After many years of working with angel investors seriously trying to find new ventures worthy of their hard-earned money, I find their frustration often exceeds that of entrepreneurs sincerely looking for financial help. That’s a lose-lose situation, so I’ve given a good bit of thought to how every entrepreneur can improve their odds, and keep investors less frustrated at the same time.
My first suggestion is that entrepreneurs need to forget the old myth that all they need to do is sketch an idea on a napkin, and investors will line up to invest. That approach may work for an entrepreneur who just sold a successful business for a huge profit, but it doesn’t work for the rest of us who are not proven successes yet, or don’t even have a business yet.
Getting investors to trust you with their money is always a challenge, and it’s even more difficult in the early stages, where you don’t have a significant revenue stream, a few customers, or maybe even a product yet. At these stages, it’s all about you, and your ability to communicate and execute effectively. Here is my list of red flags that cause many investors to look elsewhere:
- No well-defined need or viable customer set. The most investable ventures stem from painful needs by customers who have money to spend. “Nice-to have” and “easier-to-use” products, or social ventures needing government support, are not likely to provide a financial return to investors. Investors expect a good value proposition in every pitch.
- Non-credible funding request or unreasonable valuation. Investors are looking to buy a chunk of the business, not the product. They need to know how much money you need, and what portion of the current business you are willing to offer for the investment. Future unproven projections don’t set today’s valuation. Ask only for the money you can justify.
- Naïve expectations on funding terms and process. Experienced entrepreneurs understand investor expectations of Board representation, preferred stock, and payments based on interim milestones. Founder insistence on non-dilute clauses, arms-length relationships, and quick closure without due diligence will short-circuit active interest.
- Dysfunctional or non-functional team members. Investors invest in people, often more so than in the product. Therefore evidence of team members who don’t fit, family members who don’t have a role, or evidence of conflicting priorities will quickly derail investor interest. All internal teams need to have relevant skills and experience.
- Undefined business model or very low gross margins. Potential return on investment cannot be calculated without a clear understanding and evidence of actual costs, revenue flows, and margins. Marketing programs and distribution channels are required for even the best solutions, with an appropriate and viable rollout and growth strategy.
- Solution development undefined or incomplete. Investors are most interested in providing money for scaling of a proven solution. They are not interested in research and development, or funding at the idea stage. For seed stage funding, entrepreneurs should be looking to friends and family, crowd funding, and relevant institutions.
- Lack of intellectual property. Having a patent, trademarks, or other “barriers to entry” are always a critical advantage in attracting funding, since investors need to see real commitment to beating competitors. Being first to market is not a strong competitive argument for startups, since larger existing players can easily overrun this position.
- Surprises during due diligence. Smart entrepreneurs pre-disclose any possible due diligence issues, with full and open explanations and no excuses. Due diligence also normally involves onsite visits and employee discussions, so the entire team needs to be fully aware of expectations. Investors pass if they find conflicted team members.
Certainly there are many other red flags that will discourage investors, but every entrepreneur will find that it pays big dividends to be proactive on the key items outlined here. If your startup is dependent on investor funding, you should remember that your first competitors are peer startups who are also fighting for scarce resources.
Your job is to stay a step ahead of them in professionalism, communication, and preparation. You make your own luck in this game.