solve with the industry itself before placing outsized focus on market externalities. One could easily spend a lifetime trying to build a system that empowers consumers to become better stewards of their health care journeys and feel that they have only scratched the surface. Thus, as business cycles come and go, investors and entrepreneurs must guide themselves toward a shared true north of building great companies, leaving the prediction work to the coin flips.
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A message to entrepreneurs
There appear to be two fundamental truths for all markets, regardless of the business cycle: 1) businesses solving truly meaningful challenges through strong execution will receive the lion’s share of financing and 2) valuations will inevitably fluctuate.
While investors can opine on the burning question of whether digital health is currently in the midst of a bubble, entrepreneurs don’t have the luxury of playing Nostradamus. They have open positions to fill, team members to motivate and lead, contracts to negotiate, new products to develop, additional markets to enter, users to support, funding to secure, and more.
That said, they are not immune either. It is unreasonable to ask a founder or entrepreneur to ignore the potential of a digital health bubble. Rightly or wrongly, the mere specter of a market correction fundamentally upends their ability to raise capital and grow their business. Where things get trickier is figuring out what we should be asking of entrepreneurs. At the end of the day, they have businesses to build. Consequently, they must consider the various risks and probabilities, focus on what they can control, and execute. Execution is everything.
My message to digital health entrepreneurs is a simple one: Build sustainable, category-defining businesses, look to your investors for expertise and guidance in addition to financing, and continue to drive impactful change in health care. Everything else is just noise.
Since time immemorial, people have consumed countless hours trying to predict the future, yet we haven’t come a step closer to doing so. Entrepreneurs, unless you’re Robert Shiller, spend more time working together to build businesses and less time gazing into the crystal ball.
Alyssa Jaffee is a partner at 7wireVentures, a Chicago-based venture capital firm investing in digital health companies.