Top attributes I now ABSOLUTELY avoid when I invest 🛑
How to dodge the next write-off by looking for red flags
As investors we always like to talk about our winners, these glorious IPOs (the ones that actually stand the test of time) and acquisitions. The reality is that being a great investor, (especially angel investor) is as much about avoiding the losers than investing in the winners — unless of course one’s resources are pretty unlimited and opts for the “spray and pray” investment strategy.
Like most things in life I learnt more from the “not so great” to catastrophic investment experiences than from the wins. It also happens that it is more common to reflect on and assess the causes of failure than of success…and we all tend to have the “investor greatness bias”, meaning that success is caused by Wonderful Me while failure is caused by Awful Others. 😉
Below are a list of founders’ traits I am now on the lookout for when investing, it is sometimes difficult to detect them but it is our job as investors to try. Due diligence is as much about the information we are given than the one we uncover ourselves. And yes, all of these examples are real-life examples I went through. Most of them could have been avoided with better due diligence on my part. All of them were great lessons that I am happy to share with you, and hopefully you can learn from my expensive mistakes. 🙄
🛑 Product versus sales priority. A sole focus on product is a killer for a company. It is quite frequent, especially with technical founders, in geographies where the culture is not supportive of selling. “Build and they will come” has been a huge pitfall that many founders unfortunately fall for. Most of the resources are allocated to the product with very little thoughts and capital flowing to sales. For very early-stage companies, founders have to sell themselves which is extremely uncomfortable, and difficult. This scenario often leads to companies running out of cash, being sold at a massive discount, and acquirers monetizing the products built and getting the returns. 👉I have been caught once and witnessed many times this dynamic, so much so that marketing and sales are my predominant area of focus when doing my due-diligence. You will notice that my investment recommendations always swing in the direction of sales-focused organizations.
🛑Greed — No, greed is not good (sorry to our non-Gen X and Baby Boomer readers, this is a 1980’s movie reference 😁). A great illustration of greed is the founder wanting to maximize the valuation of its next round, so much so that he waits until the last minute (so the metrics look their best) to start fundraising and runs out of cash. And ends up having to take the first term sheet at a significant valuation discount because he lost all negotiating power. That is a good example of greed hurting investors’ return. 👉Potential investors can pressure test this attribute by asking questions re fundraising approach. I am a firm believer of situational questions to get more realistic answers.
🛑 Bling- the Madoff scenario. That story might seem extreme but unfortunately it’s absolutely true. So our founder James has all the attributes of the successful entrepreneur: in his 50’s, an exit under his belt, flashy lifestyle, new business aligned with his expertise, great network — the work. Unfortunately, a flashy lifestyle is expensive to maintain (it also takes time to attend all those parties) and an exit doesn’t necessarily mean the founder and his family can live on it lavishly for decades. One thing leading to another, James starts to use the company’s funds to sponsor his lifestyle…which obviously doesn’t end well for our investors (but actually not bad at all for our founder). 👉This trait would have required more DD on integrity via former business connections, but was honestly a difficult one to detect.
🛑 The Media Darling. This one is tightly tied to the “oversized ego” situation. Our founder likes very much being in the spotlight, especially to explain to budding entrepreneurs how to be a successful entrepreneur. He likes it so much that it becomes his first area of focus before the business. Unfortunately, it is extremely time-consuming to be a media darling and the company never takes off due in part to a lack of presence from the founder. Balancing media requests and the business benefits associated with the visibility (especially for under-represented founders who are constantly solicited) with the time constraints of doing so is a real challenge. 👉As a potential investor, asking about the founder’s approach to media and laying out this scenario will help to get a sense of the inclination for media queries, one way or the other.
🛑 Know-it-all. Another challenge comes from founders who know it all and are oblivious to market dynamics; and no, Steve Jobs and Elon Musk are not typical founders. I saw that a lot in Fintech ~10 years ago when founders had an aggressive position towards financial institutions and didn’t want to partner, thinking they would bring down JPMC and RBC. Needless to say that it didn’t happen. At the time I invested in such a founder who refused partnering with banks for his payment solution. 5 years later the business was acquired at a significant loss for early-investors. 👉 VCs use the word “coachable” to define the ability of a founder to accept new information and guidance. Asking some questions that are challenging the founders’ perspective will give you a good understanding of the coachability of the founder.
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🛑 Lack of communication. I invested and collaborated with founders who don’t give visibility on the business to their investors (especially to angels). This is unfortunately extremely common even with founders of successful organizations. I believe that a quarterly update is good hygiene (even if I understand it has the vicious effect of opening the door to some frequent-flyer investors who always have something to say about the strategy and the growth of the business). In addition, the lack of communication prevents the founders to receive valuable introductions and potentially additional capital when needed. 👉I do now ask about the frequency of future investors’ communication, even if I know that it is likely to be the first thing to go by the window. 🙄
🛑 Contempt for investors — Accountability & Dilution. This has been a great challenge for me. I have had a couple of examples where my investments have been totally wiped out and the founders didn’t even acknowledge that “things went wrong”. The lack of recognition and gratitude for early-stage investors is quite baffling to me, as without them there would be no business. More importantly this cavalier behavior have great repercussion on early-stage investors in the context of future dilution, when institutional investors come in and ask for special terms that hurt angels’ potential returns. 👉That is something to absolutely pressure-test when investing in early-stage. Will the founder protect the early-stage investors in the later rounds? Does the founder think he owes anything to the investors or that this is “free money”?
🛑 Contempt for the board. I have been fortunate to collaborate with many board of directors, as an advisor and a member. There is a big misconception, especially with early-stage companies, that Boards have a lot of power. This is not the case! If the founder (who is still usually the majority owner) decides to go in one direction against the will of the Board, there is not much that will prevent him for doing so. Same if the founder doesn’t want to share all the information, it is pretty impossible for the Board to know that information is withheld. 👉 Considering that the Board represents the shareholders’ interests it is important to understand the perception of the founder in that regard and how much he expects to collaborate with the Board.
🛑 Smoke and mirror exits. Having an exit doesn’t mean having a profitable exit. Having a profitable exit doesn’t mean it was profitable for early-investors (Hello preferred terms for late stage institutional investors). Beware of founders flaunting previous exits as a hallmark, there is often more than meets the eyes. 👉Ask to be put in touch with early-stage investors of exited businesses to assess the reality of the returns.
🛑 Personal life driving business decisions. As mentioned many times, it is very challenging to be an entrepreneur and very often a time will come when founders will feel the internal and/or external pressure to work less, or even exit the business. As an investor and board member, I have seen first-hand irrational business decisions, such as the sudden urge to sell a business, based on personal considerations. These are extremely challenging times to face as an investor and especially as a board member, trying to balance compassion for the entrepreneur with investors’ best interests. Moreover, rare are the founder who will admit that they can’t take it anymore, so investors end up in endless (and useless) strategy discussions while the outcome has already been decided by the entrepreneur. 👉During DD, understanding the family situation and support can help avoid that pitfall, even if in ~7–10 years many things can shift in one’s personal life. Grit also plays a great role on the ability for the founder to sustain pressure.
🚀🚀🚀As I mentioned in the past, early-stage angel investing is not for the faint of heart. It is important to understand that everyone’s bias is to speak about the great business and investment success. However, statistically speaking, they are the outliers. Knowing what to look for, above and beyond the basic due diligence questions, can save you a lot of trouble. And my last advice is, in doubt, follow your guts!
It is challenging to be a successful startup entrepreneur, investor or advisor. Knowing best practices and pitfalls, maximize the probabilities of success! Good luck 🙂