As physicians achieve financial stability, they often start looking for ways to invest in opportunities other than their retirement accounts and taxable brokerage accounts. Many physicians branch out into investing in other hard assets with more predictable cash flow predictions, such as real estate or franchises. However, for those physicians who are willing to tolerate more risk and who are interested in innovation, the idea of being angel investors investing in early stages that have the potential to offer outsized returns on their investments if the company does well is exciting. Because of the risk profile, this is definitely not for everyone, and it’s important to know how to vet investment opportunities before investing your hard earned money. Below, we’ll provide a high level overview of angel investing, including what it is, how to get started with finding and vetting opportunities, things to be aware of or cautious about, and more.
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What is angel investing?
Put simply, angel investing is investing in early stage startup companies. These companies usually have not raised significant outside capital from banks or venture capital yet, and founders and entrepreneurs often use angel rounds to bring in funding for their ideas.
Who are angel investors and what is their role?
While angel investors can technically be anyone willing to provide funding for a company, they are typically high net worth individuals or investors that want to support a business idea that they like. They want to share in the potential upside of its success, but should also be able to afford to take the risk that the company doesn’t take off. They don’t necessarily need to be accredited investors like in other investment opportunities that are more regulated by the SEC, but many are. They can be friends or family of the entrepreneur, family offices, or other professional investors. In more recent times, angel investors can also come from investing groups or networks and crowdfunding platforms.
Many entrepreneurs prefer to take money from angel investors at early stages, as they won’t come with the personal risk assumed when a founder gets financing from a bank loan, the need to have as vigorous vetting as a venture capital investor may perform, or, depending on the structure, the need to give up as much equity, control, or voting rights that they may need to give up in future funding rounds from more formal investment rounds.
While an angel investor’s role is usually primarily to raise capital necessary to get an idea off the ground, they can also serve as advisors to a company and provide their knowledge, expertise, or networks to help the company grow and succeed.
What is the difference between angel investing and venture capital?
Both angel investors and venture capitalists invest money in companies, but there are some key differences. These include:
Angel investors are usually investing their own personal money, whereas venture capitalists typically have other people’s money and choose where to invest it.
Angel investors typically invest at the very beginning of a company’s origin based on faith in an idea and/or a founder, whereas venture capitalists usually need to see some demonstrated proof of concept that gives them reason to believe there is potential for significant enough growth to provide a substantial return on investment for their investors.
Venture capitalists are typically investing much larger sums of money, often in the millions of dollar range, whereas angel investors can invest much less depending on what the founder allows (could be as little as a few thousand dollars).
Venture capitalists vary in their level of involvement, but are generally more hands on in ensuring that their investment is protected. This could involve having a seat on the board, providing expertise to the entrepreneur, and more. Angel investors tend to be more hands off unless they also have an advisory role within the company.
What are the pros / advantages of angel investing?
Ability to learn about and help bring products you believe in to market
Many angel investors love innovation and are excited to follow emerging market trends and ideas. Angel investing offers you the opportunity to pick the ones you believe in most and support them on their journey.
Potential for large returns on your investment
Most angel investors are seeking at least a 10x return on their investment in a relatively short period of time (usually less than 10 years). By comparison, historical returns in the stock market generally give you a 2x return over 7-10 years. If a company does really well, the sky’s the limit on investment returns with an angel investor (imagine, for example, being one of the initial supporters of a company like Meta or Google).
Opportunity to leverage your expertise in a consulting or advisory role
Depending on the investment and the level of involvement you desire, some entrepreneurs offer angel investors the ability to become advisors or help shape the future of the company.
Diversification of investment portfolio, assets, and opportunities
As a physician, if you reach the stage in your financial stability where you can take some chances, having more diversification offers opportunities to leverage different investments in different ways. It’s generally better not to have all your eggs in one basket, and getting to play in new spaces can create new opportunities.
What are the cons / disadvantages of angel investing?
Angel investing is risky
This cannot be overstated. You should understand that very few (~10% or less) of companies funded by angel investors ever achieve success, and even when they do, that level of success is variable. Not every great idea will turn out to be a unicorn company that IPOs on the stock exchange. Statistically, the majority of angel investments will not return the initial capital that was invested. Those who choose to be angel investors should not invest a large percentage of their overall portfolio in this asset class (even those who love angel investing typically don’t invest more than 10% of their net worth into these assets).
Angel investments are illiquid and have unclear timeframes
Once you have invested the money, you have to assume it doesn’t exist anymore. You cannot count on getting the money back in any defined timeframe, even if the company is growing rapidly. Returns of capital will come only when the entrepreneur is in a stable enough position to offer you an exit or at the time of a major exit or acquisition for the company itself.
Very little data present to base decisions off of
Most of the time, angel investments have very little data at the time an opportunity to invest arises. You may know the founder or they may have a great reputation, or you may know the industry and believe in the idea, but you won’t usually have the benefit of years of data or in some cases even have similar business models to project success off of. It can definitely feel like a leap of faith.
What kinds of returns can you expect in angel investing, and when can you expect them?
Usually angel investors are looking for at least a potential 10x return, but the more reasonable thing to expect is 0.
