Startup tips everyone should know
3 Types of Investors You Should Avoid.
Don’t take money from them— this could be the beginning of a nightmare.
Hurray! You’ve got a great business idea, your team is solid, clients are interested and it is time to get your rocket into outer space. Now you need fuel for your rocket and that fuel is money.
Raising capital is one of the hardest and most interesting parts of the startup journey. It’s surrounded by a mist of unknown and for first-time entrepreneurs may look terrifying. And it is terrifying if you don’t understand how it works and why people invest. If you do, it’s not too scary, yet it’s full of traps.
If you’re on the hype-train or worst — if you feel that you’ll soon run out of funds, emotions will most likely guide your decisions. When it comes to running a business, doing the opposite should be true. Here I’ll lay down 3 types of investors you should avoid in order to make a more rational decision when fundraising.
I share my personal experience when dealing with investors and what I’ve seen in other startups.Inexperienced investors
Investing is not only about money. It’s in the first place about building a relationship between the entrepreneur and the investor. Therefore, it’s crucial to choose investors wisely and not go with the firsts who will wave their money.
The most dangerous type in my personal opinion and the easiest to fall for are inexperienced investors. That could be anyone from your family members to rich fellas you went to high school with. These are people that want to be investors or want to help you and don’t fully understand the risks of investing in a startup.
What are the dangers?
People that have never invested in startups tend not to fully understand how risky it can be. Most startups fail. Most startups burn through investments. And it’s normal because the competition is fierce and creating something that will generate huge returns is hard, very hard.
This is fine when things are going well, every milestone is met and revenues are just going up. But when the road gets bumpy — that’s when the dangers appear.
As an entrepreneur, your job is to lead your team and make sure you deliver to the clients. Now, if you’ll have to split your time between doing that and trying to justify every decision to the investors it will be frustrating and extremely unproductive. If in addition, the investor will start doubting you or the business overall, you’ll have so much struggle, you could write a book about it.
Another major danger is the lack of understanding of how to invest. As a fresh startup, you’ll most likely not know how to raise funds and will sign anything that will raise some dough. If the investors don’t understand the risks involved, they will likely ask for personal liability and sometimes those investments won’t even be investments — it will be loans.
I’ve spoken with founders who raised money, failed and then found out that what the investor had in mind was absolutely different from them. Some ended up with death threats as the investor felt he was scammed and didn’t understand the business model. Others ended up with hundreds of thousands in debt, because the liability wasn’t on the company but on the individual.
All these things can be avoided when you deal with professionals, who made investments before and know the risks involved.
How to spot?
To spot an inexperienced investor is fairly easy. Just ask questions and do your homework before raising funds. Ask where they have invested before, see if they understand the risks involved and most importantly — listen to their questions. If your investor is asking very vague generalized questions about your market, business concept or idea.
If your investor is too hyped about the idea and the product — slow down a bit. The fact that the idea is revolutionary doesn’t mean you’ll be able to fulfill it, doesn’t mean that the market needs it. See if the person fully understands what are they getting into and will be able to be there in the good and especially in the bad.
Be extremely aware of people that are family members or friends. These are people that will believe in you and will want to invest, but it doesn’t mean you should take their investment. Businesses crash and you wouldn’t want a ruined relationship because someone will feel you tricked them.
The opportunist
These are less risky investors and sometimes it’s even good to have somebody from a totally different industry — they can bring perspective and help. Yet most of the time, the story goes differently.
If you’ll ask a real estate mogul to invest in your IT startup and show some great numbers, data — they might. Why wouldn’t they? If your pitch is solid and you’ve got data to back it — you’ll get the cash. Now, what else do you get?
In the beginning, it might feel like all you need is money and then you’ll figure everything out. Fortunately or not, the reality is different and there are way more factors to a successful startup than just money. Relationships with investors is one of them.
I believe that every founder should understand how important is the relationship between investors and them. A good investor will bring money and knowledge, a great investor will be there to help you grow.
What are the dangers?
You’ll missout on other investors. This is the main danger — by taking someone with no expertise, you’ll miss out on all the potential help and knowledge you could get from someone that has it. If the person is investing solely because of the great possible ROI that relationship will be shaky.
I truly believe that in order to achieve greatness you need help from people that did it and are passionate about it. Those are people that will be your friends, mentors, and partners. Choose them wisely.
How to spot?
If your investor doesn’t know any terminology of your industry, if they cannot relate to the problem or don’t even care too much — those are signs that the person is in for the money and that’s it. They will most likely not bring you a lot of help or knowledge and those will be fundamental for your success.
Don’t be afraid to ask your investor about their opinion, experiences and even personal experience with the problem you’re solving. A lot of younger entrepreneurs are intimidated by investors, but there is no need to be. This is a relationship and if you don’t feel comfortable with that person when you have no business together, you shouldn’t have a business together.
Sharks (the bad ones)
When there’s success in the air and blood in the sea, the sharks you shall see. In other words, if things are moving you’ll have sharks coming to check.
I don’t mean sharks as from the amazing TV show Shark Tank. Those are pretty cool and I love the show.
I call sharks the type of investors who are going to grab every possible opportunity to capitalize on your startup. Those are investors that intimidate and pressure you to sign quickly. Those are the investors who know everything about every possible industry and will get you “good deals”.
What are the dangers?
Working with this type of investor will leave a bitter blood taste in your mouth. This type will make you feel under constant pressure to deliver and will often micromanage your spendings.
As an example, some investors will invest only if you will buy services from the companies they own — marketing agencies, legal services, etc. Consequently, they will get back a good portion of the money they invested while keeping the same amount of shares. In some cases, this might be beneficial for the startup, but the obligation makes it an unfair agreement that is not based on trust and mutual benefit, but rather on personal gain.The main danger is a conflict of interest between you and the investor. This type of investor might bring up problems when you’ll want to raise another round or choose a different supplier. If the investor is there of a quick money grab — you don’t want them in the long run. (Unless you’re there for a quick money grab too)
How to spot?
Spotting a shark is not always easy. If you’ve never dealt with investors it might seem like a totally normal practice to move things as fast as possible and sign hundreds of legal papers without thinking too much. Always remember that taking time is important and evaluation is critical. If you’re being pressured and it feels wrong — it most likely is. If it feels that their intentions are not matching yours — figure out why.
I personally was pressured once to take investment for a ridiculous amount of shares in my company. As I had done my homework beforehand, I knew the approximate valuation of the company and what was on the table was not even remotely close to that. It was a spontaneous offer at a time when we weren’t even looking for investments, which made it even pushier. The offer was declined and although the startup didn’t succeed — I’m happy I didn’t get into any doubtful agreements and left blood-stain-free.
What to do?
Mix. It’s hard to find one perfect investor and sometimes you really want to have a friend on board even if she has never invested before. Or maybe you have a glorious opportunity to work with but he doesn’t want to put the entire amount alone. My personal recommendation is to have a few investors, who by being together creating the right balance and will help you make wiser decisions. In addition, investors will negotiate with one another and more experienced ones can guide others.
Don’t rush. Money is important but getting it from the right place is equally if not more important. Therefore, take your time to thoughtfully analyze various capital raising opportunities and build a relationship with your investors.
Ask for advice. Don’t trust your investors blindly and always ask for advice from people that went down this road before you. Even if you’ll have to hire a lawyer to help you out — rather do that now than regret later.
I hope this article will help you when raising funds and you will build longlasting relationships with your investors. Life is a journey and choosing the right people for it will determine the outcome.
“Experience has taught me choosing the right people to have in your life should be a well thought out, deliberate process.” — Carlos Wallace
