How to Avoid Dangerous Investors and Possible Embezzlement
I once ignored the warning signs of a dangerous investor -- we’ll call him Mike -- and had $700,000 embezzled from my company. It’s widely known that there is both smart and dumb money, but there is also dangerous money. I’ve raised over $1 million for my first startup from wonderful investors who I’m proud to be partnered with, but in the midst of all of that successful fundraising, I made one massive mistake -- accepting money from Mike.
The cost of this mistake to my business goes beyond just the $700,000. It damaged team morale, leeched hours of my time and my team’s time and kept us from actually growing our business. While we did get some money from him, it was not worth it for the headache and the stress of what ended up being a nine-month long constant headache to deal with. And yeah, losing the $700,000 obviously sucked.
I saw warning signs in Mike’s behavior but ignored them, because I was in such need of the money. I now have no tolerance for certain behaviors from investors, and there are certain red flags that, when I see them, I run far away. I will turn away investment money before I get into another dangerous situation.
Mike convinced me that he needed the shares of stock to be held in his company, and then he planned to sell them to his wealthy contacts for a profit. After that, he would pay a promissory note back in cash, and we would have our funding. A promissory note is exactly what it sounds like -- a legal IOU. It was all smoke and mirrors rather than actual funds. I realize it seems ludicrous that I believed him, but he spent a long time building rapport before all of this. I thought I could trust him. (Free nugget: don’t give friends preferential treatment.)
Here are a few behavioral giveaways:
- Greedy: Mike didn’t actually care about me or my team, he only wanted to make money. Investors and entrepreneurs are out to make a profit and that is not at all a problem. The danger comes when that is all they care about. In my situation, my team didn’t get paid several times because of his inability to deliver.
- Superman: Mike spent the first 30 minutes or more of every conversation talking about his accolades, accomplishments and credentials. Money doesn’t need hype -- it speaks for itself. At the end of the day, he should be able to write the damn check. But he couldn’t, so he hyped himself up. (The exception to this is if you have a competitive bid out for equity. In that case, your investors need to prove themselves to you.)
- Doesn’t know industry: Mike took his real estate investing model into the consumer product goods industry. Embezzlement aside, this turned me off to him, because he wasted a lot of his time and my time trying to force this model to work.
- Paranoid: Mike was stingy, because he didn’t have the margin in his budget to invest. I was stuck in countless meetings and calls to reassure him that everything was fine with the small amount of money that he gave me. An investor like Mike puts a lot of demands on a little bit of money.
To turn it all around from negatives to positives, here are the kinds of investors you want to partner with:
- Wealthy: He believes in you and is willing to put his own money down, not just promise you that he will bring in money from other sources.
- Passionate: He is passionate about your company and excited about partnering with you.
- Moves fast: He gives you realistic promises that he intends to keep and is willing to immediately back up those promises.
- Knowledgeable: He knows your industry, and understands how investments are handled within it.
- Risk-tolerant: Finally, he is able to invest without stress and is willing to lose money on your venture, acknowledging along with you that this whole entrepreneur game is a risk.
There are many wonderful investors that are truly great people, and some of them might even be named Mike. But if you want to avoid the pains of dangerous investors, go into the fundraising process with both eyes wide open. Don’t ever let the size of an opportunity cloud your judgment.