11 Investor Red Flags

Letting someone onto your cap table is irreversible, so how should you vet investors?

I wrote last year about red flags to avoid in your pitch deck and, somewhat ironically given his ousting of Travis Kalanick at Uber, Bill Gurley wrote a good piece about red flags investors look for as well.

But there aren’t many (if any) good resources for founders to know what red flags to look for when evaluating potential investors.

Remember, equity in your startup may one day be very valuable, and the opportunity to own very valuable things tend to bring out people’s worst tendencies.

So this week I wrote about 11 red flags to watch out for when talking to investors 👇

11 Investor Red Flags

Vision Misalignment

This seems obvious but you’d be surprised how often founders end up feeling trapped and like they need to shape their business or product decisions based on investor sentiment and opinion.

It can derail a startup.

Thankfully you can test for this.

You just need to share your vision for where you honestly believe the company is going. How will the product evolve? Who will your users be? Why will they care about it and stick around? How fast will it grow and through what channels?

Give the investor whitespace to disagree with you. Push back on them where you feel they’re wrong.

If they respond aggressively or dismissively, they’ll likely bring that attitude and opinion into conversations down the line where you actually need to make the choices you’re discussing now.

References Poorly

Get a sense of the investor’s reputation and what it will be like to actually work with them.

The best way is to reach out to founders they’ve previously invested in, especially if those companies went through tough times or failed. You can find an investor’s portfolio on their Crunchbase profile.

It’s harder to identify founders an investor passed on but, if you can, talk to a few of them to learn why it didn’t work out.

Founders are generally pretty candid with each other but make sure to ask for any negative feedback too. I’ll share a future post that details how to run a great reference call and actually get useful information from it.

Pressures You to Accept Quickly

If anyone should be in a rush during a fundraise, it’s you (not the investor). You’d rather be getting back to building and growing your startup.

Investors know this, so if they see you’re dragging your feet they know it means you’re likely shopping around with other investors too.

Good investors will want you to sign (of course) but won’t pressure you to do so or threaten to pull the offer off the table if you don’t sign within a certain period of time.

The truth is that you’re offering them a chance to get a seat on your rocketship, they’re not offering you a chance to get some money. Your startup is one of a kind, and capital is a commodity.

If they see things differently then that will likely carry through to the later stages of your relationship where your startup gets treated as a line on a spreadsheet.

Withholds Help (Until You Sign)

The world is not zero-sum. It’s positive-sum.

Good investors are passionate about helping startups, period, full stop. They won’t gatekeep their network, or refuse to give advice or feedback while you’re fundraising.

If an investor tries to use their ability to help you with something as leverage to improve their negotiating position, run away fast. That’s someone who’s looking to get a good deal for themselves, not help you build a great company.

Would you want them in the weeds with you if things go wrong at your startup? What happens if they withhold help in a tough situation unless you meet their conditions?

That’s the last thing you’d need.

Pressures You to Accept More Money than You Need

I’ll leave this one to Paul Graham:

From an investor’s perspective, putting in more money likely means they’re able to own more of the company (which is good for their fund but not necessarily for the company or you).

But the second-order effects are actually what make this truly bad, as PG notes. Having too much money too soon can lead to spending it indiscriminately and burning cash too fast and can put the entire company at risk.

I fought hard at my last startup to keep our Series A lean for this reason. After a16z came in to lead the round and we set a price with them we could have leveraged that to bring on many more investors. But we kept the round small and only raised an additional ~$3 million to avoid accidental unnecessary spending.

I’ll dive deeper into cash management in a future post.

No Flexibility in Negotiations

If you have valid reasons to adjust terms or even valuation/cap and they’re not willing to consider them, it sets a bad tone for the relationship, they may not respect the needs of the business or you as a founder.

Remember that you are offering them something that’s potentially extremely valuable. You have more leverage than you think.

Tells You Termsheet Terms are “Standard” or “Friendly”

This one really gets under my skin.

I recently helped a first-time founder negotiate their pre-seed terms with their lead investor and the investor told them that getting a board seat at the pre-seed was “standard” and “friendly.”

This is a big red flag (board seats at pre-seed are not standard).

Investors are professional dealmakers who know that founders likely don’t know what really is standard in fundraising deals.

If they try to take advantage of that knowledge gap in order to gain influence or power in the company right from the start, how can you trust them going forward?

Even in a best-case scenario it communicates that they feel they need to be involved and don’t trust you to steer the ship fully.

I’ll write more about board composition another time, but needless to say a “friendly” investor in the early stages may not be friendly later on, just look at what happened to Uber.

Gets Weird When You Involve Legal Counsel

Lawyers are expensive but fundraises are the highest leverage negotiations for a startup. Getting them right matters, often a lot, and founders aren’t familiar enough to catch everything that may not be in their favor.

So I favor bringing counsel in early for actual advice during the negotiation (just in the background, as someone for you to run things by), rather than just executing the documents.

There’s nothing wrong with telling an investor you want to run something by your counsel. If the investor gets weird about that in any way it should raise some yellow or red flags.

Unable to Wire Funds

A lot of funds are still hurting from a complicated year in venture:

• Interest rates are up, so LPs are looking to invest in lower-risk assets

• LPs are mad at GPs for a perceived lack of discipline during the high valuations of the last few years (and the resulting down rounds)

• AI interest is keeping seed valuations high, making it tough for funds to hit ownership targets

GPs are calling capital less frequently as a result which means some may try to tell you they can’t wire the funds right away. Do not accept this. The money is never real until it’s in your bank account.

Say that again with me: the money is never real until it’s in your bank account.

Yes, even if they’ve signed, what are you, the company without their money yet, going to do… sue them rather than focus on building? They know you won’t.

TLDR: require investors to wire if they want to participate in a round.

Misrepresents their Experience

Ask each investor about their own experience. What war stories do they have that will help them give you relevant advice for your own startup?

Then check out their claims. Talk to people they worked with, or the founders they invested in who they mentioned.

If it seems like the investor is (to put it nicely) sugarcoating things, they may do the same when you need honest feedback. This is doubly important if you expect them to be a strategic partner and rely on their supposed industry knowledge.

It’s completely fine to accept capital from investors who won’t add any strategic value and will just give you capital. You just want them to be honest about that too.

You Feel It In Your Gut

At the end of the day you know if something doesn’t feel right.

You’re going to need to have this investor be part of the next few years of your life. Make sure you trust them. Trust your gut.