[Editor's Note: Today's guest post was submitted by one of my former partners, emergency physician and entrepreneur John R. Dayton, MD, FACEP, FAAEM. As a member of the SLC Angels, he evaluates, advises, and invests in healthcare startup companies. He is the founder of MedForums.com, a ‘yelp’ for medical education. We have no financial relationship. Long term readers may be aware that I'm not a big fan of angel investing (see the editor's note below for reasoning), but it is not a topic this blog has ever hit before, so today let's discuss all things angel!]
What is Angel Investing?
Angel Investing is a process used by early-stage companies, or startups, to obtain funding and mentorship. The young company has usually bootstrapped as far as it is able, and needs an influx of money to grow. Instead of opting for a business loan, they approach angel investors to reach their next stage of growth.
During a startup’s lifecycle, you can see that a new company will need to go through several rounds of fundraising before it can announce an Initial Public Offering, or IPO. Angel investing offers an initial, “high-risk high-reward” opportunity to own a part of the company long before the general public is able to buy shares. Deals are usually structured so that the startup either sells shares of its stock to raise money or borrows money and converts the debt to equity at a later date.
Because angel investing is high-risk, you could lose all your money. At the same time, every angel investor wants to follow the example of Andy Bechtolsheim, who was the first to invest in a company started by two Ph.D. drop-outs named Sergey Brin and Larry Page (Google), or be like one of the 20 angel investors who bet on a young Jeff Bezos when he was selling books on the internet from his basement.
Who is an Accredited Investor?
‘Accredited Investor’ is a legal term used to describe an individual with income exceeding $200K/yr, for the last 2 years, or with a net worth of $1,000,000, not including their home. Most full-time physicians meet these criteria. Because the SEC considers angel investing to be high-risk, it limits this type of investing to those who are able to financially tolerate high-risk investments. In addition to angel investing, accredited investors are also able to invest in hedge funds, venture capital funds, and real estate syndications.
The American Angel conducted a study of angel investors in 2017 and made these interesting discoveries:
- The average check size is $25K, but ranged from just a few thousand to $100K.
- Women wrote 22% of checks and supported women entrepreneurs with 51% of their investments. They represent thirty percent of new angel investors.
- The mean age for a first angel investment is 48.
Image: The American Angel study
Why Physicians?
Historically, investments in health care have provided good returns, and physicians have a strong background in this field. The graph below, from Cambridge Associates, summarizes the rate of return for different types of healthcare investments. The time spent with medical devices, EHRs, and other healthcare tools gives physicians a distinct advantage when predicting what future products would be accepted and adopted by their colleagues in the healthcare industry.
Image: Cambridge Associates, US Venture Capital: Index and Selected Benchmark Statistics
Most angel investment groups are composed of several individuals who bring advanced knowledge of their particular industry to the group. Because many new companies work to address needs in healthcare, physicians become valuable members of their angel groups.
My angel investment group includes three physicians. Over the last year, we’ve seen deals related to medical devices, pharmaceutical safety, digital health, wearables, and medical billing. One of our recent exits came from a medical device that gave investors a 2X, or 200%, return on their investment.
John Dayton, MD
In addition to money, new companies also need advisors and have other needs that physician investors are able to meet. Dr. Alren Meyers, Founder of the Society of Physician Entrepreneurs, describes these needs as the “M’s” at the 2019 InnovatorMD Global Summit:
- Money – investments
- Maturity – wisdom from an experienced physician
- Monitoring of Environment – subject matter experts with knowledge of trending topics, needs, and competing solutions
- Manpower – assistance with market research, product evaluations, and related projects
- Marketing – advice for reaching their target audience of healthcare users
- Media and Networking – introductions to other physicians and healthcare contacts
What are the Pros and Cons of Angel Investing?
Pros
David Rose, who wrote Angel Investing and founded Gust, a platform for early-stage investors, notes that angel investments have historically good returns when compared with other asset classes. He used this graph when describing those returns in answer to a question on Quora.
