Stephen Hays
Jan 1, 2024
Healthcare valuations have been in rehab since late 2021. That’s nothing to be ashamed of. I went to rehab in 2018, and it saved my life. I believe this stint in detox has resulted in a healthier market and that valuation trends are starting to show signs of sustainable recovery. Below, I’ve summarized my thoughts on where valuations are today and why I believe a bottom has been formed.
I track public and private market valuation data very closely since What If Ventures has 67 healthcare portfolio companies — $80mm deployed — at all stages of the startup lifecycle. Some of our companies are pre-IPO, and some are very early-stage companies looking to raise that next round of capital. We are constantly thinking about valuation trends from the public market all the way down to the pre-seed market.
From mid-2020 until the end of 2022, healthcare startup valuations were driven by top-line growth alone. Companies such as GoodRx, Amwell, and others went public in mid-2020 at revenue multiples far above the market comps. At the same time, companies such as Teladoc traded to multiples north of 20x revenue compared to a long-term historical average for the peer group of 6.6x revenue.
During the times of easy access to cheap capital, venture capital investors began competing on price to win their way into the hottest deals. This competition drove private market valuations to an unsustainable place. Investors’ actions led founders to prioritize ARR growth above all other metrics while ignoring metrics such as unit economics, margins, and the like.
Times have changed. Valuations have sobered up, and investors care more about profitability — or a path to profitability — than they have in a long time. You can see this in the public market data recently, and it’s also being played out in private markets.
Let’s take a look at the public market data to see what we can infer about startup/private market valuations.
The table below shows the comps we use to value disruptive healthcare companies today. The peer group broadly trades at 3.4x 2024E revenue right now, and the average growth rate for those companies is 14.3% y/y with an 2024E EBITDA margin of 18.0%.
Generally, the comps with the highest growth rates and margins command the most significant valuation multiples. Often, we expect startups to have much higher growth rates than their more mature public peers, and as such, we assume the startups should command premium valuation multiples as a function of revenue. Over time, as a startup matures and year-over-year growth moderates, then we see the valuation multiple tracks down toward the public market comps.
As you already know, valuation is part “art” and part “science.” There is no perfect comp, and there is no perfect algorithm for determining price.
We can use the data above as one benchmark to estimate what valuation may be fair for any private company. If the company you’re trying to value has a much higher growth rate and could achieve a much higher margin at maturity, then you can expect a higher valuation multiple. This principle doesn’t mean these metrics will track 1:1, but this is a good benchmark.
We can’t just look at this data at one point in time; we need to look at the broader trends both recently and over a more extended time period. Now, let’s look at the way these valuation metrics have been trending over the last five years.
Historically, publicly traded disruptive healthcare companies trade at a one-year forward multiple of 6.6x NTM revenue — see chart below. Prior to September 2020, the group traded tightly around this range and averaged 7.3x in mid-September 2020.
Multiples began to really expand in late September 2020 when AMWL and GDRX went public. AMWL’s EV/NTM Revenue multiple at IPO was 20.8x, and GDRX’s was 30.0. The addition of these two names to the peer group drove the index up to 10.6x in just one week from 7.3x. As seen in the chart above, in September 2020, this situation resulted in the straight line going up.
From September 2020 until February 2021, the peer group climbed to a peak of 14.1x NTM revenue — with some peers trading well above 20x NTM revenue during that time, such as TDOC and others. Since then, the market has been trying to find its bottom. As of today, the trough valuation for the group has been 2.5x NTM revenue on November 9th, 2023. At the end of 2023, the group had recovered to 3.4x NTM revenue, and we believe the group will recover back toward its long-term historical average in 2024.
To me, this chart appears to show a bottom forming around 2.5x. If this is genuinely the bottom, then we can expect a reversion to the mean in the coming year, lifting the sector back to the long-term historical average of ~6x. This rising tide will lift all boats, not just public stocks but private valuations as well.
