After experiencingrecord-breaking startup funding across various stages from seed to late roundssome market observers expect overall venture capital to moderate in 2022. Against the backdrop of rising interest rates and cash-rich startups seeking next steps such as mergers and acquisitions or exits, the digital health sector may be no exception.

However, others believe funding levels will only continue to climb, supported by factors including: a healthy mix of first-time and existing investors, which injects fresh interest while continuing the sustained bets of digital health veterans; and investment and acquisition activity in digital health by external players—including well-funded tech companies such as Amazon and Microsoft.

Furthermore, adoption of digital health products and services appears to be stabilizing, patient demand persists, andproviders have not broadly withdrawn virtual services. This alleviates concerns that demand for such solutions would plummet once the impact of the COVID-19 pandemic subsides.

Experts say startups that use digital health solutions to manage high-cost, prevalent chronic diseases, free up physicians' time, achieve scalable care, and align with trends toward personalized, high-touch healthcare are expected to capture the majority of funding this year.

According toPitchBook data, just over a week into 2022, U.S. venture capital firms had raised nearly $13 billion—roughly equal to the amount these firms raised in an entire year a decade ago.

This capital must find a home, and the healthcare industry is likely to be a major recipient. According to Crunchbase data, in 2021 the sector ranked second globally in venture capital, behind only financial services.

Health tech has attracted significant attention.

U.S.-based digital health startups receivednearly $30 billionin investment in 2021, almost double the total from the previous year. Investors and market observers are cautious about whether 2022 can break the 2021 record, but most still view the year optimistically.

"I expect deal flow to continue this positive momentum in 2022," said Ravi Kumar, a partner at professional services firm Connor Group.

Market observers believe that as the pandemic enters its third year, digital therapeutics, personalized medicine, provider-facing infrastructure, and mental health and chronic disease management are particularly poised for sustained investment.

"It's hard to see what would stop this trend," said Marc Albanese, senior director of healthcare and emerging technology research at market intelligence firm CB Insights.

Digital Therapeutics and Personalized Medicine

Digital therapeutics experienced significant funding growth in 2021, with startups using evidence-based software to deliver medical interventions, manage, and treat a variety of diseases reporting a surge in investment. This is an ongoing trend: according toMcKinseydata, investment in U.S. digital therapeutics companies has grown an average of 40% annually over the past seven years.

Albanese noted that the goal of digital therapeutics is to treat chronic diseases at scale, alleviating one of the biggest pressures on the current healthcare system, such as physician shortages. Digital therapeutics decouple care delivery to some extent from the supply side, allowing patients to receive care asynchronously and remotely without requiring physicians to continuously monitor the application.

Multiple factors are converging to drive growth in digital therapeutics investment. Last year, coverage pathways for prescription digital therapeutics expanded and regulatory approvals accelerated. Startups are accumulating more clinical evidence to support their technologies. Additionally, healthcare stakeholders, including payers and providers, are increasingly interested in integrating digital therapeutics and building payment models around them.

Digital therapeutics were a huge bright spot in 2021, but "when we think about this space, I think we are still in the early stages," said Amanda DiTrolio, healthcare intelligence analyst at CB Insights. Many startups are still developing their therapies and may seek additional capital infusions.

"I think we are still in the early stages."

— Amanda DiTrolio, healthcare analyst at CB Insights

DiTrolio noted that two prominent examples are virtual reality therapy and cognitive behavioral therapy applications.

AppliedVR, a VR therapy company for pain management, received Breakthrough Device Designation from the U.S. Food and Drug Administration (FDA) early last year for its flagship product (for treating fibromyalgia and chronic intractable lower back pain). This was the first VR prescription therapy to receive FDA designation, and for many market observers, it signaled increasing regulatory acceptance of the field.

"This is truly exciting," DiTrolio said.

The analyst also noted that as digital therapeutics launch more clinical trials and expand into more indications beyond chronic care, such as gastroenterology, irritable bowel syndrome, women's health, and neurodegenerative diseases, "the coming year will require significant funding."

According to Kaia Colban, emerging technology analyst at Pitchbook, growing interest in delivering more precise care may also help startups in the emerging personalized medicine space.

Colban predicts that personalized medicine startups using AI- and ML-based data platforms to gain insights into patient care and develop personalized treatment plans will achieve record venture capital funding in 2022.

Colban said this is a massive addressable market with strong market drivers, including the convergence of technologies such as remote patient monitoring devices, electronic health records, genomic databases, and cloud computing, all of which are driving the development of such applications.

Mental Health

In terms of clinical indications, the mental health space is likely to continue attracting the majority of funding.

According to Rock Health data, digital health startups providing mental health services raised $5.1 billion in 2021, nearly double the previous year. CB Insights' Albanese said investors will continue to seek funding for tools that can deliver mental health services at scale.

Unfortunately, as the virus becomes endemic, the mental health pressures of the COVID-19 pandemic are unlikely to fade quickly. The pandemic has exacerbated conditions such as anxiety and depression, while shortages of U.S. medical professionals have combined tocreate historic demand for treatment. Reimbursement has also never been more generous, as employers and payers increasingly see the downstream value of proactively addressing members' mental health issues.

All these factors combined have led to a wave of new virtual care options for high-intensity psychological and behavioral health needs. Well-funded startups in this space, such as Lyra Health (which raised $387 million last year alone), often combine traditional treatment options with wearables, targeted therapies, chatbots, and other features to meet consumer expectations for preventive care, mental health coaching, therapy, and medication.

