In his blog on start-ups, VCs, angels, and university entrepreneurs, serial investor David Lerner warns investors about “hair on the deal” — namely, distasteful features that immediately signal the kiss of death for a company’s investment prospects. According to Lerner, investors should avoid companies and/or founders that exhibit the following 10 characteristics lest they find themselves with a hairball:
1. Legacy shareholders. It’s normal for a start-up to have legacy shareholders, provided they’re not a) disgruntled, because they’ll try to interfere with the deal; b) missing, because they may come back to haunt the company in the future; or c) overabundant, because “rounding them up will be like herding cats,” Lerner says.
2. Unrealistic (inflated) valuation. If an angel-backed company touts a $15M pre-money valuation but doesn’t yet have customers or revenue, “how receptive do you think they [will be] to a conversation in which you tell them their pre-money is $2M?” Lerner asks.
3. Irrelevant founders who think they’re still relevant. Sometimes a founding team needs to make way for the next phase, according to Lerner. If the founders can’t come to grips with this, the company will fall flat — a situation that is very common, he says.
4. Founders who suffer from delusions of grandeur. When a founder is singularly focused on his or her destiny as a magnificent and fabulously wealthy hero, unchecked egomania will color every important decision the start-up will have to make. This treacherous reef has sunk thousands of start-ups, Lerner maintains.
5. Unscrupulous broker-dealers. First-time entrepreneurs may be sucked into the shadowy world of the “broker-dealer,” the “investment banker,” or the “middle-man,” who then latches onto the start-up’s coattails by “helping” to raise capital for a fee, taking a percentage of the money raised and, perhaps, charging a retainer and warrants to boot. Lerner writes more on this problem in Eyes Wide Shut: Welcome to the Masked Ball.
6. Encumbrances (lawsuits, disputes, debts). If there are lawsuits afoot — such as disputes among the founders and previous investors — large debts, or any other type of serious encumbrance, “there is an overgrowth of thick hair on the deal through which no machete will be able to cut,” Lerner warns.
7. A@#holes. This type of person of course comes in all shapes and sizes. The appellation can, for example, refer to founders who want to use investors’ money to pay for a job for their spouse and, perhaps, a corporate apartment. The term also can refer to founders who, although successful in their business, treat their employees like dirt. In a nutshell, the term “refers to a mercenary, not a missionary,” Lerner writes.
8. Sloppy governance. Due diligence sometimes reveals poor recordkeeping, lack of accurate accounting, and incomplete documentation. These red flags often signal a deeper mess that may require an archaeological dig to clean up.
9. Lack of transparency. Obfuscation also can manifest itself in various kinds of questionable behavior. A founder may seem defensive. Stories may change over the course of several conversations. You can never quite get a handle on the financials, the technology, or some other vital aspect of the company. Lerner writes more on this problem in different types of white lies often told to investors.
10. Lack of respect. If a founder/CEO is critical of others, dismissive of the competition, and/or generally rude, he or she most likely will not succeed at the venture, and working together will be a miserable experience.
Source: David B. Lerner