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February 27, 2013

So you want to be an angel investor?

Last month, Rock Health and Fenwick & West hosted the first of a workshop series on angel investing for clinicians—Rock Health Angels—dedicated to educating doctors and other healthcare professionals on angel investing. Our first session included speakers Bob Kocher of Venrock and Ash Fontana of AngelList.  Here were a few of the key takeaways:

Focus your investments where it counts:
We spend close to 17% of our GDP on healthcare, but our health outcomes are still on par with Cuba. Meanwhile, new legislation and market forces will bring the physician to patient ratio from 1:10 to 1:23. Healthcare technologies, especially those worth investing in, should either decrease cost and/or substantially improve the quality of care. 

You’re in a regulated industry, so pay attention:
Shifts in legislation or changes in regulatory policy will have a profound impact on a healthcare businesses, either by creating opportunities for new products, building demand among new customer groups, changing incentive structures, or creating potential hurdles to success. As an angel investor, it is wise to have your hand on the pulse of relevant changes and engage experts in understanding them. Familiarize yourself with legislation. Brush up on recent regulations and guidance, which will pave the way for a number of new startups in coding, collections, payments, hospital administration, and benefits exchanges. We expect these opportunities to continue to shift with policy.

Be seen and heard:
The age of proprietary investing is over. You have to do a bit more legwork to source top deals. If you have not done so already, create an AngelList profile—you’ll be able to search startups and they’ll be able to find you. Then, consider becoming active on social media where you can not only connect with people, but also state your opinions on what kinds of deals interest you. The more you share, the more you can help entrepreneurs who are the best fit self-select into speaking with you. Finally, get out from behind your computer and meet people. Show you’re an active investor by attending relevant industry conferences or events in health (we have plenty to get you started…) Meeting entrepreneurs in person is a great entry point for conversation and a good way to get a sense for the individual before significant time is invested.

Develop your investment litmus test:
With time, you’ll develop an intuition for the types of deals that work for you. In general, start by assessing your potential investments across three areas of team, product, and traction.

  • Team: 2-3 founders is usually ideal. For technology companies, some combination of technical expertise (the builder) and business expertise (the seller) is best, so consider teams with all business people, lawyers, or outsourced development groups a red flag. Always look for intelligence, energy, and integrity.
  • Product: Get your hands on the product, or at the very least a prototype—is it easy to use? Beautifully designed? Is this a team that can seamlessly translate idea to implementation? Even better, try to connect directly with a customer who is willing to speak to you about their experience. Ideally, the founders will be able to connect you not only with current customers, but also early users who helped them think about design, product, and user experience.
  • Traction: Look for customer acquisition, engagement or other measures that confirm product/market fit. Try to develop a sense for what’s reasonable for an early stage startup by type: consumers = 100K users, enterprise = 2-3 big customers, physicians = can’t be more than 900K in the U.S.!

The exact weight provided to team, product, and traction depends on the business. In enterprise companies, team probably matters more. In consumer products, traction is probably more important.

In the end, you’ll want to have developed your own framework, or checklist for screening investments or “mitigating risk”. This one (slightly adapted) was provided as an example:

  • Is the unmet need clear and large? (market)
  • Does the technology create a high ROI for customers, rapidly? (product)
  • Where does the ROI come from? (aligned incentives or product/market fit)
  • What barriers to entry are you building? (competitive advantage)
  • How do you reach customers efficiently? (scale)
  • Does ROI get better with more users? (stickiness)

The due diligence process
Do your research on team, product, and traction before making an investment decision. That may involve stalking your entrepreneurs on LinkedIn, looking for interest about the company on Quora, or identifying customer interactions on Twitter. As mentioned, it may also involve speaking with customers (if a startup can’t refer you to a top customer, an evangelist, take that as a hint). Even if you like a company, try evaluating twenty (or two hundred) other startups before making your first investment.

If you don’t like a company, be mindful of an entrepreneur’s time by letting them know it won’t work as soon as you know, whether it is after the first email or in the middle of your second meeting. Not sure? Give them a fast no instead of stringing them along, hoping to keep the door open. Don’t share deals with other angels/VCs that you wouldn’t do. It biases the investor against that startup and it hurts the entrepreneur by closing a door that would have otherwise been open.

The economics vs. the purpose
Healthcare startups are unique in that they offer double-bottom line benefits, cash and social impact. The same goes with angel investing in healthcare.

If you’re ready to say yes to a company, congratulations! So, what happens next? Most angel rounds take 5-10% of the company—but don’t expect a board seat. Look to invest alongside VCs who can take it to the next round, leaving the option open for you to invest. Try to make sure that your riskier angel investments are balanced with other ultra safe investments in your portfolio. Finally, make sure you’re emotionally ready to write that check. Until you get really good, consider it a learning expense.

Most importantly, angel investing is about helping exceptional people do amazing things, not about getting rich with the returns. Keep in mind that part of being an angel means that your can contribute to the company’s success beyond just writing a check—spend meaningful time with a startup as an advisor, help these companies attract and interview talent, or tap into your network to help them accelerate growth. Ultimately, the more you put in beyond the cash, the more you stand to gain, on both a personal and financial level.

Image from http://www.flickr.com/photos/svenstorm/