Should Doctors Consider Angel Investing? The Other 5% of Your Money

Several years ago, after realizing that I was ready to start winding down my career in emergency medicine but not ready to hang it up on my productive working years entirely, I decided to get a master's degree in finance. I had always been interested in personal finance and investing, but I wanted to dive in deep so that I could truly understand more of the nuances. I went into it without a specific direction in mind in terms of how I would use the degree in a second career, if at all. But I figured that if nothing else, it would help me understand my own finances better and help me make more educated decisions.

I purposefully kept my curriculum choices broad to get a taste of as many areas of finance as possible. Besides the general curriculum, I took elective courses in commodities, derivatives, financial modeling, and behavioral finance. I also joined a student-directed venture capital investment club where we had the opportunity to vet businesses and invest school money in those that we felt were worthy. It was mentored by someone who had been in the financial industry for decades but who had retired and was volunteering his time to guide the next generation of finance professionals.

Many of the companies came to the attention of our student committee through an angel investing group called Denver Angels (now Denver Ventures), comprised mostly of successful local businesspeople who wished to invest in early Colorado companies. And unlike any of my 20- or 30-something fellow students, I was an accredited investor and could personally invest my own money if I was interested enough to do so. So, I ended up joining Denver Angels as an investor, and I began dabbling in angel investing.

[AUTHOR'S NOTE: Strong Disclaimer: Fast forward somewhat through my education story, I ended up obtaining the CFP® designation and becoming a financial planner focused on physicians and other healthcare professionals (as well as special needs families). As a CFP writing an article about alternative investments, I must strongly reinforce the usual general disclosures of The White Coat Investor that you, as a reader, should not consider this article as a recommendation or personal investment advice. I am only providing general education about angel investing as an asset class and describing my personal experience with it. The fact is that angel investing is a high-risk strategy, which is why the SEC requires you to be an accredited investor to participate. Why? Because there is a chance you could lose most or all of your money, and they want to ensure that you are either financially savvy enough or financially secure enough to handle that risk.]

What Is Angel Investing?

That being said, let’s talk about angel investing and private equity investing in general. When you invest in the stock market through buying an individual stock, a mutual fund, or an ETF, your money goes into a publicly traded exchange—like the New York Stock Exchange or NASDAQ—governed by a strict set of rules and regulations that companies must abide by to participate. Only about 4,000 companies are traded in this way. Yet, there are millions of companies in the US that require capital to run their business. Sources of that capital may be the personal assets of the owners, bank loans, friends and family—or the owner just tries to make it work with the profits generated by the business. If you are trying to grow a company and make it successful, however, it usually takes some significant upfront and ongoing cash. It often takes years for companies to become profitable.

Many founders who feel like they have a great business idea turn to private investors to make their dream a reality. For small startups or owners with a limited track record, those investors, most of the time, are private individuals or small groups of individuals who invest a relatively small amount of money for a percentage ownership of the company. That amount may be as small as a few thousand dollars, or it could go up to a few hundred thousand. That is angel investing.

Companies that have more of a track record with several years of financials to show but need help taking it to the next level will often approach venture capital firms that can invest larger sums and use their business expertise and resources to give the company a much better chance to grow. The end goal is generally to garner attention from a larger company interested in acquisition or to become so successful that they make it to the public markets themselves. The VC firms are going to expect a higher ownership stake and more control over the process in exchange for their investment, however.

On an even larger scale, private equity firms buy up established companies and take majority ownership with the intent of increasing company success—and making money by doing so. Those investments are many millions (or hundreds of millions) of dollars in size.

For most individual investors wanting to invest in companies outside of the public market, you start with angel investing.

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How Do You Get Started as an Angel Investor?

First, you should examine your motivation and capacity for this type of investment strategy. I would encourage you to speak to a trusted fee-only financial advisor with experience in alternative investing about whether this approach fits your goals. At the very least, find a mentor or colleague who has traveled the road before you.

Then, consider joining an angel investing club in your area (like Denver Ventures is for me). There are also some national ones to choose from, even some that are physician-centric. Some may require a commitment to join (such as promising to invest in so many companies per year), or you could become a member for free or for a small yearly fee, which would give you a low-risk way to get a feel for the process and learn from others as they vet the various projects.