One early-stage startup to watch in this space, according to Pitchbook's Colban, is Woebot, which develops AI-based chatbot technology to deliver mental health care through digital therapeutics. Woebot has raised nearly $130 million in venture capital to date.

Additionally, DiTrolio expects more funding to flow to startups targeting specific underserved populations, including Folx Health, which provides virtual care for the LGBTQ community; Equip Health, which treats eating disorders; and Eleanor Health, a value-based startup targeting opioid misuse.

"The theme of targeting underserved populations really took root in 2021, and there is still plenty of room for investment there," DiTrolio said.

Chronic Disease Management

Investors may also continue to increase funding for chronic disease management startups, which aim to prevent downstream health complications while capturing a share of the cost savings.

Rock Health has identified diabetes and musculoskeletal care as key investment areas because they are high-expenditure diseases and are increasingly managed virtually. Growth in startups managing such diseases may help alleviate pressure on the overburdened physical healthcare delivery infrastructure, as COVID-19 hospitalizations in Januaryhit record highs。

For example, MSK (musculoskeletal) funding grew sixfold between 2020 and 2021, reaching $1.4 billion. Virtual MSK clinics like Hinge Health and Sword Health completed multiple funding rounds throughout the year, and analysts say this pace is unlikely to slow.

Hinge alone doubled its valuation in the past 12 months, making it the highest-valued venture-backed retail health tech startup—and according to Colban, it could be an IPO candidate in 2022.

Jacob Effron, a partner at Redpoint Ventures, predicts that overall focus on specialty care will also increase due to greater risk assumption. As more healthcare companies take on risk, they will need partners to help manage patients with more niche and high-cost conditions.

"I feel like every week I meet a different entrepreneur starting a company in a different specialty," Effron said.

Behind the Scenes: Infrastructure Investment

Investment in backend infrastructure and interoperability startups has been strong over the past few years, but appears to be accelerating. According toSilicon Valley Bank data, such provider-operating companies accounted for more than one-third of total seed and Series A funding in the U.S. and Europe last year, up from one-fifth in 2021.

Amid increasing pressure for more user-friendly systems, venture capitalists are likely to continue investing heavily in companies that help providers modernize processes such as billing, care coordination, and research. Experts say this will benefit startups that can embed their tools into existing IT systems, streamline experiences for administrators, physicians, and patients, and reduce friction and costs.

"We continue to see very strong capital inflows there. I don't think this will decline," Albanese said.

Investment will increasingly be driven by federal regulations requiring free electronic information sharing between different software systems and increased regulatory pressure for price transparency. The resulting emphasis on data interoperability and portability will foster more growth for digital health startups in this space, said Connor Group's Kumar.

Other macro trends driving investment include the emergence of more direct-to-consumer healthcare delivery options, which puts health systems at risk of losing their most profitable patients (the commercially insured population). This trend incentivizes them to digitize their platforms and provide better consumer experiences in areas such as appointment scheduling, patient registration, communication, or billing.

Growing interest in risk assumption is also prompting providers to increasingly seek digital health solutions to help them take on and manage risk, which will lead to increased funding for startups in this space, said Redpoint Ventures' Effron.

"I think the shift to risk is probably the biggest macro trend. And the opportunity to build supporting technology and services around that to help physicians succeed in the new environment is probably the top area I expect for provider technology investment in 2022," Effron said.

Additionally, the COVID-19 pandemic has exacerbated labor shortages and physician burnout, and experts say hospitals and health systems are scrambling to improve workflow pressures for staff.

This represents a huge opportunity for startups that received funding last year, including those integrating data streams into unified API ecosystems, such as Innovaccer, Redox, and Ribbon Health; TripleBlind and Truveta, which support cross-company data analysis; ScienceIO and Centaur Labs, which simplify data structuring and labeling; Commure, TruePill, and Wheel, which provide building blocks to help others implement digital health tools; and Olive, which offers healthcare robotic process automation technology.

Fintech

Billing is also an area to watch, as healthcare prices rise unsustainably and were already hurting many Americans' wallets even before the COVID-19 pandemic. Hospitals were already doing more financial assistance transactions before the pandemic, but COVID accelerated this trend, intensifying financial pressures on providers and patients due to rising costs,credit agency TransUnionnoted.

Financial services was a major area of venture capital last year. As consumers seek ways to pay for needed medical services without going bankrupt, startups operating in this space in healthcare are likely to continue attracting investor interest.

Startups providing technology to streamline claims and billing processes, as well as those attempting to ease the payment burden on financially strained consumers, reported rapid growth in adoption and funding.

For example, "buy now, pay later" platforms allow consumers to pay in installments. San Francisco-based PayZen is one such startup operating in the healthcare space. PayZen raised $15 million in a Series A round in 2021 to expand its model, which uses artificial intelligence to assess patients' ability to pay after insurance and then automatically creates personalized payment plans for patients, while providing hospitals with an automated billing management system.

PayZen says this results in hospitals recovering a higher percentage of costs without having to send patients to collections.

But whether you are a startup tackling healthcare billing pain points or any other type of digital health player, "now is the best time to start a digital health company," Effron said. "I think 2022 will bring many interesting opportunities for investors."