How to protect yourself from a bad investor

How to protect yourself from a bad investor

Today I met Sifiso, an avid young entrepreneur from Benoni. Sifiso had been in an abusive relationship with his seed investor. According to Sifiso, his investor has not honored their terms of engagement and has rather opted to pay a salary to Sifiso for the past 9 months, thus jeopardizing and further deteriorating their relationship. I believe that in this case Sifiso failed to say no to this kind of investment and relationship with his investor. So I decided to write this article to help budding entrepreneurs establish how to say no to investors who don’t have skin in the game and don’t fit in their vision.

If you’re in the position where you need to turn down a potential investor, the good news is that you’re in great company. The hottest deals are often courted by many investors — too many investors to fit in a single round.

Not many entrepreneurs or founders will agree to this thought specially when the Number 1 Challenge for any entrepreneur worldwide in the seed or early stages is wanting to get FUNDS ! Yes some of the entrepreneurs may not even get to this stage of saying NO while trying every option in the world to hunt for funds.

While turning down investment might seem awkward, understand that much like VCs have to turn down a lot of startups, they also receive a lot of rejections from the most popular deals that they pursue. My best advice is that you be upfront and honest in your response.

Much like entrepreneurs don’t want to be dragged along by an investor who knows they aren’t interested in doing a deal, VCs also don’t want to be dragged along by an entrepreneur who knows they don’t want to take an investor’s money. When you know it’s not a fit, politely decline the interest and, ideally, provide a reason.
Possible reasons for not wanting to take an investor’s money include a lack of personality fit or industry expertise, a mismatch of company cultures or misaligned goals, terms in the deal that you aren’t comfortable with, the fact that you aren’t interested in raising at this time, or the fact that you are already oversubscribed.

If you are saying no to an investor because you have an oversubscribed round, you are totally in the driver’s seat.
While it’s good to be upfront about not wanting to take investment, it’s also good to leave the door open where possible. You never know when you might need to go back to an investor down the line. You can leave the door open to future conversations by giving VCs a soft no, rather than a hard no. A hard no would be, “thank you, but we are not interested in your investment.” A soft no would say “thank you for your interest, but we don’t see a fit at this time.”

When you receive a cold email from an investor interested in your company, a great response to decline the interest is usually something along the lines of “thank you for your interest. We’re heads down on project X right now and not looking for investment, but will keep in touch should that change down the line.”
As an entrepreneur raising money, you’ve probably seen VCs use the soft no on you in the past. Rather that saying ‘no’, investors will tell you ‘not now’, encouraging you to send updates and keep in touch. They do this so that they can maintain their relationship with you, in case one day they change their mind and want to invest. Your best bet is to use this same tactic on investors. While this may seem a bit manipulative, it’s really just a smart way to keep the door open for a relationship in the future.

There’s one time you might want to keep an investor that you aren’t interested in taking investment from at the table: when you need their interest as a bargaining chip in a negotiation with another investor. In this scenario, you’d use their interest to make other investors act faster or drive better terms. If you choose to use this technique, be careful. Driving too hard a bargain may scare the investor you actually want away — leaving only the investor that you weren’t actually interested in at the table. Or worse yet, scaring both investors away.

Many entrepreneurs have also suffered as they have lost to the bait of giving away critical share or authority to the investors in this process.

In my own experience and having met or spoken with some brilliant entrepreneurs worldwide this is one question that I bounced out on.

