How could the Software sell off and AI bubble in early 2026 affect Digital Health, HealthTech and MedTech funding and M&A for the rest of 2026?

Nelson Advisors
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Structural Realignment: The 2026 Software Sell-Off and AI Valuation Correction in Healthcare Technology and MedTech

The global financial landscape in the first quarter of 2026 underwent a profound transformation, characterised by an aggressive re-rating of software valuations and a critical interrogation of the artificial intelligence investment cycle. By late February 2026, the North American Tech Software Index had declined approximately 30% from its mid-September 2025 peak, a volatility primarily driven by the emergence of autonomous "agentic" tools capable of automating high-level cognitive tasks. This technological shock, often identified as the "Anthropic Effect" or the "Claude Cowork Event," fundamentally disrupted the traditional Software-as-a-Service (SaaS) business model, forcing a shift from "tool-based" value propositions to "outcome-based" delivery.

While this retrenchment created immediate volatility in the initial public offering (IPO) market, leading to high-profile postponements of companies such as Clear Street Group and Liftoff Mobile, the healthcare technology and MedTech sectors entered a phase of disciplined resilience.

This report explores the mechanisms of this sell-off and the subsequent strategic pivots within Digital Health, HealthTech and MedTech for the remainder of 2026.

The 2026 Software Sell-Off: Origin, Mechanisms and Market Contagion

The catalyst for the market correction in early February 2026 was the release of agentic AI platforms that demonstrated the capacity to perform complex legal, financial and data-services work. The immediate market reaction was a sharp decline in tech stocks, as investors began to fear that traditional software "wrappers", services that essentially provide an interface for underlying data or models, could be easily replicated by smaller, AI-native startups. By February 25, the iShares Expanded Tech-Software Sector ETF (IGV) had fallen 24% year-to-date, impacting heavyweights such as Microsoft, Palantir and Salesforce.

The Evolution from Tool Provider to Outcome Provider

A primary driver of the valuation realignment was the realisation that traditional software metrics, such as seat-based licensing and seat growth, were becoming obsolete in an era of agentic automation. Historically, SaaS providers sold access to tools, CRMs, analytics dashboards, or project management interfaces. In the 2026 paradigm, value shifted toward delivering a finalized outcome, such as a resolved support ticket or a drafted contract reviewed against a proprietary playbook.

This transition effectively expands the total addressable market (TAM) by converting traditional labor costs into software investments, yet it simultaneously erodes the "moat" of companies that rely solely on code rather than proprietary data or workflow integration.

Market Volatility Index: Software and Services (Feb 2026)	Performance Change	Context and Driver
North American Tech Software Index	-30% from peak	Decline from Sep 2025 highs
iShares Expanded Tech-Software ETF (IGV)	-24% YTD	Impacted top holdings (MSFT, CRM)
Bloomberg Software & Tech Services Index	-9% (weekly)	Week of Feb 2 Anthropic release
Figma (Post-IPO Performance)	-74% from peak	Concern over AI design disruption
Bessemer Health Tech Index	+18% (2025 avg)	Outperformance of general cloud index

The sell-off was not limited to public equities. Private markets, particularly the 2021 and 2022 private equity (PE) vintages that deployed capital at peak valuations, faced significant markdowns. Limited Partners (LPs) began to apply heightened scrutiny to the actual defensibility of software portfolios, demanding clear AI roadmaps that enhanced business moats beyond simple co-pilot integrations.

The AI Bubble Narrative: Dissecting the 2026 Reality Check

The narrative of an "AI bubble" in 2026 was fuelled by astronomical capital expenditure (CapEx) budgets that often lacked immediate revenue returns. By early 2026, AI CapEx accounted for approximately 2% of global GDP, or $650 billion, with 2,800 new data centers planned for construction in the United States alone. Concerns intensified regarding the "circular validation" of deals, where major tech companies like Nvidia invested in AI startups (e.g., OpenAI) that then used that capital to purchase Nvidia's own chips.

