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‘Red-flags’ in Early Stage Investing

‘Red-flags’ in Early Stage Investing

Investing in Startups can intimidate some for fear of the unknown!

The obvious Red flags automatically catch attention of an Investor. But then there are those that are not so evident! We have come across a good write-up on the same(link in comments)

In our last article: why part time venture investing doesn’t work? we had mentioned that a

“ Startup is all about a sound Founding Team”

Let’s find out, what are the few things about a Founding Team that should be watchful of while making an Investment decision.

An excerpt from our article mentioned that, ‘Founders need to deliberate their innate problems with you’. This makes unresponsiveness, laid back attitude, and market-ignorance, an obvious First, on the list!

What if they lack critical know how of their startup should work? What if they start off something they have no experience in and rely on others to run it for them? This is worrisome in my experience. It may work for Technology Driven Startups that compete heavily on technology, but will spell doom for Execution- Startups, which compete on teams!

Founders need to have a fire in them to succeed, but they needn’t be fiery with people around. Maintaining composure under pressure is a must quality for the Founding Team.

Do the Founders really trust that this will become big or are they looking for a quick exit?

“ Real traction can be disguised”

Watch out! If you are told ‘we have many pilot customers in the pipeline’. And pop the question; ‘why haven’t they converted?’ Find out if the business has a lack of paid customers. For all you know, they may still test the products or have a low willingness to pay.

Another important factor to check is the start-up’s marketing expenses! If they are too high, it shows the margin will keep low (or negative) if the company wants to grow users! Some marketplace businesses may have a high GMV, which looks very attractive. However, it is the margin that matters.

Some startups make tall claims on their TAM size & Revenue pools. Like say, claims about monetizing the data they collect. But a valid question to then ask is, who would need that data or how much do they think they will get for it?

“ Fund raising is a skill”

Same investors or different for two different rounds of investment, could be a really a tricky subject to discuss! A successful startup would attract a diverse set of investors in their follow-on rounds. If you are seeing the same angels taking lead position in the follow-on, then it raises a few questions. However, if the previous investors drop off, that is not a good sign either.

Corporate VCs usually invest in Startups for a strategic value, but an investment by CVC in the early rounds could be detrimental to a Startup for two reasons: First, the Corporate may ask the Startups to work on something the Corporate needs, limiting the product development; & second, the Startup’s customer base could get limited.

I would say, if we see too many of the aforementioned conditions together in a startup, we might want to be careful about our investment decisions.

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