Entries Written By Tobin Arthur
Like the late Peter Drucker, I find anything written by Jim Collins compelling. He is a keen observer of human behavior through the lens of companies. One of his more poignant insights was that of the Flywheel concept. He first articulated this concept in his bestseller “Good to Great” and has now expanded on it in a short form book (monograph) appropriately entitled “Turning the Flywheel.”
As Collins writes:
“Once you fully grasp how to create flywheel momentum in your particular circumstance, and apply that understanding with creativity and discipline, you get the power of strategic compounding. Each turn builds upon previous work as you make a series of good decisions, supremely well executed, that compound one upon the other. This is how you build greatness.”
The concept is powerful as a framework for understanding why some businesses build momentum while others idle or die. As an investor I particularly love anything that leverages the concept of compounding.
Collins shares the story of how Amazon embraced and honed their flywheel and went on to become a juggernaut. The flywheel behind Vanguard also presents a solid reference.
But flywheels aren’t easy. If they were, every company would get them right. Rather, they require rigorous thought, experimentation and iteration. If there are five key elements of the flywheel and only three of the five are operating efficiently, then the flywheel doesn’t work.
Each of the core elements has to contribute to the momentum,
I suspect there are a lot of flywheels in training out there that need some consideration and polish, but with effort could transform a mediocre business into a force. Part of that consideration and polish is implementing a core system like OKRs that can help a company keep itself guided toward its true north.
This post is being written as a book recommendation for both startups and investors. Every business owner needs to be considering whether or not there is an opportunity to build a flywheel effect into their business. Similarly, every student of business, otherwise known as an investor, should have a clear grasp of this concept in order to determine if an investment candidate has a flywheel embedded into their business model.
Throughout history, gatekeepers have erected barriers to keep people from having direct access to markets. Real estate buyers and sellers needed an agent. Travel agents had access to better deals. Brokerage houses maintained critical data for investing. Heck, even the church conducted mass in Latin so that you had to rely on a priest to tell you what was going on. (Perhaps that’s blasphemous to say during Lent, but I digress…)
The Internet has enabled massive, rapid disruption of the gatekeepers. Consumers now have more direct participation than ever before, and the gatekeepers are floundering.
This disruption is not slowing. We will continue to see major impact where it has already began, and we can expect to see untouched markets become targeted. Healthcare is no exception to this rule. The consumerization of healthcare has a host of implications, and doors are opening to a wealth of opportunity for entrepreneurs. (To be fair, self-diagnosing that red spot on your arm via WebMD and Google is not an especially byproduct of this democratization.)
As an investor, you’re aware of the importance of trends. This democratization of information and markets needs to be part of your calculus. It will create headwinds for traditional players such as brokerage houses and payers, while enabling new blood to thrive. The middle man is gasping for breath as more efficient mechanisms of connecting consumers with providers take hold. Technology-enabled connectors and consumers are going to come out as the winners.
But there is a catch. Disruption of inefficient markets doesn’t happen overnight, and it’s not cheap. It takes pools of capital to gain critical mass, and it takes time to move beyond the early adopter. Amazon is a shining example of these facts. While it’s now obvious how much impact the company has had on traditional players, 1998 told a much different story. Then it was novel, but Barnes & Noble, Borders, and others didn’t take the threat seriously. Even if they had, it’s unlikely that these stalwarts could have evolved fast enough to save themselves.
As you are evaluating startup investments, it’s important to look beyond the potential for disruption. Examine the time horizon that is required to gain market penetration, and the amount of capital needed to get there. The company should have research and thoughts on these topics, so the onus does not rest on you alone. If the numbers or the logic don’t add up, then it may be too early to invest. But, if the management seems to have ideas that are well-thought, and contingencies in place for when things go wrong, it may warrant further consideration.
Early stage investing is not only inefficient, but almost entirely driven by varying levels of guesswork and amateur efforts. In the meantime, virtually every other industry is getting smarter through the adoption of big data or artificial intelligence (A.I.). The primary goal of AngelMD is to revolutionize early stage investing into a legitimate asset class, combining the power of an expert network and artificial intelligence.
