Here is a list of some big red flags that I think a lot of investors try to avoid. Here are a few of the bigger ones:
1. We have a great idea, but we have no clue how to monetize our product/service!
a. There are few exceptions to this huge red flag (Facebook again), even ad revenue sounds better than “we don’t know”.
2. Lack of demand for said good or service
a. Are people really willing to pay for what you’re offering? Is anyone else out there doing or making this product? Are they successful? You can’t fix what isn’t broken.
a. Overhead is expensive versus a software company. You need inventory, lots of employees, lots of space, etc.
a. This all comes down to dealing with inventory and actually physically accounting for goods. You need all the things listed in retail you simply deal with other businesses instead of the public.
5. Lack of adaptability
a. I have seen several entrepreneurs be challenged in meetings with investors. Most of them, for some reason, stick to their guns on a topic that they should clearly rethink. I don’t know if its pride or lack of vision but if the company can’t adapt it can’t survive.
6. No ability to scale
a. If you need 2 employees to make 5 sales and that ratio never changes over time ... this is a problem. Technology companies are appealing because they can get away with 1 employee to 30 customers, and generally that number improves over time.
7. Low margins
a. This is self-explanatory, if you’re making under a 20% margin you need to rethink your pricing/model.
8. High burn rate
a. Again, if your company is spending a lot of money even if you’re profitable, odds are investors will want to trim those expenses. That or they will put their money elsewhere.
9. High valuations and unrealistic growth projections
a. If you’re generating $30K in revenue per month with $5000 profit, you’re not a $5 million company. You’re also going to have a hard time going from $30K in sales to $3.5 million in a year, unless you just created the cold fusion car or something.
10. Lack of an exit
a. Who would want to buy your company? Could you take this company public someday (worth over $100 million)? A lot of ideas work for founders that won’t work so well for an investor. If we can’t get our money and some return back from our investment, then why would we invest?
There are plenty of red flags out there; some of these may not apply to every investor either. This is just a simple guide to consider before you send that email asking for funding. I will post another guide on things we like to see in a prospective investment.