This article assesses the characteristics of the digital health industry and examines whether the market is ripe for notable private equity investment. The broad scope of digital health includes categories such as mobile health (mHealth), health information technology, wearable devices, telehealth and telemedicine, and personalized medicine. After several years of exponential growth, the telemedicine and digital health industry has reached an inflection point — moving from infancy to adolescence — as consumer-oriented digital health care solutions gain popularity, and traditional health care providers turn to virtual care. Naturally, investment in digital health companies has seen a corresponding increase, primarily led by venture capital. But with increasing size of venture investments deployed into fewer emerging companies, telemedicine is just now starting to gain the interest of private equity. Moreover, a handful of notable mergers could signal more industry consolidation, another sign of market maturation in this still nascent industry. Clearly, many health care institutions are investing in telemedicine and digital health (including via their own venture funds), if only to remain competitive. What is it that has venture capital, private equity and other players so interested in digital health? And what are the key legal considerations an investor should note when evaluating a telemedicine or digital health investment?
Recent Private Equity Activity in the Digital Health Space
Companies that have proven themselves early successes in digital health are maturing out of their initial stages of development. These companies seek capital investment not to fund the development of their idea, but instead to fuel marketing and business development to expand their service into new geographies. As a result, digital health is no longer exclusive to venture capital, as private equity firms and larger companies have begun to enter the field, targeting digital health companies that have demonstrated more than just being cash flow positive and are in fact profitable, heating up deal activity. In 2017, roughly 224 companies made funding announcements constituting just over $5 billion in investments. This was roughly twice the amount announced in 2016. Several notable deals include:
- Modernizing Medicine, which makes a mobile-based electronic health record, or EHR, for specialists, raised $231 million from global private equity firm Warburg Pincus.
- GTCR, a leading private equity firm, acquired GreatCall Inc., the largest provider of connected health and personal emergency response services for senior citizens, serving over 800,000 subscribers across the United States.
- Verily, the Alphabet subsidiary formerly known as Google Life Sciences, raised $800 million in funding from Temasek, a Singapore-based investment company.
- Bright Health, the Minnesota-based health insurance startup that boasts "a smarter, more connected" experience, raised a new round of $160 million.
- American Well, the Boston-based telemedicine software company, acquired Avizia for an undisclosed amount, strategically expanding American Well’s footprint with health systems and institutional providers.
Mature Digital Health Companies Satisfy Criteria Private Equity Firms Desire
A decade ago, the digital health industry was in infancy. Participants in the space mostly consisted of startups and small, emerging companies with limited financial backing. Companies sought venture capital funding, as well as multiple partnership arrangements with erstwhile competitors, in an attempt to expand their product and service capabilities. The companies that survived have proven themselves and are taking the next developmental step toward mature operations. These companies are seeking larger investments and the opportunity to grow. Private equity firms and other investors are just now beginning to respond by dipping their toe in the industry to fund these companies. It is still early, and most private equity firms interested in telemedicine and digital health are interested in the technology as a value-add to their existing portfolio companies. While there are some notable “pure telemedicine” private equity deals, those have been few compared to the numerous venture funding deals. However, this will change over the next few years, and the market will see more private equity come to the table. As investors continue to explore the new opportunities offered by digital health, certain industry characteristics have emerged, signaling the time is right for investment opportunities. These characteristics include, but are not limited to:
- A Reasonable History of Financial Performance. Several companies within the telemedicine and digital health industry maintain a “startup mentality” but have realized that the history of financial performance is necessary for outside investment and that they should no longer be considered startups.
- Scalability. Some digital health companies have obtained scalability through previous alignments and are able to demonstrate to sophisticated investors how they will drive future growth. Furthermore, they can demonstrate how to deliver a digital product in a manner that is cost-efficient and offers a high-quality user experience. Health plans and hospitals also seem to support the industry through adoption of various digital health technologies. The greater the sales volume/margin, the greater the potential profitability and accompanying return on investment for the investor. Private equity firms will also focus on areas of digital health that have products and services that need capital to increase sales to the masses, along with the impact these companies have on the economy and society.
- Value Proposition. Companies in the digital health space that satisfy the above criteria tend to attract interest from private equity firms and other investors if they offer services and products in the following areas of health care:
- Technology and technological products;
- Consumer-oriented health care services;
- Clinical decision support;
- Precision medicine;
- Artificial intelligence and machine learning;
- Disease monitoring and diagnosis.
- Sustainability of the Company. Private equity firms tend to seek sustainability. This could mean choosing to invest in digital health companies that were consolidated or merged with other digital health companies in the early stages of development or digital health companies that offer multiple products and services that display continued growth year after year. Some investors prefer not to place all their eggs in one basket, so if a digital health company can show it has several successful products or services as opposed to just one, it might garner more attention from private equity.
Regulatory and Reimbursement Changes Support Investment in Digital Health
Recent changes in the regulatory and reimbursement landscape also support the rise in investment in the telemedicine and digital health industry. Some of these changes include:
- In 2018, the president signed into law the Bipartisan Budget Act, which introduced some of the most significant changes ever made to Medicare law to use telehealth, including eliminating rural restrictions for certain services and allowing Medicare reimbursement for telehealth while the patient is located at his/her home (something previously never allowed). Some of the changes become effective in 2019 while others go live in 2020. Either way, the law marks significant expansion of telehealth reimbursement, particularly for stroke and dialysis services.
