Whether physicians envision setting a new career course by working with a startup, plan to use the product in their practices or just want to diversify a portfolio, experts say robust due diligence is in order. When Chen was approached by a friend to invest in the device company, the friend also asked to help with product development, marketing, and company operations. He asked the company’s two founders detailed questions about the data in their slide presentation pitch to investors, but didn’t pick up on some underlying disagreements between them. The original partners have split up and Chen, still an adviser, is re-negotiating equity terms of the partnership.
Ask startup founders how they will accomplish the day-to-day operations and bring the product to market, particularly if they are involved in companies in addition to the current venture, Chen recommends.
And even if the product is in a physician’s own specialty area, Chen says it’s important to run it by colleagues. For the portable resistance device, he validated the idea with physical therapists who work with seniors.
Internist Jennifer Meller, MD, MBA, who recently founded her own startup venture, agrees. “Just a great idea isn’t enough,” she says. “You have to evaluate whether these are people who can execute an idea.”
Patience is key
Physicians ready to explore startup investing further should be realistic, patient, and diligent about the details. Experts advise the following:
Private investors, even if they are silent partners, need to set out their expectations for how frequently the founders will report on product development, operations, and marketing issues, Chen says.
Investors also need to embrace realistic guidelines for any potential payoff. Just 30 percent of startups in the Kauffman study logged positive returns for investors. Among those, about 5 percent saw significant gains, returning more than 10 times their original investments.
“Sometimes original investors barely make anything,” says Carrie Coghill, CFP, AIF, president of Coghill Investment Strategies in Pittsburgh, an investment firm with several physician clients.
Be ready to wait
Chen also recommends setting a much longer time frame for product development than founders typically envision. “Our timeline was three years, but we ran into production issues overseas so that is maybe five years now,” he says.
Angel investments in the Kauffman study averaged 4.5 years from initial funding to exit, either through a purchase or an initial public offering, though industry experts say the timeframe can exceed seven years.
Even if the investment represents a very small portion of an investor’s total assets, experts often recommend scaling back the initial outlay. Parizianu cites a physician client who was asked to invest $50,000 in a friend’s startup. She felt the company was a little unrealistic about growth prospects, so she recommended investing half that amount until some benchmarks were reached.
Deal with legal questions
Hire an attorney to review any contracts associated with the deal, Parizianu says. It’s critical to understand the subordination agreements that govern priority standing among investors, she says, because they spell out how initial investors will get paid once the company is sold or goes public. If the investments involve debt instead of equity, creditors need to know where they will stand in line for possible repayment in the event of bankruptcy.
Beyond the specifics of ownership in the investment are a host of legal and ethical considerations, says Reesa Handelsman, JD, a partner with law firm Wachler & Associates in Royal Oak, Mich. She typically recommends consulting tax and securities attorneys, as well as healthcare attorneys familiar with federal and state referral and anti-kickback statutes.
Even if the investment is an early-stage startup with no direct connection to patients yet, it’s important to think about how it will look in the future to anticipate possible conflicts of interest down the road, she says.
Any prospectus or documents a startup provides should highlight potential legal risks to discuss with an investor’s own attorney, she says. Will physician investors be personally referring patients or getting involved in other ways to generate business? If so, physicians need to consider their payer mix and whether their contracts prohibit that kind of activity.
As a rule of thumb, she adds, physicians should be sure they are paying fair market value for their investments to avoid the appearance of being given a stake in exchange for referrals.
From an ethical standpoint, she says, consider if the venture raises any concerns about over-utilization of health services or creates an incentive for unnecessary services on the part of the physician.
Study the competition
Another common trap for investors is assuming they are the only ones thinking about their business opportunity, Coghill says. “They get really excited about an opportunity without realizing someone with much deeper pockets might come along.”
Finally, consider the personal credibility of anyone involved in the deal, says Chris Chen, CFP, chief executive of Insight Financial Strategists in Waltham, Mass.
“Financials always look good because they are contrived to look good,” he says. In other words, treat any future projections with skepticism. “Beyond that, look at whether the principals are properly motivated and have credibility from doing this work before.”
Physicians should trust their own industry knowledge says Meller. “They bring a different perspective to the table,” she says. “They’re going to poke holes and key in on what they think is interesting about an idea,” which may be completely different than what a founder thinks.