As we’d alluded to earlier, you should essentially expect nothing but hope to be pleasantly surprised by the best. Even if a company idea takes off, it could be many years before the returns go back to the investors instead of continuing to fund future growth. Make sure you understand the entrepreneur’s plans and when they’d like to return capital, but also understand that none of it is predictable. Lots of challenges and changes can arise as companies grow and pivot, and your role as an angel investor is going to be to be along for the journey, both good and bad.
How do you hear about angel investment opportunities?
Word of mouth through your personal and professional networks
Many physicians aren’t actively seeking out angel investing when they’re first introduced to it. A friend or colleague may approach them looking for angel investors, or they may hear of someone investing in an opportunity that they find intriguing and also want to get in on the ground floor on.
Crowdfunding sites for angel investments
As crowdfunding sites become more popular and as regulations on crowdfunding have overall eased over the past decade and a half, several platforms have popped up which specifically allow entrepreneurs to list their investment opportunities in hopes that angel investors will want to fund them.
Angel groups
If you really enjoy angel investing and want to do it more regularly, you could seek out or form your own angel investing group. Together, these groups will evaluate and invest in ventures that they find appealing. By pooling their capital, they may also have access to investments they wouldn’t have had access to with their own smaller investments.
These can take many different forms, but the more formal groups will typically have regular meetings where they can review investment opportunities that they have prescreened, potentially with the founder or entrepreneur there to make a presentation about their value proposition, and then vote on whether or not they should invest. They will share the burden and expertise necessary to conduct due diligence.
Some groups will choose to focus on a specific investment asset class or industry. For example, many physicians or physician angel groups want to invest in healthcare startups, as they best understand this space and feel the most qualified to pick the winners here over other industries.
Getting started: tips for becoming an angel investor
Here are some general best practices as you dip your toe in the space.
Invest only in products or industries you understand
Entrepreneurs have become very savvy in their pitches. It’s easy to get sold on bad ideas if you don’t understand the industry. Stick to what you know and instinctively understand.
Invest in things that excite you
If they excite you, hopefully they’ll excite others too. Also, in general, getting to be a part of the journey of a product in a space that you are interested in or passionate about will be fun in and of itself. You may meet other people in the space or get access to other opportunities, you’ll enjoy the correspondence and updates about your company, and even if it doesn’t work out, you’ll have learned something.
Diversify your angel investment portfolio
Remember, only a small percentage of these succeed. Most people don’t invest all their eggs in one basket but spread the portion of their investment portfolio allocated towards angel investing towards multiple smaller investments. If you invest in 10 things and one makes it big, chances are it’ll more than offset the 10 total investments you made.
Also, try not to put all of your eggs in to too specific a niche, such as a particular device type or a particular disease. If a new invention, technology, or research finding comes out to render that space obsolete, you’ve now lost all of your investments.
Understand the actual investment terms
Every entrepreneur or startup is going to structure the terms of their investment offering differently. Make sure you understand the lingo, the risks and benefits associated with each structure, and things like voting rights according to your share class, current and projected valuations, and what percentage of the company you will own and how you can be diluted.
Network widely and find mentors in the space
Your network is truly your net worth in this space. The more people you talk to, the better access to deal flow, inspiring founders, and connections to help the companies you have invested in to grow. All of these things will ultimately increase the likelihood that your investments will be part of the small percentage of angel investments that succeed, and hopefully in a big way.
Always do your own due diligence
Recognize that everyone’s incentives in this space are different, and you can’t trust anyone else to do your due diligence for you. Some people pitching you investments, even if not their own companies, will have a formal or informal incentive to help the founder raise capital. You really want to learn how to assess a deal on your own, so that you’re investing with the best understanding of the product’s chance of success, rather than taking someone’s word for it. Make sure you base your assessment on as many facts as possible rather than hype or speculation.
How do you vet an opportunity to be an angel investor in a startup?
The essence of startup investing are that you want to find an investment opportunity where you believe in both the founder and the product, as well as their ability to create a return on investment. Usually angel investors are looking for at least a 10x return in a relatively short period of time (usually less than a decade). In order to achieve this, they want companies that have the potential to grow and scale quickly, usually by disrupting an existing industry or creating a new market entirely.
Therefore, you should be asking the following questions:
Who is the founder or the team, what is their experience, and how motivated and determined are they to make this succeed?
Does the product or service address a true need or gap in the existing market?
Who is the competition, both existing and in the future?
Why is this the right time to build this company?
What data indicates that this idea will be successful and scalable?
What potential challenges or threats do you need to be aware of? What potential hurdles exist to the product or service ever going to market?
What do others I trust think about the idea?
What is my gut instinct or spidey sense on this startup?
We dig into each of these points further in our article on how to vet an opportunity to invest in a startup.
Conclusion
Angel investing is an exciting, albeit risky, investment opportunity for many physicians that are excited by innovation and the prospect of investing in companies at early stages to get large returns. It’s important to understand the pros and cons of angel investing and what questions to ask before going forward with an investment opportunity. The more you engage in this space, the more of a spidey sense you’ll develop, so dip your toes in, go to relevant conferences or network with those who are actively investing in startups, and enjoy the process!