5 Red Flags About Investors

Jul 21, 2011

I recently received an email from some experienced Entrepreneurs, as well as many Investors, asking me to write more about the importance of Entrepreneurs doing due diligence on their investors.  Many of those investors also stated they felt Entrepreneurs labeled them, and their intentions were misunderstood.  Entrepreneurs felt there were too many investors acting in bad behaviors that made it too difficult to separate the bad from the good.

FYI: a great place to get real honest feedback from other Entrepreneur’s experiences with investors is thefunded.com

There is actually some very simple, huge red flags, that should indicate if you’re going to have a problem.  So we put together this short list:

Here are 5 red flags about investors:

1.  Lack of Experience in General

This isn’t always bad when you’re going after an angel investor.  This is because angel investors only make 1-2 investments per year at best, so the likelihood you’ll catch a newbie is high.  No problem though, everyone has a first.  But make sure a newbie angel investor has an experienced lead.  A new angel investor should be co-investing the first time around.

Now with a VC, this is much different.  The VCs job is to grow you big, that requires a lot of experience.  You can usually identify this by looking at their portfolio companies, their fund sizes, and a VC will usually have something called a “track record” on their website.

2.  Lack of Entrepreneurial Experience

This is a big red flag for myself and many Entrepreneurs.  VC’s or angel investors that have no entrepreneurial experience, and take a seat on your board, often times do not make the right decisions or give the right direction.  Instead, they offer unrealistic suggestions.

3.  Inner Circle Investing Only

Inner circle investing only often times means you’re wasting your time, and jeopardizing your business, by even contacting them.  These are VCs or angel investors that only invest in those they know personally, and often times won’t give someone a chance outside their circle…regardless of whether or not you have given time to build a relationship.  Could you still pitch to them?  Of course.  But these are the types who will take pieces of business models or ideas, and apply them to only benefit those in the inner circle.

Look for VC firms or angel investors that are just the opposite: they will be open collaborators, very active in the Entrepreneurial community, and will allow themselves to be reached.  This doesn’t mean you will receive an investment, or that you’re the one…but at least these guys dedicate time to helping.  Firms like Hummer Winblad, Quorumm, and the Foundry Group are a few I know that are good about this.

4.  VC Turning Entrepreneur

This is not good for anyone, except possibly the VC.  Even other VC’s such as Brad Feld have spoken strongly against this.  The reason so many of us Entrepreneurs and other investors feel strongly against this is because:

  • It ruins trust in the Entrepreneur community.
  • A VC is exposed to thousands of confidential business plans.
  • A VC doesn’t sign NDAs.  Entrepreneurs have no protection.
  • They already have connections and money.  It’s too easy.

5.  Ego Trip

Alot of investors don’t have an ego trip, so don’t assume all do.  You’ll always be able to tell at the first meeting.  This is also the kind of investor that has pretty much destroyed the reputation of investors everywhere.  He acts alone or with a bad partner, behind closed doors with Entrepreneurs.  This type also follows an exact pattern, every single time, that is very easy to spot:

  • There is a difference between constructive criticism, and being a jerk.  He will be a jerk.
  • He finds you at a critical moment- right before a launch, or during a crisis.
  • He laughs at you, tells you you’re going to fail, then makes you feel stupid.
  • Then, he will hand you a ridiculous term sheet.
  • This is his negotiating strategy.
  • He intentionally takes control over the board, kicks out the founder.

For all the good investors out there, this is why it so important to reach out to Entrepreneurs early.  Before this guy gets them.  Let them know in a start-up, the highs will be really high…and the lows will be really low.  This doesn’t mean you have to invest, but at least keep yourselves open when Entrepreneurs contact you for advice in this exact situation.  And please don’t tell me that is the advisory board’s job, because by the time real investors or board advisors notice this Entrepreneur…it is often too late.