How Digital Health Has Ushered in a New Era of VC Investments

May 03, 2023 - The COVID-19 pandemic caused a shift towards using digital software platforms to allow the economy to continue functioning. The pandemic also caused significant changes in the healthcare industry, with the federal government allowing more flexibility in digital healthcare practices, resulting in an unprecedented increase in the percentage of doctor visits happening online.

The relaxation of regulations and the increased demand for virtual healthcare during the pandemic has led to the emergence of remote-first telehealth companies utilizing various technologies for video and in-app communication. Similar to the emergence of online banking services in fintech, digital healthcare startups are now in need of infrastructure to provide advanced solutions that streamline care delivery and enable providers and patients to benefit from next-generation electronic health record systems and patient engagement tools.

Kelley Damore, Chief Content Officer at TechTarget, recently sat down with Jeremy Kaufmann, partner of Scale Venture Partners, to discuss trends in investments within the venture capital tech community and how CIOs can take a VC approach to how they prioritize technology spending.

Transcript

Hello, I'm Kelley Damore, Chief Content Officer at TechTarget and I'm here with Jeremy Kaufmann, partner of Scale Venture Partners.

Jeremy, what I'd really like to talk about is investments within the VC tech community, and how CIOs can take a VC approach to how they prioritize technology spend.

I'd like to start with that first inflection point which is the pandemic. How do you think the pandemic has affected investing? And what lessons have you learned going through the pandemic with regards to VC investments?

Kaufmann: One of the interesting things about investing in the seven years I've been in venture is that the pandemic period was such an unusual period in what it did. You had this kind of conflicting impulse over the last two years, which was, one, you saw this acceleration in software purchasing, when the whole world went digital, all of a sudden: like the entire healthcare economy. Wow, what an impetus for digitalization there and at-home care.

In the e-commerce world, suddenly, you went from 14% of total commerce being done online to 28% in a single year. It was creeping up from 11% to 12%, to 13%. What you basically had was this one-and-a-half-year period of extraordinary acceleration and software adoption. And then what happened next, was everyone assumed that that acceleration was going to continue. And what you had in 2022, was this conflicting argument, would things revert to the mean? The classic mean reversion phenomenon, do you go from 28% of commerce happening online, back to 16%? Or does it become 30%? And a lot of people looked at these acceleration trends and said, ‘My mental estimate for what happens next is I think it's going to be 30%’What actually happened was in most categories in the last six to 12 months, you've seen mean reversion. Everybody had these really high estimates of high growth rates and then the reality has been more sobering. We're all dealing with this kind of interstitial period of high expectations of growth, but then, in reality, growth has moderated.

Now [we have] this second inflection point: this [possible] recession. Have there been particular technologies that you've looked at [or] that you may not have looked at if we were not in a pandemic or an impending recession?

Kaufmann: Well, first off, I mean, the obvious one is that our whole lives became Zoomified, right? We were all using these digital software platforms in our daily work lives. And I think, oftentimes the narrative in tech or at least the common media vibe is, ‘Oh, the Silicon Valley people, they just don't get it.’ There's a lot of negativity. But as one of my partners said, ‘nobody knew that the world could basically go home for an entire year and a half, and DocuSign and Zoom. And these productivity tools would basically hold up a large part of the white-collar economy. So that was surprising. I don't think people realize that. But then, to your second point, what were the things that happened specifically in particular industries because of the pandemic? I spent a bunch of time in digital health care and the change there has been extraordinary. Basically, what happened was that the federal government kind of waved a bunch of rules around interstate practice and interstate licensing. All of a sudden, you could do things in digital health that you could never do before.

So the percentage of doctor visits that happen online go from 8% to 41%, in a single year. Simply extraordinary things happening. Healthcare is one example.

I think another space that really benefited during the pandemic was cybersecurity. As the percentage of transactions happening online went up, the relative value of protecting those transactions, verifying digital identity, making sure cyber criminals aren't gaining undue access to something, dramatically went up in importance.

It's interesting, you talk about Zoom. How did that affect you and your workflow? Was it challenging to do your due diligence on Zoom or in this hybrid model?

Kaufmann: I think there's an ongoing debate over that. Let me argue for the extremes, and I'll probably side more in the middle. I think most people would have said before the pandemic, it's absolutely crazy to think that you could write a $20 million check without meeting somebody in person. What basically happened was that suddenly you could do this in a way that most people didn't think was possible. At Scale Venture Partners, we did the same number of deals in 2020, as we did in 2019. All those deals in 2020 were largely done virtually. You met the entrepreneur over Zoom, they pitched the partnership over Zoom, and then maybe towards the end of the process, you met them once for coffee in person as you're trying to sign a term sheet. I think the reality going forward is that it's going to be more hybrid. The pattern seems to be the first meeting is over Zoom, and maybe the early diligence happens over Zoom. Towards the end of the process, you meet in person, you meet the executives. The partnership pitch these days is largely done over Zoom so I would say the tendency right now is a bit hybrid. It's certainly not the in-person nature of 2017 or 2018. It's certainly different. The countervailing point is I was in Tel Aviv three or four weeks ago as our firm does a lot of Israeli investing. I did 15 or 16 in-person meetings in three days. And in that part of the tech community, the norm hadn't changed as much so I think things are still in flux. My guess was that if the expectations in 2020 was everything's going remote, reality is setting in that there's probably going to be certain parts of the diligence process that are still in person, and we're all trying to figure out what those things are.