Structural Plateau and the Economic Boundaries of Compute

Investor skepticism was further stoked by evidence that large language models (LLMs) were hitting a performance plateau, where capability improvements showed diminishing returns despite exponential increases in training costs. To justify the $4.8 Trillion market capitalisation of leaders like Nvidia in early 2026, analysts calculated that the company would need to capture nearly 15% to 30% of all global corporate profits by 2036, a scenario deemed far-fetched by many economists.

Furthermore, the "marginal cost of compute" emerged as a natural economic boundary. As demand for automation rose, the cost of compute increased; if this cost exceeded the marginal cost of human labor for specific tasks, the substitution of AI for humans would cease to occur, creating a "plateau" in the adoption S-curve. This reality began to weigh on the valuations of AI-first companies that had not yet achieved financial sustainability.

Digital Health: The Rise of "Health Tech 2.0" and the Trust Gap

While general software indices tumbled, the digital health sector exhibited a surprising degree of resilience, underpinned by what has been termed "Health Tech 2.0". This new generation of companies, including Waystar, Tempus AI, Hinge Health, and Omada Health, is characterized by strong unit economics and clear paths to profitability, diverging from the "growth at all costs" mentality of the 2021 era.

The Valuation Paradox and the "Trust Gap"

Despite demonstrating revenue growth and free cash flow (FCF) margins that often exceed those of high-growth cloud software companies, health tech stocks continued to trade at a 10-20% discount relative to their general tech counterparts in early 2026.

This "trust gap" reflects lingering investor skepticism following the 2020-2021 bubble and the subsequent collapse of firms with weak retention models. However, the fundamentals of the 2026 cohort suggest this gap may narrow as companies prove sustainable performance over multiple quarters.

Health Tech 2.0: Core Valuation and Performance Metrics (2026)	EV/Annual Revenue	Revenue Growth (y/y)	FCF Margin	Rule of 40 Score
Hinge Health	5.7x	72%	26%	98
Caris Life Sciences	8.9x	117%	-7%	110
Tempus AI	9.3x	85%	-22%	63
Waystar	6.9x	12%	27%	39
Omada Health	2.5x	65%	-1%	64
Health Tech 2.0 Avg	7.2x	67%	-2%	65

The "Rule of 40", the sum of revenue growth and FCF margin, has become the definitive metric for public market entry and late-stage funding in 2026. The average Rule of 40 score for the Health Tech 2.0 cohort (65) significantly outperformed the Nasdaq Emerging Cloud Index average (19) in early 2026, signaling a decoupling of digital health from general speculative tech.

January 2026 Funding Momentum

The strength of the digital health sector was evidenced by a robust funding landscape in January 2026, immediately prior to the software sell-off. Startups addressing clinical bottlenecks, patient experience, and care accessibility successfully secured capital across all stages.

OpenEvidence: Secured $250 million in Series D funding led by Thrive Capital and DST Global, with participation from Nvidia and Mayo Clinic.
Oviva: Raised €200 million (~$220M) to expand its digital chronic care network across Europe.
Evaro: Closed a $25 million Series A to scale its AI-first triage and pharmacy platform
Omniscient Neurotechnology: Raised growth capital to commercialise its Quicktome brain mapping platform globally.

These investments indicate that despite the broader tech volatility, capital continues to flow toward "clinically-grade" AI solutions that are deeply embedded into healthcare workflows rather than general-purpose "AI-wrappers".

MedTech M&A: Strategic Consolidation and Portfolio Realignment

The MedTech industry entered 2026 on the heels of a record-breaking 2025, during which deal value surged to a decade-high of $97.6 Billion. While transaction volumes remained selective, the average deal size increased significantly, reflecting a shift toward larger, strategic acquisitions aimed at "future-proofing" businesses against structural shifts in technology and care delivery.

AI Maturity as a Gating Item for Valuation

In the 2026 MedTech market, AI is no longer viewed as an optional growth lever but as a "gating item" for valuation.Acquirers are prioritizing targets with validated, regulator-ready solutions that integrate into real-world clinical workflows. This is particularly evident in high-growth segments such as surgical robotics, cardiovascular care, and AI-enabled diagnostics.

