How to identify and mitigate risks in healthcare startups.
A big part of early stage investing is identifying and mitigating risk. While risk is inherent in all startups, knowing which risks are acceptable and which ones aren’t is key. Below, I outline the what and why for a thorough early stage due diligence process.
1. MARKET RISK
Market timing is crucial for startup success. I always ask founders, “Why now?”. What tailwinds are you banking on which will drive market adoption?
We spend a considerable amount of time evaluating if the market is ready for this product and identifying market trends. Knowing what the market adoption pathway looks like is also important.
To put it simply,
Great founder + bad market = Market wins
Market size is also important and can be difficult to determine for disruptive/novel technologies which will create new markets.
2. TEAM RISK
The main thing I look for here is founder-problem fit and to a lesser extent founder-market fit.
If the market is ready and the founder is capable, focused, humble, formidable and reflective I believe this will transition to traction and product market fit.
We are not growth experts and I plan to leverage my network post product market fit to ensure a smooth scale/growth phase before exit.
3. PRODUCT/TECHNICAL RISK
I will usually start my risk assessment with this step. I look for founders who are problem focused but customer obsessed which I find results in the best products.
A simple question here is:
Can this team build this product?
I follow my curiosity and keep digging deeper. At times it’s natural to want to take mental shortcuts but I personally only invest in things I understand and will continue digging until I am satisfied.
4. COMPETITIVE RISK
Having an in depth understanding of competition is important. A crowded market or empty market are both signals for an unfavourable competitive landscape. Commonly, people say there’s a significant new mover advantage in new markets.
Unfortunately we haven’t seen this translate to successful exits in the past. Some well known examples being Google and Facebook - there were over 15 search engines before Google and many social media platforms before Facebook.
For healthcare, telemedicine has been around for more than 20 years, but adoption and successful exits have only started to happen recently with an emerging tailwind driven by the covid pandemic.
In short, first mover advantage is a myth.
We look for growing markets with a few competitors.
5. DEFENSIBILITY RISK
This speaks to the question, why is this startup different?
Let’s start by talking about patents. A good patent strategy is important but is not the be all end all. Generally speaking utility patents are more defensible than design patents. Software patents are generally difficult to defend, and the defensibility lies in the code itself.
Strong network effects are hard to replicate and could be a sign of defensibility.
Going deep into the due diligence process, looking at defensibility is where you’ll start to uncover the uniqueness of a particular network effect.
6. REGULATORY RISK
Startups should have a good understanding of a registry pathway to market. Most startups will choose a Class 2, 510k pathway. There will be a predicate for this pathway and we look at the predicate and the differentiator from it. A Class 3 pathway, while novel and disruptive, needs significant funding and time before market, and requires more conviction that the product they’re making solves the problem 5-10x better than the current standard.
Thank you for reading!
Rishad
