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:<\/p>\n
1. Legacy shareholders.<\/strong> It’s normal for a start-up to have <\/strong>legacy shareholders, provided they’re not a) disgruntled<\/strong>, <\/strong>because they’ll try to interfere with the deal; b) missing, because they<\/strong> may come back to haunt the company in the future; or c) overabundant, because “rounding them up will be like herding cats,” Lerner says.<\/p>\n 2. Unrealistic (inflated) valuation<\/strong>. <\/strong>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.<\/p>\n 3. Irrelevant founders who think they’re still relevant.<\/strong><\/strong> <\/strong>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.<\/p>\n 4. Founders who suffer from delusions of grandeur.<\/strong><\/strong> <\/strong>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.<\/p>\n 5. Unscrupulous broker-dealers<\/strong><\/strong>. 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.<\/a><\/p>\n 6. Encumbrances (lawsuits, disputes, debts)<\/strong><\/strong>. 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.<\/p>\n 7. A@#holes<\/strong>. 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.<\/p>\n 8. Sloppy governance<\/strong>. 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.<\/p>\n 9. Lack of transparency<\/strong>. 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<\/a>.<\/p>\n 10. Lack of respect<\/strong>. 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.<\/p>\n