The Existential Impact of GLP-1s on MedTech Strategy

The widespread adoption of GLP-1 metabolic drugs has become a central factor in MedTech M&A strategy for 2026.Companies are pursuing two distinct paths:

Defensive Realignment: Divesting or spinning off businesses in segments vulnerable to declining procedure volumes, such as traditional sleep apnea or diabetes management tools.
Offensive Expansion: Acquiring technologies that address advanced and downstream complications of obesity, such as advanced heart failure, complex cardiovascular disease, and venous thromboembolism, where device-based intervention remains necessary even as medication usage accelerates.

Major MedTech M&A Transactions (Late 2025 - Early 2026)	Value	Strategic Catalyst
Boston Scientific / Penumbra	$14.5B	Expansion in neurovascular/thrombectomy
Danaher / Masimo	$9.9B	Bolstering diagnostics and oximetry
Abbott / Exact Sciences	$21B (est.)	Leadership in cancer screening/diagnostics
Thermo Fisher / Clario	$8.9B	Clinical trial data and AI-driven analytics
GE HealthCare / Intelerad	Disclosed	Enterprise imaging and workflow infrastructure

The Move to Ambulatory Surgery Centers (ASCs)

Another key theme for 2026 is the migration of care from traditional hospitals to lower-cost, higher-throughput outpatient settings. MedTech M&A is increasingly focused on technologies that enable complex procedures, such as those in orthopaedics and cardiology, to be safely performed in ASCs. This includes a shift from "capital equipment sales" to "recurring value models" where payment is aligned with the delivery of outcomes rather than a one-time equipment purchase.

The IPO Landscape: Selective Reopening and "AI Resistance"

The software sell-off in early 2026 significantly disrupted the momentum of the IPO market. Investors, once eager for "AI growth" stories, transitioned toward a "show me" phase, requiring companies to prove that their models were trained on billions of proprietary clinical data points and were not easily replicable by startups using commoditised LLMs.

The Digital Health IPO Blueprint

Despite the broader tech volatility, the successful IPOs of Hinge Health and Omada Health in 2025 provided a definitive blueprint for the 2026 vintage. These companies prioritised FCF positivity and sustainable growth for at least four quarters prior to their debut.

Hinge Health: Projected 2026 revenue of $732 million, showing 55% growth post-IPO.
Omada Health: Reported $61 million in first-quarter revenue, up 49% year-over-year.

These results signal that public investors remain willing to support digital health, provided the companies demonstrate financial discipline and clinically validated outcomes.

IPO Pipeline and Candidate Outlook

The backlog of IPO-ready healthcare companies remains substantial, though the market has bifurcated into "product-focused" and "platform-oriented" issuers.

2026-2027 IPO Candidate Pipeline	Sector	Status/Metric
Oura Health	Wearables/Data	$1B revenue in 2025; $11B valuation target
Doctolib	Digital Health	$6.4B valuation; category leader in waiting
CMR Surgical	Surgical Robotics	$3-4B; Dual-track IPO/M&A consideration
Zelis Healthcare	Health FinTech	Multi-billion; anchor candidate for 2026
Huma	Digital Health	Hospital-at-home; LSE candidate
Sword Health	Digital MSK	CEO guiding to 2026/2028 NASDAQ exit

In the biotech sector, the IPO window showed unmistakable signs of reopening in early 2026, with companies like Agomab Therapeutics ($200M NASDAQ listing) and Eikon Therapeutics ($381M listing) successfully raising capital despite general software volatility.

Private Equity and Venture Capital: The $1 Trillion Deployment Mandate

By the start of 2026, private equity firms were holding a record $1.1 trillion in "dry powder". The pressure to deploy this capital, combined with a Federal Reserve rate-cutting cycle (rates at 3.50-3.75%), is expected to make 2026 a "year of execution" for PE sponsors.

