Starting A Business? Stay AWAY From These Investors!
Starting A Business? Stay AWAY From These Investors!
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This is a story about why not all money is good.
Today I’m going to be speaking about predatory investment, malicious investment.
Who is this going to be helping?
This is going to be helping entrepreneurs or looking for money.
Who are looking to raise money, to start a business, and they get caught up with the wrong folks.
What do I mean by this?
Over my career, I’ve worked with a significant number of entrepreneurs.
I’ve also tried to start my own businesses, consulting businesses, software businesses.
I’m an entrepreneur at heart.
And I’ve dealt with a wide variety of investors.
Now, investors can be many different types of individuals and they can also come into your business at different stages.
But usually, the people that run into, perhaps aligning with a bad investor, are the people that have never done this before.
They’re the people that are trying to raise money for the first time to start their business.
Because as the saying goes the best type of money to start a business with is with OPM or other people’s money.
It’s usually based on the premise that you don’t want to risk your own capital or your own money that you saved, perhaps by working for many years, you have a nice little nest egg, and you want to start a business.
It’s usually still smarter if possible, to use other people’s money.
So, you may be asking…Scott, I’m going to go raise money.
If somebody gives me money, isn’t that good enough?
And the answer is no, definitely not for a variety of reasons.
Let me first list off the reasons why just anybody’s money, isn’t good.
And then I’ll go into some practices that you should look out for that would cause you to raise a red flag so that if you do run into people like this, you need to run as fast as you possibly can in the other direction.
But first let’s speak about, just some of the reasons why you don’t want to take everyone’s money or anybody’s money.
And even if these people aren’t malicious aka they’re not trying to do something bad towards you.
There’s still reasons why you shouldn’t take certain individuals’ money.
Adding Value
When you’re raising money, you need to work with people who are going to add value to your business.
You want to work with people that can bring something to the table.
And what does that mean?
It means something different for everybody.
Granted, not every investor you’re going to work with is going to know the ins and outs of your business or your industry.
Especially if you’re doing something that’s cutting edge or bleeding edge or breaking into a new industry that perhaps they’ve never heard of before, or they’ve never dealt with, and the research or the industry itself is just so new that it’s hard to find somebody who’s an expert or a veteran in the industry.
Depending on who you’re looking to raise money from.
And also depending on what stage your company is at, for example, when you’re raising money, usually you will have a friends and family round.
Then you can go to angel investors and then you’ll probably want to go to institutional investment, otherwise known as venture capital.
Friends and family, usually is exactly what it sounds like, where you’re literally borrowing credit cards or money from people that you know.
Then you’ll have an angel round or angel investment.
They’re usually high net worth individuals.
They could just be people who have great jobs.
People who make a lot of money.
It could be people who have exited a company before, but it doesn’t always have to be.
You could think of doctors, lawyers some people in real estate, some people in finance, whatever it may be.
People who have made a lot of money may just want to put their money somewhere and invest.
So that would be angels.
And then you’ll have venture capital or firms, organizations, investment banks, whatever it may be, who have been set up to invest.
And at every stage each type of investment comes with different nuances that comes with positives and negatives.
Also, each type of investment is appropriate for different size companies.
For example, if you have 200 employees and you have, say 30 to 40 million in annual recurring revenue… you’re not going to ever go to friends and family.
Most likely. You’re probably going to go to an actual firm to go raise money, a venture capital firm.
But whenever you’re going to raise money, regardless, it could be friends and family.
It could be angel investors.
It could be venture capital.
You want them to be able to provide some value.
Of course, the more institutionalized the investment is the better chance they’re going to be able to provide value.
So, a VC firm is going to probably provide a lot more value than just your friends and family, but let’s assume that everybody who you’re dealing with could offer some sort of value and that has the opportunity to offer you value.
So, if you’re going to raise money from a VC firm A versus a VC firm B, you want to make sure they can offer some value to your business more often than not.
If you have an exciting project and a great business venture, you’re going to raise money, from somebody who gives you perhaps the first offer, if you’ve never done this before or the most exciting offer, and you forget to see what else they can bring to the table.
They could bring operational experience.
Maybe somebody’s a high net worth individual or a venture capitalist, or maybe perhaps your friends or family (a little bit less likely that’s going to happen).
This person could have had incredible success with businesses in the past. And they can actually help you in the operations.
Not everybody, but some can do that.
They can have network access.
They can “lead the round” aka, an individual can put money in first, and then that means that they’re going to have a network of individuals, that will also likely put money into your company after that first individuals put money into your company.
They can have decision maker access.
It could not be somebody who’s leading a network of individuals who wants to invest, but it could be somebody who just has a great network of people who could be potential decision-makers or stakeholders that they can reach out to… and you could potentially sell your product to also.
They can have subject matter expertise.
