You are an entrepreneur with a great idea. You've gotten positive early validation from your market. Early customers are helping to improve your beta product and even providing some revenue. You've made a couple of critical hires. Maybe your product has even appeared on an industry “best new innovation" list.
And investors are interested.
It's the opportunity you've dreamed of ever since you started your company, and you don't want to mess it up.
The unfortunately reality is, maybe you already have.
The red flags that often halt promising business plans can pop up long before due diligence begins.
Here are nine red flags—legal, business and personal mistakes—that may derail your company's success.
1. Your attorney is your friend.
The attorney/client relationship is often the first and most important professional relationship an entrepreneur can have. Choosing an attorney because he or she is your friend, or family member, can kill a deal quickly. Instead, you may want to find an attorney who is not a friend or relative—even by marriage. Consider buying an hour with a few different attorneys to ask questions and find a fit. This is a relationship that you want to grow and endure. Your attorney may not only help guide you through a capital raise, but can reflect upon your business sense, something to which investors will be paying close attention.
2. You have pre-existing agreements.
Agreements with employees; complex shareholder agreements or exclusive arrangements with vendors or customers may drive investors away. Keep all contracts standard and smooth. Ensure that there are no issues with intellectual property, whether with licensing, patents or ownership. If you are in a partnership, ensure that you have an agreement that addresses legal dissolution of the business. If your partner is also your spouse, that agreement may need to include dissolution in case of divorce.
3. You want an NDA.
Non-disclosure agreements, or NDAs, with investors are non-negotiable. Arguing with an angel or venture capitalist can be a waste of time. Investors generally do not sign NDAs. It's not because they want to steal your secrets; it's that they don't want to risk the legal exposure of a contract as open-ended as an NDA. Remember that investors review hundreds of concepts and products a year. Signing NDAs could create potential legal issues if they were to engage with and fund similar products in the future.
4. You've been involved in a lawsuit.
Prior, current or pending litigation can be the kiss of death for any deal. Disclose agreements or any litigation up front when you begin meeting with investors. Just as important, review any contract with your attorney before you sign it. Don't sign a contract you can't or don't intend to keep.
5. Your terms are off.
Asking for terms that are not normal for your industry or your region can kill your chances of funding. Don't expect investors to accept your terms; do expect to accept theirs. If you insist upon a valuation that's beyond the norm for your region and industry, or on terms that don't align with those typical with angels or VCs, investors may move on to the next deal.
6. You can't manage the cash.
Strict cash management and bootstrapping (paying as you go with revenue) are important in the early days of your company. Investors look to this as a sign of how you'll run your business going forward. They are not interested in paying off existing liabilities or founders' salaries. Be clear about the capital you need and how it aligns with the milestones that will help your business scale.
7. You've got skeletons.
From speeding tickets to bankruptcy from a divorce, your past can kill a deal quickly. Be prepared to share them up front to help increase your odds of support. You may want to consider proactively running a background and credit check on yourself and your founding team. Similarly, you may want to consider running a background check and a randomly scheduled drug test on every person you plan to hire. Believe me, if there are skeletons in your closet, they will see the light of day.
8. You have no gaps.
Starting and growing a business is difficult. Investors know this and are looking for entrepreneurs who understand they can't go it alone. They're looking for consistent, coachable entrepreneurs who know what they're good at—and where they have gaps. Before you approach any investor, you may want to work with a trusted mentor or two to practice listening and recognizing what you don't know and where you need help. Learn when to accept advice and when to decline it without destroying a connection or your credibility.
9. Your story is inconsistent.
Inconsistent stories and spin can be a huge red flag for investors. Don't bring up pending customer contracts that don't really exist. Don't embellish your competitive advantage. Reality will come out during due diligence. Tell the truth and operate with complete integrity. Follow the highest standards of ethics. If you are uncertain, seek advice before you act.
The bottom line is that potential investors are generally searching for reasons not to invest in your company. Knowing the potential red flags and how to avoid them may keep you from doing something today and that will drive investors away tomorrow.