There are a number of reasons startups ultimately fail to obtain funding. The following due diligence showstoppers are often overlooked by the entrepreneur.
Many startups find the due diligence process difficult.
- Some don’t obtain funding because they find it difficult to find an angel group with investment criteria that’s a good match to their opportunity.
- Some companies don’t possess a compelling idea.
- In some cases, the investors conclude the management team may have difficulty executing.
- Finally, some startups simply will not successfully complete the due diligence process. – This is where we will focus today.
There are a number of reasons startups ultimately fail to obtain funding. The following due diligence show stoppers are often overlooked by the entrepreneur.
Due Diligence Showstoppers:
Investors Need A Security Clearance to Learn About Your Opportunity
Investors typically avoid startups that demand an NDA be executed. There are a number of reasons this occurs including the potential time and monetary costs to the investor and increased susceptibility to litigation. To learn more about the investors’ perspective related to NDAs please see the article entitled, “Why VCs and Angel Group may Torch your NDA and Your Company’s Candidacy for Startup Funding”.
The Management Wall is Higher than the Great Wall
Occasionally executive management desires to be the filter to all conversations with employees, other members of management, contractors, professional service providers or references. Should the investor feel an open two-way conversation with one or more of these stakeholders is not possible, it may alter their perceptions as to the investability of the opportunity.
You Refuse Their Check
Seasoned investors will almost always require that the key participants be open to background checks. Entrepreneurs declining such a request may leave the investor with the perception they are hiding something. It should also be noted that we all make mistakes. If there is something that will be discovered in a background check that the entrepreneur believes may negatively reflect on their candidacy, they should inform the investor up-front. Investors are unlikely to find surprises at the back end of the process acceptable.
Dirty Balance Sheet
Startups with significant amounts of debt which must be repaid from investor proceeds are unlikely to obtain much funding traction. Investors strongly prefer to invest in companies which will use their investment proceeds to grow the startup. To learn more about the investor’s perspective related to debt, please see the following related articles:
We Must Act Now
High-pressure sales are a signal to the experienced investor there are potential problems with the opportunity. Entrepreneurs should be careful not to oversell.
Executive Team Likes the Figures, the Six Figures
Founders which are expecting to utilize the proceeds of the investment round to provide themselves a six-figure salary prior to gaining market traction are likely to find investors unwilling to support any use of the investment proceeds not focused on the growth of the company.
It’s a Family Affair
If your executive team and board primarily consist of family members, investors will likely take their investment proceeds elsewhere. Investors in scalable startups seek investment opportunities with diverse, experienced teams. Teams with multiple family members may indicate the startup may be a family lifestyle endeavor. Such teams also tend to bring with them issues problems not experienced on teams that lack participation of other family members.
So you want to be CEO?
Executives with the primary objective of being the CEO of a large company will find investors resistant. Angel investors are typically seeking a 3 -5 transaction event allowing them to cash out their investment. Entrepreneurs with objectives inconsistent with this investor goal will likely be unable to obtain investment.
You’ve Set a Messy Table
Should the startup’s Cap Table include a large number of small investors, especially non-accredited investors, it may be difficult for the company to obtain follow-on funding. It is important that current investors believe the startup, upon meeting its milestones, will be attractive to future investors at a higher valuation.
We Get to Invest in How Many Companies?
The existence of multiple companies tends to complicate the opportunity for investors and significantly increases the due diligence effort. Investors typically avoid multi-company structures.
Where’s the Paper?
Entrepreneurs who have not “papered” their company (i.e. put into place documentation such as an operating agreement, stock subscription agreements, and technology assignment agreements, to name a few) need to do so prior to seeking outside investment.
The “All in One” Opportunity
Option-rich opportunities are good. However, if management is pursuing multiple opportunities simultaneously in an effort to see which sticks, they may come across as having little focus. Ultimately it is difficult to pursue multiple opportunities in a startup simultaneously. Investors will look for management teams with a focus.
I’m Smart, I Can Do that Myself
Investors are seeking entrepreneurs who are focused. None of us have more than 24 hours in a day. We may be able to accomplish a given objective better than a third party, but we can’t accomplish all required startup objectives in a scalable startup simultaneously and on a timely basis ourselves. Such a pursuit likely represents a company that lacks breadth and ultimately, may not be scalable.
Don’t Look Over my Shoulder
Many investors simply avoid entrepreneurs seeking funding only; those unwilling to be open to investor ideas and support.
Your Pre-Money Valuation is What?
An unreasonable valuation will quickly turn off potential investors. Look for a balanced approach.
They are From the Government and They are Here to Help You
If your company is under review by government regulators or independent regulatory bodies, be prepared to discuss the issues at hand early on in the process and openly. Regulatory issues have chased many an investor away from otherwise stellar opportunities, especially regulatory surprises!
So you Have Two Startups…
Investors will desire you to focus your efforts on providing returns for their investment. Hedging your bets with dual startups simultaneously sends the wrong messages. The investor will ask themselves, are they really committed? How will they allocate their time between the two?
Many if not most of these issues can be addressed in advance of the company seeking investment. Turn the due diligence process into a positive. Make your company’s strong, transparent responses to due diligence a selling attribute that hooks the investor!