From left to right, Doug Lehrman, founder & CEO, Junction Health Partners; Tom Shehab, managing partner, Arboretum Ventures; Blake Wu, principal, NEA, and Aly Lovett, partner, Radian Capital
Rock Health’s 2019 Midyear Digital Health Market Update notwithstanding, three venture capitalists from different parts of the country unanimously declared that digital health is in an investment bubble.
Aly Lovett, partner, Radian Capital and based in New York, Blake Wu, principal at NEA, and based in San Francisco, and Tom Shehab, partner, Arboretum Ventures and based in Ann Arbor, Michigan, were speaking on a panel at MedCity News’ INVEST Digital Health conference in Minneapolis on Tuesday. The panel was moderated by Doug Lehrman, founder and CEO of Junction Health Partners, a strategic healthcare consultancy.
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Unprompted, Lovett of Radian Capital, shared a story of how valuation is completely off the charts and unless you build relationships with management early on, good deals get stolen right from under you.
Lovett was interested in a Nashville healthcare company and the company knowing its success had hired an investment bank to shop around a deal. Radian Capital submitted paperwork to show where the fund felt the value of the company should be but never heard back from the banker. So she decided to call.
” The banker says, ‘I am so sorry, I didn’t call you. One of your competitive funds just preempted me … and said they would close in 30 days with no meeting with no additional meeting or phone call with management.'” Lovett described to the MedCity audience. “That’s the market that we are in right now.”
Later, in response to a direct question about whether the industry is in the midst of a bubble, this is how Shehab of Arboretum Ventures responded:
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Yes, I think we are in a bubble The fact that anyone up here would say that the way that the market is right now we are getting scooped on valuation speaks to the fact that there’s a bubble particularly given that up until last month, we hadn’t had an IPO in a healthcare IT in a long time, so I think that’s an important thing to think about.
Shehab was referring to the four companies that went public in August.
Wu from New Enterprise Associates (NEA) responded in even greater detail about why he believes we are in a bubble:
I agree with Tom [Shehab]. I think the current valuation environment is unsustainable. Especially now entering an election year where healthcare is going to be in focus. I think the way that some of the deals that have been priced of late is assuming there is zero regulatory risk. Everything is priced to perfection and that cannot continue and it’s never continued historically and it won’t moving forward. And so I’d say we tend to look at the current environment fairly skeptically.
The advantage, I suppose of us being longer-term holders, is we can play the long game. Because we have a dynamic capital allocation, we don’t have to invest X percent of the fund in healthcare IT. We can decide to say, ‘Hey instead of putting money into healthcare IT let’s do therapeutics because the therapeutics environment looks better.’ That’s how we handle it on the fund level.
Lovett shared another anecdote that painted a picture of frothy valuations expected by startup CEOs.
To give you an idea of some of the expectation from a valuation perspective, I had a call on Friday with a health and wellness company that was selling fundamentally to small and medium-sized businesses. So churn fundamental churn from a unit perspective in the business is actually pretty high. No barriers to entry, crowded space — they were growing really nicely but off of a small base, and the call was going well. I was keen on learning more and then the CEO said, ‘And we’ve been told by some of our peers that we will trade or command a really robust mutiple.’ And I was like ‘What does that mean exactly?’And he said, ‘Low double digits forward revenue.’ So I said, ‘Off of 2019?’ He said “No, 2020.”
I nicely sort of disengaged and said that I probably would not be able to lean in as aggressively as maybe some of my peers would …..
That was just a call that I was not expecting to hear based on some of the actuaries of the company and the lack of barriers to entry in that subsector of healthcare. They will probably get it done. Honestly, someone will probably pay for it given the year-over-year growth and the amount of revenue they’ve cobbled together thus far. It’s just an interesting market environment right now.
Shehab also counseled prudence when it comes to valuations, noting that it may be counterproductive in the long term.
“For entrepreneurs, I think there’s a bit of a cautionary tale there. It’s extremely flattering to get a high valuation. It validates what you’re doing. But if the market changes, you may have a down round. You may have a really, really big down round unless you perform because you have to outperform that valuation in terms of doing more faster and growing faster than probably possible, particularly in a down market. There’s an irrational exuberance around valuation,” he said. “Play the long game. That’s not to get the deal on the cheap but it’s also to not have to explain when you get to Series C, why your valuation from Series A to Series B went like this. [tracing a downward graph]
Photo: Stephanie Baum, MedCity News