How do these clubs work? I can only speak from my own experience at Denver Ventures. There is a core group of partners who find and vet the deals using their collective investment and business backgrounds. They may hear hundreds of ideas or pitches and pick a handful of those that seem the most promising. If they choose to invest, they create a syndicate and offer it up to the wider membership to join with a minimum investment of $5,000. Once it passes the partner screening process, we are given an overview of the company, why the partners like it, the detailed pitch deck with company financials, and the opportunity to participate in a group call with the founder to hear directly about their vision and to ask questions. Even if I don’t invest in the project, it is interesting to see how the process works and what questions others are asking.

Why Would You Want to Become an Angel Investor?

As I mentioned above, angel investing comes with high risks. The reality is that most companies fail—45%-50% to be exact—in the first five years. And it can be very difficult to predict which companies will fail vs. which will not, even if you think they have a good business idea.

The historic rule of thumb among professional VC investors is an average “hit rate” as follows (although there is data from Cambridge Associates and the Kauffman Foundation that suggests it is worse in reality):

Those that are complete failures (0 return): ~30-40% Break-even or modest loss (<1x of your investment): ~30% Profitable (>1x return of your investment):~30-40%

In other words, the best-case scenario is that one-third of your investments will lose everything, one-third will essentially break even, and one-third will be profitable. Even the best private equity/VC investors—guys like Marc Andreessen, Ben Horowitz, and Peter Thiel—pick losers far more often than they pick winners.

Those aren’t great odds, right? So, what is the appeal?

It is because about 1-2 out of 20 companies hit it big and generate a greater than 10x profit on your investment. Those companies can make up for all the losers in your portfolio and drive a successful return. It really is a numbers game, even for the smartest VC investors. They go into it understanding that most of their choices will fail or limp along, but they are looking for those few unicorns that make it all worth it.

If you are truly interested in being successful at angel investing, you need to have a diversified enough portfolio to absorb the hit from all the companies that are going to fail, so you can profit from the one or two companies that make it big. If you choose only a few companies, you are assuming that you are way smarter and better at vetting projects than the best VC professionals who do this for a living and who have a whole team of analysts to back them up. Plus, the big successful VC firms with the best track records usually don’t invest in very early startups, which is what is likely going to be the most available to you. Instead, they are risking their money on the best of the best—great ideas, potential industry disruptors, proven founders, and some early solid financial data.

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Any Other Reasons for Angel Investing?

It is kind of fun, I think, to learn about and meet people with innovative ideas and to consider how their companies could impact an industry or the world. Founders are passionate, engaging, “all-in” kind of folks. You have to be if you are going to spend 100 hours a week creating successful teams, keeping them engaged and focused on a goal, and constantly selling your idea to people who can help you turn it into a reality—with the ever-present threat of it all immediately imploding. It is not for the faint of heart.

Watching and helping those companies succeed, when they do, can be quite gratifying. It feels like you made a difference to that success—unlike buying some stocks in Nvidia.

Plus, you may have skills or advice that can actively help a company do better. I have met several doctors who became involved in angel investing groups or healthcare/biomedical/life-science accelerators and later took positions on the board of directors of the companies they invested in—or even became their chief medical officer due to their related expertise and business acumen. It is a potential avenue to a non-clinical medical career and a way to change medicine for the better.

How have I done with my angel investments? The truth is, I don’t know yet. First, I’m still building my portfolio and am not yet diversified enough. Second, like many real estate syndicates, investing in private equity may tie up your money for many years (commonly 6-10 years) before anything happens—like an exit, a distribution, or a failure. I haven’t been at it long enough for any of those events.

Should Doctors Consider Angel Investing?

Most doctors have the income and/or assets to be accredited investors, and as accredited investors, you have options—angel investing is one of those. This is a high-risk, but potentially high-reward asset class. You need to go into it assuming that you will lose all your money on most of your choices, with the hope that your winners win big. This is for your “Vegas money” fund, not the money you are counting on to support you through retirement. You should never risk a secure retirement for the glamour and excitement of alternative investments (that money is best kept in low-cost, well-diversified funds with boring returns and lower volatility). That will always be your best chance to turn your high income into lasting wealth.

If you are considering angel investing, you don’t have to be ultra-wealthy or risk a ton of money, but you need to invest enough to diversify your holdings and realize that this money is going to be tied up for many years with no access to it. I would again encourage you to consult with a fee-only financial advisor who can help you analyze your long-term plan and see how (and if) it could fit into your portfolio.

What do you think? Have you done any angel investing? How did it turn out?

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