Maybe it’s somebody who does know your industry very well, a veteran in your industry, and that’s the kind of person that can actually help you improve your product or impove how you do business or how you market or how you sell.
So, there’s a lot of different benefits that you should look for when you are going to raise money.
Possibly the worst thing you could do would be to just go raise money and not assume that somebody who’s putting money into your company can offer more benefit than just the money itself, because that’s usually not true.
And if you do find somebody who does not offer any value to your company, there’s a good chance that could actually hurt you because if they don’t understand your product your potential market how to build a business and you do run into trouble.
It’s usually the people that put money into your business who will be most likely to help you.
If they have the ability to help you. That’s who you can go to that too & you can lean on, but the moral of the story is that whenever you raise money, make sure the person that you’re looking to raise money from and who you’re going to bring into your business is going to add some more value than just the capital.
Closing Thoughts On Value Added Venture Partners
And I’m going to tell you another story about, I mentioned before I was going to talk to you about red flags. Before I get into that story, because it’s a really good story.
I want to just highlight a few other things that you should be aware of since we’re already on the topic when you’re raising money.
So, things that you just have to keep top of mind…
Don’t raise money too early because investors want a clear path to revenue.
Don’t raise more money than you need.
Don’t dilute your company more than you have to.
Don’t ask for too little. So, make sure you cover your operating expenses. Make sure you cover your salary so that you can be comfortable, so, you’re not stressed out.
Don’t give up. When you’re pitching to investors, it’s going to take a lot of pitching. It’s going to be a full-time job. It’s usually actually recommended that if even if your co-founders one person focuses exclusively on pitching and the other person focuses exclusively on building the business or taking a product to market at that early stage, because it can be so time consuming, make sure you actually have a plan for building your business.
Make sure you aren’t again, taking on partners that don’t offer value.
Make sure you know your numbers, know your market, know your product, know your revenue, projections, know your competition, know everything that you need to know, so you can prepare and properly pitch.
Make sure that you’re upfront about issues that you’re going to have in your business so that there’s no surprises for the investor after the fact.
And like everything in business, make sure you actually ask for advice, go find mentors who have done this before. Even if they’re not going to invest, we can give you advice and they can probably point you in the direction of somebody who could actually invest and add value in your business.
Story Time — Predatory Investors
So that let’s pause there.
That’s why you should always focus on investors who add value and then some other things just to keep top of mind.
Now let’s go into the main point I wanted to drive home.
Let’s start with a story.
I have a friend and this friend got a call from one of their friends.
My friend has been trying to start a business for a while and, their friend just so happens to have been working in the startup space.
They had been working to broker deals and to find money for companies that wanted to start new businesses.
The friend of a friend had actually set up a deal for a company that wanted to start a new business (what these brokers do is they bring together both the business and the lender. So, they bring together the startup, the people that are looking to find money, as well as the investor who wants to invest in their business).
Basically how the deal was structured was the investor was going to invest so much in their startup.
The investor wanted to take their company public soon so that they could be liquid.
And then the friend of a friend (broker) was going to get 25% of the deal.
The deal was only going to go through if there was a promise to go public.
However the deal it fell through.
So, the broker goes back to the investor and says, “listen the startup didn’t work out so well — I want to work with you, but we have to find another company”.
And the investor says “That’s fine. Find anybody as long as they go public.”
Let’s talk about this.
What is happening right now?
I don’t know if the broker knows or if the broker is in on this, but what is happening right now is the startup really lucked out by not taking it that deal.
And why did they do luck out?
What’s happening here is the startup wants to raise money because they have a great idea.
The investor always wants a return on their money.
In traditional business, the investor will put money into the startup in hopes of another exit event.
What is an exit event?
An exit event is when a startup raises another round of funding.
So, a startup, for example, could raise $5 million. And then in a year they’ll raise maybe $25 million or $50 million.
And when they raise that next round of funding….that’s, when you hear the term Series, A, B, C.
Series A is a round of funding.
Series B is the next round of funding.
And when startups raise the next round of funding, then the investors that got in the previous series, so, the Series A investors, make their money back.
And there’s a whole bunch of different terms that can be set up for how a startup raises money, but that’s the basic premise and the basic concept.
That’s how startups work.
That’s how investment works.
But what this investor was trying to do was that they were trying to invest money, but they were saying, “I want you to take the company public”.
What is public?
Being a public company means that you, (you as a citizen, as an individual) can purchase shares in that company on a stock exchange.
Stock exchanges that you would probably know… NASDAQ, DOW, TSX, there’s other ones; TSXV, FSX, NEO, CSE.
All those smaller ones like FSX, NEO, CSE
These are small caps, small stock exchanges.
And then the big ones like the TSX or NASDAQ…. those are the large stock exchanges.