Here are some of the top reasons why YOU SHOULD DAMN WELL SAY NO TO AN INVESTOR.
1. RETURNS: When the effort, expertise and time that you will invest in the business out weighs the startup capital, and the benefits you would get on evaluation don’t balance out. It also holds good when they want too much equity for the investment they are making versus the benefits they will bring
2. DRIVER: Who will be the driver of your business post your funding ? If the Investor is bringing unwelcome steering or controlling decision affecting your business. You say no (thank you) when their ideas for the company, product line or personnel are not in line with yours. Unfortunately (many VC) investors can like your idea but want a path to control. They love to “help” identify your CFO…..:)
3. SMART MONEY, IS BETTER THAN MONEY: Smart money brings more than just rands. These are investors with great social proof, connections, or assets that are specifically beneficial to your business. If you can, say NO to investors that aren’t a good fit, or who aren’t bringing anything else to the table, say no to the ones who treat you as though you are on opposing sides during negotiations for the round.
4. TERMS OF LENDING: You should say ‘No’, to any investor whose term sheet looks like a lender’s document rather than an investor’s document. Most investors secure their money and lock in their returns at the expense of the promoter. Carefully check the Drag Along rights and the Exit Clauses particularly if they insist on a high guaranteed return on investment. Then it is not an equity deal in the real sense. It is always wise to wait for the right investor because struggle is a given in a start up. A wrong investor will only focus on his return. In the process, your shares will get further diluted if another (right) investor comes in at a realistic valuation.
5. BEYOND JUST MONEY: There are a number of times and reasons from the actual cost of the capital, to how they plan to seat the board. Are they hands-on or hands-off the business? Does their portfolio align to your organization, product or services? Does their philosophy make sense?
6. JUST ROI DRIVEN: You say NO to an investor when he/she are interested only in numbers and not in operation hurdles, your great idea, your passion to succeed. Clearly he/she is not visionary or may not be supportive in your critical operational chores. You will always carry a burden of such investors. Better walk alone than walking with an assassin.
7. DO YOUR DAMN HOMEWORK FIRST: Investors come in many forms…hands on, arms length and cash only: which means…they want to be In (make decisions for their percentage), they want to influence (limited decision making but active monitoring of their investment) or hands off (they are a more no less). Unless you really know what they are bringing to the table that will help fuel your company forward with an anticipated limited ownership period for their investment with an expected payoff every case, you are also running the risk of losing more than you might think you are gaining. Investors and partners, while they have their place and can bring benefit …..can also create the worst of business divorces. If at all possible, first seek the option of having them as a lender…hands off for exchange of a fair interest rate and term. If you fail, they are getting your assets anyway. If you are expecting to keep ownership of the business, ensure their voting and decision making rights can never over rule yours. If you are looking to investors as a means of an exit strategy, invest in a great business lawyer up front…to protect your return at the end. Be very careful. Like marriages, all business partnerships and investors start with the best of happy and intentions filled with potential…but when the honeymoon is over…the real personalities begin revealing themselves..and it can be devastating.
8. GUT FEEL: When you sense that post-money your freedom, expression, being, passion, command, freshness, etc could be even a fraction less than pre-money situation! An investor needs to understand your vision otherwise it is simply not worth their capital, if they want to make changes etc. especially before you’ve even taken their money that’s a massive red flag.
9. LIMITED LIABILITY: Don’t sign if the investors ask for personal warranties. Some of the entrepreneurs have been made bankrupt through other’s actions. Only accept liability in direct relation to your ability to control and/or exit. This is where a lawyer comes handy.
10. DUE DILIGENCE: A Key Attorney and a Key Note Speaker pointed these critical things. AFTER you have done your due diligence and discover things about the investor that a reasonable person would deem questionable. Here are some questions that are recommended for startups to consider getting answers to:
* Are they who they say they are?
* Can they do what they say they will do?
* What do you need to give up in exchange for their help?.
* What do their client references say about how they do business?
* Why do they want to help me?

Having said that however, you also need to understand that your demands from the investors are reasonable so that they will actually see their money back. One of the reason why they tend to try to dominate the venture so much is to protect their investments and the ROI. If you can assure them the investment will deliver, then I’m sure the need to say no will be lowered by a huge ratio.

StartupGuy’s Take:

Honesty is the best policy here and it’s definitely a good idea to keep the relationship on good terms for future collaboration.

VCs like me know that getting turned down by founders is just part of the business. Unfortunately, saying ‘no’ is a big part of our job, but hearing ‘no’ is also a part of our job. If you are chasing smart entrepreneurs, you are not going to win the right to invest in all situations, no matter who you are or what your track record is. From personal experience, I can tell you that it’s a punch in the gut for sure, but it’s nothing compared to the minefield of rejections that founders go through when they are fundraising.

I would also suggest that you say ‘no’ as quickly as you can for each investor. It will help free up your time to focus on getting to a ‘yes’ from both sides. If you had a terrible first meeting and you couldn’t dream of working with this VC for the next five plus years, trust your gut and communicate to them soon after that you are not moving forward with them. The same way you’d appreciate a quick ‘no’ from them, a professional VC will also appreciate this.

1 Comment
  • Sphiwe Ka Ngwenya
    Posted at 02:13h, 07 October Reply

    Bafo this is perfect article for thriving entrepreneurs, one day I will tell my story.

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