Angel Investing: Was It Worth It? Part II
Part II: The Framework
The difference between betting on startups and betting on horses is that one of the horses must win.
In angel investing, there is no guarantee that any particular company will succeed or generate substantial, if any, returns. Investing in startups carries a high level of risk and uncertainty, as the outcome is influenced by myriad factors such as market conditions, competition, execution capabilities, regulatory changes, and so many other variables.
I’ve heard it said that there is no diversification of risk when you angel invest; you only add more risk with each investment. So why do people do it? It's a high-stakes game that requires an almost certain acceptance of failure. But while there is no denying the inherant risk of angel investing, it's precisely this risk that opens the door to extraordinary opportunities for those willing to support founders bringing something entirely new to market.
In Part I, I shared the outcomes (so far) from my angel investments. And in Part II, I will attempt to share my thoughts on:
What does it take to be a good angel investor?
A rule I usually follow
A rule I should probably always follow
A framework for evaluating opportunities in digital health
Betting on the jockey, not the horse
Is angel investing like the claw machine?
What does it take to be a good angel investor?
The biggest challenge I’m currently struggling with is objectively determining if I’m actually good at this, or not. Since there’s 5-10 years between your investment and an outcome, the feedback loop is really long.
There are a few factors, I think, to being a good angel investor.
Good deal flow
The right opportunities need to land on your desk. For me, I haven’t had time to track down deals and reach out to founders like VCs do (like VCs are paid to do). The investments I’ve made are because I already knew the founder, someone introduced me to the founder, or the founder reached out.
When I look at the best deals I’ve done, they’ve either been in founders I’ve known (from school or work) OR deals that were introduced to me by the VC leading the round.
My advice on this front is to put yourself in the middle of innovation. For me, that was geographically in SF for nine years, followed by NYC. It was working in healthcare. It was starting a company. Going to conferences. Being active on social media. etc..
Good decision making
The second ingredient to being a good angel investor is saying yes to the right deals and passing on the wrong ones. This is obviously way easier said than done. I have had a lot of conviction in companies that went on to go sideways… and I’ve definitely passed on companies that have gone on to be extremely successful.
When looking at a startup, I ask myself what assumption(s) is the founder making? and do I agree with those assumptions? Starting a company is one big hypothesis. It’s the investor’s job to buy into the vision, or not.
Good timing
Even if I took a deep dive into what worked well in earlier investments, the market is constantly changing and your investment thesis has to evolve with the market. Companies and product launches have to be timed just right — not too early and not too late.
There are also macro factors to consider like if there will be later stage investor appetite, if the large players are feeling acquisitive, or if there’s a healthy IPO market.
Good luck
Lastly, is old fashioned luck. The unpredictable nature of startups and the market means that luck can make or break any startup. So much of success is just having good luck.
A rule I usually follow
For 75%+ of deals I invest in, I won’t invest unless/until there’s a lead VC investor already committed. Here’s why: VCs are paid six or seven figures to do their jobs. They are full-time investors, with more capacity than I have to run proper due diligence on a deal. Investing in a round led by a VC I know and trust greatly reduces the risk.
Sometimes I’ll help founders out and introduce them to VCs, and other times VCs are helping the founder fill out a round and they make the introduction to me. Either way, having a VC lead the round is a positive signal.
A rule I should probably always follow going forward
I’m a healthcare person. But sometimes it’s fun to look outside of healthcare, and about a third of my investments have been in other areas, from beauty to transportation to SaaS.
On one hand, the portfolio companies that have become unicorns (valued at $1B+) are all healthcare. My healthcare portfolio is more likely to be active with higher valuations, whereas my non-healthcare portfolio is more likely to have gone out of business. But on the other hand, my best exit to date was in a tech SaaS company 🤷🏻♀️.
In retrospect, the fact that I’m a better healthcare investor than non-healthcare investor is not surprising. I’m able to poke more holes in businesses within my domain. When I invest in healthcare, I have more conviction. When I do pick up angel investing again, I’m going to be more disciplined about staying in my lane.
A framework for evaluating opportunities in digital health
Here are some of the diligence questions I have collected over the years, that I share with my students. They are broken down into categories of risk: Market, Execution, and Product.
Market risk
At a high-level, does this address a real problem in healthcare (cost, quality, access)
Is there a clear value proposition that addresses an unmet need
Is this well positioned for where healthcare is going
Has a payer been identified and validated
Is there a strategy that creates a moat to protect company from competitors and new entrants
Is there risk of regulatory changes
Are there favorable unit economics, including low cost to acquire a customer compared to LTV
Execution risk
Is the team capable and driven
Does the team have the right skills to build and sell this product
Is the team is coachable, but not coaxable
Can they likely hire the missing pieces on the team
Do they have high commitment to ethical standards and building a positive company culture
Product risk
Have they demonstrated efficacy through clinical trials and/or real-world use, creating a compelling ROI for user (i.e. the product works as advertised)
Is the product user-centered (e.g. patient, clinician), easy to use, and does it integrate into existing workflows
Is there any unique IP that creates tangible value
Are switching costs in favor of company
Is it scalable
Betting on the jockey, not the horse
The questions above are just guideposts to help assess the potential risks and opportunities associated with a digital health venture. Ultimately (and you will hear investors say this all the time) you are betting on the jockey and not the horse. At the very early stages, when uncertainty and risk are at their highest, it is the jockey—the founder or founding team—that will determine success.
While market dynamics and product viability are important, it’s the team’s knowledge, agility, resilience, adaptability, and sheer determination that will figure it all out (or not). Even the most promising idea, that passes the above questions with flying colors, will encounter hurdles and require pivots along the way. It is the jockey's ability to navigate these challenges, learn from setbacks, and lead their team with unwavering dedication. It is the human element—the entrepreneurial spirit and leadership qualities—that ultimately determines the potential for success.
The best entrepreneurs are not the best visionaries. The greatest entrepreneurs are incredible salespeople. They know how to tell an amazing story that will convince talent and investors to join in on the journey.
― Alejandro Cremades
Is angel investing like the claw machine?
One time at an arcade, my son wanted to play the claw machine. I told him that it’s rigged, and he asked what rigged meant (he is 5), so I explained that the machine wants you to spend your money trying, but that most people don’t win. Now, as he points out things in the world that he thinks are rigged, I wonder: is the claw machine really rigged or am I just bad at it?
This quote on the claw machine in Vice feels quite relatable:
Many also love the thrill of knowing that the toy of their choice could fall into their hands (or out of it) with one skillful move. But whenever it seems like the prize is sitting precariously close to the chute — just one solid grab away from being yours forever — the claw drops the damn toy. This happens again and again, until you’re out of patience or out of coins, or both.
But no, angel investing is nothing like the claw machine. With the claw machine, you know if you’re good or not soon after you put in your change.
Read more: