When Angels Go Bad

Don't care where the funds for your business come from? Here's why you should.

After more than 20 years of helping entrepreneurs raise money, I've found one thing to be almost universally true: They don't care where the money comes from as long as they get it when they need it. As silly as it may sound, many entrepreneurs believe all money is created equal. As long as somebody recognizes their brilliance and writes them a check, the source really doesn't matter.

With any luck, this article will disprove that notion. Here are a few types of "fallen angels" that illustrate why accepting money from the wrong source may be the beginning of your worst nightmare.

The Control Freak--This angel started out looking like your new best friend. He talked about common goals and achievable milestones. He wanted to know how you were going to spend the money, when you'd see a benefit and, of course, how soon you'd hit break-even. Once you were funded, he waited until you hit your first pothole and then pointed out certain clauses in your agreement that gave him more control if you failed to perform as promised.

You see, the classic control freak actually plans for your failure by including such "gotcha" clauses in his investment agreement. The clauses are common among minority investors because they provide some leverage when the investors don't otherwise have a controlling interest. But control freaks abuse these clauses to exercise control. The end game is to leverage his investment into an opportunity to run your company himself. Unfortunately, once the control freak takes over, his relationship with the visionary entrepreneur becomes toxic, and 99 percent of the time, the company fails.

The Micro-Manager--The micro-manager investor is a completely different animal. On the surface, they look like ideal investors. Not only do they want to write a check, but they're also willing to lend their expertise and help--for free. Unfortunately, it soon becomes apparent that you have one of two problems: in their desire to be helpful they become a nuisance, or they become so concerned about losing their investment, they check on your progress every waking minute.

Initially, your gratitude for their investment may prompt you to tolerate and even accommodate them. After all, an interested and involved investor is a good thing, right? But by the time you realize they won't go away, it's generally too late. They've lost faith in you--even though they would've found something wrong with Bill Gates--and you've lost all patience with them. If you're lucky, once the relationship turns sour, some micro-managers will just "write you off" and walk away. Unfortunately, many will become litigious investors.

The Litigious Investor--The litigious investor will look for almost any excuse to take you to court. I firmly believe this group of investors never focuses on the returns your company can deliver, but instead tries to make money by intimidation, threats and lawsuits. They know you won't have the resources to fight them, so they count on you "caving" and working to find a settlement. This group will go after you for the smallest thing--failure to send them their stock certificates, failure to keep them informed on a timely basis, or failure to meet milestones. I've even seen one entrepreneur sued because the investor didn't like the office furniture they bought.

Granted, some entrepreneurs do things that deserve litigation. But frivolous litigation only adds to the stress of the management team, it's costly and distracts from the company's goals.

The Desperate Investor--This last example may not occur all that often, but I've seen it happen once, and that was enough. In this case, the investor started out being a bit of a micro-manager, but in a nice way. He then stopped believing in his entrepreneur, thinking he was taking the company in a wrong direction. Rather than confront the entrepreneur about his concerns, he assumed the situation was hopeless. So he decided it was the entrepreneur, not the company, who should die and tried to poison him--really!

Fortunately, the attempt failed and rather than create a political circus that would yield negative press for the company at a very critical time, the board decided to not press charges. It instead refunded the investment and banished the investor from any further involvement with the company.

Given these nightmares, how can you ensure that as an entrepreneur you don't encounter similar problems? Here's my advice. The question is: Will you have the guts to follow this advice when someone is waving a check in your face, saying they believe in you and your company?

  • Whenever possible, only accept investments from credible, professional investing organizations--not private individuals.
  • If you are a raw startup and have no choice but to accept investments from private "angel" investors, do the following: Ask what other companies they've invested in and talk to the CEOs of those companies to find out what kind of investor they've been. Also, make sure your lawyer writes the investment document--not your investor. This document should be standard for all your investors and not negotiated on a one-on-one basis. Watch out for any attempts to add clauses that can come back to bite you. And don't eat any soup that tastes funny.
  • Whenever possible, hire an investment banker to prepare a proper Private Placement Memorandum that's consistent with National Association of Securities Dealers requirements. We generally refer to PPMs as "anti-investment" documents because they warn the investor about everything that could potentially go wrong, minimizing any basis for a lawsuit.
  • Divide your investors into two categories: pure investors and those you feel may bring additional value. For those in the first category, don't encourage or allow them to "get actively involved" in the company. Be polite but firm in telling them you'll keep them informed of your progress through written means only. If you want more active involvement, you'll ask them to formally join an advisory board or the board of directors. However, if you do so, there will be strict, written guidelines as to what is expected.

Jim Casparie is the "Raising Money" coach at Entrepreneur.com and the founder and CEO ofThe Venture Alliance, a national firm based in Irvine, California, that's dedicated to getting companies funded.

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