Image: David Rose, Quora
Physicians, with their unique knowledge and skill set, have an advantage when evaluating health care innovations.
Investing is also becoming recognized as a solution to physician burnout. Physicians increasingly feel like they are becoming cogs in a wheel. Angel investing becomes a way to move that locus of control from external to internal, re-claim their role in medicine, influence the future of healthcare delivery, and benefit financially from their involvement.
Finally, angel investing is also a great way to network. Angel investors tend to be leaders in their professions and companies that pitch businesses are led by rising entrepreneurs. Physicians that don’t have a business background are also able to learn how other industry leaders evaluate companies and investment opportunities.
Cons
Regarding the cons, there are three main ideas to keep in mind:
#1 Risk
Angel investing is risky! It is so risky that the SEC only allows individuals who can afford to lose money to participate.
#2 Illiquidity
Investments are not liquid. Some investments are tied up for several years. Investments in “zombie companies” may stay financially solvent, but not grow rapidly enough for another round of funding or a potential exit for angel investors.
#3 Loss of Equity
As companies grow, there is a risk that you can lose your initial equity as companies raise future rounds of funding or become involved in mergers and acquisitions. This risk can be mitigated by proper legal work during the initial investment but is always a risk.
Pro Tips
If you decide to become an angel investor, here are some tips to help guide your investments:
- Stick to what you know. Focus on investments related to healthcare and your other areas of expertise.
- Learn from other angels about trends and opportunities related to their areas of expertise. What are their industries’ pain points and emerging opportunities?
- Use a portfolio strategy by making several investments. This spreads the risk and allows for the high-performing startups to make up for losses with other companies. While a majority of investments won’t pan out (<1X), the ones that work out can have high (5-10X), and sometimes very high (>30X), rates of return. This is shown in the graph below which shows results of angel investments during studies tracked by the Angel Resource Institute from 2016 (red), 2009 (orange), and 2007 (blue).
Image: Angel Resource Institute, Tracking Angel Returns
How can I get involved as an Angel Investor?
- Find an angel investment group in your area. There are groups like the Angel Capital Association that have regional directories of angel investment groups.
- Check out angel investment groups focused on physicians including AngelMD, Global Health Impact Fund, and Life Science Angels
- Look into other physician entrepreneur groups like the Society of Physician Entrepreneurs and InnovatorMD, and events like Leverage & Growth Summit for Physicians.
[Editor's Note: I think that last chart is the most important part of this article. If you read it carefully, you will see that 53-69% of angel investments lose money. This is the main reason I think this asset class should be avoided. Lots of people like to dip a toe into investments, trying one or two out before really committing to the asset class. Well, what is the likely outcome of doing that with angel investing? Losing money. And not just a negative return. I'm talking about losing your entire investment most of the time. And if you didn't lose money, the truth is you probably just got lucky.
I also think the idea that physicians can pick winning health care companies is a fallacy. Certainly, it hasn't been the case in publicly traded companies, so I'm not sure why it would be any better in small start-ups. Like some other types of investments such as direct real estate investing, you either need to do it right or not do it at all. David Rose gave a good discussion here about how to do it right:
- IF you are an Accredited Investor, and
- IF you are prepared to invest at least $50K to $100K per year, and
- IF you make sure to reserve quite a bit for follow-on financings, and
- IF you develop a strong deal flow of good companies, either through an angel group or your own contacts, and
- IF you invest consistently so that you have at least 20 companies (ideally more) in your portfolio, and
- IF you are professional in both your due diligence investigation and your deal term negotiation (including specifically with regard to valuations), and
- IF you go in with the knowledge that you are going to be in it for at least a decade, holding completely illiquid assets, and
- IF you can help add value to your portfolio companies above and beyond simply money (such as board service, contacts, fundraising, etc.)
