Due Diligence: Is Your Startup Investor Ready?

Raising Capital: Is Your Startup Investor Ready?

If you want to raise capital for your startup, then don’t waste your time and money trying to find investors if you are not willing to invest in your own company by bypassing small, but critical, details.

Amateur mistakes and business shortcuts will not lead you to a successful financing. From time to time, I will share the details of real world startup situations, so that you can compare your business activities against other startups and see what they are doing right.

In the case below, all of the arrows pointed to what they were doing wrong.

I was contacted by an entrepreneur on LinkedIn who said that he needed to raise money for prototype development for his technology startup. We shared a few connections on LinkedIn, so I sad: “sure, let’s get on the phone and discuss your financing plans.” The company is based in California, has filed patents and has even received local television coverage.

The founder and I later had a call to discuss the company and its financing plans. During the call, many issues, questions and red flags quickly surfaced. So much so that I knew we were just scratching the surface on this company and that it was not ready to withstand investor due diligence.

Would I invest in this company?

As you read the founder’s comments below (and my initials gut reactions at the time), put yourself in the shoes of a potential startup investor.

1. “I see that I have a call on the calendar but I forgot what it was about – are you the IP guy?” No – I am actually the business guy. He reached out to me to set up the call. This conversation is not starting well and he does not appear to have his act together.
2. “I set up my corporation with LegalZoom.” – Ok – This company is not ready to raise money. Corporate cleanup and restructuring definitely will be needed before investor due diligence. (Read more about why LegalZoom is doom, here).
3. “I have a Nevada corporation to save on California taxes.” – Rookie mistake – he is not saving on taxes (if complying with law). Does he have Nevada counsel? (Same holds true for Wyoming.)
4. “I don’t have an attorney and have relied on friends and family for guidance.” – He is not willing to invest in his company and do things right.
5. “We are not registered to do business in California.” – Another mistake. He definitely needs help and is doing too much on his own – by this fact alone. Even if his company is not a California entity, he still needs to be qualified to do business here.
6. “We don’t have any stockholders – I received the brown book from Legal Zoom but we have not done with anything with it.” – Still more corporate cleanup is required here.
7. “We don’t have to worry about taxes because there is no profit” – What? The financial side of the business is likely a mess.
8. “We don’t have a CPA or bookkeeper.” – This company needs to get good advisors in place. He has been making various business decisions without the advice and guidance of key financial advisors.
9. “I talked to my Board about the need for business attorney help.” – What Board? He has not structured his company yet and I bet that he has not taken the proper legal and administrative steps to put a Board of Directors in place.
10. First impressions matter. Preparation matters.

Our short call likely was just the tip of the iceberg for this company. I started to consider other possible legal/business issues that needed to be reviewed: Has this founder made equity ownership promises to anyone? Has he protected his intellectual property properly with Non-Disclosure Agreements, Proprietary Information Agreements (e.g., for employees and consultants), etc?

A startup investor wants to raise money, but he may be reluctant to spend money to cleanup and correct the corporate mess that he had created. He is jeopardizing his fundraising opportunities and I have my doubts that he will want to do things right in order to increase the likelihood that he will raise the money that the company needs.

Bottom Line

You know that starting a business and running a business present many challenges. And raising money often times is one of the biggest challenges.

Don’t make the fundraising process even harder on yourself. Put the right building blocks in place at the beginning and make sure that your company is ready for the investment process.

I quickly realized that this company had a lot of hair on it and would require a good amount of investigation and corporate cleanup. Investors also quickly will smoke out their own business and investment issues about this company during due diligence. And they will do so quickly. In this case, I can only imagine that this company has various issues with its business model, intellectual property protection and other hot button issues for potential investors.

Your Turn:

Would you invest in this company?

Have you experienced any of the missteps outlined above with your company? Did they affect your fundraising efforts and how did you overcome them?

We would love to hear from you, because your work in the startup trenches will help the entrepreneurs coming behind you.