Home > Startup > Funding a Startup > 5 Due Diligence Tips Before Investing In A Startup

5 Due Diligence Tips Before Investing In A Startup

Business angel on a dark background. Investment, business, sponsor concept

startup-investment-entrepreneurAfter you have heard a few startup success stories, like Google, Facebook, and Microsoft, you may be tempted to invest some money yourself, maybe by pooling your funds with other investors who claim to have a great track record. My advice is to leave the investing in startups to the professionals (or friends and fools).

First of all, despite a few visible blowout successes, the odds of a payback from investing in startups is very low (that’s why VCs look for 10X returns to cover failures). Most investors agree the odds are better buying traditional public stocks, or even commodities. Even the hot new crowdfunding companies carefully don’t talk about their record of returns to investors.

Secondly, there are many scammers out there who look and act just like Bernie Madoff, even though he is safely tucked away in prison for the next 150 years. Most frauds are not on the scale set by Bernie, but even a few thousand dollars lost would hurt you and me as much as a few million did for some of his victims.

So what can you do, and what are the “red flags” to look for as you do your due diligence before pooling your money with other investors, or accepting money for your startup from investors? Here are some common sense tips:

  1. Get financial statements and verify. Every reputable investment firm is registered with FINRA and files regular reports with the SEC. Look for these and investigate thoroughly to check the truth of every statement about the company. Ask for references, and call or visit previous “successes” of the company to verify experience and satisfaction.
  1. Avoid “insider deals.” The Internet has just made it easier and faster for vultures to feed on investors tempted by the possibility of an “inside deal.” Someone you don’t know promises you an “inside” deal. Why would a stranger pick you out to make rich? Does that make any sense?
  1. Listen for “unnamed sources.” Run away if all current investments are with “sensitive” clients, who are unnamed or unable to be contacted. Remember the old newspaper publishing rule of “All facts must be verified by two independent sources.” People claiming to be unbiased may actually be paid promoters or company insiders.
  1. Any mention of “offshore.” Watch out if someone has a complex plan involving offshore bank financing or gemstones or oil leases in Iran to make you rich. Why get involved in a complicated scheme you don’t understand, when there are plenty of opportunities that are legal and you can understand?
  1. Sounds too good to be true. The age-old wisdom here is that if it sounds too good to be true, it’s probably not true. I continue to be amazed at the fact that the Secret Service still gets 100 calls per day from victims of the Nigerian unclaimed cash scam alone. What are these people thinking?

Here are a few questions you should ask that might allay any remaining qualms, or convince you to run immediately:

  • How much am I paying in commission or fees?
  • Has your source been involved in any arbitration cases or lawsuits?
  • How do they get paid? By commission? Amount of assets managed? Another method?
  • Has the firm ever been disciplined by the SEC or a state regulator?

Unfortunately, in the startup and investment business, we are trained to rely on networking, connections, and professional integrity for many decisions. Remember that people who run scams may be highly polished and sophisticated, and can wrap their con games in such an air of legitimacy it may be hard to see the truth.

Don’t assume you are safe now that Bernie is out of the picture. If you have evidence of fraud, don’t be too embarrassed to contact the Securities and Exchange Commission. If others had done this sooner, his clones wouldn’t be out there today looking to help you out (of your money).

Published: November 16, 2020
1170 Views

Source: Reprinted with permission from Startup Professionals

Trending Articles

Stay up to date with
Avatar photo

Marty Zwilling

Marty Zwilling is the Founder and CEO of Startup Professionals, a company that provides products and services to startup founders and small business owners. Marty has been published on Forbes, Harvard Business Review, Huffington Post, Gust, and Young Entrepreneur. He writes a daily blog for entrepreneurs, and dispenses advice on the subject of startups to a large online audience of over 225,000 Twitter followers. He is an Advisory Board Member for multiple startups; ATIF Angels Selection Committee; and Entrepreneur in Residence at ASU and Thunderbird School of Global Management. Follow Marty on Twitter @StartupPro.

Related Articles