As public markets sell off and gloom replaces the euphoric optimism of 2021, some have come to question the sustainability of venture-backed digital health (here and here, for instance). In particular, some question if care delivery businesses — with more headcount and less operating leverage than many software businesses — can meet the required return profile of venture capital funds.
On one hand, healthcare is a $3.8T industry, of which approximately 80% goes toward care and treatment today, per Deloitte. It is well documented that American healthcare costs are unsustainable long-term, resulting in the need for technological and system-wide innovation. Optimists would argue that entrepreneurs are already building businesses achieving decreased cost of care and increased access to care, in many cases leveraging venture funding. Though recent markets have not been kind, several care delivery businesses have already reached the public markets or been acquired for billion-dollar outcomes (Livongo, Amwell, Hims, Ginger/Headspace), while several private companies have reached billion+ dollar valuations (Hinge, Lyra, Thirty Madison, Ro, Cityblock, Carbon Health, Sword Health, Everly Health, Spring Health, among many others). Venture funds have found opportunities that support billion-dollar outcomes.
Yet some may argue care delivery businesses face structural disadvantages that preclude venture-like returns. For instance, care delivery businesses require a clinical workforce, resulting in a lower margin profile as well as lower EBITDA margins as a result of additional SG&A costs associated with maintaining the workforce (not to mention the challenges of managing utilization of that workforce). Additionally, state-by-state regulations may make it hard to scale a workforce across state lines among myriad other regulatory complexities. By comparison, software companies in other sectors typically do not face these challenges.
Public comparables demonstrate the different financial profiles. A basket of digital healthcare companies achieved a median LTM gross margin of 46% vs 74% for a broad basket of public software companies. Even though digital health companies are growing faster on average (35% vs 32% NTM forecasted growth), the public market ascribes a discount to the public digital health basket on a median NTM revenue multiple basis (3.2x vs 6.5x).1
Given these fundamental challenges, should care delivery models be venture-backed? At Greycroft, we certainly believe so, but only if the model solves a few core challenges. Below, we’ve laid out these challenges in an effort to support founders who are considering a fundraise in today’s more skeptical funding market.
 Calculated from 1/3/2022 to 6/24/2022; Basket consists of 10 public digital health companies: ONEM, HIMS, AMWL, OSH, GDRX, OM, TDOC, SGFY, PGNY, ME. Basket of software public comparables from Clouded Judgement’s index.
1. Built-in “Churn”
Many treatments that are condition-specific (vs. primary care) are episodic or transactional in nature. After a handful of treatments or a time-limited standard (e.g., a 12 week program), patients may no longer require treatment. We celebrate models that deliver a one-time treatment that resolves a patient’s issue in a cost-effective way. Yet disease states that are treated episodically require a unique model to generate defensible unit economics. We look for businesses that acquire (and retain) patients and provide care efficiently, resulting in strong gross margins and quick payback periods. While a recurring stream of revenue is appealing, ultimately businesses will be valued on their ability to consistently generate free cash flow. Indeed innovative business models have unlocked substantial outcomes in other “one-time” or “episodic use” spaces:
- Dating → Bumble ($6.2B mkt cap)
- Leisure travel → AirBnB ($69.3B)
- Job Boards → ZipRecruiter ($2.0B)
Moreover, many disease states have an acute phase followed by a maintenance phase. The acute phase can require more intensive care and interventions, but is also typically covered by plans. Sustainable payment models for the maintenance phase are difficult to achieve before companies have significant scale and outcomes data to use in negotiations. In a value-based world, companies are compensated for improving outcomes and reducing costs, yet few digital health companies today have attained scalable at-risk contracts.
2. Hard and Calculable ROI
For venture-backed care delivery businesses to reach massive scale with attractive unit economics, they must find ways to sell into employers, payors or work with government-funded entities (Medicare, Medicaid or Veterans Health Administration). Stakeholders in these ecosystems are overwhelmed by the number of solutions. In order to win pilots and contracts, businesses must show hard and calculable ROI as quickly as possible in prioritized areas of need.*
For employers, improving employee engagement, productivity, retention and attendance can show the value of an offering. For instance, Spring Health and our portfolio company ianacare recently released clinical studies (here and here) demonstrating their impact on employer populations. Moreover, working with an employer to prove out these metrics can also provide the data to then demonstrate value to payors. Payors could be even more stringent in their calculations of ROI. To sign a contract with a payor, clinical outcomes are key: A1C scores, high spend episodes, post-surgical readmissions, emergency room visits, among others.
