Market Review for Venture in 2023 with a focus on Healthtech Investing and Europe

2023 is behind us and what a year it was. Let’s review the year in digital healthcare investing and find out how much we achieved, despite the challenging environment.

We have started 2023 recognising the resilience of the market, in particular the health side.

In 2023 that resilience made way to a correction. Market volumes have come down and many investors went to the sidelines or home.

Venture Funding overall in the US and Europe

2023: review

Based on CB Insights the Global Funding number is down to 248bn from the high in 2021 at 648bn a drop of 62%. Compared to last year 426bn it is a drop of 42%. We are back to 2019 levels and seem to have stabilised given the last 5 quarters are consistently between 50 and 70bn.

Pitchbook, as always, offers good numbers on US and Europe with US ending 2023 at 170bn down 30% from 242bn in 2022 and down 51% from the high in 2021, at 348bn. Europe ended 2023 at 57bln down, 46% from 105bn in 2022 and down 48% from the high in 2021 at 110bn.

Overall VC numbers are back to the 2020 level and have given up all the hype funding inflows seen during the pandemic.

How did we get here?

Many reports are coming out looking to explain this drop and identify the US VCs disappearing from the European side, the non-standard investors dropping out, or other reasons. These all have a role to play. Some of these have shown a similar drop compared to the overall market. Such a parallel development does not serve as a good explanation. Digging deeper, reports show a clear drop in the later-stage funding rounds and within that a drop in the large rounds. We can conclude the drop is most explained by later-stage rounds getting smaller, or fewer very large rounds. It looks like the interest has waned to provide large sums to late-stage startups in expectation of fast growth and quick returns.

Not a surprising change in expectations, given the economic environment and the higher capital cost / higher competitiveness of other asset classes.

Let me propose a different perspective from the longer-term VC ecosystem. The steep 3x growth from 2019 to 2021, followed by a 60% drop from 2021 to 2023 reminds us very much of the peak recorded in the dot.com bubble (late 90’s to 2002).

The volumes then were jumping 10X from 1997 to 2000 and dropped 90% from 2000 to 2002. At the time, this was driven by a hype in expectations and capital overallocation to the asset class in the run-up. The correction was because many of these investments did not deliver on the high expectations. That disillusion led to many investors moving away from the asset class. Given the limited supply of startups, such an inflow of capital leads to excessive valuations which will reduce returns. In particular, inexperienced venture investors will accumulate bad investments. They conclude that the asset class is not able to deliver so they leave it for a long time. In particular, in Europe, it took up to a decade for investors to look at VC investing with a neutral perspective again. Compared to the dot.com bubble, this peak did not climb as high and so far, nor drop as low. We can hope the aftermath is not as drastic as 22 years ago.

2024: Influences and Outlook

Drawing parallels from the dot.com period we can expect some of the effect dominating the next year or two.

1. Private assets correct their valuation more slowly than public, leading to overallocation of the private assets beyond their target and therefore a reduced appetite to invest in private assets. This will be resolved over time by (i) funds returning capital to their LPs and (ii) the public assets growing in relative value and (iii) additional capital aggregation.

2. Money invested at the peak likely was invested at valuation, which cannot be maintained or earned in the short term. Returns for these investments are likely unattractive and maybe negative. Experienced investors understand this relationship and have kept to a balanced investment pace to avoid investing disproportionately at unattractive valuations. Less experienced investors might have overallocated at the peak and will suffer from bad returns. New investors with only the last 2-3 years of historic comparison might conclude that this asset class is not attractive. In the past, this group took away a very negative perspective of VC investing and took a long time to return as investors.

3. VC funds and GPs will have to prove they can deal with changed circumstances and produce reasonable returns from their portfolio. Investing reserves at corrected valuations will enable them to generate good returns across the fund. These decisions will be tough and will include triaging of portfolio companies. GPs without reserves will be challenged to generate good returns and raise new funds in this environment.

4. Funds raised now and portfolios built in this new normal will be performing very well. The VCs will be able to benefit from low valuations and lower competition for deals in the next two years. Expertise in their sectors and a proven track record to support their companies in difficult times will be winning traits in this competition.

GPs with great track records are built in these environments.

5. Exits will be difficult, in particular, IPO will be off for 12-24 months. M&A activity will come back more quickly as companies are maturing and demonstrating value to a strategic acquirer. Many strategic buyers have been waiting for better pricing of assets for the last 2-3 years. They are ready to deploy their war chests.

Digital Healthcare and Life Sciences 2023: Review

On the Digital Healthtech side, we are still waiting for some of the analysis, but it is clear to see the subsector has corrected across the board back to levels seen in 2019, before the funding inflow during the pandemic.

CB Insights has published a worldwide overview of the subsector and shows 13.2bln funding in 2023, even lower than the 17.9bn in 2019 down from 52.7bn (-75%).

Rock Health has already published the view for the US and volumes are back to levels of 2019 and 2020. At 10.7bn for 2023 we are down 30% from 15.3bn in 2022 and down 63% from the peak in 2021 of 29.2bn. If we look back over 10 years we are still up from 4.5bn in 2014 where we had a more steady increase to 8.1bn in 2019. The attention brought to the subsector by the pandemic is visible. The end of the pandemic might explain the shift in attention away from the segment again.

