Common pitfalls of digital health startups & advice on how to avoid them
2023’s stacking up to be a bloodbath for early-stage digital health startups… and it’s only January. Digital health has always been challenging to build in — with lengthier sales cycles, higher implementation costs, and regulatory red tape all over. Tack on the pressure of rising interest rates making capital costly and startup valuations tank, investors are skittish. Funding into digital health startups in 2022 was only half of 2021’s.
Yet, it’s a great time to build a digital health startup. Funding in 2022 marked the second highest year ever. Experienced investors are sticking around because the long-term opportunity is clear. And on top of that, the digital health gold rush over the past ten years has produced builders with earned industry knowledge. This resetting moment leaves us with more disciplined, profit-driven founders.
I’ve met with 100+ of these early-stage founders over the past year building both healthcare SaaS and tech-enabled care delivery services, to understand the challenges and opportunities across their companies. I’ve also gotten a front row seat of the successes and mistakes of my own healthcare infrastructure startup. I’m here to share with early-stage founders the common pitfalls I’ve seen specific to building in digital health — and advice on how to avoid them.
The goal is to help founders on the frontlines pushing healthcare innovations forward weather the storm over the next few years, so there are more winners that emerge and better outcomes delivered. I also hope this advice helps generalist investors better evaluate and win digital health deals, and support healthcare founders with empathy.
- Surround yourself with a bilingual team who speaks tech and healthcare
- Start focused by building a wedge, not a platform
- Own the secret sauce in your digital health tech stack
- Sell into the whales of healthcare
- Manage your financial health obsessively, more so than non-healthcare peers
- Deliver and track the right clinical outcomes
1. Surround yourself with a bilingual team who speaks tech and healthcare
The pitfall: Founders who’ve never worked in healthcare, thinking they can build a successful healthcare company on their own.
In other industries, a compelling founder story may suffice as founder-market fit. Example: “I wear a lot of makeup, so am going to launch a new makeup line” says every celebrity makeup brand founder ever. But this doesn’t work in healthcare. Healthcare is still an exclusive and clubby industry, with a high learning curve to map out all the players and incentives.
Having a bilingual team means having both technical and healthcare expertise. A common archetype you see in founders is the technologist-clinician duo. Being able to speak both clinical and technical language becomes an unfair advantage in making it easier to open doors to enterprise players and quickly building user-centered products that play well with practitioners’ and members’ entrenched workflows.
As you hire your team, it’s especially important that this healthcare proficiency exists in your key product and sales hires. Your leadership teams needs to be able to translate patient and provider needs into roadmap, and build relationships with healthcare decision makers.
If you don’t have the expertise on your founding team, supplementing with strong clinical advisors or strategic healthcare investors can be the next best thing.
2. Start focused by building a wedge, not a platform
The pitfall: Founders who start out by building an “all-in-one” digital health platform serving tons of different customer segments.
For a time, I trialed the tagline, “Shopify for digital health” at my startup. It didn’t stick. The analogy of “Shopify” conjures up the image of a breadthy platform that you can build any patient engagement solution on top of. What I forgot was that Shopify in their early days had a clear value proposition they could point to in their product: helping e-commerce owners track orders and automate inventory automatically. They were a tool, not a platform.
Instead of focusing on breadth, it’s smarter to build depth in the early days. The natural evolution of winners like Shopify are tool → platform → ecosystem. Be a wedge by doing one thing very well that solves a big pain point for customers. If your ambition is to build the “Shopify for digital health,” maybe wedge in by solving the scheduling conundrum first. You’ll have a clear value proposition, more repeatable go-to-market motions, and differentiation of yourself in markets with growing numbers of competitors. This drives acquisition in your ICP, and customer value on your P&L.
The key is that while you’re building a wedge, you should already have a vision, and ideally, multiple paths mapped for becoming a platform. You should test hypotheses with your early customers in order to decide which paths will catapult you into becoming the winner of a market with large TAM. Expansion can take two flavors: how many new customers you can capture, and/or how much more ARPU you can capture.
