2017 Looking Good for Health Care Investment;
Diagnostic Industry Poised for Large, Future Exits

So far, 2017 is proving to be a good year for fundraising and investment in the broad health care industry, according to report by Silicon Valley Bank (SVB). There have been some big bets placed in the diagnostics and tools (DX/Tools) sector, particularly in companies that use artificial intelligence- and machine learning-based technology.

Fundraising
The report, Trends in Healthcare Investments and Exits: Mid-Year 2017, says that in the first half of 2017 $5 billion was raised in health care venture fundraising and the industry may be on pace to be a record-setting year, passing the $7.5 billion raised in 2015. Venture fund investments have been primarily focused in biopharma and the DX/Tools sectors, with traditional investors having “lost interest” in the device area, writes Jonathan Norris, managing director of SVB, in the report. He notes, though, that nontraditional venture investors, such as private equity, family offices, angel groups, and corporate funds are still investing in devices.

In the DX/Tools sector the most active investors are tech-focused firms, including AME Cloud Ventures, Data Collective, Innovation Endeavors, Felicis Ventures and Khosla Ventures. There has also been significant investment from a wide range of corporate investors, including biotech (Lilly Ventures), tools (Illumina), general health care (GE Ventures), and tech (Google’s venture arm, GV). These tech investors are seeking Dx/Tools companies involved in artificial intelligence- and machine learning-based technology. SVB predicts that this focused area will continue to see “aggressive fundraising” in the second half of 2017 and into 2018.

Early-stage, Series A investments across all sectors are on pace to exceed the 2016 record, SVB found. For the first half of 2017, Series A investment has been “strong” in the Dx/Tools sector. Norris says that almost 40 percent of these deals did not disclose investors, which suggests “significant angel investment.”

Exits
There were no Dx/Tools exits (mergers and acquisitions [M&A]or initial public offerings) in the first half of 2017, which Norris calls “troubling,” but he sees future opportunities due to the “significant” Dx/Tools investments, including “big bets” that have been placed on next-generation sequencing, liquid biopsy, artificial intelligence- and machine learning-based technology activities.

“We expect to see some exceptional exit opportunities in the next two to five years, and possibly a $1 billion-plus M&A exit in 2017,” writes Norris, who expects the

acquirers will more likely will be large pharmaceutical and tech companies.

Since 2015, PMA/de novo 510(k) device acquisitions have generated larger upfront multiples and a quicker time to exit than iterative 510(k) pathway exits; these returns now are approaching what we see from biopharma M&A. This makes a case for more investment in innovative early-stage device companies, and potentially a reallocation by traditional venture funds to device.

What is driving this trend: Iterative 510(k) pathway companies

Trends to Watch
SVB identified several trends to keep an eye on.

• Innovative PMA/de novo 510(k) device acquisitions have shown larger returns and a quicker time to exit than iterative 510(k) pathway exits. Norris notes these returns now are approaching what is typically seen from biopharma M&A. This trend is being driven, he says because companies pursuing iterative 510(k) pathways often require regulatory clearance, followed by an equity raise for commercialization and revenue ramp prior to generating acquirer interest. However, “nearly all” innovative PMA/de novo 510(k) acquisitions occur pre-approval.
• As previously mentioned, tech-focused investment firms are “aggressively” investing in health care companies developing artificial intelligence and machine learning technologies designed for biopharma and Dx/Tools applications. Since 2015, $2.2 billion has been invested in 44 deals involving Dx/Tools companies that artificial intelligence- and machine learning-based technologies. While the median deal size in this area was $12 million, companies like Grail, Guardant Health, and Human Longevity have raised multiple $100 million rounds, and 11 other companies have each raised more than $30M, since 2015. Norris expects this “aggressive fundraising” to continue.

Takeaway: The broad health care industry is poised for a strong 2017 in terms of investment. Look for large, future exits in the Dx/Tools sector.