I had a CIO Advisory Board meeting on Zoom a few months ago and I was asking them when they look at new emerging who do they go to. What information do they look at? They said peer communities and VCs. So my question to you is, how can CIOs get this VC mentality? What do they need to do to boost efficiency or come up with products and services that differentiate [their organizations]?

Kaufmann: It's helpful to talk about what VCs know, and where they can be helpful. And then honestly, when VCs really looked towards the CIOs for our internal guidance and not pretend that [we are] the Oracle or the sage. I'll start with where do I think CIOs can learn from VCs. VCs will have some interesting data points around emerging categories. For example, we have a portfolio of 50 companies. If an executive comes to us and says, ‘Hey, who are the six vendors I should check out in the sales tech category,’ a VC can say, ‘Here are the six that our portfolio companies are using.’ We have an entire community around this. We can help you survey our community and get feedback directly from the horse's mouth. Who are the other executives with similar portfolios? What have they tried? What have they decided, and why? We always try to be pretty unbiased. We're not going to promote our portfolio company. I think that's one way we can help. Secondly, VCs have early data on some industry growth rates, which are interesting. For example, we track every quarter, what percentage of our portfolio companies are hitting plan, and we know what it was a quarter ago and two quarters ago. We know in the current economy, only about 15% of our current portfolio companies are hitting plan. I think that knowledge is helpful when it's broadly disseminated to entrepreneurs, building companies, and also CIOs, as they understand why vendors are behaving like they are. I think VCs have some data that might not be in the broader community. And then the second part of the question, which you didn't ask, but I think is actually important to say, what can VCs learn from the CIO community? You guys are the folks that can help us understand priority stack. VCs are hearing hundreds of pitches a month what we want to understand is, of the five problems that the CIO of an e-commerce company is dealing with, what matters and why?

One of my favorite boards has one of the leaders of one of the nation's largest hospital systems on the board. The board meeting starts when the entrepreneur basically calls on this guy and says, ‘What's the number one, two, and three priority in your hospital system? Every VC is listening very closely. When he says that hiring nurses is problem one, two, and three, we're all thinking, ‘All right, that's the problem. We’ve got to go fund and find those companies.’ CIOs know relative prioritization. VCs don't. And it's our job to learn from those CIOs.

That's really interesting. Another thing you probably have exposure to is just an overabundance of people pitching you. How do you prioritize? They have a similar problem there, right? They get [endlessly] pitched. Which ones do you focus on? What makes you know when to invest your time?

Kaufmann: Totally, and I think most investors would reply that their strategy tends to depend on the stage they focus on. If you were to broadly say there's three stages of venture capital: There's this seed round that pre-product market fit. A lot of those folks tend to index highly on people-founding experience of the team. So those folks want to go broad. They tend not to be specialists. Our stage at Scale Venture Partners is Series A and Series B. We tend to be very thesis-driven. There are seven partners at Scale, and each partner at any moment in time probably has three, four, or five trends they care the most about. Your mandate is to become the expert or the go-to person for those trends. Right now, I'm focused on generative AI, I'm focused on emerging climate tech startups and I'm really interested in kind of new innovation in digital health.

So interesting, I'd like to move to those particular technologies that you're focused on. Generative AI, where do you see the biggest promise there?

Kaufmann: What's exciting is that suddenly, everybody can be a creator. Up until now, if you wanted to create a video, you generally had to be trained in this. There was a skill set associated with videographer and videography. If you wanted to broadcast your voice, you tended to become a voice actor. Designers typically had to go through school and be educated on certain norms to do their work. I think the one sentence summary of generative AI, is that suddenly the newcomers and beginners have an equal chance to be a creator.

Whenever something interesting happens in machine learning, we come to the inevitable [question]: is AI augmenting human workers or is AI stealing jobs?

Do you feel like it is augmenting jobs or do you feel like it's stealing jobs what jobs may not be as relevant in the future?

