An article by Financial Times journalist Jonathan Moules recently caught my attention. “A Spotter’s Guide to Bad Angels” spotted and tagged several species of high-net-worth private venture investors (often known as “angels”) that startups would be well-advised to avoid.
From the ridiculous (dumb angels, megalomaniac angels) to the serpentine (shark angels, litigious angels), the article was a poignant reminder to early-stage entrepreneurs and investors that not all angels come from heaven. Just as founders need to pick their investors carefully, venture investors should exercise diligence and caution in concerting with co-investors and syndicate partners.
This advice is easy to overlook, particularly when a cash-needy startup is caught in the heat of a money hunt. The entrepreneurs or syndicate managers may begin with a profile of the ideal target investor, but often cede their criteria as the rigors of fundraising incite “founder’s (or finder’s) fatigue”—when all money begins to look like the same shade of green. Inevitably, there is a tendency among entrepreneurs to chase and accept money wherever they find it.
Indeed, when the perceived time value of money becomes more important than the color of money, it can be difficult to discriminate desirable investors from bad angels. Advisors aggregating angels in a syndicate group need to carefully assess their motives to screen out potentially disruptive personalities as an investment syndicate is often an arranged marriage expected to survive for three to 10 years.
The best way to screen for bad angels is to determine the primary underlying motive of the investor as not all angels are exclusively in pursuit of asymmetric upside. Bored professionals, retired entrepreneurs, wannabe venture capitalists and wannabe CEOs often seek to achieve their ambitions or end their ennui through “passive” investments. Moules tags these types as meddling angels: They are manageable and considerably less menacing than the chief executive angel whose “real agenda is to run your company from the back seat. They are very intrusive and will push you to make decisions and commit resources that will put your company at risk.”
No entrepreneur is looking for a shadow CEO and should thus be wary of the shark angel, a bottom-feeder whose underlying motivation is to take advantage of a business balance sheet, poor counsel or negotiation skills, and hopes to inevitably control the company, intellectual property and other assets. Perhaps counterintuitive to some, these investors are the worst to co-invest with as they are likely to have no regard for your interests in their attempts to marginalize management and hijack the company.
Entrepreneurs and syndicate investors alike should be on the lookout for red flags:
- Listen carefully to the investor to determine motive. Warning signs can often emerge in the early meetings and certainly during the diligence and term sheet process.
- Avoid conflicts of interests. It is appropriate and recommended for investors to hold entrepreneurs accountable for performance thresholds, but those who insist on including investor-centric punitive measures in the term sheet for adverse events beyond the control of the company are likely to pounce at the first opportunity as they may be equally attracted to the venture’s downside as its upside.
- Be wary of younger and retired investors. They may consider the target venture to be their new full-time project.
- The larger the investment, the more diligence you should perform on the investor. Ask the angel to name the most recent prior investments he has made and then talk to the company. Consider background checks.
- Consider personality. The marriage metaphor may be mundane, but nonetheless accurate.
- Know-it-alls are an easy red flag, particularly those who don’t abandon their position in the face of contrary evidence. Investors who are persistently wary of the truth are exhausting and poor team members.
- Avoid those who preface their investment commitment by reciting a laundry list of perceived negatives regarding the venture’s business model or investment terms, but nevertheless agree to invest. Ideal investors are partners who invest on the merits of the opportunity—not in spite of them.
Entrepreneurs desperately seeking capital are prone to ignore these red flags. Advisors, though, are likely to be more aware of warning signs as bad angels have personality traits that resemble those of bad clients.