Industry analysts point out that against the backdrop of a persistently weak initial public offering (IPO) market, healthcare companies that rely on cash burn may have to turn to other financing methods to sustain operations if they want to advance their listing plans.

The IPO market for medical technology companies is experiencingits worst year in nearly two decades. The COVID-19 pandemic, Russia's war on Ukraine, record inflation, and continuously rising interest rates have collectively squeezed public market valuations and led to significant stock price declines.

Until this year, medical technology companies considering issuing stocks had ample reason to remain confident. Driven by low borrowing costs and pandemic relief funds, public markets surged significantly in 2020 and 2021. Meanwhile, the rise of special purpose acquisition companies (SPACs) also helped more private enterprises access capital markets.

According to Stock Analysis data, last year,1,035 companies went public on U.S. exchanges, setting a historical record. Healthcare companies also rode this wave of public market activity, raisinga record $56.36 billion through 403 IPOs。

However, this financing boom quickly faded in 2022. This year, the number of companies that havesubmitted listing applicationshas plummeted to 173. Healthcare companies have also performed poorly. According to Renaissance Capital data, as of October this year, excluding SPACs, there were only20 IPO applications。

This decline occurs against a backdrop of continuous year-over-year declines in the stock market. According to data from investment and analysis firm Silicon Valley Bank, as of September, most medical technology stocks were on a downward trend,with a median decline of 58%。

A graph showing the decline of healthcare public stock
SVB Global Healthtech IPO and De-SPAC Performance
Permission granted by Silicon Valley Bank
 

Experts do not expect a rapid recovery in the public markets.

"I think 2023 is going to be very tough," said Jonathan Norris, managing director of Silicon Valley Bank's life sciences and healthcare business. "I hope we start to see some bright spots in the second half of 2023."

"Whether it's long-term listed companies or companies that have recently gone public in the past few years, there has been a lot of erosion in public market valuations, which really casts a shadow over companies' ability to go out through an IPO," Norris said. "So the question is... what are they doing now?"

Capital Raising: The Trade-off Between Private Rounds and Internal Financing

Analysts say that with IPO demand drying up and investors becoming more cautious in lending, companies waiting for the market to improve may turn to private round financing.

However, relying on private capital also carries risks. This year, capital raised across all sectors has generally declined. In August, global venture capital fundingfell to a two-year low。

"Not only are the conditions for public market exits unfavorable, but the market downturn, inflation, interest rate hikes, and thescrutinytriggered by bear market investments in 2021 have made it harder for IPO-stage startups to raise private capital compared to last year," said Adriana Krasniansky, research director at digital health venture fund Rock Health.

Specifically for healthcare companies, the capital they raised has decreased compared to 2020 and 2021. According to Rock Health data, the third quarter of 2022 wasthe lowest quarter for digital health financing in the past 11 quarters。

"I hear many venture investors saying that tightening belts is a wise move," said Stephanie Davis, senior research analyst at Silicon Valley Bank. "Therefore, compared to purely investing for growth, I think many people are adopting a more balanced strategy to weather this storm."

As overall financing scales decline, companies that decide to raise funds in the current market may face valuation declines, known as "down rounds," Krasniansky said.

This may prompt companies to turn to internal rounds, extension rounds, or bridge financing, which can provide funds without harming the company's valuation, Krasniansky added.

"Many late-stage companies originally thought they could all go public, but based on market conditions that didn't happen, and they ended up doing some kind of internal round with existing investors, trying to extend their cash burn runway as far as possible into 2023 or beyond," said Norris of Silicon Valley Bank. "This basically gives them breathing room."

With large tech companies like Amazon and Meta laying off thousands of employees, medical technology companies may particularly feel the impact of the overall negative outlook in the tech sector, said Adam Sorensen, Americas health integration and divestiture leader and strategy and transactions leader at Ernst & Young.

"Especially technology-driven companies in the healthcare sector, their value propositions are being truly stress-tested," Sorensen said. "I think without a compelling value proposition, they will find it harder to raise capital."

Companies can also explore financing avenues other than equity, such as debt and warrants, Davis added.

Thanks to the stronger financing environment last year, some companies may not need to raise more capital for the time being. "There was a lot of financing activity at the end of 2021," Davis said. "I think you won't really see tremendous pressure until the previous round of capital runs out."

Nevertheless, these companies may be among the lucky few, Norris said.

"Some companies are well-capitalized with cash reserves that can last into 2024. But I think that's a very small percentage," Norris said, adding that even well-capitalized companies may have to start considering financing matters in the second or third quarter of 2023.

M&A Returns: Exits and Consolidation Under Valuation Pressure

Capital constraints, low valuations, and a lack of attractive public market options may drive demand for mergers and acquisitions as companies seek exit paths, said Nathan Ray, partner at management consulting firm West Monroe.

"I think the demand for pitching deals to buyers is coming back," Ray said. "Those buyers are trying to acquire, and those companies in need of capital are looking for funds or trying to enter the market."

Although healthcare deal volume and total transaction value are trending downward in 2022 compared to the previous two years, deals may be returning to the "new normal" level seen before the pandemic, such as in 2019, Ray added.

From the seller's perspective, digital health startups in particular may be more welcoming of M&A offers, which can help them strengthen product capabilities, control costs, and provide liquidity for "impatient investors," said Krasniansky of Rock Health.

On the other hand, declining valuations may prompt strategic buyers to become more opportunistic, said Sorensen of EY. Despite facing a "tougher" environment compared to last year, private equity firms are also continuing to look for deal opportunities, he added.

"I think the interest in healthtech over the past two years has really been at a broader level," said Davis of Silicon Valley Bank. "So this pullback in valuations provides some companies with the opportunity to enter the market at a more attractive entry point."

According to Davis, most medical technology companies that have not yet achieved profitability may be hit hardest by declining valuations if they enter the public market.

"I can't imagine valuations staying at these levels forever," Davis said. "It's like the pendulum has swung in the other direction... I'm starting to see some extremely high-quality companies trading at puzzling price-to-earnings ratios."

The market downturn may lead more companies to engage in mergers of equals, which could make companies more resilient and unlock more financing options, Norris added.

"But the problem is, no one likes being the acquired party," Norris said. "Everyone wants to be the acquirer."

Correction: A previous version of this article incorrectly stated that Definitive Healthcare had been acquired.