Kaufmann: I'm of the belief that today, it's very much augmenting work. When spellcheck came out, suddenly, everybody who was writing had a tool that could assist them in their work. And as we've all seen [this] with tools like Jasper AI. We've gone beyond just checking the spelling or checking the grammar. We've been able to start, you know, iterating. It's not [for] a scientific research paper, but in the marketing and sales domain, it can be very helpful. I don't think in the next two years, we're going to be seeing mass layoffs of marketing professionals or copywriters. Everyone can theorize about the future and have their own opinion but you can't really argue that in the past, this type of AI or automation has led to higher rates of natural unemployment, which you haven't seen the data so far. You've seen historically are these moments in time. Take the 1930s, where suddenly you had a whole bunch of folks who were in the agriculture industry. Or maybe go back before the 1930s. Go back to the late 1800s. What happened was suddenly farming became more automated. What happened was we could produce equal amounts of food with less amounts of human labor and more technology. And what did that human labor do? They migrated to the city. They took those other jobs.

And I think the common critique of that argument is, well, this time could be different. The AI is actually getting better. I think you have to take that argument seriously. I don't think this technology is going to obviate the need for true artists but I very much believe Andrew Yang. He has this famous quote, which is that the radiologist will not be replaced with AI rather, the best radiologists are the ones that will figure out to work in combination with the AI. I tend to say I don't think in the next three to five years we are going to be seeing structural unemployment caused by mass automation. And I'm kind of open to revising my opinion, day by day, as we watch what's happened.

Let’s talk about the trends with regard to emerging technology that is used to support digital health operations.

Kaufmann: So one of the big trends-- and this actually relates to what we were talking about earlier with the pandemic-- was that the relaxation of regulations and the drive for patients to visit their doctors virtually has led to this emerging plethora of remote first telehealth companies.

Suddenly you have these entrepreneurs that, in the last two or three years, built these companies all on the back of how can I get a patient in front of a clinician and do it virtually. These companies are making use of a whole bunch of interesting technologies, horizontal technologies, like Zoom for the video, Twilio for the in-app notifications and some of the patient-to-doctor communications. Then you've also started seeing what I would call the emerging infrastructure of the digital health startups. I've been paying attention to this trend in the last 10 years in the world of fintech. Suddenly you had all these neobanks emerge, and they all had the same needs. They all had to verify identity. You had the emergence of companies like Socure. They needed to communicate directly with customers, so you had the emergence of conversational AI to support banking. So rather than each neobank, needing to build out this their own stack, you had the emergence of vendors, and in venture speak, you call that picks and shovels.

I'm spending my time today on what are the picks and shovels of the emerging kind of different digital health startups. I don't have any investments in the space yet. But a couple areas I'm looking, there's some interesting businesses in the doctor credentialing and licensing verification stack, just like Plaid built an API that can connect a bank to a fintech, these businesses are building APIs to connect into government databases. So a digital health company can verify that a doctor is certified in that state [and] the license is up to date. And as these doctors need to practice in multiple states at once, you can use technology to do that. I'm also spending time on companies building next-gen electronic health record systems and companies building portals to help these companies better schedule and engage with patients. Because just like what happened with the neobanks, you're not going to build all this infrastructure yourself. And I'm always interested in emerging picks and shovels bets in these spaces that are really driven by big technology trends.

And it's an interesting conversation to have. I will close out with climate tech. So you mentioned climate, climate tech, if you could talk a little bit about that.

Kaufmann: Before I was in venture, I came from the public policy sphere. I worked at the Federal Reserve so I've always gravitated towards entrepreneurial opportunities that involve some form of regulatory-driven change. One of the early investments I sourced at Scale was a company called Keep Trucking. Now it's called Motive. It was very much around helping truck drivers comply with new regulations around hours of service, how long they can be in the truck, how long they can drive the truck for the general safety of the other drivers on the road. There was a software platform that could help them comply with a regulation [and] coach them on their safety. And that business is Samsara, which is now a public company valued over several billion dollars software on the back of regulation. The firm also invested in BigID, which is helping businesses comply with GDPR and privacy regulations. And that's an investment we're really excited about.

In a similar domain, the regulations in Europe that are starting to emerge, are going to start to force businesses to track the carbon supply chains, track the carbon emissions at a corporate level. Both track and then action off of that. What can I do as a business to reduce my carbon footprint? This is an interesting space because it both attracts the folks who are, very civically minded that are evaluating it from how can we do something that's really necessary to protect the entire planet. Then you have these other folks who are doing it to be blunt, for regulatory reasons. They're doing it because their consumers expect them to do so. They're doing it because it's becoming a social norm that consumers demand. I think this confluence of both the regulations in Europe, the confluence of this emerging social norm, that we start to care about this as a society means that big businesses, corporations, investment firms need to start tracking this data. If you're going to make a commitment to the public markets, that by 2030, you're going to reduce your carbon footprint, by 30%, you wake up the next morning, and you're like, wow, now I need to do that. You have to understand what is your current carbon accounting. What are the reasonable plans you can make to execute on those words? And I think the best way to go from words and commitments to those actions is the ability to measure carbon account software that can bring the organization under one roof and kind of allow these goals to be accomplished.