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Three things to watch out for before your startup partners with an early-stage investor

A lot of start-up founders I’ve met believe that if they can raise money from professional early-stage investors such as The Sharks from Channel 10’s Shark Tank or a Venture Capital (VC) fund, then they’re guaranteed success, a large exit, and early retirement. But this is dangerous thinking. These investors are almost always only investing in you for one reason – they believe they can make money out of what you’re doing. They’re definitely not interested in your early retirement.

[Related: Let’s Talk… founder/investor fit, Let’s Talk… Raising Capital (Part One), Let’s Talk… Raising Capital (Part Two)]

So what are the tell-tale signs that you need to watch out for when considering investors for your start-up? Here are three things to watch out for.

1. A case of misdirection: There’s a good chance any investor who spends too much time talking about what THEY can “bring to the table” (other than their financial investment), is almost certainly trying to draw your attention away from some other part of the deal which is less attractive. For example, it could be a low valuation, small investment or bad term sheet. Don’t fall for this. Unless they’re willing to sign an agreement holding them to their non-financial investment, be very wary.

At Found, in the early days, we once had a prominent VC tell us to reject a significantly better deal from another party to take theirs – despite them offering a lower valuation, smaller investment and much worse term sheet. This was because they were “smart money” who could “help us along the way”, however when questioned about where they had done this in the past, they failed to provide any concrete examples or references. No thanks.

2. The devil is in the detail:  For early start-ups, this really means, “the devil is in the term sheets” (the legal document which sets out what the investor is contributing, and what rights they get in return). In normal business, working out who controls and owns a business is pretty straightforward – it’s whoever has the most shares. This is far from the truth for “early stage” deals though. Any founder who believes that they’re still in charge because an incoming investor only owns a small fraction of their company needs to be very cautious.

It’s relatively common for investors to introduce terms like “Founder Vesting” (you “earn”shares in your own startup over time), “Ratchets” (if the business doesn’t go well, the investor get more shares for free), “Bad Leaver” (if you leave on bad terms with the investor, they force you to sell them your shares at a low valuation) or “Drag and Tag” (where they can force you to sell your own startup). The VC who we spoke to wanted all of these, which would have left them in effective control of our company, despite contributing only a fraction of the total investment into the business. Again, no thanks.

3. Married at first sight: Finally, be aware that any relationship with an investor is going to run for many years, and is much closer to a marriage than dating. It’s unlikely you’d marry someone just because they’re interested in you, so apply the same logic to an investor. If the first few dates with a potential partner/investor include a lot of unhelpful suggestions, criticisms of what you’ve done in the past, or a one-sided conversation where you’re forced to listen to an “expert”, it’s unlikely that you’d go beyond the first couple of dinner dates – and you certainly wouldn’t put a ring on it. Don’t take the money if you’re not comfortable working with the individual/s over a long period of time. I’ve seen it happen, and it rarely ends well… founders get burnt-out, investors become frustrated, and ultimately, it’s the business that suffers.

The bottom line

Despite the upfront challenges and sometimes-dangers of working with investors, there can also be significant upside if you’re able to find a great group of people to partner with to grow your business over time. Globally and within Australia there are plenty of examples where amazing companies have been built with the help of professional investors. Often, these people are well connected, and have achieved success in growing and scaling businesses over time, and this can be invaluable with the right structure and circumstances. Just have your wits about you during the decision making process.

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Andrew Joyce

Andrew Joyce

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