- Then (and only then) will the odds be in your favor for you to join the relatively rarified band of successful, professional angel investors who show average IRRs over their investing years of over 25% per year.
In short, successful angel investors did not become wealthy from angel investing. They were already wealthy. And they're not doing this passively, they're doing it as a serious side pursuit. I have no idea how a busy doctor can have time to add value to 20+ companies, but if that's you, go for it. My best investments are small start-ups that I can add value to. But I think it is a pretty easy argument to make that angel investments should not be any significant part of the portfolios of most physicians.]
What do you think? Should an accredited doctor consider angel investing? Why or why not? Comment below!
I wasn’t familiar with angel investing before this post. It’s interesting but won’t be a part of my investment strategy anytime soon. Despite being in the field, too often I’ve observed doctors misread what the needs of their specialty is unfortunately.
I think that most doctors can get to financial freedom through saving 20% or more of their income and investing wisely in broadly diversified low cost index funds.
I do however think it’s ok to have a portion of your portfolio that is a bit higher and the risk/reward spectrum. For me though, that is direct cash flowing real estate investing (my wife and I are actually closing now on our first investment property less than 30 days after I graduated training and before I even received my first attending paycheck!). It is vertically not passive but offers benefits of cash flow, equity pay down, leverage and tax benefits.
Your excerpt at the end seems spot on although I have no experience with this type of investing obviously. If you’re going to angel invest, you better have your ducks in a row. Like real estate, this is not something to go in on a whim. If you’re looking for passive, index funds and truly passive real estate may be better for you.
The Prudent Plastic Surgeon
Sounds interesting for some, but if it’s going to return about 20-25% and be very risky, might as well go with a high-risk index fund (There are some that have averaged 22%/year over the last 10 years) that returns that much. Angel Investing sounds like a lot of work and time spent that I’d rather spend with family/friends/hobbies!
To each their own!
What index funds are you aware of that will return 22% per year??
FSCSX and FBIOX from Fidelity both have a 10 year annualized rate of return above 20% currently. I’ve more than doubled my money in both of them. They’re very volatile, but I’m far from retirement so I don’t care. Long-term returns trump all for my portfolio right now. No idea if that trend will continue, but I don’t see biotechnology or IT becoming any less important in the future.
If you expect stock long term returns similar to your returns from 2010-2019 you are highly likely to be disappointed.
We shall see. I don’t necessarily expect a continued 20%, but I sure do expect a much higher return than what I believe Angel Investing is capable of. People were saying stocks were doomed back in 2011 too. Reality is often surprising.
We’ve invested in 3 small start up companies, and the total amount is a very small percentage of our net worth. The first has not worked out and we’re hoping to get our capital back, but could lose it. The second is probably 50/50 at this point, and the third and most exciting is in clinical trials and doing very well. That investment could turn into a home run, and only time will tell. I think if someone is going to do this it should be a small percentage of a portfolio and you should be willing and ok with losing the entire investment. Unless of course you have gobs of money to begin with and it doesn’t matter.
Hi AP. Your post emphasizes the importance of a portfolio strategy. You want your winners to compensate for the ones that don’t turn out as well. It sounds like investment #1 may not turn out, but I hope #2 and #3 are winners for you.
I’ve raised this topic on the forum a couple times.
The angel groups that I have looked into require ongoing investments, say 25 minimum each year. One that I almost joined, ended up changing to a hedge fund style fee schedule for finding/vetting companies. Certainly noteworthy as I look for less expenses approaching early retirement.
Another major point is the social interaction: adding expertise, networking, and meeting smart, driven founders. I struggle to find time for my current friends, I dont need more activities on the schedule.
I’ve raised this topic on the forum a couple times. IIRC, AR is the only one to leave anything positive.
The angel clubs I found require an ongoing investment, at least 25/yr. No biggie, but noteworthy as I am looking to minimize ongoing (mandatory) expenses as I approach retirement. Also, one that I did almost join changed their fee schedule to more of a hedge fund. Justification being that they are finding the best companies blah blah blah.
