As an investment platform, we receive tons of applications every month from startups and small businesses looking to raise capital. As such, we have seen our fair share of pitches, both good and bad.
A good pitch aims to concisely lay out what problem the startup aims to solve, how it plans to do so, and how it plans to monetize that solution. Pitches are meant to be short, but they hold a significant amount of valuable information.
If you’re new to startup investing, it can be easy to get sucked into an interesting idea and miss potential red flags.
While there isn’t a one-size-fits-all rubric to measure a startup pitch against, there are certain red flags you should keep an eye out for when considering a potential investment opportunity.
Financials
Excessive Salaries
Building out a startup requires ample time and resources. From conducting research and developing a minimum viable product, to hiring and marketing, there is no room for inefficiencies. Typically, founders will allocate a bulk of any revenue back into further development of the business. While there are always exceptions, investors typically will view lavish salaries as an inefficient use of resources when the company is still in its early stages.
Rapidly Diminishing Runway
Negative cash flow for an early-stage startup is normal, but if a company is rapidly approaching the end of its runway with little forward movement, that could spell trouble. This can be indicative of a couple of missteps:
- The company miscalculated how much money it needed before its next round of funding.
- The funds secured in the last raise were not properly allocated.
There is no one “right” burn rate, but be wary of a startup who is struggling to make sales and is quickly running out of time.
Market
Lack of Momentum
There are many reasons why a startup may be struggling to gain momentum. If they’re not making sales, it could be an issue of product/market fit, pricing, marketing, etc. Bottom line, lack of momentum may not be a deal-breaker, but if it is an issue, you’ll need to ask the right questions.
Poorly Defined Market
As the old saying goes, “If you’re trying to be everything to everyone, you’ll be nothing to no one.” If a startup is projecting outsized market potential, it’s likely puffery. A startup who has done thorough market research will know who their target is and optimize to serve it.
The Team
Spread Too Thin
If the founders are involved in a multitude of other projects, the company isn’t getting 100% of their time, energy, and attention. Investing in part-time founders is generally riskier than investing in a full-time team.
Bad Reputation
This one should come as no surprise, but founders with a history of legal or ethical issues are likely not a good gamble. Similarly, if they have a bad reputation within their space, that is something to note. If you have any doubts about the integrity of the team, it’s best to heed caution.
The Presentation
Buzzwords Over Substance
How many times have we seen a startup described as the Airbnb or Uber of its industry? It’s a tired comparison, and lacks real substance. A good pitch is brief, clear, and precise – buzzwords are just fluff. Be wary of pitches that are heavy on buzzy jargon and light on concrete details.
Lofty Promises
Every claim a startup makes in their pitch should be backed up by factual evidence. Salesy, marketing verbiage or lofty promises are a huge red flag.
Conclusion
Of course, there is no perfect formula for identifying a startup that will go on to be wildly successful. Similarly, a company may not display any of these red flags, and could still end up failing. That said, as an investor, it’s important to do your own due diligence and keep these things in mind when considering an investment opportunity. High risk is inherent to these kinds of investments, but it’s in your best interest to make sure you’re not missing any glaring risk factors from the start.
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
