Red Flags In A Startup
If you are an early-stage startup, you’re probably wondering about the red flags that investors look out for. Let me share the most common red flags, so you can already address them.
- Advisors. Do you have advisors on your pitch deck? That is one of the biggest red flags. I dedicated a blog post to this topic, detailing why investors do not want them.
In summary, it’s an unnecessary cost point, and they will doubt your ability to do business. To investors, this opens up Pandora’s box of doubts and questions. There is no logical explanation for why they should pay salaries or share equity with advisors who have not invested a dime in your startup. An investor will advise you in your favor because they need their investment to grow as quickly and efficiently as possible. An investor has skin in the game. What risk does an advisor take? Furthermore, what else do you feel insecure about if you need to pay for advice? Should they trust your drive and entrepreneurship to give them the return they want? Advisors do not look good on your pitch deck. You will be asked to part ways with them; why not do it now.
- (Tech) Companies as co-founders. So far, I have only seen tech companies using this approach, so I will use it in this example. But you may have encountered a similar situation in a different field, which may apply.
Here is how it goes: There are countless tech companies out there who are approaching startups, proposing to build their product in exchange for equity. If this is done right, it’s a great opportunity. But make sure to crunch the numbers and know what you agree to. I have repeatedly seen quotes with 20 times the fee they normally charge, then asking you to pay 20% upfront. They will “invest” the other 80%, not in cash but in hours worked building the product. The condition is that someone from their company will become your co-founder on a salary. So, you essentially pay 20 times the price for 20% of a product with the commitment of paying salary to pay off the other 80%? Investors despise bad deals, and so should you. No co-founder is worth this kind of messy structure. Hire them as contractors; present them as the company that builds your product with a straightforward product development agreement. Investors are smart with their money and their time. If you understand and respect that, your pitch deck will look very appealing to them.
- The urgency for money. Wanting to raise money for your business ASAP is one thing. Needing to raise money because you are running out of it personally is an entirely different story.
A Swiss investor once told me that the moment they sense pressure, they step back to figure out where the pressure is coming from. Keep that in mind when approaching investors. Take a look at the article How to raise funds fast. You want to raise funds quickly because it is efficient and will profit the growth of the business. The thing is that even when you are funded fast, this does not mean that you will be rich fast.
I met a founder from Finland. I liked his idea, he was experienced, and I thought he had potential. So, I agreed to coach him through his fundraising round. The next day, he called me to discuss his calculations and that he would need x amount of money to start. We then discussed the details of his plan, and for me, this was it. But he kept returning to it every evening until I set him down. Because I did not understand his urgency. I am always up for closing fundraising rounds ASAP, but we were not ready to pitch. So, I asked him: Do you have debts? Do you have some financial problems? Because that’s the impression I am getting. He just said it’s not what it looks like, but he also doesn’t want to go into detail. This was a major red flag, and he knew it, talking to investors. He was insecure and not able to give straight answers. Investors will back off because there is no justifiable urgency to raise funds as a startup.
- High salaries. Investors need to know your burn rate. They want to know how much of their investment are going to “burn” per month and why. I worked with this startup from Switzerland, and the founder wanted a $15,000 monthly salary. It was an early-stage startup with zero customers and employees. I asked him, “Why? What for?” His reply: “I have a mortgage to pay.” Investors don’t give a shit about your mortgage. That’s your problem, not theirs. Imagine investors giving you half a million knowing that freaking 20% of that is for one person’s salary! Investors do these calculations before you can say “Please.” They are numbers people without any intention of throwing money out the window.
- What will you do with the money? You need to give them an execution plan showing how the money they invest will be used to grow and expand the business and guarantee them profit. In my next post, I will discuss how to decide the amount you want to raise and plan your goals. It has to make sense to them. If you don’t have a plan for what will happen once the money hits your account, that is a bright red flag for investors.
When investors see a red flag, they will usually step back. And typically, they don’t even have the time to reject you. They want to talk to entrepreneurs who are serious about building a business about being successful. Raising funds for your business is not easy money for you to live comfortably off. So, investors will be diligent about those numbers.
I want you to be successful, so take the time to review your business plan, your pitch deck, and whatever you will pitch with, and get rid of those red flags ASAP. Look at your business from their perspective and be honest. Would you give yourself money to build this business?