Another point is that the social interaction ( networking, advising, meeting interesting founders) is a key benefit. I barely have enough time for my current friends, the last thing I need is more stuff on the calendar.
Hi G. I appreciate the feedback. Not all Angel groups require annual investments. Although my group doesn’t require this, one of the other local groups does. I looked specifically for one that would allow me to be an observer for a year, so I could get an idea of how the process works. Of note, of the physician-based groups, AngelMD does not require a minimum investment.
looking at that graph it appears most people lose money. 25% make a moderate return. And <10% make it big.
This is not risk. This is dumb.
With a "high risk" equity portfolio the chances of real risk is very low over a long period of time. With Angel investing the chances of real risk appear to be 60-70%
This is speculating not investing.
By all means if you have some special information that can bend the numbers but I would not bet the farm on it.
Agree. Great returns (15-20%) are possible with much less risk using some medium-high risk index funds.
Expecting a long term 15-20% return on publicly traded equities is foolish IMHO. That’s not realistic. I don’t know whether it is realistic for angel investing, real estate investing or anything else, but I know it isn’t realistic for the stock market, even relatively risky sectors/investing styles/asset classes within it.
Whether or not it CONTINUES to be realistic is what’s in question, as those returns are already historic in quite a number of mutual funds. I’m not foolish enough to think those returns will remain that high for eternity, but I do believe they will consistently outperform most other assets just by the nature of those specific funds.
We’re talking about a small portion of the nest egg here (<10%), so it certainly doesn't hurt to wait and see.
I don’t think stocks have ever returned 20% over a long period of time, so I don’t know why you would expect that, especially with so many good reasons to expect lower returns than average. The risk of those expectation is that you undersave.
I mean, do the math. If you could really rely on 20% returns, everyone could retire within 5-10 years. If you make $300K a year and save 40% of it and earn 20%, 5 years out of training you have $893K. If you spend 15% of that ($134K) your money would still be growing at 5% a year.
If you worked for 10 years, you would have a nest egg of $3.1M, 15% of which is $467K a year.
It’s just not realistic. A pessimist expects 5% out of stocks. A realist 7-8%. An optimist 10-12%. 20% is an expectation only for the foolish.
Stocks in general returning that much? No. Specific mutual funds? Yes. What do you define as a long period of time? There are a number of mutual funds with higher than 20% returns over the last 10 years. But I am not foolish enough to think these returns will continue at this precise level, or even near this precise level.
The exact numbers are irrelevant. My point is that you can get stable, often good, and sometimes even amazing returns from stocks at much less risk than angel investing.
Well I agree with your final point.
Long period of time? I’d say half an investing career, so 30 years plus.
