Medical technology companies weigh financing strategies to address cash burn and sluggish IPO market

Industry analysts point out that against the backdrop of a persistently weak initial public offering (IPO) market, healthcare companies with significant cash burn may turn to alternative financing channels to sustain their operations.

The IPO market in the medical technology sector is facingits worst year in two decades, due to factors including the COVID-19 pandemic, Russia's war on Ukraine, record inflation, and rising interest rates, which have depressed public market valuations and led to significant stock price declines.

Until this year, medical technology companies considering going public still had reason for optimism. In 2020 and 2021, driven by low borrowing costs, pandemic relief funds, and the rise of special purpose acquisition companies (SPACs), public markets surged significantly. Last year, according to data from market observer Stock Analysis,a total of 1,035 companies went public on U.S. exchanges, setting a record. Healthcare companies also rode this wave, raisinga record $56.36 billion through 403 IPOs。

However, the market frenzy faded in 2022.

This year,the number of companies filing for public listingshas plummeted to 173. Healthcare companies have also underperformed; according to Renaissance Capital, as of October this year,there were only 20 IPO filings(excluding SPACs).

This decline has been accompanied by a broad downturn in public market stocks. 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%。

Experts expect that the public market will be slow to recover in the short term.

"I think 2023 will be very difficult," said Jonathan Norris, managing director of life sciences and healthcare at Silicon Valley Bank. "I hope there will be some bright spots in the second half of 2023."

"Whether it's long-term listed companies or those that went public in the past few years, there has been significant erosion in public market valuations, which really casts a shadow over the IPO outlook," Norris said. "So the question is... what are they doing now?"

Capital Raising

Analysts say that with IPO funding drying up and investors being cautious with their capital, companies waiting for the public market to improve may turn to private financing rounds.

However, turning to the private market also carries risks, as the financing market itself is also facing a downturn. Global capital financing volumes have generally declined this year. In August, global venture capital fundingfell to its lowest level in two years。

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

Healthcare companies have raised particularly less capital than in 2020 and 2021. According to Rock Health, the third quarter of 2022 wasthe lowest quarter for digital health financing in the past 11 quarters。

"I hear many VCs saying that tightening their belts is a wise move," said Stephanie Davis, senior research analyst at Silicon Valley Bank. "So, rather than purely investing for growth, I think many people are taking a more balanced approach to weather the storm."

As overall financing declines, companies deciding to raise funds in the current market may face lower valuations, known as a "valuation adjustment—i.e., a down round," Krasniansky said.

This could lead companies to turn to quieter financing rounds, such as insider rounds, extension rounds, and bridge rounds, which can provide capital without harming stock prices, Krasniansky added.

"Many late-stage companies thought they could all go public, but due to market conditions they couldn't, and ended up doing some kind of insider round with existing investors to extend their cash runway as long as possible, into 2023 or beyond," said Norris of Silicon Valley Bank. "This basically gives them breathing room."

Medical technology companies in particular may be affected by negative sentiment in the broader technology sector, as large tech companies like Amazon and Meta have laid off thousands of workers amid economic pressure, said Adam Sorensen, Americas Health Integration and Separation Leader and Strategy and Transactions Leader at EY.

"Technology-driven companies, especially in health, have had their value propositions truly stress-tested," Sorensen said. "I think without a compelling value proposition, they will find it harder to raise capital."

Companies may also seek other financing channels rather than pure equity financing—such as debt and warrants, Davis added.

However, due to the strong financing environment in 2021, some companies may not need to raise more capital if they already raised funds last year.

"There was a lot of financing activity at the end of 2021," Davis said. "I don't think you'll really see a lot of pressure until the last round of capital runs out."

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

"Some companies are well-capitalized and have cash to last until 2024. But I think that proportion is small," Norris said, adding that well-capitalized late-stage companies may need to start considering fundraising in the second or third quarter of 2023.

Return to M&A

Capital constraints, low valuations, and poor public market options may also drive demand for mergers and acquisitions, as companies seek financing and exit routes, said Nathan Ray, partner at management consulting firm West Monroe.

"I think the demand to sell to buyers is picking up," Ray said. "Those buyers are trying to buy, and those companies that need capital are trying to find capital or get to market."

The large amount of capital raised in 2020 and 2021, along with excess capital held by private equity (often called "dry powder"), is also driving buyers, he said.

Although healthcare deal volume and total transaction value in 2022 have shown a downward trend compared to the previous two years, deals may be returning to the pre-pandemic "new normal" level, such as in 2019, Ray added.

On the sell side, digital health startups in particular may be more receptive to M&A offers, which can help enhance products, reduce costs, and provide liquidity for "impatient investors," said Krasniansky of Rock Health.

On the buy side, lower valuations may prompt strategic buyers (supported by capital raised in 2020 and 2021) to enter the market for more opportunistic acquisitions, said Sorensen of EY. Despite a "tougher" environment than last year, private equity firms are also continuing to look for deals, he added.

"I think the scope of interest in medical technology over the past two years has been broader," said Davis of Silicon Valley Bank. "So the decline in valuations gives some companies the opportunity to enter at a more attractive entry point."

Medical technology companies, most of which are not yet profitable, may be most affected by valuation declines if they enter the market, Davis said.

"I can't imagine valuations staying at this level," Davis said. "It's like the pendulum has swung the other way... I'm starting to see some very high-quality companies trading at puzzling price-to-earnings ratios."

The downturn may lead more companies to pursue mergers of equals, which could make companies stronger and unlock more financing options, Norris added.

"But the problem is, nobody likes being acquired," Norris said. "Everyone likes being the acquirer."

Correction: This article originally incorrectly reported that Definitive Healthcare had been acquired.