2015 has been a year of inflection points in the true mathematical sense of the word: key trends slowed after years of acceleration. I expect that 2016 will be a year of cross-currents, when old trends die and new trends are born. As entrepreneurs and investors we need to be ready for change and spot new trends and opportunities as they firm up.
You can see the fading of trends in the macro-economic data. The U.S. stock market slipped in 2015 after 5 years of rapid rise. The growth rate of the U.S. economy is likely to soften in 2016: decent levels of domestic demand will be damped by rising interest rates and slower growth of key trading partners in Europe and Asia, and low oil prices will continue depressing demand for oil-related industries while producing relatively little increase in consumer spending.
The venture capital market is also losing momentum. In 2015 private company valuations began to level off or slip after a period of rapid rise. Tech companies’ share of the IPO market dwindled. Venture investing has surged in recent years, fueled by “venture tourists” (hedge funds, public market investors) coming into the market plus increased corporate participation. As valuation growth slows or reverses, much of this capital is likely to flow elsewhere.
The venture world has been driven by some clear and simple precepts for the last 10 years: software, especially web/mobile-based software-as-a-service, is eating everything (so don’t invest in hardware); only unicorns matter (so don’t bother to invest in a company that won’t quickly attain a $1 billion valuation); and most of the money is made by a few top names in Silicon Valley (so don’t invest elsewhere, especially Europe).
These precepts are looking shaky. The unicorn concept, coined by venture capitalist Aileen Lee about three years ago, has drawn fire. Many observers doubt that unicorn valuations are meaningful. They see excessive risk in the high rates of cash burn that large, high-priced unicorn rounds have produced. And, there is strong evidence that much of the value creation in venture capital comes from companies that exit below $1 billion but at a high multiple of invested capital, returning a large fraction of capital commitments for the (mostly smaller) venture funds that supported them.
Cambridge Associates, the leading independent venture industry analyst, recently published a study titled “Venture Capital Disrupts Itself: Breaking the Concentration Curse”. Cambridge debunks the idea that a few top names in Silicon Valley create most of the value. It concludes: “The old wives’ tale … that a concentrated number of venture firms … account for the majority of venture capital value creation … is flawed. As the venture capital industry and technology markets have evolved and matured … more managers are creating significant investment value for LPs, with value increasingly created through companies located outside the United States and across a range of subsectors.”
The field of investment opportunity is looking much more complex. Software’s tide continues to rise, however, software is enabling new growth markets that involve significant hardware too: robotics, including drones and driverless vehicles; 3D printing (the “maker movement”); and internet-of-things are strong contenders. Likewise, Europe, which has been in the venture dog house since the 1999 bubble, is coming on strong. Europe has produced a series of solid exits, many European regions are developing a healthy start-up eco-system and culture, and venture capital inflows are rising strongly.
Venture capital investment in digital health in the U.S. Data via Rock Health.
Digital Health, where I focus most of my investing, is likewise at a turning point. The rate of investment has leveled off in 2015 after several years of rapid growth. The five years since the passage of the ACA (1) produced a surge of new initiatives as companies and investors made moves that they believed would make sense in the new healthcare economy, and as the taps opened for huge new spending on Medicaid expansion, health insurance exchanges, and healthcare information technology (e.g., electronic health records). A lot of those early plays have been made now, and the time has come to see what is working and what is not. As an example, CastLight is a venture backed company that put an early stake in the ground in the market for healthcare information intended to guide consumer decisions and achieved a fast IPO. Experience is showing, however, that it’s hard to get people to behave like consumers when purchasing healthcare, Castlight's stock has traded down almost 90%, and CastLight’s website now describes a broader range of health benefit related services for corporate clients. Likewise, the growth of health insurance exchange and medicare expansion clients is leveling off as these programs mature.
Some areas of digital health have either clear momentum or untested promise, however. Creating liquidity (access in usable form) and connectivity for healthcare data and digital therapeutics are two areas where we are in the early chapters of the story.
So what will 2016 bring? Discontinuity, as old trends die. And new beginnings: more than ever, entrepreneurs and investors will need to look at a broader field of industries and business models and discard received wisdom to capture the emerging opportunities. One thing is clear: lather/rinse/repeat is not promising.
Notes:
- The Patient Protection and Affordable Care Act of 2010, often called "ObamaCare".