The digital healthtech and life sciences segment is subject to the overall venture environment. As the data shows, the drop has been in line with the overall market. We should keep in mind how far the segment has evolved over the last 10 years. Yes, we have just had a big correction, but the segment is still more than double its size from 2014, in particular in Europe.

Even more than the general VC funding, Digital Healthtech has achieved a lot of attention and interest due to the Covid pandemic. This attention and funding pushed the industry towards adoption and overcoming the slow pace of transformation from before the pandemic. What that general view misses is the underlying evolution of the segment. The broad availability of funding has allowed for many ideas to be tested. Both customers and founders have learned what works and what is needed. In the last 5 years, the products and solutions have proven themselves and companies have developed.

The ongoing correction in the funding environment will emphasise focusing on proven businesses. The continued high number of seed deals indicates the seed investors are still supporting new founders, but will focus on products that integrate the learning from the first wave of companies.

For companies, 2023 was a year of persistence. Continue to work towards key milestones, do it with the money available or only with small add-on funding, resize to a sustainable level and prioritise intensely. As Rock Health points out, we have seen many not labeled rounds or insider rounds in 2023 as regular fundraising was not available.

2024: Influences and Outlook

For 2024, the funding environment for existing companies will remain difficult. In particular, the valuation levels will revert to a lower level. That has not been recognized in many cap tables or fund reports. Down-rounds, flat rounds, and non-labeled or not-priced rounds will continue to happen in 2024. The most proactive companies and those in need of funding did have to accept down-rounds as low as 50% of prior rounds. Many continue to kick the ball down the road with bridge loans and insider rounds. Some even try to maintain high valuations by setting terms at high price points but with drastic punishing terms (ratchets and liq preferences). In 2024 that postponed reality will be hard to maintain and the winner will be the ones moving forward into the new reality.

For Investors, it is an interesting moment. Rebuilding the cap table and redefining the active syndicate is a key process in each portfolio company. Building the future with fairness to the past will be key to building great portfolios but also a great reputation for the GP.

Exits

On the Exit side, 2023 was an extension of 2022, slowing activity across the board. Based on CB insights, we are looking at a large drop in IPO and SPAC activity and a 25% reduction in M&A transactions. Industry players continue to acquire innovation from the startup ecosystem and in 2024 we should expect continued activity at the level of 2023. IPOs will likely return only when the stock market remains solid and the economic outlook demonstrates continued improvement.

For GPs and their LPs, the slow cashflow back into the pockets of LPs is a drag to the fundraising for VC funds. We should expect this to pick up in 2024 again, but the available pool of funds to be recommitted will be limited in 2024.

Conclusion

It is up to the ecosystem to manage this environmental shift well. Old hands like Vi Partners will be around to support founders and co-investors to enable the continued transition of the healthcare and life science industry.

The market will work through this in 2024 and we hopefully will see the first signs of normalisation and up rounds for the successful. We should be ready to see 2024 as a transition year as well. Less hectic than 2023 but back to work rather than back to party. The work is to find and build the next 5-year overnight success.

Swiss Perspective add-on.

On Jan 30th startupticker.ch and SECA published their report for 2023. Funding was 2.59bn down 35% from the high in 2022 at 3.97bn. This drop is lower than the global one and about in line with the European development. The most dramatic change was in ICT (-69% from 1157mn down to 361.7mn) and Fintech (-53% from 909mn to 424mn).

All of Health and life sciences (bio-, med- & healthtech) even gained 4% (869.7mn to 908.2mn). It did see a large shift to biotech and in particular medtech and away from heathtech. The last segment lost almost 160mn, a fall of 80% (197.3mn to 37.8mn). As we had already analysed last summer,the 2022 numbers were dominated by the 97mn fundraising of MindMaze. In 2023, healthtech did not have any round included in the top 20 (>30mln) indicating most of the segment is in earlier stage, or managed to extend their cash and not fundraise in 2023.

Overall, the Swiss ecosystem showed strong resilience and a wiliness to invest across all segments in difficult times as well. This again shows how far the Swiss ecosystem has come since the last challenging time after the great depression.

2024 will be an important year for the Swiss ecosystem and in particular for the healthtech ecosystem to prove it can weather the storm and continue to build a strong future.

Thanks and Acknowledgements

Thanks to rockhealth.com (2023 funding report) for your great overviews of the digital HC&LS industry. Thanks to Startupticker.ch and SECA for the specific Swiss data (Swiss Venture Capital Report 2024). Thanks to CB insights for the global view (State of Venture).

And obviously, pitchbook.com for their excellent market overviews (European Venture Report & Q4 NVCA Venture Monitor).

To avoid the general confusion of what is the new early and that nobody wants to be late anymore reference to stage is based on Pitchbook terminology. Seed are all rounds prior to A. Early is A and B, Late is C and D and Venture Growth is E and later.