Investors encounter hundreds of startups every year. To give you a reference point, at Warsaw Equity Group, in H1 2023, we've reviewed nearly 900 startups with our 8-member investment team. Of course, reviewing decks is not our only job – we also juggle other responsibilities such as supporting our portfolio companies, handling internal matters, attending events and conferences, and conducting in-depth analysis of selected startups.
Due to time constraints the initial review of most pitch deck only takes a few minutes, and investors are constantly trying to find ways to optimise the whole process. That’s why most (maybe even all) VCs develop a list of red flags they are on the lookout for, based on their own experience as well as industry case studies and general common sense. It is not to say that anyone or any set of these things will kill the deal immediately, but they will certainly make investors more cautious Some of them are universally applicable while others are very specific – like Chris Sacca’s aversion to investing in founders who won’t do their dishes.
In this article I’ve compiled the most common universal red flags that can significantly reduce your chances of raising money from outside investors. I’ve divided them into two groups: founder-oriented and business-oriented.
Starting with the founder-focused red flags that VCs hate to see:
- Lying. If things go right (and most VCs don’t invest thinking about things going wrong) a VC-startup relationship has the potential to last as long as, or even longer than around 40% of marriages in Europe (it’s true). It’s just stupid (bearing in mind that stupidity is also not the most desirable trait in a founder) to lie at the very beginning, and it’s especially stupid, to lie about things that are easily verifiable. Founders most often bend the truth about things like being in talks, or even having commitments / term sheets from other investors, state of the product / features, having certain people as advisors, stage of negotiations with clients. It’s very easily identifiable - there is this theory, that we are 6 phone calls away from any person in the world. Well, the VC world is crazy small, so it’s 2 at the most - the truth is bound to surface sooner or later.
- Treating the startup as a side project for the founder, or the founder having side projects from the startup. Founders should fully commit to their venture, as it requires more than full-time dedication. Also, investors don’t like it when founders have a bigger (or just another) fish to fry elsewhere which draws their attention away. Having competing side projects also signals that the founder lacks confidence in the startup– then why should investors be?
- Another founder-related issue often seen in startups is a so-called ‘broken captable’. Founders usually work more and earn less than they could do in other jobs such as consulting or big-tech. However often they have this idea to start, develop and sell a company and never have to work again (what exactly does that mean is up for debate, depending on how much one spends and for how long they plan to live). In this situation giving away too much equity can demotivate founders, making them question the potential rewards versus the risks and sacrifices involved.
- They can’t explain well crucial parts of their pitch such as the product, the problem, or the value proposition In most cases, VCs have a limited understanding of your product, and the problem it addresses –you need to speak to them, as you might to a young child, or a golden retriever. Founders must be able to articulate their ideas clearly, even to those unfamiliar with their field. if they can’t explain it well to the investor, they probably won’t be able to explain it well to new hires, clients, partners, to whomever.
There are also red flags that have nothing to do with the founder personally, but with the business itself:
- Existing investors not participating in the round - sometimes there's a perfectly reasonable explanation for this - e.g. the fund has a no-follow-on policy, or they've invested all their money. Sometimes however there's no obvious reason for them not to re-invest, and it can raise concerns among potential investors, who may wonder why those closest to the business are opting out.
- High employee turnover – can mean one of two things – one better, one worse, both bad. Either the founders waste time and money hiring the wrong people(this is the better option); or the company culture is broken and employees are simply jumping ship.
- Small market size – this is one of the areas where size really matters. Most VC funds are looking for “fund makers” – companies that can return the total size of their funds. Let’s skip the math behind it and assume that to be a fundmaker for a fund a company needs to reach EUR 100M in revenue – it’s relatively easier to do on a EUR 2B market than on EUR 200M one.
- Slow progress – to become said fund maker, a company has to grow many times over in a limited period of time. Historical growth is an excellent indicator of whether the company is able to do that. And progress is measured not just in MRR growth, but also in geographic expansion, product development, organizational growth and many other metrics. Let’s remember that VCs have seen hundreds (or thousands) of startups – and have as many benchmarks.
- End of the runway and/or struggling to find investors – I'm sure most VCs are very nice and sympathetic people - just not when it comes to investing. Running out of money not only shows poor planning skills but also signals that others have seen your deck, talked to you, and, for whatever reason, decided not to invest.
One more important thing to consider – and this is not a red flag in itself – is the fit with the fund's investment criteria. Most VCs are very open about what they invest in, and you're unlikely to get more than a generic feedback email if you don’t spend 30 seconds googling the investor you’re cold-mailing.
