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10 Startup Red Flags Investors Can’t Ignore!

Jehan | Feb 16 2023
10 Startup Red Flags Investors Can’t Ignore!

Investing in a startup can be a risky business, and the last thing any investor wants is to put their money into a venture that has red flags from the get-go.

There isn’t really a definition of bad founders or the worst startups. All founders have unique obstacles and every start up has its own journey.

However, there are some patterns that one would consider to be hallmarks of an unreliable startup/founder.

10 Traits of an Unreliable Startup

A focus on quick exits, copy-cat business models, weak unit economics, and a lack of transparency with investors are all warning signs that could indicate an unsuitable investment.

Here are some red flags that investors are on the lookout for when considering funding a startup:

1. Founders Obsessed with a Quick Exit

One of the last things that an investor wants to hear – especially during initial conversations – is how quickly you intend to sell your business.

Investors put time and money into your idea and want to know that you care about the problem you are aiming to solve. Investor confidence can suffer a serious blow if it seems that a startup is looking to make a quick exit (and a quick buck).

2. Equity Dilution at an Early Stage

When a startup gives up a significant amount of equity at an early stage, it can indicate a lack of discipline and foresight on the part of the founding team.

This is a concern for investors because it suggests that the team may not have the motivation or capacity to execute the business plan effectively. This concern is only worsened in later stages when the stakes are higher and the pressure is greater.

Therefore, it is imperative for founders to be strategic about how they allocate equity and to ensure that they maintain enough equity to stay motivated. This will ensure the success of the company in the long run.

3. No Significant Traction over an Extended Period

If the startup has been around for a long time, and significant progress has not been made, it is unlikely that it will in the near future.

Low customer acquisition over the period of a year or more and high marketing spend with little to no results reflecting in traction is usually indicative of a bigger problem such as issues with the target market or ineffective marketing strategies.

It is essential to ensure that you’re building the right product for the relevant market. According to a Forbes article by marketing expert, Neil Patel, 42% of unsuccessful startups attribute the inability to reach product market fit as their main source of failure.

4. Copy-cat Business Models

Bad founders pick ideas that don’t stem from solving a problem. Instead, they opt for an easy way out: identifying what has worked in similar socio-economic contexts and using it as the basis for their business.

That being said, you don’t have to reinvent the wheel. A way to strike a balance is to localize foreign business models and design while keeping Pakistan’s consumer behavior in mind.

5. Past Solutions in the Same Space Have Failed

While multiple startups in a single space are a healthy sign of a prevalent problem that founders are looking to solve, multiple solutions within the same space that have previously failed can be a red flag for VCs.

If several startups with similar solutions that were well-funded but still shut down, it is unlikely that a similar startup will succeed.

6. Ambiguity in Numbers

A good idea will have a lot of clear and concise data to support it. A solution isn’t viable unless the numbers support the fact that there is a problem to be solved to begin with.

One of the biggest startup red flags for investors is when sweeping statements made by founders in their pitch decks are unclear or unverifiable. Investors such as Faisal Aftab, Co-Founder & MP at Zayn Capital, are on the lookout for such inconsistencies or evasiveness when assessing founders.

7. Issues within the Founding Team

Some of the worst-run startups demonstrate a lack of organization and issues within the founding team. These can stem from a variety of sources, such as:

  1. Conflicting visions
  2. Personality clashes
  3. Lack of communication

These issues not only harm the team’s performance, but also create a negative image for investors.

Aside from the founders’ ability to lead, problems within the core team are usually apparent to external stakeholders. This becomes reflective of the team’s ability to execute their solution.

8. Previous Investors not Following on Later Rounds

A sign that a startup is doing well is that investors from prior rounds are also eager to be a part of later rounds. A lack of consistent interest may reflect on investor experience with the startup after investing previously.

As per Ayesha Saleem of Lakson VC, it all boils down to the quality and kind of investors on the cap table. If a startup was supported by ‘Seasonal’ foreign investors, who make very few investments in Pakistan, then previous investors not following on later rounds is not much of an issue.

However, if a solid local or foreign investor who holds a sizeable position on the cap table doesn’t invest, it may be a cause for concern. Investors may be tempted to dig deeper, especially if previous VCs are making similar size investments in other companies.

9. Weak Unit Economics

If your numbers don’t support you, no one will! Weak unit economics can be one of the major startup red flags for investors, as it may indicate that the business model is not sustainable in the long term. Without strong unit economics, the company may struggle to generate profits and may be unable to scale.

Investors will typically conduct their due diligence to verify that the margins, growth rates, and other key performance indicators align with their investment criteria and support the viability of the proposed solution.

10. Lack of Transparency with your Investor

Not being upfront with yourselves and your investors about potential threats, flaws, and areas of weakness is the biggest indicators of unreliable founders.

Founders that engage VCs in not only the positive parts of their business but also the negatives are much more likely to see better engagement from investors. In turn, this will increase their likelihood of getting follow-on investments.

According to Ayesha Saleem, a lack of transparency is what distinguishes supposedly bad founders from good ones!

“The relationship between investors and startups is unique and based on trust and transparency. We as VCs have a duty to our own LPs to invest sensibly. If a startup is not willing to be transparent about their financials, their operations, and potential gaps in their model, we can’t trust them with our money.”

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