Venture capital firms have poured billions of dollars into the behavioral health sector over the last five years or so — and it remains a top investment target.
However, investors are shifting their focus, seeking out business models with proven track records and taking calculated risks on innovative approaches.
The venture capital approach contrasts with the common approach taken by private equity firms, which drive dealmaking in behavioral health. While private equity investors tend to prioritize tried-and-true business models, venture capitalists are known for their willingness to back novel ideas with significant growth potential, placing bets on forward-thinking concepts.
“It’s our responsibility to help invest in founders who are forward-thinking and see where the puck is going, but [also] know how hard it is and what the existing infrastructure looks like today,” Margaret Malone, principal at Flare Capital Partners, told Behavioral Health Business.
Boston, Massachusetts-based Flare Capital provides capital for early-stage health care technology companies. Flare Capital’s portfolio includes multiple behavioral health companies, including Author Health, Marigold Health and BeMe.
Investors have long been focused on companies that improve access to behavioral health care. While still a persistent problem, venture investors are now beginning to focus on other aspects of the business.
More than $12.5 billion has been bet on digital behavioral health in the last five years, according to Rock Health. Funding peaked in 2021, with $5.7 billion spent that year alone.
“There’s an opportunity [for venture capital investors to get involved] as we shift more from just increasing access to increasing quality access, but I think we’re still early in the quality part of that,” Malone said.
Where venture capital is headed
Investors have a growing interest in enablement services, also known as “businesses in a box.” These businesses have experienced “spectacular growth and even profitable growth,” Marissa Moore, principal at OMERS Ventures, told BHB.
“The Headways and Grow Therapys of the world [are] enabling independent practices or therapists to stand up a business under their umbrella and take insurance and all of that,” Moore said. “The operational overhead of running a business like that is far lower than standing up a practice. And you have the network effect that enables you to grow a lot faster.”
Toronto, Ontario-based OMERS is an early stage venture capital firm that invests in Series A to C companies. The firm has net assets of $127 billion and a portfolio that includes behavioral health providers Caraway and HelloSelf.
Enablement services avoid some of the up-front costs associated with growing a more traditional digital behavioral health provider, including acquiring patients and employing clinicians.
Investors are more optimistic about enablement services that avoid these costs, according to Michael Yang, senior managing partner at OMERS Ventures. But the behavioral health industry will eventually reach a saturation point.
“You can only absorb so many of those in the market,” Yang said. “[Enablement services are] going to be a thing, but again, like every segment of medicine and type of provider, how many of those things do you really need?”
Along with enablement services, venture capital is also looking to invest in collaborative and integrated care models.
The potential for behavioral health integration into other health care practices, particularly primary care, represents a tailwind for venture capital investments in behavioral health, Moore said.
“Behavioral health needs to be integrated with other types of care, more longitudinal care and more holistic care,” Moore said.
Similar to integrated care models, collaborative care — in which a behavioral health business builds relationships with health systems — allows for behavioral health companies to get patient referrals directly from a health system’s EMR.
One company utilizing this model is Concert Health, a digital behavioral health provider that integrates with primary care and women’s health clinics. Concert raised $42 million in a Series B round in 2022, led by Define Ventures.
“We’ve had our eye on collaborative care for a while,” Chirag Shah, partner at Define Ventures, told BHB. “We’ve always thought it was the right model [in which] to do mental health. I think there’s a place for all of the aggregator models. Ultimately, there needs to be a connection back to the patient’s existing care delivery for it truly to be impactful to the individual and go beyond the sort of episodic treatment that you see with a lot of companies and models today.”
There is also potential for venture capital to invest in behavioral health businesses that focus on wellness services and trauma care, according to Malone. Peer-based business models are now often reimbursable by insurance, including by Medicaid in 35 states, opening up further opportunities for venture capital to address the needs of more niche populations and increase scale and access.
Risk versus reward
Venture capital investors “swing for the fences,” Kevin Taggart, founder and managing partner of M&A firm Mertz Taggart, said in a recent report, yielding frequent strikeouts with the occasional grand slam.
The stakes are especially high in an industry upon which patients depend for crucial health care.
“At the end of the day, venture capitalists raise money from limited partners,” Yang said. “They have a duty to generate a rate of return on the money that they invest in these behavioral startups in a limited period of time. That’s why they push growth. … If the startups can’t grow spectacularly or ultimately can’t become profitable, which is really how you create value, then it’s not going to work. … These companies die away and patients are left suffering.”
Some venture capital-backed virtual companies have continued to score impressive funding dollars while planning for growth. Fifth Down Capital-backed Two Chairs raised $72 million in a Series C round in April, and Atomico-backed Pelago raised $58 million in a Series C round in March.
Venture-backed behavioral health companies are not the only ones facing the risk of failure.
The Center for Autism and Related Disorders (CARD) was acquired by private equity firm Blackstone in 2018. In 2022, the company shut down operations in 10 states. A year later, CARD filed for bankruptcy.
Still, venture capital’s high-risk, high-reward model means investors push for high profit margins. There is not a consensus on a specific figure to expect from a behavioral health investment.
For technology-enabled virtual behavioral health businesses, the median gross margin target should be around 40%, according to Moore.
“But as venture capitalists, we’d love to see something higher,” she said. “A venture capitalist typically backs something that’s more than 80% gross margin. So we’re talking about a two-fold difference. Something that gets closer to the 60% range is great for a virtual care practice.”
Other investors, including Shah, maintain that profit margins for behavioral health are not much different than other investment categories.
For behavioral health investments with tech-enabled care delivery models, Malone expects 60% gross margins or more. Ultimately, she said, all VC-backed businesses want to build an attractive business that can successfully exit.
Profit margins expectations may also differ based on the company’s stage of development.
“It’s less about profit margins [in] earlier phases of venture. It’s really about growth,” Yang said. “Once you take venture dollars, the expectation is [that] growth is truly exceptional.”
During seed, Series A, Series B and at times up through Series C rounds, it’s “definitely not growth at all costs,” Malone said. During these phases, companies must grow and find product market fit. Companies that do so while showing profitable unit economics will find a path to longer-term profitability.