5 red flags your startup should be cautious of when choosing potential investors
How can founders ensure they are picking the right investors for their startup? A Forbes contributor named Alejandro Cremades wrote an article about this subject. He says “The amount of money that can be raised may even be one of the least significant factors when picking an investor for your startup business.” Because your investor choices can either destroy your dreams and turn them into nightmares, or help you too overcome numerous barriers on your path to your full potential. Meaning a startup with a good product or idea that collaborates with the right investors, can increase your business’s success rates dramatically. However, working with someone else can have its own challenges.
Now you think that the most difficult part is finding an investor that is interested in making an investment but if you don’t know how to recognize alarming situations in your interpersonal interactions with investors, and deal with them accordingly, your business relationship or cooperation can go downhill fast.
Mr. Cremades stated in his article that “when you onboard an investor, that institution or individual becomes part of your cap table, and it’s for the long run. It is well known that divorcing your wife or husband is much easier than divorcing your investor. You need to be very careful with who you are getting into bed with.” A VC firm Lighter Capital published an article titled “how to tell if your investor is a bad fit” and they reiterate that while pitching investors and knocking on doors for seed funding or Series A capital is an exhausting and all-consuming process. Not only does it require countless coffee meetings, tedious pitch deck revisions, and many hours away from running your business, but you’re in a vulnerable and emotional position. You need capital, and your business can only survive for so long without it. And while it may be tempting to partner with the first investors who says “Yes,” it’s critical to partner with the right investor. After all, these are people who you’ll be working with for at least the next five to seven years.
So it makes sense to educate yourself on any potential pitfalls or difficult scenarios then to be oblivious and get blindsided by them later on.
When you do your due diligence, homework and are well prepared, you’ll be able to prevent bad vibes with investors from progressing since you’ll be able to recognize when something is going in the wrong direction. Here are a few potential red flags to look out for when vetting investor partners for a funding round.
1. They may push for unrealistic goals or growth at all costs
How confident are you that you and your investors are in alignment? If your investors seem taken aback by your growth projections, are constantly asking about your exit plan, or are being pushy about what advice you should—and shouldn’t—take, then perhaps your expectations don’t line up. These are signals that you’re in for a bumpy ride with the potential investors. Remember, you should be a team. When an investor spends some time with your company, they might start to think that they know everything about it. If the business is doing well, the desire for bigger returns on their investment can cause them to start having unrealistic expectations and goals. Having a baseline agreement on expectations is a good place to start.
Being mindful about who you work with takes time, patience, and gumption. But if you get to partner with intelligent, trustworthy investors who can help your startup soar, it’s all worth it in the end.
2. They’ve invested in one of your competitors
If you are doing your homework on a potential VC before you meet with them and you see they’ve invested in one of your competitors, skip the meeting. At best, they offered a meeting without understanding your company’s role in the space; at worst, they’re the unscrupulous type who tries to “fish” startups in a ploy to obtain information and confidential intel. If you have ever watched an episode of SharkTank you have seen investors such as Daymond John say to a startup something like, “I am out since I have already made investments in competing companies.
The Lighter Capital author suggests that you should be very careful about how much you share in the early casual meetings and emails. (And note that this doesn’t hold true for banks or debt providers.) Although sometimes there are situations where the investor such as Barry Diller, founder of IAC, will invest or purchase a majority stake in several businesses competing in a sector such as Dating or home remodeling. IAC owns 80%+ of publicly traded Match.com, which owns Match, Tinder, OkCupid and a few other sites.
3. A poor reputation or won’t provide references
Your goal should be when choosing an investor is to find the right partner, not just any warm body. Find one who shares your goals and will support you. Partnering with an investor is just that—a partnership. You may not agree on everything (you don’t have to) but you should trust that your investors are going to act in the best interests of the company. In addition to funds, the right investor can help by being a trusted adviser; facilitating connections with potential business partners, employees, or additional funding sources; and by lending credibility. Someone who isn’t trustworthy won’t be of much help. Just like a hiring manager may call references to get a feel for your character, you should be doing the same for any investor. A Crunchbase article by Tero Isokauppila, a wellness startup founder, states “you should ask every potential investor if you can talk to a few of their portfolio companies or people they’ve invested in.” Then, jump on a call with a few and do your due diligence to get the nitty gritty on what they’re like to work with.
4. A lack of relevant experience or industry expertise
Investors who do not have experience in the industry that you are in or with the types of customers you are serving are not going to be able to relate to your situation and provide as much value. If your potential investors haven’t worked or invested in your industry, you may be wasting your time. Sure, they may genuinely want to help you, but if they aren’t able to advise you the way you need to be advised, and connect you to the right people to help you gain traction, your benefits will be limited. So try to figure out how much influence they have in your industry, with other investors, with distribution and media channels, and with other influencers? This can far outweigh the amount of money being invested or the terms.
Randy Rayess, a cofounder of VenturePact to an INC contributor “On the other hand, investors who have strong ties in the industry and understand the problems you are solving will be able to provide better introductions and feedback.” The best investors are ones with deep industry expertise or experience with like business models.
As an example, the Forbes contributor, Mr Cremades points out that some of the top tier early stage VC investors like First Round or Andreessen Horowitz have a tremendous amount of influence in the venture space. If they invest in your company they could also support you with resources around hiring, HR, operations, marketing, scaling, subsequent financing rounds, etc. That type of value is something to look after when doing your capital raising efforts.
5. A misalignment with your vision.
Taking investment from someone who seeks to change or alter the founders’ vision for the company isn’t a good choice. It’s the same as going into a romantic relationship assuming you are going to change your partner. Do they believe in the mission and you as the key team to make it happen? Will they give you room to do your best work? Or will they sabotage you and your reputation, and look for reasons to push you out of your own venture? If an investor invests thinking they will change the vision of the company, that will ultimately lead to strife, arguments, and disappointment. Investors should help shape the vision, but not dictate it. Now obviously some companies will end up pivoting but that should be a collaborative management decision.
Clearly, who you pick as investors is absolutely critical to your success. It will make or break you. And the Forbes article I mentioned earlier explains that looking for positive and negative factors can help to build a checklist of sorts for vetting potential investors in your startup. Keep this in mind when tackling due diligence, engaging in investor meetings, preparing questions, and learning how to read between the lines with people.
And don’t just settle for the capital investment. Look at what else an investor can add. If you’ve ever watched an episode of The Profit with serial investor Marcus Lemonis, you’ve witnessed how an expert with a fresh perspective can add a ton of value.