Marcus Whitney: Banking struggles are limiting healthcare innovation

T here has not been much ado in the healthcare world about the failure of Silicon Valley Bank (SVB), but maybe there should be.  

Once considered the go-to bank for startups, SVB was the target of a bank run March 9 driven by news of their held-to- maturity bonds being underwater, and it was taken over by the Federal Deposit Insurance Corporation (FDIC) 24 hours later. On a weekend that was filled with uncertainty, startup founders and venture capitalists wondered if they would be able to get their money out of the bank. By the evening of Sunday, March 12, the Federal Reserve Bank, the U.S. Treasury and the FDIC announced a plan to ensure that all depositors would be paid in full.  

The result was that SVB, one of America’s 20 largest banks at the time, was no more. SVB was a casualty of the fast and significant rate of change in the federal funds rate, which caused seemingly safe long-term bonds pegged to a 10-year interest rate to become a losing bet.  

This collapse sent shockwaves through the venture industry, as many startups and venture funds relied on SVB for funding and support.  

Healthcare organizations have a constant imperative to figure out how to do more with less while boosting productivity, and it once again comes down to their ability to innovate. But with all the pressure driven by the central bank’s efforts to get inflation under control, SVB stands as a warning of the kinds of rapid collapses that we may see ahead if our leaders do not treat this moment as critical. 

The direct effect on the healthcare industry is not substantial, but in an industry struggling with durable labor issues, a major disruption to the innovation economy is not helpful either.  

The Bureau of Labor Statistics (BLS) recently reported that the U.S. economy had experienced five straight quarters of productivity decline, with nonfarm business sector labor productivity decreasing an annualized 2.7% in Q1 2023. This marks the longest streak of productivity decline since the financial crisis of 2008. 

Simultaneously, the cost of labor has done the inverse. The BLS also reported that the hospital cost of labor in the United States rose by 1.3% in Q1 2023, driven by increases in compensation and benefits. The cost of labor across all industries rose 1.2% in the same period. These are challenging trends for the entire economy, but healthcare is among America’s industries consistently impacted by negative trends in labor force and productivity.  

Drive for efficiency impeded

The healthcare industry cannot afford to slow its march to more efficient productivity through innovation, but that’s precisely what will happen thanks to the rapid rise of the federal funds rate. Due to interest rates rising from about 0% to more than 5% in less than a year, the finance world has been turned upside down. While SVB has been the most significant interest rate-related failure of the year, the rising rate environment also has catalyzed many other challenges in the equities and banking markets.  

According to the PitchBook-NVCA Venture Monitor, the number of venture capital deals in the healthcare services and system sector fell from 369 in Q2 2022 to 321 in Q3 2022, a decrease of 13%. In the same period, deals in healthcare devices and supplies fell 4.2% to 182 from 190. 

The number of services and systems deals continued to decline in Q4 2022, with only 295 deals recorded, although deals in devices in supplies recorded a stronger total of 183.  

In Q1 2023, the trend continued with only 229 services and systems deals recorded, marking a decline of 22.4% compared with the previous quarter, while the devices and supplies segment fell 18% to 146 deals. This trend is principally due to fundamental valuation swings in all equities based on interest rates. 

A decrease in venture dealmaking impacts healthcare, as innovative healthcare tech companies are more capital-intensive than pure tech startups for regulatory reasons. They must also present as more mature to get risk-averse healthcare incumbents to partner with them.  

While innovation skeptics may have some schadenfreude at this turn of events, the impact of raising interest rates will not end with wealth destruction in venture capital. A much more fundamental challenge looms: the commercial real estate credit default threat.  

Real estate connection 

Many regional banks with meaningful financing relationships with America’s healthcare industry have built their asset base on financing commercial real estate. The rapid rise of the federal funds rate, alongside a push for working from home from a labor force with considerable leverage, is threatening the viability of the commercial real estate industry. If the commercial real estate market were to collapse, it could have a devastating impact on the banking sector, which would assuredly further impact both the startup industry and the healthcare industry.  

A bit of insight for healthcare leaders: There is a lot of leverage available in negotiations with venture-backed companies right now. This shift in the macro environment threatens us all, but in the meantime, as things remain relatively stable in healthcare, healthcare organizations have an opportunity to get ahead of these perils with some innovative sprints.  

The competitive environment between companies for capital in the venture landscape is fierce, and traction and cash flow are the most important currencies.  

This is a time of great fear, but forward-thinking healthcare organizations can extract significant value to address their labor and productivity-related issues by investing in innovators during these uncertain times.  

As Warren Buffet wrote, “Be greedy only when others are fearful.”