Private Equity Strategies: Carve-outs and Continuation Vehicles

With traditional buyouts constrained by valuation gaps, PE firms in 2026 are focusing on "strategic creativity" :

Divestitures/Carve-outs: Large healthcare players are refocusing on category leadership, selling non-core assets to protect margins and redeploy capital into high-growth segments.
Continuation Vehicles: These have become a preferred mechanism for PE firms to retain high-performing, resilient, cash-generative businesses (e.g., in CROs or CDMOs) beyond the typical fund life while offering liquidity to LPs.
Take-Privates: Sponsors are targeting MedTech firms whose operational complexity has led to their public stocks trading below intrinsic value.

Venture Capital: The Return of the "Strong Horse"

The venture ecosystem in 2026 has moved away from "unicorns" toward "strong horses", startups grounded in demonstrated cost savings, clinical workflow improvements, and market interest. While late-stage valuations saw a jump of 63% in 2025 (primarily driven by Health AI), the market remains selective, focusing on assets with durable revenue growth and defensibility beyond code.

The Provider Crisis: Labour Costs and Distressed M&A

The software sell-off occurred against a backdrop of intensifying financial pressure on hospitals and health systems. Labor expenses, which account for 60% of hospital costs, have stabilized at a permanently higher baseline. This has created a "structural reality" where providers must either automate or face financial insolvency.

Distressed Hospital Transactions and Consolidation

The financial stress on providers led to a record 43% of hospital M&A transactions in 2025 involving a distressed party. Well capitalised systems are increasingly stepping in to acquire these assets, committing new capital to modernise facilities and expand outpatient and virtual care capabilities.

Rural Health Transformation: The widening gap between strong and weak health systems means that many stand-alone hospitals are finding their pool of potential partners shrinking as buyers become more cautious about absorbing distressed balance sheets.
The Scale Imperative: Consolidation is increasingly seen as a vehicle for the efficient deployment of capital and the avoidance of cost duplication in recruiting specialists and managing payer contracting.

Technological Hazards and the AI "Reality Check"

As AI moved from experimentation to implementation in 2026, the sector encountered significant "reality checks" regarding the safety and longevity of automated models.

Algorithmic Decay and "Zombie Algorithms"

A major concern emerging in 2026 is the phenomenon of algorithmic decay. Diagnostic AI systems in medical imaging and clinical decision support began to fail as they encountered shifts in disease patterns or demographic evolution that were not captured in their original training sets. Research published in JAMA Health Forum found that 43% of AI device recalls occurred within just one year of market authorization, highlighting the risks of static models in dynamic medical environments.

The TechBio Phase II Failure Peak

The "TechBio" sector, which promised to revolutionize drug discovery through AI, faced a significant bubble burst in early 2026. Leaders such as Recursion Pharmaceuticals and Exscientia encountered Phase II clinical setbacks. While their AI-designed molecules successfully solved the "chemistry" of receptor binding, they frequently failed to account for the redundancy of human immune pathways or the "phenotypic trap" where cellular models did not reflect human biology.This has led to a 20-30% workforce reduction across the AI drug discovery sector as valuations adjust to the reality that AI does not yet meaningfully lower the 90% human trial failure rate.

Top Health Technology Hazards for 2026

The nonprofit organisation ECRI identified the misuse of AI chatbots in healthcare as the #1 hazard for 2026. Risks include:

Incorrect Diagnoses: Chatbots suggesting body parts that do not exist or recommending dangerous treatment placements.
Automation Bias: Clinicians over-relying on algorithmic suggestions without human verification.
"Digital Darkness": Unpreparedness for sudden loss of access to electronic patient information due to cyberattacks or internal system failures.

Historical Parallels and Sector Volatility

The 2026 software sell-off echoes the Dot-com bubble of the late 1990s, where tech mania left defensive sectors like healthcare underperforming by wide margins. When the tech bubble eventually burst in March 2000, healthcare emerged as a defensive safe haven; from 2000 to 2002, the S&P Healthcare Index rose 29.9% while the broader S&P 500 declined 15.8%.