3. Own the secret sauce in your digital health tech stack
The pitfall: Founders who take venture dollars to build a tech company, but don’t build a tech moat and end up becoming a services company.
Healthcare is a services industry with thin margins; 33%+ of hospitals are operating on negative margins. The vision of tech-enabled care delivery is that the “tech” can lower COGS, increase revenue, and drive better margins; and this can produce venture-sized returns. Yet, there’s this inevitable pull in healthcare towards becoming services heavy, and for founders to eschew building their own tech in favor of speed to market.
For a tech-enabled service, you avoid this trap by building and owning your secret sauce. A good exercise is to map out your product specs. Go down your feature set and ask yourself: Is it core to your clinical model? Does it differentiate you from competitors? Does it create future value for your enterprise strategy? If all three are checked, then it’s your secret sauce to build. Everything else, you can buy. Let’s take the example of a tech-enabled care navigation company; they’ll likely buy an off-the-shelf EHR and build the risk-scoring technology to power intelligent navigation.
What founders often forget is the long-term value created of owning your secret sauce from the start. As you grow, you aren’t dependent on external vendors (product limitations, changing pricing, vendor death), avoid switching costs, and can shore up your product IP and moat.
A general rule of thumb to know if you’re on the right track:
the difference between a tech-enabled services company and a services company is simple.— Morgan Cheatham (@morgancheatham) January 31, 2023
for a tech-enabled services company, revenue scales non-linearly as COGS scale linearly. anything else is a services company
On vendor death, as more and more “digital health tech stack” vendors have been spinning up with tempting promises to save companies time, money and compliance headaches, you should understand the risk of becoming reliant on a startup vendor who faces the same market pressures as you do. Always do your diligence on your vendor’s business, including asking for their runway (see #5).
Meanwhile, for healthcare SaaS founders, be mindful of your implementation process. You don’t want to become a consulting services shop building systems integrators, doing custom work, and racking up high implementation costs for each customer. The goal is to be self-serve which oftentimes comes with being a tool, not a platform (see #2).
4. Sell into the whales of healthcare
The pitfall: Founders who see early success with small fish, with no plans to sell into whales.
On the journey to product-market fit, founders are looking for quick and early signs of traction. For a tech-enabled service company, this means selling direct-to-consumer; and for a healthcare SaaS company, to independent practitioners, SMBs and other digital health startups. The trouble with these early successes is that it doesn’t scale, as you’ll ultimately run into high CAC, low ACV, and high churn.
To achieve usage at scale, you need to have a plan of how you’re going to win enterprise from the start. Derick En’Wezoh from Susa Ventures said it to be best: You’ve got to sell into the “whales” of healthcare — health plans, hospital systems, provider groups, and let’s include biopharma and employers in there too for good measure.
These relationships take lengthy sales cycles to close — closing a hospital system averages 12 to 18 months to navigate their operational budget cycles (closing health plans take even longer!), identify an internal champion, put together a compelling ROI use case, and navigate bureaucratic procurement processes. Which is why you need to plan for your GTM upmarket earlier than later. The minute you see repeatable usage patterns among a core customer profile, you should begin your motions into enterprise.
Another relevant pitfall I see here is founders thinking their enterprise strategy is completely separate from their DTC or SMB starting point. It’s true that SMB and enterprise sales are different motions and require different GTM teams. But founders should be able to identify needs that are common to both small fish and whales so early traction can be laddered up into building a compelling ROI use case for enterprise. For example, if you’re planning on doing VBC contracts with payers, you have to make sure your gathering the right evidence in your DTC channels. If you want to sell into big employers with a B2C2B strategy, it probably makes sense to focus your customer acquisition in regions where they have lots of employees.
Two resources I recommend here are a16z’s B2C2B playbook, and Rock Health’s old but still highly relevant guide on streamlining enterprise sales.
5. Manage your financial health obsessively, more so than non-healthcare peers
The pitfall: Founders pushing growth at all costs, just to find themselves at the end of the line with zero cash in the bank.