- States continue to pass laws requiring health insurance plans to reimburse for services delivered via telehealth in the same manner plans reimburse for services delivered in person. These laws, called telehealth commercial coverage laws, currently exist in 36 states plus D.C., and the list of states continues to grow.
- Starting January 2018, Medicare now pays a monthly recurring reimbursement for remote patient monitoring services, which will significantly assist in accelerating the adoption and use of these virtual care technologies.
- State laws have evolved such that a physician can create a valid doctor-patient relationship via telemedicine, without an in-person exam, in all 50 states. In 2017, Texas Gov. Greg Abbott signed new telemedicine laws, bringing to a close some significant antitrust litigation brought against the Texas Medical Board. By signing SB 1107/HB 2697, Texas became the last state to allow physicians to connect with new patients via telehealth, rather than having to first meet in-person.
- The Food and Drug Administration’s Center for Devices and Radiological Health, or CDRH, adopted the Digital Health Innovation Action Plan, which outlines the FDA’s approach for assuring that all Americans, including patients, consumers and other health care customers have timely access to high-quality, safe and effective digital health products. This plan lays out the CDRH’s vision for fostering digital health innovation while continuing to protect and promote the public health.
Key Due Diligence Considerations for Digital Health Transactions
Health care is one of the most highly regulated industries in the United States and constitutes 18 percent of the nation’s gross domestic product. While telemedicine and digital health offer the promise of transformative care delivery and bending the cost curve, health technology has its own unique risks to investors and is subject to significant regulations, making due diligence critical for potential investments. Digital health is not geographically limited in the same ways as traditional medical practices, and a telemedicine provider can be subject to the laws of each state where its patients are located. Because of this complexity and multistate legal issues, additional consideration and sophistication is mandatory in a digital health transaction in order for the buyer to meaningfully determine whether or not the target company is in compliance with state and federal laws. Some of the key due diligence considerations for digital health transactions include:
- State Telehealth Laws. State laws vary on what constitutes digital health, the services it covers, and those that can provide services. However, the location of the patient typically is what dictates which state law applies; telemedicine providers therefore need to understand and comply with the laws of potentially 50 states. There are compliant solutions, but it is important to identify and address risky shortcuts or failures during the due diligence stage.
- Stark Law. Stark Law and state law counterparts prohibit most self-referrals of Medicare “designated health services” to entities in which a physician or family member has a financial interest.
- Anti-Kickback Statutes. Federal and state anti-kickback statutes bar exchanges intended to induce or reward the purchase of goods or referral of health care services.
- Antitrust Compliance. Premerger notification filings under the Hart-Scott-Rodino Act may be required if the transaction exceeds $84.4 million.
- HIPAA and State Privacy Laws. The Health Insurance Portability and Accountability Act of 1996 and state privacy laws surrounding patient privacy and data security may require increased scrutiny for digital health when determining compliance.
- State Licensing Requirements. All states require physicians to be licensed to practice in the state in which the patient is located, which means physicians providing services via digital health (i.e. telemedicine) will sometimes require licenses from multiple states, different medical boards and will be subject to differing credentialing regulations.
- Corporate Practice of Medicine Rules. Because many states restrict the employment of physicians by nonphysicians, counsel should examine the rules in each jurisdiction and review all employment relationships for compliance.
- Civil Monetary Penalty Laws and the False Claims Act. These laws prohibit different forms of inappropriate business practices, such as submitting false claims for payment to the federal government or failing to return overpayments. A billing and coding audit may be useful to ensure compliance with these laws at the federal and state level.
- FDA Regulation. The Food and Drug Administration has oversight on medical devices, including software as a medical device. Telemedicine and digital health companies must determine whether or not their product is a regulated medical device and if it requires FDA clearance or approval before it can be sold.
- Tax-Exempt Considerations, if Applicable. Tax-exempt providers also face risk in entering into transactions with private equity investors. The parties in investment transactions must take care to structure transactions between tax-exempt providers and for-profit entities so as not to jeopardize tax-exempt status of a hospital organization, or create private use, which could jeopardize the tax-exempt status of outstanding bonds, or generate unrelated business income for the hospitals. Notwithstanding these challenges, private equity remains an interesting option for a nonprofit provider looking to finance or develop its digital health network.
The telemedicine and digital health industry meets many criteria making it ripe for private equity investment. The industry has grown extensively in the past several years, and outside investment in digital companies has likewise increased in recent years. Consequently, there has been a notable increase in venture capital firms, private equity firms and other investors entering the digital health investment space.
Companies with reasonable histories of financial performance, scalability, and sustainability may present the most attractive opportunities for investors. With the reimbursement and legal/regulatory scheme changing at the federal and state level to support the growth of the digital health industry, investors should seriously consider opportunities in this growing market.
 See Teladoc Inc. v. Tex. Med. Bd., No. 1-15-CV-343 FP, 2015 U.S. Dist. LEXIS 166754 (W.D. Tex. Dec. 14, 2015)
This article was originally published in Law360.