What are some red flags for people new to angel investing when evaluating companies?
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Answers by Patrick Mathieson, Christopher Mirabile, Tim Berry, Heather Wilde, John Eden, Greg Brown, Niv Korah, and Howie Schwartz.
Patrick Mathieson, venture investor @ Toba Capital
Answered Mar 14
Investing in the idea, as opposed to the founders. Big rookie mistake for early stage investors is to think “this is such a good idea… I’m so-so on the founding team, but the idea is too good to pass up” and then invest in that company. Bad. Bad. Bad. At the angel stage you are exclusively investing in people. Not the company. The people.
Pitches that heavily feature the investor syndicate. It doesn’t matter who else is investing — if you allow yourself to be swayed by social proof, then you’re allowing yourself to be enticed into a shell game. Why the f#$% should you care that Jared Leto is investing?
Flattery. I saw this in a pitch (addressed to someone else) just the other day: “We have several top VC firms lined up to fund, but the founder would prefer more value-added investors like yourself to participate instead.” This is a combo of social proof + flattery + faux urgency (“call in the next 10 minutes before this offer expires!”) and it’s almost definitely bullshit.
Confusing pitch; confusing deck; confusing website. Every interaction you have with an early stage company is a signal of the entrepreneurs’ ability to communicate — and communication skills may be the No. 1 predictor of a company’s future success. If you’re perplexed by their pitch, or if you can’t figure out what they do from their website, then it’s likely that their customers will feel the same way too. (Note that this is different from design — some of the best companies started out with the ugliest pitch decks and ugliest websites. But even though they were ugly, they were clear.)
Promises about future returns. The only truthful returns projection you should ever hear at the angel stage is “the most likely outcome is that this company will fail and you will lose all your money; but if we don’t fail, you’ll be extremely happy that you invested.”
Promises about future involvement with the company. This is used on Silicon Valley outsiders: “We’ll keep you super involved with the company and you’ll get to see the inner workings of a real startup.” This is likely either 1) a lie, or 2) a signal of crappy priorities. If it’s a lie, (1) you should ask yourself “why does this person feel the need to deliver this lie to convince me to invest?”. If it’s not a lie, (2) you should ask yourself “doesn’t this entrepreneur have more important work to do than looping his angel investor in on the minutiae of his business?”.
Answered March 21
If I were to try and add some thoughts to this red flags discussion, it would be in terms of the risks with the underlying company. I’ve done a bit of writing and thinking in that space and recently outlined some thoughts on the seven early stage investing risks that are worth doing some diligence on or at least thinking through. They are:
• Technical Risk
• Market Risk
• Team Risk
• Financing Risk
• Regulatory Risk
• Competitive Risk
• Intellectual Property Risk.
Going into all of them here would obviously require a treatise far beyond the scope of this answer, but as an investor each is worth thinking through. For help on how to think them through and what to look for, you can find the underlying piece at 7 Early Stage Investing Risks. And for more on evaluating companies you can find a lot of my thinking and my partner’s thinking (based on having invested in over 100 startups) at Finding Great Companies and at Minimizing Angel Risk.
Best of luck!
Answered Mar 11
What are some red flags for people new to angel investing when evaluating companies?
Issues around trust or integrity. Alternative truths don’t fly. Lies, gross exaggerations, hiding significant information. Fudging past financial data. Not mentioning about or grossly exaggerating their previous business history. Omitting significant facts. The pitch brags about a founder’s previous successful exits that turn out, later, to have been grossly exaggerated. Founders holding back critical information for problems of perceived confidentiality or trust. Lawsuits that weren’t mentioned. Cap tables that hide things. Gaps in the history.
Issues around leadership. For example, the scientist alone, instead of the scientist in a team with experience in the industry and business sense and experience. Or the team that lacks the CEO and is promising to get one after funding. Or the team of very young people that assigns all C-level positions to team members without realizing they need somebody else.
Answered Mar 11
I’d like to start by pointing out that while there is a huge distinction between the types of investments that Angel Investors, Seed Investors and Venture Capitalists make, this kind of advice should be a good rule of thumb across the board.
1.Lack of domain expertise – Anyone can have an idea, but if the person you’re considering has no clue about what’s possible, what’s been done before, or even a tangentially related background – that’s a huge red flag.