To understand the role of A.I. in investing, it’s important to recognize a core weakness of all investors: subconscious bias. Many of you are familiar with Moneyball, the Michael Lewis book chronicling the rise of data in the world of sports (baseball). It has had a fundamental impact on a sport that has remained largely unchanged for a hundred years. For years the statisticians swore that metrics like batting average and home runs should be the focus of scouts and managers. Billy Bean applied real statistical rigor to baseball decision-making and the rest is history. Concepts from Moneyball are now being applied to retail, insurance, travel, real estate, public market investing and more.
Lots of startups talk about being based around “big data”, or being A.I. centric. The reality is that saying you are a big data company doesn’t mean anything until you not only have the data, but you are also using it to make better decisions than you did without it. That’s why the early stages of AngelMD focused on growing the various member types within the network: startups, physicians, investors, and industry. We needed to harness the collective expertise of this community to more effectively identify trends and make better investment decisions.
Now, every time a member of our community logs onto the site, provides a valuation on their startup, reviews a company, follows a startup, takes a poll, attends an event, or invests in a company, we are able to gather that data. As this proprietary body of data grows, we are able to form that data into what we refer to as the Meta Knowledge Engine “Metis”.
The product team at AngelMD is always working to build features that can help you, while also engaging you. This “sticky” factor, where members of the AngelMD network return to the site and complete different actions, enables us to gather more proprietary data than anyone else.
We have also begun to augment this information with third party data sets including external investment transaction information, mergers and acquisitions data, patent data, and much more. All of this feeds an artificial intelligence engine that will get increasingly accurate and predictive with time.
It’s important to understand that adding A.I. to AngelMD does not mean that we are eliminating human judgement. Quite the contrary. The AngelMD network and platform grows from a center of physicians and other allied health experts. It is their input, cultivated and analysed by software, that allows AngelMD to outperform any methodology or system that has come before it.
When Robinhood burst on the scene 5 years ago the ability to trade stock with no fees attached was semi miraculous. That innovation helped drive what today is a startup valued at $5B. Recently, the WSJ dug into the business model and revealed how they are able to thrive while taking no fees.
The fact of the matter is they are taking fees…just not from their trading customers. They are selling those trades on the back end to four high-frequency trading shops. Of course this begs the question as to why those shops would pay for those trades. And this is where it gets interesting. The answer: DATA
I was listening to Tim Ferris interview the CEO of Walmart this week. On the podcast the CEO described Walmart as an increasingly data and technology-driven company. Data is vital to every industry and is the underpinning of AngelMD.
While AngelMD has a long way to go, in the early stages we are aggregating intelligence from our network of physicians and healthcare insiders. We use that intelligence to guide our investment decision making. As we evolve, the data sets will continue to grow and so to will our reliance on this intelligence to give our members an edge in early stage investing.
To implement any sound investment strategy, you can save a lot of time by learning from the best and using their strategies that are already battle tested. Fortunately, Bruce Greenwald’s framework for value investing is an excellent starting place to act as your initial criterion:
- Search: your plan to source qualified deals
- Valuation: determining the worth of a company and the potential returns
- Review (due-diligence): analysis of an investment’s key materials to understand your biases, understand the risks and identify opportunities.
- Risk Management: management of the understood risks to remove or reduce the impact if that risk occurs
At AngelMD, we also would add a fifth to the list which is:
- Post-Investment Influence: your ability to influence successful outcomes by assisting the executives in reaching their goals through introductions, resources or your expertise.
As you can see, these are fairly weighted to the upfront process of finding and evaluating deals. AngelMD is certainly geared toward helping make smart decisions on the front end while believing returns are built by support after the investment.
Given this is a framework, you’ll be able to customize this to your own investment style; and by following a more rigid approach, you’ll be able to reduce your bias and make better decisions over time.
In future articles, we’ll provide you with more tools to use in your own process, but for now, we’ll go into each of these in a little more detail.
This is more or less how you find deals. This is where you can leverage creative sources, but the secret here is finding a few sources that produce qualified deals to save you time. Investors can spend an inordinate amount of time attending events, making phone calls and meeting with startups directly, but the research shows this doesn’t necessarily mean better decisions and its very time-consuming. A better approach is letting others do the legwork which reduces the noise and ultimately helps you focus.
- Build your network in the sector you’re investing and continue to nurture those relationships. You’ll be able to get “pocket” deals that may not even be made available to the broader public.
