Digital Mental Health Startups Face Profitability Pressure as Investor Landscape Shifts

This is an exclusive BHB+ story

Digital behavioral health startups experienced a tsunami of investor interest from 2020 to 2022. Founders now face a tough funding environment when growing their companies.

As competition for funding dollars has increased, some say the pressure to become profitable as a new digital behavioral health startup is higher than ever. Still, investors look to other factors, including growth, to know when to bite on a behavioral health investment opportunity.

“[Profitability is] top of mind more than ever,” Faye Sahai, managing partner of Exbourne Group and founding managing general partner at Telosity Ventures, told Behavioral Health Business. “Several years ago, it was really about the interest, the idea, the momentum, the growth. Now we’re in a market that is really looking at your revenue, your unit cost, net profit, how much you plan to grow.”

Redwood City, California-based venture capital firm Telosity invests in pre-seed, Seed and Series A stage startups focusing on youth mental health and well-being. Its investments include the mental health app Wave, text message-based coaching provider MindRight Health and virtual counseling provider Daybreak Health.

Profitability starts with unit economics, according to Bob Kocher, co-founder of Lyra and partner at venture capital firm Venrock. Reimbursement must be higher than the cost of delivering a single therapy session, plus money left over to cover a provider’s overhead.

Step two, Kocher said, is using technology to lower the cost of treatment. For example, Lyra was able to improve major depressive disorders in fewer sessions by offering patients tools to use in between sessions, including videos and online messaging. Providers must also consider customer acquisition costs (CAC), balancing those costs with a customer’s lifetime value (LTV).

“You hope and pray and you better have, your CAC be lower than the margin dollars you create on the episode of care,” Kocher said. “Oftentimes, that’s not true when a company is small because it’s still trying to find a space in the world and prove that it has a product-market fit. But over time, that ratio should improve, and a good one is three to one. If you spend $1 on a patient, you should make $3 in gross margin dollars and profit after the cost of the therapy.”

Palo Alto, California-based Venrock has two separate investment programs, one focused on early-stage technology and health care companies and a later-stage health care program with a long-term approach to investment. Venrock’s portfolio includes Lyra and Included Health.

Burlingame, California-based Lyra provides virtual mental health care through relationships with employers. The company has raised about $910 million in funding, according to Crunchbase.

Time to profit

Investor expectations for time to profitability differ, but all start with a theory of how profitability will be achieved.

The initial year to year and a half of a company’s life gives investors a sense of profitability potential, Kocher said, and the potential to negotiate higher rates from the entities paying a company for its services.

Kocher prefers to have confidence in basic unit economics to be profitable during a company’s Series A funding round, within about two to three years of a company’s inception. By a Series B round, investors want to have data that a company could be profitable.

This timeline is somewhat dependent on the nature of a business. Providers with physical centers must show profitability sooner, Kocher said, because it costs more to grow. Still, the difference in timelines is only a matter of months.

For Sahai, digital behavioral health companies can take three to five years to become profitable, though investors who are less experienced in health care may expect faster results.

“It depends on the investor,” Sahai said. “I came from the health care industry, so I know the complexity, regulatory [factors] and the long scale cycle in healthcare, especially in the B2B timeframe, so I know it takes longer than typical other industries. … If you’re a new investor, or you’ve invested in other industries in that health care, you might expect higher profitability sooner.”

Time to profitability may differ among behavioral health companies. Companies operating wellness-type apps do not need FDA approval and generally face less regulation. Providers caring for more severe mental health and chronic conditions face greater levels of complexity – “but there is a lot of money in that area,” Sahai said.

Startups feeling the pressure

The funding environment for digital health startups has become much more challenging since 2022, according to Alice Zhang, co-founder and CEO of virtual mental health provider Anise Health. She credits this trend to higher interest rates and market saturation.

New York City-based Anise Health offers therapy, coaching and self-guided resources to Asian American patients in California, New York, Massachusetts, Florida and Washington. Founded in 2021, Anise has raised a total of $5 million in funding, including a $3 million raise in December.

Most VCs interested in behavioral health have already made their bet on the sector, and many firms avoid backing multiple startups in this area to prevent portfolio conflicts, Zhang told BHB. The sheer number of digital behavioral health startups has also increased, so investors may be less likely to bet on an early-stage company.

These factors have led to increased focus on profitability, according to Zhang. Venture capital investors have also learned from previous mistakes with digital health investment and are now focusing more on unit economics, she said.

Balancing profitability and growth isn’t easy, Zhang said. Still, she aims to reach profitability during Anise’s seed stage. To do so, Anise plans to expand margins by negotiating higher rates with health plan partners.

“Our approach has been collecting data around patient engagement and outcomes from the outset, to be able to clearly present to our payer customers, ‘Here’s our model, and this is the outcome,’ which is much better than engagement,” Zhang said.”When payers are presented with this kind of data, they’re more willing to pay for the service because they know what they’re paying for. That is one of the ways that we are reaching profitability faster.”

Anise’s “unique” patient acquisition strategy will lower costs, Zhang said. Because Anise caters specifically to Asian Americans, the company can create referral partnerships targeting a very specific population. These partnerships include Asian employee resource groups (ERG) or colleges in areas with many Asian students. These partnerships have lower costs than paid ads, according to Zhang, though the company still uses ads to create traction in its early days.

Growth vs. profit

While pressure to demonstrate profitability has increased, it’s far from the only factor investors consider.

Venture capital firms have long dominated digital behavioral health investing. VC investment requires bets on high potential, high growth and unprofitable startups, according to Michael Yang, senior managing partner at OMERS Ventures.

“There are other investment asset classes that are more focused on investing in profitable businesses such as private equity,” Yang said. “An easy tell for you is determining how businesses are valued. Businesses that are valued on patients, on lives, on cases, on beds, on revenues, [are] likely to be unprofitable, hence the topline metrics. If the business is valued on EBITDA, operating income or cash flow (core financial metrics), then it’s less likely to be a VC-styled business and more of a [private equity]-style business.”

Toronto, Ontario-based OMERS is an early-stage venture capital firm with net assets of $133.6 billion. Its portfolio includes behavioral health providers Caraway and HelloSelf.

Companies can be successful but not profitable because they are spending every dollar of profit on growth, Kocher said. These successful companies must demonstrate that if they were to slow down growth, they would have significant profits to pay out.

Still, it’s important to ensure that mature parts of the business are profitable, Kocher said.

Growth is valuable, in part, because once a company is large enough, it can manage its expenses to be profitable, Kocher said.

“Profitability, honestly, is not as important. What’s important is growth and the unit economics of the business,” Kocher said. “A higher growth rate is essentially three times more valuable, from a multiples perspective, to a public investor than EBITDA, than actual profits. That’s why we focus more on the growth side, as long as we can demonstrate that the unit economics suggest that it’s profitable.”