There are 28 funds that have 20%+ returns over the last 10 years. Here they are:
Overview
28 total funds found
All funds | Vanguard funds
Select a category:
Overview
Fund Name (Ticker) Fund Type Fund Category Expense Ratio
Note SEC Yield* SEC Yield
as of Average Annual Total
Returns (NAV) as of 06/30/2020 Inception Date Invest Now
1 Year
5 Year
10 Year
Since Inception
Morgan Stanley Insight Fund Class I (CPODX) Domestic Stock Large Growth 0.91% — — 48.96% 27.05% 23.14% 12.52% 07/28/1997 Invest now
T. Rowe Price Global Technology Fund (PRGTX) Specialty Technology 0.88% — — 34.81% 21.67% 22.76% 9.04% 09/29/2000 Invest now
Fidelity® Select Software & IT Services Portfolio (FSCSX) Specialty Technology 0.71% — — 30.76% 23.56% 22.50% 16.55% 07/29/1985 Invest now
Transamerica Capital Growth Fund Class I (TFOIX) Domestic Stock Large Growth 0.88% — — 45.15% 23.44% 22.24% 20.33% 11/30/2009 Invest now
Morgan Stanley Institutional Fund, Inc. Growth Portfolio Class I (MSEQX) Domestic Stock Large Growth 0.59% — — 46.34% 24.03% 22.20% 12.71% 04/02/1991 Invest now
Morgan Stanley Insight Fund Class A (CPOAX)
Load: 5.25%** Domestic Stock Large Growth 1.17% — — 40.77% 25.31% 22.12% 11.97% 07/28/1997 Invest now
Berkshire Focus Fund (BFOCX)
Redemption Fee: 2% if held < 90 days Specialty Technology 1.95% — — 37.70% 23.28% 21.97% 8.82% 07/01/1997 Invest now Morgan Stanley Institutional Fund, Inc. Growth Portfolio Class A (MSEGX) Load: 5.25%** Domestic Stock Large Growth 0.84% — — 38.31% 22.35% 21.23% 11.79% 01/02/1996 Invest now BlackRock Technology Opportunities Fund Institutional Shares (BGSIX) Specialty Technology 1.03% — — 45.90% 26.40% 21.21% 8.72% 05/15/2000 Invest now Fidelity Advisor® Growth Opportunities Fund Class I (FAGCX) Domestic Stock Large Growth 0.84% — — 35.92% 21.61% 21.17% 9.81% 07/03/1995 Closed to new Investors Transamerica Capital Growth Fund Class A (IALAX) Load: 5.50%** Domestic Stock Large Growth 1.14% — — 36.79% 21.71% 21.13% 11.71% 03/01/1999 Invest now T. Rowe Price New Horizons Fund (PRNHX) Domestic Stock Mid-Cap Growth 0.76% — — 27.31% 18.88% 21.08% 12.12% 06/03/1960 Closed to new Investors Virtus KAR Small-Cap Growth Fund Class I (PXSGX) Domestic Stock Small Growth 1.11% — — 18.09% 22.63% 20.96% 13.31% 06/28/2006 Closed to new Investors Fidelity® Select Biotechnology Portfolio (FBIOX) Specialty Health 0.72% — — 30.69% 4.08% 20.90% 13.62% 12/16/1985 Invest now Virtus Zevenbergen Innovative Growth Stock Fund Class I (SCATX) Domestic Stock Large Growth 1.14% — — 49.21% 23.77% 20.84% 13.58% 02/23/2004 Invest now Columbia Global Technology Growth Fund Institutional Class (CMTFX) Specialty Technology 0.99% — — 30.40% 22.33% 20.82% 9.81% 11/09/2000 Invest now Fidelity® Select Semiconductors Portfolio (FSELX) Specialty Technology 0.72% — — 35.00% 22.31% 20.75% 12.79% 07/29/1985 Invest now Fidelity Advisor® Biotechnology Fund I Class (FBTIX) Specialty Health 0.76% — — 29.69% 4.13% 20.61% 8.08% 12/27/2000 Closed to new Investors T. Rowe Price Health Sciences Fund (PRHSX) Specialty Health 0.76% — — 17.47% 8.53% 20.50% 14.60% 12/29/1995 Invest now Fidelity Advisor® Semiconductors Fund Class I (FELIX) Specialty Technology 0.83% — — 35.00% 22.21% 20.40% 8.10% 12/27/2000 Closed to new Investors Fidelity® Select IT Services Portfolio (FBSOX) Specialty Technology 0.73% — — 12.73% 17.62% 20.39% 13.53% 02/04/1998 Invest now Fidelity Advisor® Technology Fund I Class (FATIX) Specialty Technology 0.76% — — 42.86% 23.25% 20.33% 12.15% 09/03/1996 Closed to new Investors Vanguard Information Technology Index Fund Admiral Shares (VITAX) Specialty Technology 0.10% 0.94% B 07/24/2020 33.83% 22.96% 20.27% 12.79% 03/25/2004 Invest now BlackRock Technology Opportunities Fund Investor A Shares (BGSAX) Load: 5.25%** Specialty Technology 1.30% — — 37.89% 24.72% 20.19% 8.03% 05/15/2000 Invest now Fidelity® Select Technology Portfolio (FSPTX) Specialty Technology 0.71% — — 42.69% 22.91% 20.18% 13.65% 07/14/1981 Invest now Janus Henderson Global Technology and Innovation Fund Class T (JAGTX) Specialty Technology 0.93% — — 33.91% 23.45% 20.09% 10.45% 12/31/1998 Invest now Fidelity® Select Retailing Portfolio (FSRPX) Specialty Consumer Cyclical 0.74% — — 18.44% 16.49% 20.07% 14.05% 12/16/1985 Invest now Shelton Capital Management Nasdaq-100 Index Fund Direct Shares (NASDX) Domestic Stock Large Growth 0.74% — — 33.25% 18.48% 20.05% 5.20% 01/18/2000 Invest now They're mostly niche tech funds, none of which I would invest in. They're not any sort of broadly diversified index funds.