- If you have the expertise, you can apply to be an expert analyst. This is a great way to get early looks. AngelMD has a deep physician evaluation group called the Scientific Advisory Board. See our website for more information.
- Attend pitch nights and innovation events at local incubators and universities.
- Utilize AngelMD to crowdsource winners.
- Follow institutional investors like GE, J&J or Kaiser, who have tons of resources to find deals.
This one is pretty straightforward, but the secret to success is in building a personal formula or algorithm and building up your industry/sector knowledge. The algorithm should give you a sense of whether or not a company is over or undervalued and your potential returns within minutes. With a small amount of information, you should be to able plug in the variables and decide whether or not to move forward with due diligence. This saves a ton of time and you’ll be able to refine your formula to make better decisions based on your results. Most people don’t have the background and information with which to really analyze valuation. In most cases, this is best left to trusted resources who do have the expertise and resources.
The other variable is your overall knowledge. You can build this into your formula, but ultimately, you’ll develop an instinctual sense of which companies are leading in a sector and which ones are likely to exit. This is a critical skill to develop over time and you can learn a lot from your colleagues and mentors.
- Build your own valuation spreadsheet and use it to review deals quickly.
- Form a mastermind group to evaluate deals and compare notes.
- Set a goal to evaluate 50, 100, or 300 deals. You will learn a lot!
- Read industry newsletters and articles daily.
- Follow national media for macro trends.
Review (Due Diligence)
The secret to due diligence is following a checklist, and following it every time! The other secret is finding other larger networks or companies that are doing due diligence for you. The point of due diligence is to find opportunities and identify risks, but it can also be used to negotiate better terms as an investor. A lot of times it’s hard to get great terms unless you can invest substantial amounts in a deal. If you are investing $15K in a $5M round, you don’t have much leverage. If you are the main investor, you can set your terms.
- Develop a checklist and use it
- As a gift, here is a quick tool you can download and customize for your own use. AngelMD Due Diligence Quick Sheet
- Find larger companies or investors and follow them to invest.
- Understand your ideal terms and get those in an investment document you provide to the CEO. A lot of times CEOs won’t have this ready, so it’s an opportunity to give them YOUR best terms. At AngelMD, we get our investors great terms up front, so that is another reason to utilize the network.
Traditional risk is pretty easily defined by the likelihood a risk will happen and the scope of impact if it does happen. Ideally, you will eliminate a risk entirely, but if you can’t do that, you should reduce the likelihood or impact if it does occur. With investing, you will have losses, part of mitigating that is diversification, but also it’s important to have your peers be able to see things you might have missed.
This really becomes the next step in the due diligence process where you make your list of positives and negatives for an investment and understand what you can do to manage them. As a tip, for impact you should also understand what is the best and worst case scenario. Sometimes if the worst case is negligible, you can just accept it and move on.
- Diversify your investments relative to your overall investable capital. (I.e. if you have $300K to invest, invest in 8 to 10 companies at approx $30K instead of making one single investment.)
- Specialize in a sector or industry that you know.
- Be the lead investor. AngelMD has some great programs to support you up as a lead investor (a position we call Syndicate Leader). Leads typically get first looks and have the ability to work hand in hand with the executives. They also build lots of credibility as an influencer in the community. Want to be a lead? Fill out this form.
This final one is where we like to focus a lot of time. Once you’ve invested you should be able to influence success through your connections and expertise depending on what the company needs. You don’t want to be the pain in the ass investor calling the CEO daily, but you can be an advocate and help when it’s needed. If a company needs sales, maybe you can introduce them to your procurement manager at your hospital. Maybe you could demo their product to other colleagues in your field, so they can see the benefit firsthand.
- Ask for a quarterly report and a list of their ongoing needs.
- Ensure you have rights to invest in future rounds.
- Try to do one to two things to help your invested companies per year.
- Bring in your colleagues and friends to invest by being a syndicate leader. If it’s a cardiac device and you have 20 to 30 cardiac surgeons investing, you can make a huge difference in validating that company making it a target for acquisition.
Overall, each of these criterion is an entire topic on their own, but this should give you a great starting point to start to understand how you make investment decisions and to get your framework down on paper. Let us know how we can help.