We’ve assembled your top twelve questions around early-stage investing in the orthopedics space here, with answers to help our network members (and prospective network members). Take a look, and if you have any follow-up questions please don’t hesitate to email andrew@andryventures.com.
Q: What is early-stage (or angel) investing?
A: Early-stage (or angel) investing means investing in private companies at the earliest stages of its fundraising journey. These early stages usually have lower valuations, so your investment purchases you a bigger “piece of the pie” (i.e., ownership stake) than in later stages of fundraising, when valuation may be higher and your same check size would purchase you less of the company’s shares. Angel investing is a type of private equity investing, in which investors attempt to earn higher returns by taking on more risk compared with investing in the public markets.
Q: What makes a startup a startup?
A: A startup is essentially a new company built around solving a problem by creating a product or service to tackle that problem. When you’re investing in startups, you’re voting with your pocketbook that (a) you recognize the problem being solved, (b) you think enough people have this problem to constitute a meaningful market, (c) you believe that this market (or a strategic acquirer) will pay you in return for designing and developing a solution to their problem. Whether it’s a medical device or a software product or anything in-between, ultimately angel investing is about identifying startups tackling meaningful problems and, in so doing, expecting to be rewarded for their efforts by the market (or by a larger strategic acquirer who could supercharge distribution of that product from within their company).
Q: What does it mean for a company to go through funding stages?
A: During the mid-20th century venture capital investors devised a method of investing in startups using a tranche system, which means investing in an early-stage company in successive waves rather than one lump sum at the beginning. This approach enables investors to provide just enough capital for the company to reach key milestones around product development, senior hires, go-to-market, or other factors, which “de-risks” the investment compared to their original starting point (note: the startup isn’t fully de-risked, it’s just “less-risked” compared to the point it was at when it originally raised funds). In other words, providing capital in successive waves gives investors the choice to invest or not invest in later “rounds” of investment based on their judgment of the performance of the company in their use of the earlier stages of funds, while also taking into account the traction the company has generated using those earlier stages of funds to make their decision. So if a company doesn’t hit the milestones investors would like to see by their next funding round (or simply isn’t getting the traction investors wanted to see), then investors don’t invest in the later funding rounds – meaning that instead of the big lump sum, they got better information about the company for a smaller sum, allowing them to make a better (or more informed decision) and allocate that capital elsewhere.
Q: What are these funding stages called?
A: The landscape has actually changed slightly over the past five years or so, but the most common fundraising path through funding stages looks like this: Pre-Seed Round → Series Seed (or Seed Round) → Series A → Series B → Series C → ad infinitum (e.g., Series D, Series E, etc.). The size of each round differs per industry, based on the capital intensiveness of the business being built (e.g., a construction company would require significantly higher early investment in machinery than a software business).
Q: What does “valuation” mean?
A: There’s actually two types of valuation.
First is pre-money valuation, which is the theoretical value of the company before the investment agreed upon by the company and the investors. Pre-Money Valuation is calculated by multiplying the number of Fully Diluted shares of the company before the investment transaction by the purchase price per share in the investment transaction.
Second is the post-money valuation, which is calculated by adding the dollar amount invested in the transaction to the Pre-Money Valuation.
You’ll often hear investors simply refer to the “valuation” of the company without making a distinction between the “pre-money” and “post-money” valuation of the company – but they’re usually referring to the pre-money valuation.
Q: What’s the difference between investing in startups versus investing in the stock market?
A: The stock market represents publicly-traded companies – that is, companies who’ve gone public and agree to be governed by the SEC’s rules about public company governance. Another factor is that the stock market consists of liquid assets – where “liquid” means they can be easily bought and sold on the public exchange. But private companies are “illiquid” investments, meaning once you’ve invested, there’s no getting your money back until the company goes through a “liquidity event” like going public (i.e., an Initial Public Offering, or “IPO”) where your shares are sold to the public, or getting acquired by a larger company (i.e., going through a mergers and acquisitions process, or “M&A”) where your shares are purchased by the acquiring company. In both cases, there’s a counterparty to buy your shares – for IPO’s it’s the public, for M&A it’s the acquiring company. For a more thorough treatment of the differences between private companies and public companies, see this article.
Q: How long does it take on average for a company to hit a liquidity event? In other words, when would I expect to see my return on investment?
A: The length of timefrom company inception to reach a liquidity event differs for companies with different types of products. Medical device companies can take a longer time than software businesses (which traditionally have a liquidity event between three and seven years) given the regulatory hurdles that are necessary to overcome early in the life of the company. Software businesses, often lacking these obstacles, can often experience a liquidity event sooner. But there are exceptions to this rule – some companies lasting a long time private, other companies getting acquired or going public very quickly – so it’s important to learn from the management team of any given startup what their expected timeline is (if they even know yet).
Q: What are the risks associated with early-stage investing?
A: Early-stage investors (or angel investors) are often wealthy individuals that invest in startups in their early stages of development or seed round of fundraising. Due to the inherent risk of loss of capital or significant dilution in subsequent fundraising, angel investors typically pursue investments with returns that they believe may have the potential to return multiples of the initial investment.
Q: What does “dilution” mean”?
A: Generally speaking, as subsequent financing rounds occur, existing investors will own proportionally less of the company than they did previously since additional equity is generally issued as part of a new financing round. Dilution is not necessarily a bad thing – since new stock can be issued at a higher price, you may own a smaller piece of a larger company, which means the value of your investment is actually higher than it was previously.
Q: How do you know if a startup is a good investment?
A: It’s important to qualify what we mean by a “good investment.” A good investment is one in a good market, with a solid product (concept or actual), with a highly-capable team, and a formidable and persistent founder (or co-founders). Also important are product-specific metrics (like user growth and retention) and financial metrics (like net dollar retention and annual recurring revenue growth) that can be evaluated once a product is in the market. All these factors and more are included in the investment memo sent to network members in support of any particular investment opportunity.
Q: What does a syndicate (like Andry Ventures) do?
A: Andry Ventures connects the most promising orthopedic startups with the savviest orthopedic angel investors. We bundle together each individual angel check into one large check, winning our investors allocation into competitive deals that might not normally accept a small check. And we also provide education and community for our surgeon network of investors.
Q: Why would orthopedic surgeons invest in orthopedic startups?
A: In a risky endeavor like angel investing, it’s key to mitigate as many risks as possible in order to make a good decision (where “good” means “higher probability of a successful outcome,” never “surefire opportunity”). One important risk to mitigate is that of not understanding the space. For example, for an orthopedic surgeon looking at consumer Internet businesses – ecommerce, DTC, marketplace, social networks, etc. – the orthopedic surgeon wouldn’t necessarily have any unique advantage to understanding the market. But for orthopedic startups, that advantage is in play – you do understand the space, you do understand the problems being solved, and moreover there’s a great deal of innovation happening where you do understand the implications of what could change if the company is successful. So there’s the possibility of conviction around orthopedic startups – believing in what they’re doing enough to invest – which is why orthopedic surgeons might want to explore investing in riskier opportunities for the chance at higher returns (following the basic dictum that there’s no reward without risk, and the greater the risk, the greater the reward).