It’s not as easy to put together a pretty chart of private market deals and show you an average valuation. The data is difficult to aggregate, and we have to consider stage, capital needs, business model, projections, and many other variables. In the private markets, it is quite challenging to triangulate a single company valuation from just one data point. This difficulty is why we consider the public market data above and then look at the closest comps we can get our hands on in the private markets. Then, we triangulate between all of that data to make a best guess on how a private company should be valued.
In 2021 and 2022, we saw astronomical valuations placed on startups by venture firms competing on price to get into the “hottest” deals. Often, that money came into the market from investors who did not understand healthcare businesses at all. We believe that capital, at those prices, ultimately harmed the market more than helped, as over-capitalizing companies in this space generally cause misaligned incentives and push leadership teams to pursue something other than their original mission. This circumstance isn’t good in an industry where we’re talking about life and death. That’s a topic for another blog post.
At the peak of the market in 2021, some startups in our space were getting valuation multiples north of 40x and 50x ARR. The investors who made those deals will likely lose money and hopefully stay out of our backyard.
While we can’t put together a chart showing all the private market valuations that took place in 2023, we can offer you some data points in seed stage and later stage deals that we have seen recently. These data points are not intended to be a comprehensive list of all possible valuations but rather some data points to help you triangulate value in your situation.
It’s convenient to talk about valuation in terms of a revenue multiple, but comparing revenue multiples of two startups at the earliest stages can feel like comparing apples and oranges. One Company’s ARR may just be one month of revenue multiplied by 12, whereas another Company’s ARR may be what they think it could be a year from now. Applying valuation multiples to those numbers can be nonsensical.
When discussing pre-seed and seed stage valuation, I almost always focus on the percentage of the company being sold to investors or implied to be sold in a convertible round.
For example, if you’re raising $2mm and selling 15% of your company, then you’re raising at a valuation of about $13mm. If you’re raising $3mm and selling 35% of your company, then you’re raising at a valuation of $8.5mm.
In typical market environments, we expect to see a seed round founder selling somewhere between 15%–25% of their startup in the seed round. This figure can fluctuate up or down depending on mitigating circumstances and investor demand.
Today, in seed-stage deals, we see a broad range of prices. On the most founder-friendly end of the spectrum, we see companies selling 16–17% of their company for a seed round. On the most investor-friendly end of the spectrum, we are seeing deals get done for 35% of the company. As the capital markets improve in 2024, we expect this range to consolidate more around the lower end of the range, the founder-friendly end.
Later-stage deals are a bit easier to compare because we’re usually looking at companies with some historical revenue data and some history of forecasting, plus they have proven their ability to forecast. This information allows us to believe — or not believe — their forecast based on actual results and decide what valuation multiple to apply not only today but in the future when calculating possible returns based on projections several years out.
It’s difficult to put together a table of comps because so much of the private market data is either unavailable or we can’t publish something since we were given the information in confidence. We can share a few data points we’ve seen recently for context. Here are a few deal trends and structures we’ve seen in recent months:
In short, they already are.
However, to answer this question, we have to think a bit more macro about capital flows. Our view is that capital will ultimately chase the greatest yield with the least risk. Recently, investors have demonstrated a demand for public equities, which has driven stock prices higher. In our peer group, on average, companies are trading around 68.4% of their 52-week highs right now.
As stock prices reach higher levels, investors will realize the upside isn’t as significant in public equities and will chase yield down market into private securities — growth equity and then down to startups. This situation will increase the access to capital, lowering the price of that capital — supply and demand — thus resulting in rising valuations for private companies in 2024.
We believe a lot of private market investors are already pricing this in and acting accordingly. Many VCs are aware that capital will chase yield down into the private markets at some point — meaning the hedge funds and PE shops will come back into venture deals. VCs want to get ahead of that curve and do deals before that happens.
In just the last few weeks, we’ve seen quite a few healthcare startups sign term sheets for rounds that will close in January and February. The volume has been surprising considering the typical holiday season slowdown we’d expect in the venture, and I believe it is due to the dynamic explained here.
If you have questions about any of this analysis or want to collaborate with What If Ventures, please reach out via info@whatif.vc. We’d love to connect with entrepreneurs and investors in the space.
