Over the past year or so, the digital health fundraising landscape has transitioned from a climate that where companies had more power (given the extraordinary interest in all things tech) to one where investors have more power. In 2021, this investment space was characterized by quixotic valuations and high funding round totals —but firms have now become accustomed to a far less feverish flow of capital.
Despite the change not only in who wields more power, but also in the much slower pace of investment, startups can still thrive. That’s according to two executives from Merck Global Health Innovation Fund — they said so last week at HITLAB’s Innovators Summit in New York City.
“There’s actually a lot of capital out there — but the problem is getting access to that capital,” declared Bill Taranto, the fund’s president.
He and Joe Volpe, the fund’s vice president, laid out three key pieces of advice that digital health companies should follow to achieve fundraising success.
Don’t be afraid of down rounds (or flat rounds).
Many companies that raised large funding rounds and attained high valuations in 2021 and early 2022 have found themselves in a position where they have to take a down or flat round in order to obtain capital again, Taranto pointed out.
“Those companies are struggling to actually raise money — no matter how good they are and how good their P&L is,” he said.
Oftentimes, members of a company’s C-suite will be reluctant to take a down or flat round, Taranto noted. But in his view, taking these deals is a matter of common sense if they wish to survive.
“What they don’t see is that dilution doesn’t cause bankruptcy. Lack of cash causes bankruptcy. At least with a down round or a flat one, you live another day. That’s what we’re trying to coach a lot of these firms on — you don’t need to raise a lot of money. You just need to raise enough to get you to that inflection point that allows you to raise the next round and to grow again,” he explained.
Expect slower timelines
It’s no secret that investors have slowed their roll and tightened their proverbial purse strings. Because of this, companies must be aware that they will probably have to start their fundraising process sooner than they would have in the past, Volpe declared.
Previously, startups would begin the process six to eight months before they planned to close a funding round. Now, companies should start at least a year ahead of time, Volpe said.
“There’s a lot of folks who want to be very cautious of what they’re investing in. They’re taking a hard look and going deeper in terms of due diligence than usual. What that sometimes leads to is us having to fund or bridge a company longer. So you’re seeing us put in note rounds — or other insiders putting in note rounds — to carry them through to that final raise. That’s been different for us, and we’re seeing a lot more of that. It’s frustrating for all parties,” he explained.
(A note round is a type of investment wherein a company offers equity in the form of convertible notes — meaning these notes can be converted to shares. When a company secures note investments, it uses this money to support its operations and expansion. These notes typically have the potential to transform into equity for investors in the future, often when the company raises more capital or gets acquired.)
Get your narrative right
The most important thing a company has to do before pitching to investors is ensure that it can clearly and honestly describe its narrative, Taranto explained. The honesty piece is key — he said that investors can tell when a company isn’t being realistic about its future.
“One of the things that we as investors don’t like is when you have two years of flat revenue and then you show me a hockey stick like you’re going to make an incredible amount of revenue. We know that that’s not true, but we want you to tell us what the inflection point is that’s going to make me believe you and invest in you,” Taranto noted.
Being truthful and letting investors know that large-scale revenue growth might take a few years is a much better option than telling them a story they don’t believe, he added.
Volpe said Taranto’s comments reminded him of a company that Merck’s fund has invested in. Without identifying the startup, he shared how the company’s banker “put a kibosh on them moving forward until their story was really tight.”
In order to give investors an accurate and detailed picture of the company’s plan for revenue growth, the firm had to make tough decisions — this involved making cuts. But pausing and taking the time to make those changes allowed the company to get investors back on board so it could survive.
“Hope is not a business model,” Volpe declared.
Picture: Feodora Chiosea, Getty Images