Caution: Doctor Funded Startup

By definition, an angel investor is not an “institutional investor.” Venture capitalists (VCs) are paid to invest other people’s money, and measured on the rate of return they get. Angels are typically high net worth individuals who are investing in in early or seed stage companies. Some are physician investors.

The Angel Capital Association publishes the Angel Funders Report annually to increase awareness about angel investor activity and build a deeper understanding of the investing environment. The report provides context for seemingly disparate data points, identifies trends, and highlights innovative ways that ACA members are working together to fuel the entrepreneurial ecosystem.

A typical investment is between $15,000 and $250,000, although it can vary significantly. Usually, angel investors contribute a relatively small amount of capital into a startup company. Angel investors are often friends or family members. They might also be experienced venture capitalists or entrepreneurs.

One strategy some biomedical and health entrepreneurs use to raise money and do customer discovery is to follow a doctor angel-funded startup strategy. If you are Jay McGraw and your father is Dr. Phil, that might work.

Some startup entrepreneurs really like the idea of doctor funded startups.

Here is an example.

Here is another model.

But, if you think just getting in front of a bunch of docs who will be thrilled to give you money, time and effort to develop your wonderful new technology for equity, then you might want to consider:

1. Clinicians are certainly on the front lines and in a position to identify clinical needs and gaps like no one else.

2. Unfortunately, very few have neither?an entrepreneurial mindset nor the knowledge of what it takes to get a product or service to market. In fact, if you are looking for "smart money", doctors might be last place you want to look given their biases and, instead, lump them in the category of family, fools and friends.

3. I don't believe the conventional wisdom that "doctors are lousy businesspeople". On the other hand, like most investors, they are usually not that sophisticated when it comes to angel investing like their non-MD angel investor peers.

4. The initial seed or startup raise is merely the first step in what should be a well thought out capital raising strategy to get you to the finish line. The last thing you want are a bunch of know if all doctors angry because they lost their money or were severely diluted by the follow on investors.

5. Yes, you want "smart money" when it comes to investors. Docs aren't that much smarter when it comes to seed stage investing.

6. Getting money is different than doing customer discovery and market analysis. There are other ways to get in front of doctors and get their feedback and product development advice without having them invest in the company in exchange for your having to give away a big part of the store.

7. Getting surgeons to switch from one product to the next takes a lot of convincing and you must have a compelling value proposition and business model to convince them to do so.

8. Physician investors who are expected to test and use the product, let alone be early adopters and spread the word to their friends, have a significant conflict of interest disclosure challenges.

9. Some doctors are cheap, and many have a sense of entitlement. They may not play nice with others on your team.

10. Busy clinicians are focused on the now, maintaining their income. They won't have the same sense of urgency or pay attention to things like the founders will.

11. An increasing number of doctors have transitioned into becoming venture capitalists and other financial services providers as non-clinical careers

12. While many doctors are sophisticated investors, many lack the knowledge, skills, and attitudes to invest wisely and responsibly. They will not learn the business of medicine or personal financial planning during their training.

Here are some reasons why the physician investor mindset might be different than some other investors.

Investing in startups, regardless of the color of your coat, is a crapshoot and most likely to fail at least 90% of the time. So, here are some rules to follow:

1. Build a balanced investment portfolio. Just like a seasoned stock investor would never put all his investible resources into a single stock, don’t put all your money into startups. Begin with perhaps 5-10% of your total investment base and be prepared to lose it all. The growth target should be 5-10 times your initial investment in five years.
2. Start in a business domain you know well. Since there are no bellwethers like Apple or IBM in the startup arena, your best bet is to pick one in a business area you know well. Don’t be fooled by thinking that social networks are hot, so you should invest in the next startup you see in that realm. Remember that 9 out of 10 startups fail in every realm.
3. Fund an entrepreneur you know and trust. In the business, this is called investing at the first tier for startups - “Friends, Family, and Fools (FFF).” Most entrepreneurs start asking for money from this tier when they have very little more than an idea. Here you are definitely betting on the person, rather than the idea, but the upside potential is huge.
4. Join an existing angel investor group. This is the second tier of startup investors and offers the comfort of working with more experienced investors with similar interests, to help gather and vet startup investment proposals. Some of these groups also offer you the option of putting your money into a multiple-startup fund to spread your risk.
5. Diversify your total investment across several startups. Angel investment amounts per startup per investor usually range from $25K to $250K. These may be aggregated by an angel group up to about $1M for an angel round. If a startup needs more than this in a single round, they should talk to venture capitalists, who invest institutional money rather than their own personal money.
6. Use the new Crowdfunding sites for small amounts. The hottest new way of investing in startups to go to popular online sites like Kickstarter and IndieGoGo. There you can get in for as little as $20, or even less. Typically, these are used only for non-equity rewards or pre-orders, but the JOBS Act does allow equity investments with many restrictions.
7. Participate as a mentor in local startup incubators. Incubators are a great place to learn about potentially great startups, and participating as a mentor helps you learn which ones are a good fit for you. The best-known ones, like YCombinator, led by Paul Graham in Silicon Valley, and TechStars, located in Boston, provide excellent networking to investors, and on-site technical leadership, which can make your investment less risky.
8. Do your homework before investing. Public companies with stock usually have industry analysts and SEC filings to give investors a quick view of the company stock value. Startups are private companies with no common document filing requirements. Thus, it is incumbent on every potential startup investor to ask for and read their business plans, current financial statements, and investor presentations.
9. Invest local and take an active role. Most angel investors only invest in companies and people local to their geography. Skip international and other opportunities you can’t touch and feel. Many negotiate a Board Seat for themselves as part of the investment Term Sheet. This allows them to ask for and get regular updates from the company, and allows them to have a say on how their money is used.
10. Think long-term. It’s a lot easier to buy stock in a startup than it is to sell it. Once invested, you should expect no return until the first “liquidity” event in 3-5 years, maybe longer. Liquidity events include merger or acquisition (M&A), or Initial Public Offering (IPO) when the stock goes public. There is no “exchange,” so you can’t sell the stock at will.

On the opposite side of the coin, here are some tips for entrepreneurs seeking angel investors.

Doctor angels are probably not much different than other angel investors.

In addition to smart money and dumb money, there is smart management/leadership and dumb management/leadership. The trick is to find the right balance in your team between those who don't understand the unique challenges of sick care commercialization and those who are willing to ignore them and charge forward to create a new model without being blindly optimistic.

A decentralized autonomous organization (DAO) is an emerging form of legal structure that has no central governing body and whose members share a common goal to act in the best interest of the entity. Popularized through cryptocurrency enthusiasts and blockchain technology, DAOs are used to make decisions in a bottom-up management approach.

The customer funded business is a viable model. The doctor funded business is trickier. The treatment may be worse than the disease so do your homework.

Arlen Meyers, MD, MBA is the President and CEO of the Society of Physician Entrepreneurs on Substack