After listening to hundreds of startup pitches, and reading even more business plans, most new venture investors develop their own favorite list of “red flags” that signal the beginning of the end of their interest. Others, like Guy Kawasaki, have irreverently called some of these “entrepreneur lies,” but I prefer to think of them as innocent enhancements or omissions that can kill your deal.
At any rate, here is my own list of red flags, from my years of experience advising and investing in aspiring entrepreneurs, which cause me to lose interest and start looking for a way out the door:
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Omit the facts on key management team experience and skills. Don’t forget that investors look as much at the people as the idea. They expect to hear about founders and team member’s prior experience in building a startup, and knowledge in the relevant solution domain. Not highlighting people is as deadly as not highlighting the solution.
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Lead with your intent to offer the solution free to customers. Of course, customers love free, but investors hate it. They know it’s especially hard to provide a financial return with a free business model. It takes a huge upfront investment to attract users, before advertisers are interested. Facebook spent over $100 million to kickstart the process.
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Emphasize their social commitment, but never mention profit. Even non-profits need money to scale, but their pitch should be to philanthropists, not equity investors. Many companies, including Patagonia and Zappos, have used their social focus to enhance their business, but highlight financial return when talking to investors.
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Terms “paradigm shift” or “disruptive technology” used more than once. These terms are so overused as hype that any meaning has been lost. In reality, fundamental changes in technology frighten away more customers than they attract, and take longer and more money to come to fruition than any investors wants to commit. Skip the hype.
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Target market sizing higher than $10 billion. It’s true that investors like large markets, preferably in the billion dollar range and growing, but sizing a startup market greater than the GNP of many countries is just not credible. Every startup needs focus, due to limited resources, so setting irrational goals implies overall poor business acumen.
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Sales projections are less than one percent market penetration. First, no investor is interested in a startup that sets their sights so low. Secondly, this projection usually comes with an assertion that everyone on the planet needs this, so less than one percent in five years is still a huge number. Entrepreneurs in this category are usually dreamers.
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Claims of no competitors or hundreds of competitors. Investors are wary of crowded markets, and untapped markets. Usually “no competitors” means there is no market for your solution, or you haven’t bothered to look. None of these cases are credible. I recommend a focus on the top three competitors, or top three competitor groupings.
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Spends time denigrating key competitors. Smart entrepreneurs highlight their own positives in competitive positioning, rather than competitor negatives. “Competitor X solutions are too expensive and too slow” should be “My solution provides double the performance at half the price.” Investors fear negative vibes will infect the business.
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Touts “first-mover advantage” as the primary barrier to entry. Investors read this as an excuse for no real intellectual property or innovation. When a big company is a first-mover, they have the resources to hold their lead, but when a startup shows real traction, they can be easily overrun by competitors with more money. Sleeping giants do wake up.
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Proclaims gross margin assumptions less than 50 percent. Many naïve startup founders believe that they can make good money with low margins. This may work for a year or two, until you grow to need employees with benefits, facilities, and more complex processes. Investors assume that even if you survive, returns to them will be unlikely.
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Declare a $10 million valuation with no revenue or customers. Equity investors are buying a chunk of your company at today’s value, not what you think it may be worth in five years. The average valuation for Angel investments is about $2.5 million, so early numbers in that range may be negotiable. Higher numbers cause investors to walk away.
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Annual revenue projections exceed $100 million before fifth year. Revenue projections should never exceed rational business growth constraints, or they defy credibility. Even Google, one of the most successful recent companies, only achieved $85 million in their fifth year. Numbers above this threshold will not attract investors.
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Use the term “conservative” multiple times in their pitch. Investors are not looking for conservative entrepreneurs. They expect aggressive projections (not crazy) on opportunities, volumes, and revenue. Investors know that entrepreneurs with a conservative mindset usually fail to meet even their under-stated numbers.
Remember, you only get one chance for a great first impression with investors, so don’t let any of these red flags destroy yours. I highly recommend that you screen your business plan and your executive presentation carefully for variations on any of these themes, and remove them. Your credibility is paramount, so don’t jeopardize it with hype and too much passion. Your future depends on it.