So, when a company lists their company, when they go public, that means that the average Joe can go purchase shares in a company.
Usually, companies don’t go public until they’re much larger.
You hear about IPO’s all the time when companies go public, when they IPO, they’re talking about an “IPO” on the largest stock exchanges, but a lot of companies also go public on smaller stock exchanges for a variety of reasons.
It could be for example that they just want to be liquid a little bit earlier on perhaps for example the fees associated with a large stock exchange just are too much.
They have to pay actual listing fees.
They have to pay accountants to make sure that they’re compliant every single year.
And it’s very difficult and expensive to list on a major stock exchange.
So, some companies choose to use smaller stock exchanges, if the company itself is smaller and perhaps as they grow, then they will choose to graduate to larger stock exchanges and have access to a larger market of retail investors.
So, the issue with what’s happening in our previous story, where we have a startup, and then we have an investor who wants to put money into the startup, but only if they go public, is that the investor does not actually care about the startup.
Hear me out.
Okay.
If the investor puts money into the startup and the startup, only if the startup goes public, that means that at any point, the investor can liquidate their shares.
And they can basically make their money back.
Even if the startup is failing, the investor can liquidate their shares and make their money back or, and then some, and a lot, they can make a lot of money off this.
And my issue with this is that means that the investor and the startup are not aligned.
Their goals are not congruent.
And that is really a recipe for failure.
It’s a recipe for disaster.
And what I find with a lot of these types of scenarios, not all of them are malicious, but more often than not.
Investors who want to follow this path, invest in companies, only if they go public again, the investor wants to make money.
They want to hedge the risk.
If they one don’t believe in the company, or they believe that they can pump up the stock price so that they can make money, even if the company fails.
You see a lot of this with emerging markets too, with medical tech, with blockchain, with cannabis, you see this with markets that aren’t truly developed or mature.
Where there’s still a little bit of hype around them and where there’s a little bit of FOMO.
And in theory, if you really, over sell & over market, what the company is doing.
If it’s in an exciting emerging industry, a retail investor will probably buy.
And that’s a big issue, especially if from the get-go they don’t even have a product.
And this is a point that I didn’t even bring up.
The company that’s looking for investment (in our story) does not have a product, does not have revenue.
That’s a huge red flag.
So, when the broker was putting this deal together, the investor said, I don’t even care if you don’t have a product, you don’t have revenue.
We still want to invest with you.
When the original start pulled out, the investor said, “just find another company that’s in the same space, same industry and then we’ll invest in them”.
This means that they don’t care about the product.
They don’t care about the revenue.
Is there a chance to start up is going to fulfill those things and do those things and bring a great product to market and build revenue and sell and do all the things a startup is supposed to do?
Yes, there is a chance, but there’s also a chance that they won’t.
And the issue is when an investor says I’m going to put money into you, but I don’t actually care if you do all the things that a traditional startup should do to be successful.
Yeah, I can still make my money back.
That means that you could in theory, be running into some legal issues, but also that means that the investor is not aligned with the startup and the startup.
If they’re failing, if they’re not fulfilling, they’re going to probably run on the wrong side of the law because they’ll be publicly trading.
They’ll be promoting their product and they'll have a failing business.
And the investor is going to be making lots of money but they’re really not acting in good faith.
So, I have very strong opinions about investors that do this.
If you are in a startup environment, if you’re an entrepreneur and somebody says, I’m going to invest with you, if you take your company…public run the other way, they are not acting in good faith.
And even if they are, they’re probably not somebody who you want to get into bed with because at the end of the day, their goals do not line up with your goals.
Your failure could still unfortunately mean they get a massive return on their investment and that’s not good business.
And unfortunately, if that really does happen now, we’re talking people that could pump up stocks that really have no business merit, no actual anything under the hood.
And then we’re getting into illegal territory.
If there’s an investor that’s trying to advertise or PR or market a company that doesn’t have a product or it doesn’t have revenue and that company’s public well, that’s securities fraud.
Just be aware that are the types of investors that I would tend out of 10 times, recommend you run away from as fast as possible.
There are enough entrepreneurs failing who have good partners.
So, don’t pick a bad partner from the get-go.
Don’t pick a business model that could potentially put you in a precarious legal situation from the get-go.
So, pick a partner who’s going to add value.
Pick an investor that’s not going to ask to go public before you even have a product…god forbid, revenue.
That doesn’t make sense.
An investor will always want a clear path to revenue.
What do investors actually care about?
They'll be looking at your annual revenue, your monthly revenue.
If you’re in software, your churn rate, your monthly active users, your margin, your customer base.
These are the things that, that true quality investors look for.
Not, “I don’t care what company it is. I just want to take them public”.
So, if you ever hear those words run as quickly as you can’t away from that investor and go find yourself somebody else that can actually add, not only money, but also value to your business.
