Healthcare-focused VC funds posted negative returns of 9.5% in Q1 2022, a stark contrast in fortunes considering the positive 22.5% returns posted in the same quarter a year ago. Funds showed a recovery later in the year, briefly posting a positive 0.17% return in Q3 2022 before dipping back into negative territory in the subsequent quarter.
Despite the decline, investors are optimistic about the healthcare sector's potential, counting on the technology advancements in biotech and digital health to give them multifold returns over the next decade. "LPs understand this is a long-cycle investment thesis and still believe the core drivers are intact," said Frank Angella, a managing partner of Grove Street Advisors. Fund performance aside, investors believe that abandoning healthcare investments now would impede the digital revolution, especially the development of AI / ML advancements for drug discovery and patient care.
As a result, several healthcare-focused VCs are plowing on with their investment strategy, trying to raise fresh funds despite strong headwinds. In Q1 2023, U.S. healthcare investors raised VC funds worth $6.8B, per a recent Silicon Valley Bank (SVB) report. The fundraising pace is higher than last year when healthcare-focused VC firms raised funds worth $21.8B by year-end. Last year's tally was the second-highest annual total, second only to the record-setting $28.3B raised in 2021. Several healthcare-focused VCs are raising fresh funds, including FoundersX Ventures, which has already received commitments worth $60M against a $100M target for its healthcare fund. The firm intends to raise a separate $50M fund later this year that will focus only on AI startups that impact various sectors, including healthcare.
HarbourVest Partners' managing director Amanda Outerbridge believes that developing resilient portfolios requires investing evenly across cycles and challenging market environments. Nonetheless, fund managers are taking a measured approach to their capital deployment. LRVHealth's managing partner Keith Figlioli said, "There's a lot of dry powder sitting on the sidelines waiting for valuations to normalize." Some investors are holding out for better deals, hoping to scoop up stakes in mid- and later-stage companies struggling to raise fresh capital. Startups that cannot demonstrate profitability will need to let go of their previous lofty valuations and accept down or flat rounds.
At the onset of the VC funding pullback of 2022, the healthcare sector showed resilience to the drop in VC funding. However, as the year progressed, the initial resilience vanished, and the sector succumbed to the pressures from the VC funding pullback. In Q1 2023, U.S. and European healthcare startups nabbed $9.85B in venture capital. At this rate, funding will fall short of 2022's tally of $65.73B. Healthcare sector investment peaked at $98.42B in the two regions in 2021.
The drop in valuations and the macroeconomic volatility has caused the public market investment firms — that launched crossover funds to invest in venture rounds — to recede. This will likely result in a further drop in capital available for startups.