2.Lack of Coachability – there’s a certain amount of arrogance expected in an entrepreneur (they need to beat down their competition), but if they aren’t willing to consider outside advice or suggestions, stay away.
3.Terrible Idea – I shouldn’t need to say this, but the majority of ideas are actually just bad, really, really bad. Yes, you are investing in the human, but that doesn’t mean you should throw money at a bad idea in the hopes that something they come up with later might be good.
4.“No Competition” – This is like one of those logic puzzles. Every time I hear someone say “we have no competition” it immediately is a red flag, for two reasons. One, it’s a sign they haven’t done their research, because there’s always competition, or at least something comparable. Two, it’s a sign they might be naive enough to actually think it’s true. Either way it’s a sign to stay away.
This is by no means comprehensive, but it should give you a good start!
Answered May 24
I’ve got two pieces of advice to angel investors that cut across some of the categories others have explored:
1.With respect to the company’s core idea, how deeply do the entrepreneurs understand it?
When someone is looking for angel investors, they’re at a very young stage where risks are hard to quantify, especially around product execution and competitive risk. But what can (and must) be carefully explored is the founders’ understanding of their own idea. The standard here is high. Founders must have a firm grasp of every challenge they’re highly likely to face for the simple reason that once things get rolling, it will be very hard to reactively deal with the variegated roadblocks that will inevitably emerge. (Marc Andreessen of a16z calls this the idea maze, and I invite everyone to go right to the source for what qualifies as deft navigation of it.)
2. Is there a defensible execution plan post raise?
Most seed rounds provide enough capital to help a company achieve some key milestones (product evolution/user growth/business model validation, etc.). Viewed from this lens, angels are helping entrepreneurs corroborate the value of their core investment thesis (think Karl Popper here, i.e., degrees of corroboration not being the same thing as definitive proof). Really talented entrepreneurs will have a shrewd plan for squeezing an incredible amount of mileage out of very meagre resources. This subspecies of entrepreneur is resourceful beyond belief, so look very hard for evidence of that key trait before you write a check.
In a nutshell: With respect to founders, look for a deep understanding of the startup’s investment thesis and evidence of unusual resourcefulness around post-funding planning and execution.
Answered Mar 11
You will develop a set of filters based upon your own battle scars. Some of mine are:
Beware the founder who is stingy with equity within the team.
Founder over confidence is a big one for me. The plan isn’t correct. Of this I am certain. I’ve never read a five-year-old business plan that turned out to be an accurate account of what was going to happen. A pivot will be needed. I want to invest in someone who is open to the idea that they are wrong.
Awesome team in a small market can figure out how to expand the market opportunity. Mediocre team in a brilliant market will produce mediocrity. Bet on the team.Legal and financing structures that violate the norms are non-starters for me. No need to reinvent the wheel.
If a company is pushing too hard to get your investment that’s a bad sign. If it doesn’t yet feel right hold off. It’s OK to miss out on something. There will be other opportunities. You cannot ride every unicorn.
Bad co-investors suck. Bad means fundamentally bad people or people who will provide bad advice or influence. Most founders will to some degree bend to the will of their board/investors. Make sure they will be getting good advice.
Answered Mar 20
Generally speaking, angel investors tend to invest at early stages of the startup life, and at this stage all valuations are fictions, created between the investors and the venture, in order to close the deal.
At most, 10% of those companies will succeed, is term of reaching an exit valued more than was invested in them.
Most of those won’t survive long after the few initial investments without further and larger investments in the venture.
So at this early stage – those ventures don’t actually have any REAL value of their own, and can be valued only as part of the whole portfolio of investments, in a risk management formula.
As a new angel investor I would start with evaluating myself. Venture capital is a risky business in which more professional investors lose money or reach inferior IRR than other conventional investment venues. So, if one can’t afford to lose the investment money, one should probably keep clear of VC investments.
Answered Mar 23
New angels (I went through this too) try and get in their first deals too quickly without doing enough diligence and letting ideas “sit.”
It feels like a race to make your first few investments – but its not a race. Angel investing requires patience.
This question, “What are some red flags for people new to angel investing when evaluating companies?” originally appeared on Quora, the knowledge sharing network where compelling questions are answered by people with unique insights.