While the employer and payor channels are well established, digital health is just beginning to tackle the Medicare and Medicaid markets, both of which are large addressable markets ripe for innovative solutions. As is popularly publicized, around 20% of the population drive 80% of costs, yet we often see solutions targeting 80% of the population and 20% of the costs. As digital health matures, we expect ambitious builders to address the Medicare and Medicaid populations, higher acuity modalities, and high spend categories — doing so with solid unit economics will require a clear understanding of how the solution is decreasing cost while improving outcomes. Ultimately, once the care delivery model is proven, we expect businesses to align incentives and capture better economics by taking on risk.
3. Speed to ROI
We don’t believe our system is currently set up for preventative care. With employer-provided care still dominant, and the 24–35 year old cohort spending an average of 2.8 years in a position, payors and employers may not want to pay in year zero for results that accrue in year two, three, or four. Speed to ROI is important, and early indicators matter.
We have found that ROI that can be demonstrated within the contract period (often one year) is an easier sell (and renewal, particularly in budget-constrained times). We recognize that transformational change cannot often be demonstrated in a quarter or two but being cognizant of incentives and drivers for the buyer set remains important.
4. Step function improvement in care delivery and outcomes
In healthcare, distribution is important, often leading to a single-minded focus on payor or employer go-to-market. However, first and foremost virtual or hybrid care models should provide a step-function improvement for the patient — there must be clear evidence that the model delivers a better patient experience, leading to higher adherence and better outcomes (which ultimately accrues value to all parties). As a result, we look for models that ought to be delivered in a novel, integrated, and tech-driven way, not models that simply bring offline models online.
For instance, we recently invested in Arise, a seed-stage startup addressing eating disorders and co-morbid mental health needs. Their model integrates community and clinical care, and utilizes a Care Advocate to coordinate therapists, dieticians, psychiatrists, and medical providers to holistically care for a patient without removing them from daily life. We’re excited by models like this that de-silo fragmented offline care and extend today’s limited clinical workforce.
While the characteristics above are not exhaustive, we hope that these guideposts are informative to founders building today (alongside our piece on the digital health tech stack). Despite the pessimism in today’s market, we at Greycroft believe that innovation will drive better outcomes and better patient experience in the decades to come. We fully expect to continue investing in businesses with ambitions to create true step function change in care delivery.
If you’re building in the space or have thoughts on our framework above, we’d love to hear from you! You can follow us on social media (Ellie Wheeler, Sharla Grass, Massimo Pennisi, and Tyler Olkowski) or reach out directly at email@example.com!
Last, we’d like to thank those who helped us iterate on this piece, particularly Amanda D’Ambra (Co-Founder and CEO of Arise), Sandeep Acharya (Co-Founder and CEO of Octave), and Lisa Kennedy (Founder and CEO of Innerwell) for their suggestions and insights.
* Many potential partners (payors, employers, government organizations) are focused on a limited set of priorities. Those building in must-need areas benefit from inertia and need, while those building in deprioritized areas may struggle to gain traction in spite of strong ROI.
Disclaimers: Companies noted throughout are not all Greycroft portfolio companies or affiliates and are intended as a curated list of providers in the relevant spaces.
The portfolio companies identified and described herein do not represent all of the portfolio companies purchased, sold or recommended. The reader should not assume that an investment in the portfolio companies identified was or will be profitable. A full listing of investments can be provided upon request. Past performance is not indicative of future results. This is not a solicitation of an offer to purchase securities and may not be relied upon in connection with the purchase or sale of any security.
This publication has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. The information in this document has been developed internally and/or obtained from sources believed to be reliable; however, Greycroft does not guarantee the accuracy, adequacy, or completeness of such information. Greycroft does not assume any duty to, nor undertakes to update forward looking statements. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.