The bright red flags most people miss

Here are red flags investors should be aware of when investing in a startup and red flags startups should be aware of when accepting investors’ funding.

For Investors beware of 

1. Startups that have many members on the founding team. This implies that there are a lot of people who already have equity in the startup and too many voices
2. Startups that have high overhead and low-profit margins because it is an indication of a lack of sustainability and scalability
3. Founders that have full-time jobs outside of the Startup because the startup might be a hobby or an entity not receiving attention. At the same time, beware of founders who have no other source of income apart from the Startup because your investment could be used to bankroll their lifestyle
4. Startups whose early investors have not or are not participating in additional investment rounds because it implies the Startup did not deliver on its promises or the early investors do not see a future for the Startup

For Startups beware of 

1. Investors who offer smaller ticket sizes but want larger equity. In addition to you receiving less funding, these investors devalue your Startup which will affect you in all your other funding rounds
2. Investors who have over 1x liquidation multiplier in their term sheets. When a Startup’s exit is lower than the valuation, the investor gets their full initial investment back if you have a 1x liquidation multiplier, above 1x implies the investor wants more than their full investment back which leaves the Startup at a greater loss
3. Investors who want Participating Preferred Stocks. When a Startup’s exit is higher than their valuation, shareholders will receive additional cash (in addition to their initial investment) which is based on the equity they have in the Startup. This means for example if the investor invests 5Million for 50% equity, and the Startup’s exit was 25Million, the investor will their 5Million back in addition to 10Million (50% of the balance from exit fund) leaving the Startup with 10Million only
4. Investors who are non-responsive; who go AWOL during the process and come back with heightened interest. Sounds too good to be true!

This ends our Investor and Investment series, you can go to our profile for more related articles www.msmehub.org/author/busola-boyle-komolafe/. 

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References

https://carta.com/blog/how-to-choose-investors-for-your-startup/

https://carta.com/blog/watch-out-for-these-terms/

https://techpoint.africa/2019/11/05/red-flag-nigerian-investor/

https://www.forbes.com/sites/georgedeeb/2017/01/03/16-red-flags-for-startup-investors/?sh=2606c1e1390a