Like other high-income earners, physicians are often sought after sources of angel investment funds for start-up or growing businesses. I am often asked to review and analyze these business opportunities for physician clients. In this article, I am summarizing the key considerations for evaluating potential investment business opportunities in startups or growth companies.
Vision, Values, and Strategy
Can the company’s management articulate a clear vision and strategy for the company? In other words, do they know what they stand for, and do they have a plan for where they are going? Many companies suffer from a lack of focus. Research supports that companies with a narrowly focused strategy will generally outperform the competition. I am wary of any company that can’t clearly articulate their value proposition in the marketplace in 30 seconds or less. I also look for whether management and employees are all in sync on the company’s vision and strategy. Many companies overlook the creation of a value statement. I prefer companies that know what they stand for. Difficult times will face every organization. Value statements that have real meaning and adoption provide anchors during turbulent times.
This is one of the hardest things to actually find out in due diligence, but probably the most important. Here, I am trying to determine whether the management team can actually execute the company’s strategy. Many people confuse effort and activity with execution. Successful companies have high functioning teams that execute with purpose and passion to get things done. I ask questions about how management creates accountability in the organization or look for examples of past execution to try and determine whether the management is execution-oriented. Other clues to whether a management team can execute is the level of organization, timeliness, and if they are goal oriented. I like to see clear written goals and action plans.
People raising money for a company should have a clear command of the marketplace they are competing in and how their products and services stack up against the competition. Is the company swimming in the “red ocean” of a very competitive market or the “blue ocean” of new and untapped markets? If they are in a very competitive market, then can they clearly articulate why their product/service is differentiated from the competition? In a new market, how are they pricing their products and gauging the overall market opportunity? Many companies venture out and find that their market is actually much smaller than they thought. It is helpful if the company’s industry has solid data on size and growth. High growth companies need large and growing markets to thrive. I look closely at the price sensitivity of the products/services and the barrier to entry of other people to compete. I also prefer recurring revenue companies versus companies that only have one-time sales. Is the company a one trick pony or is there a pipeline of other products/services?
No matter how good the products and services a company may offer, ultimately the success of a business depends on the quality of the people. When you invest in a company, you are really investing in the management team. Most companies in early funding stages lack a complete management team. I try to determine the strengths and weaknesses of the management group, and I want to understand how they will shore up the deficiencies in the short term and what their long-term plans are for fully staffing the management team. Does the management group complement each other or is there too much overlap? Are any of the founders part of the management that may soon have to be replaced? Replacing a management team member can be a time consuming distraction for a company. I prefer managers who have experienced both success and failure. We all know we learn more from our mistakes than our successes. I would prefer that a management team not learn their failure lessons with my investment. Great managers are great leaders. They are high performers and can attract top talent. I have found that the best leaders are great coaches and know how to get the most from their employees. You want to avoid know-it-all’s and micro-managers because they will ultimately prove to be poor leaders and will run off talented employees.
What is the Exit?
Most investors eventually want their money back out of the company in a reasonable amount of time. A typical time horizon is 5-7 years. What are the long terms plans of the company? Are the founders creating a lifestyle business or a high growth company? Typically, lifestyle companies will have slower growth but greater profitability. High growth companies, often referred to as gazelles, usually focus on top line revenue growth. These companies will typically lose money at first. I look carefully at the “burn rate” of these type companies and want to understand when profitability will occur. It is critically important that the owners and management all be in sync on the trajectory of the company and the goals for exit.
Ultimately, the opportunity to own part of the company must be for the right price tag. All pro-formas tend to look alike with slow growth in the early years and then the proverbial “hockey-stick” high growth in the later years. The investment and corresponding ownership should be reasonable based on very conservative financial projections. There are also a number of ways to creatively structure a deal to provide additional risk mitigation for investors. In addition, the legal terms and conditions of the corporate documents you will be signing are a major factor to consider. Structuring the financial deal and key terms and conditions will be explored in more detail in a future column.
While this is an abbreviated list of due diligence considerations when vetting investment opportunities, hopefully it will provide you a framework to begin to consider future investment deals. For an easy checklist summarizing these points and others, feel free to email me, and I will send you a copy. Good luck in your investment future!