Start-up investors face a lot of options when it comes to where to put their money. Any investment has some risk involved, but there are certain things that seem to always signal trouble. No matter if you’re an investor or an entrepreneur hoping to secure funding, you should be aware of these eight major red flags that can turn investors away from startups:
1. Large team
A startup typically involves a team of people ranging from co-founders to advisers and seed investors, but investors should watch out for a team with too many members. Giving equity to lots of team members, especially if they are relatively inexperienced, can lead to future problems and potential money mismanagement.
2. Outsourcing technical skills
Most startups have at least some aspect of technical development, such as website development, product development, or app building. If the founders lack those technical skills and instead farm it out to third parties, it puts much of the value of the company in the hands of someone who isn’t fully invested and can greatly increase the cost of having to pay an outsider to adapt and develop the business. The most investable companies have at least one person on their founding team with the applicable technical skills.
3. Founders aren’t all it
The most successful startups have passionate founders who dedicate all of their time to the growth of their company. A founder who isn’t willing to give up a full-time job to dedicate themselves completely to the startup shows investors they aren’t fully confident in their new business and need a job to fall back on. Entrepreneurs who have the time and availability to work on their company tend to have greater success and are more appealing to investors.
4. Bad margins
The key to a successful startup is controlling costs and keeping overhead costs low. If a startup is operating on lean margins and doesn’t have a real plan on how to bring those margins down, an investor is likely pouring money into something and won’t get much of a return, if any, as the money will all go to manufacturing costs. A startup with low margins should have a feasible plan of how to improve margins by connecting with new partners and manufacturers or increasing production levels.
5. Industry naiveté
Investors are typically looking for positive investors who recognize and address the challenges their business will face. Entrepreneurs who deny having competition or who are blindly optimistic show that they aren’t fully aware of the industry they are entering, which can be a warning sign of missing out on other major issues. Just because a business has competition doesn’t mean it’s going to fail; investors simply want entrepreneurs to address the competition and have a realistic plan of how they will operate in a competitive industry.
6. Bad personal financial situation
When an investor looks at a startup, everything in on the table. Founders with bad credit history or no other source of income can be a risk because the investor can’t be completely confident in how they will handle the money and if that money will be going to fund the founder’s lifestyle instead of the company. Responsible entrepreneurs should have financial reserves or another source of income they can use for living expenses.
7. Slow growth
Smart investors look at a startup’s history and how long it has taken the team to reach its current state. This also includes looking at previous grants or investments to see what the company did with that money. Slow or stalled growth shows investors that the team faced problems related to strategy, inventory, or finances. If growth has stalled, entrepreneurs should have a valid explanation that shows the plateau was only temporary and that they can get back on track again.
8. Weak growth plans
Entrepreneurs need to be both bold and realistic. Investors typically don’t want to invest in a company that doesn’t have a complete and strong plan for marketing and expansion because it shows the founders haven’t thought through the entire strategy and goals for the company. A complete business plan includes a strategy for marketing, growth, and expansion.