This is true for every founder, but I argue that healthcare founders need to manage their balance sheets even more closely. You must have a solid business model that bends the traditional P&L of care (remember those razor-thin margins?), either by making it less costly to provide care or by improving outcomes without making care more expensive. And in finding the right balance on the growth vs. profitability spectrum, err towards improving margins in these market conditions. Healthcare is a long game, which means being the one left standing at the end can be a competitive advantage in itself.
There are some unique levers that are worth revisiting:
Firstly, sales cycles in healthcare are lengthier. You know that closing an enterprise customer could take 18+ months, so you should plan for at least two to three years of runway. Daisy Wolf at a16z recommends founders go into investor conversations from a position of strength by having at least 12 months of runway. Running out of cash in healthcare doesn’t just impact employees, customers and investors; but more detrimentally, the human lives under care too.
Secondly, COGS are generally higher, especially as you get up and running. For healthcare SaaS, this means implementation and support costs. For tech-enabled services, expect better gross margins over time (e.g., from 25% to 60%+) as you leverage tech to improve provider efficiencies. Be patient early on and expect lower gross margins than the generalized benchmarks that are published online.
While this may ring alarm bells of “Why am I building (or investing) in healthcare, anyways?,” the big upside is there’s a much larger TAM to capture and higher YOY growth. Where the average TAM of a cloud SaaS business is $10B+, the average TAM of a tech-enabled healthcare service is 14x that.
Look to healthcare-specific benchmarks like Bessemer’s Benchmarks for growing health tech businesses to see how your costs and sales compare.
6. Deliver and track the right clinical outcomes
The pitfall: Founders reciting ARR, EBITDA, LTV:CAC, ARPU, TAM… with no mention of clinical outcomes delivered.
I sat in 75+ calls with investors when my startup was raising our seed round. It surprised me how often investors dug in on financial outcomes, and completely glossed over clinical outcomes. On the other side of the table, I’ve noticed founders making clinical claims splashed on their market site and ads, yet under the hood have little clinical robustness. While financial outcomes are not always tied to clinical outcomes and vice versa, a successful digital health startup must be able to demonstrate both.
Founders should be obsessed with delivering and tracking the right clinical outcomes. What’s “right” will vary based on your model. A good exercise is to write down the measures that matter most to all the different stakeholders of your solution, including patients, practitioners, current buyers and future enterprise buyers. Understanding what measures overlap between all your stakeholders will help prioritize and align goals and incentives. Tracking them longitudinally will help you identify how to improve the quality and effectiveness of your services.
When you’re starting out, your dataset may be limited, but you can point to compelling qualitative customer testimonials or references. Over time, you’ll rely on more and more quantitative data like readmission, mortality, safety of care, and NPS scores. And getting FDA clearance or approval on your device and therapeutics, running clinical trials, and publishing results in academic journals can establish your clinical IP and moat.
Playing the long game, all these outcomes will be packaged into a compelling ROI use case to convince risk-adverse enterprise customers into making a purchasing decision (see #4. For example, that your virtual pre- and post-ops care navigator for the surgery department can decrease no-show rates, improve timeliness of care for patients, and increase revenue.
Ultimately, make the case for how clinical outcomes are also good for your customer’s financial outcomes; for example, in improving engagement, helping you to upsell, and reducing member churn.
The best time to build in digital health
If I had five cents for every time I’ve heard someone say, “This is the best time to build,” I’d have a dollar. (Actually, Yoni Rechtman from Slow Ventures made me aware that he published an article titled exactly this, so it’s $1.05 now.) I’m apologizing in advance that you have to hear it again.
I believe this is the best time to build in digital health, and that the biggest digital health unicorns are going to come from this downturn — because they’ll be healthy, profitable, disciplined businesses.
I want to support early-stage founders who’re in the trenches building these unicorns. If you have other common pitfalls and advice to share, I’d love to hear and collate them as additional resources to founders. Reach out via email or Twitter.
Tons of gratitude to Yoni Rechtman, Sean Day, and Daisy Wolf for the feedback and notes on this article.