A similar rotation occurred in early February 2026. As tech indices freefell, GSK PLC rose 6.9% to reach a 26-year high on the strength of its core operating profit and a pipeline seen as resilient to immediate AI disruption. This suggests that for the remainder of 2026, investors will likely rotate into healthcare assets that offer predictable, recurring cash flows as a hedge against geopolitical and technological volatility.

Regional and Global Dynamics

Innovation is increasingly becoming "borderless," with a global rebalancing of research hubs challenging the dominance of the US and Europe.

The China Factor: China now accounts for roughly one-third of global clinical trials and is the world's second-largest developer of new medicines. In 2025, China-based dealmaking increased by 53%, as Western companies sought partnerships to fill pipeline gaps and reduce R&D costs
.
APAC Momentum: IPO and M&A activity continues to "roar" in the Asia-Pacific region, with government initiatives pushing for digital-first solutions in drug development and diagnostics.
Policy and Regulation: Regulatory scrutiny remains a "wildcard" in 2026, with the US FTC increasingly intervening to block major acquisitions, such as Edwards Life Sciences' $945M heart implant deal in January 2026.

Synthesis: Projections for the Remainder of 2026

The software sell-off and AI realignment of early 2026 have effectively "cleansed" the market of speculative excess, creating a more disciplined environment for the rest of the year.

Strategic Imperatives for Healthcare Tech Leaders

For investors and companies navigating the post-crash landscape, several strategic imperatives have emerged:

Prioritise FCF Resilience over Theoretical Growth: The market is rotating toward "safe assets" with recurring revenue. Target medtech firms with proven reimbursement codes and established outpatient service networks.
Focus on "Labour Substitution" Technologies: With labor shortages and wage inflation persisting, technologies that offer "fundamental labor substitution", such as AI ambient scribes and automated diagnostic interpretation—will command premium valuations.
Validate the "AI Data Moat": Avoid companies providing simple "wrappers" for general-purpose LLMs. Instead, look for "AI-native" platforms embedded into clinical workflows that possess high-quality, clinical-grade proprietary data (e.g., Abridge, Commure).
Embrace Outcome-Based Models: Move away from seat-based licensing toward business models that align payment with the continuous delivery of outcomes.

Sector Outlook	Funding Trend (H2 2026)	M&A Forecast (H2 2026)
Digital Health	Disciplined; focus on "Health Tech 2.0" metrics	High; driven by platform consolidation and VBC
MedTech	Stable; favor for at-home and ASC technologies	Accelerating; strategic "GLP-1 proofing" of portfolios
HealthTech	Selective; premiums for labor automation	Moderate; targeted acquisitions of RCM and AI-workflow
Biotech	Uneven; focus on late-stage, de-risked assets	High; urgent need to address "patent cliffs"

The 2026 tech retrenchment marks a transition from "AI Hype" to "AI Utility." While the general software sector faces a painful realignment of its value drivers, the healthcare industry is entering a phase where technological achievements, from surgical robotics to autonomous clinical agents, will take a visible leap forward in terms of real-world impact and financial sustainability. For the patient investor, the "trust gap" in health tech represents a significant opportunity, as the fundamentals of the sector are arguably stronger now than at any point in the previous funding cycle.

The remainder of 2026 will reward companies that move beyond "experimental" AI to deliver measurable productivity and margin lift, effectively turning the structural pressures of aging populations and rising costs into a blueprint for sustainable growth. In this environment, M&A remains the primary catalyst for business model modernisation, while the IPO window, though selective, remains open for firms that can articulate a clear, evidence-backed story of value creation.

Nelson Advisors > European MedTech and HealthTech Investment Banking

Nelson Advisors specialise in Mergers and Acquisitions, Partnerships and Investments for Digital Health, HealthTech, Health IT, Consumer HealthTech, Healthcare Cybersecurity, Healthcare AI companies. www.nelsonadvisors.co.uk

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