Great comment. The article has two graphs and I want to put both in perspective.
If you look at the 2nd graph from the viewpoint of one individual making one investment, you are absolutely right. However, using a portfolio strategy, and using the caveats WCI notes that Dave Rose made, results can be much better. This is time-intensive, but I’m interested in healthcare innovation, so this is an area where I already have focus.
Learning how to do angel investing with health-related companies is the ‘special information’ I’m going for. I whole-heartedly agree that you should never bet the farm on one investment, but I dedicate a small percentage of my portfolio to this.
Those aren’t people, those are investments. But if one person bought one investment each, those would be the numbers. To ensure you get your share of the winners, better plan on investing in a dozen or more or not doing it all, at least with any serious money.
For Cons, you did not mention conflict of interest. I once read a brief glossy book written as a cme for dermatologists written by a respected pigmented lesion specialist who happened to be one of the major investors in a device highlighted in the cme event. It was disclosed but the optics are terrible.
I don’t believe patients as a group want us profiting off of medical devices/meds we are using for them , even if not directly, when we could make money elsewhere. Especially when research shows that our behavior can be influenced by as little as a free ballpoint pen!
I don’t even own invidual health care stocks, just health care funds.
Stick to real estate and mutual funds, my friends!
I thank you for the reading information I were looking for investor newsletter.
https://www.whitecoatinvestor.com/free-monthly-newsletter/
I remember Hatton1 had an incredible story in the WCI Forum about her adventures into Angel Investing.
I have some wealthy friends who do Angel Investing here in Houston, but they think of it more as socializing and philanthropy, rather than investment.
The bottom line is that this isn’t “part of the portfolio” or a plan for retirement, but a commitment to developing and mentoring companies using a unique skill set. If you even have to think about watching your annual expenses as you near retirement, angel investing is 100% not for you. This is one step up from starting your own company. The word “investing” is really a misnomer here, because it’s actually about pursuing a passion to nurture these ideas and startups into something bigger and successful. Do we think Jim started WCI with plans to make it rich in blogging? No, but he saw a vast underserved need in financial literacy among physicians and worked to correct that. You had better have a similar degree of passion for the companies you invest in early stage.
Well said. On both counts.
The overly simplistic graph of Returns comparing Asset Classes hurts this argument more than it helps it. Makes the author (Rose) look uninformed or duplicitous. Would be better with data sources – for example I am not aware of good data that shows that Hedge Funds as a class have outperformed Stocks, or that Stocks over any long period return only 5%.
I can find lots of data to support Hedge Fund underperformance, and lots of data showing Equity “real” returns being 7-8% over long timeframes. e.g. https://lab.credit-suisse.com/#/en/index/SECT/SECT/overview; https://www.frbsf.org/economic-research/files/wp2017-25.pdf; etc.