Due Diligence Should Go Both Ways
When you’re grinding through yet another fundraising cycle, it’s easy to fixate on one thing: getting investors to yes. You polish the deck, rehearse the pitch, answer their questions, and mentally tick off items on their due diligence checklist. But here’s what I learned the hard way over 25+ years in the startup ecosystem: while you’re selling your vision, you should be evaluating potential investors just as rigorously.
The pressure to secure capital makes this mistake almost inevitable. You’re juggling product development, customer acquisition, team management, and a dozen other priorities. Fundraising feels like an episodic distraction—something you have to pause everything else to accomplish before getting back to “real work.” And because you interact with investors far less frequently than with your team, it’s tempting to treat any interested investor as a win.
Don’t fall into this trap.
Why Investor Due Diligence Matters
Yes, investors have every right to conduct thorough due diligence on your startup. They’re evaluating your growth potential, capital efficiency, business model innovation, team capabilities, and ultimately whether you can scale profitably. As diligence progresses, investors will dig even deeper with extensive legal reviews and background checks on key team members.
But this is a two-way street. Not all capital is good capital. An investor-startup relationship typically spans years, and a bad match can create costly problems you never anticipated. Once an investor is on your cap table, they have rights—and those rights can become weapons in the wrong hands.
The War Stories You Need to Hear
Let me share some cautionary tales from my own experience and those I’ve witnessed:
The Investor with a Bad Reputation
As a first-time CEO, I didn’t know that checking investor references was standard practice. When an experienced angel investor offered to lead our round, I was relieved and grateful. I accepted without asking around.
Big mistake.
In subsequent rounds, multiple potential investors backed out the moment they saw his name on our cap table. Turns out, he had a toxic reputation in the startup community. Over the years, he tried to torpedo a critical venture-led round, repeatedly pushed to sell the company prematurely, and sucked up a ton of our Board’s time. All of this could have been avoided with a few reference calls before I let him invest.
The Invisible Investor
I once had an attractive term sheet in hand from what appeared to be a sophisticated investor. But as we moved toward closing, I realized I was dealing with a proxy—someone managing the investment for an entity that remained completely opaque. Every conversation felt like negotiating with the Wizard of Oz, with constantly shifting requirements and no clarity on priorities or alignment with other investors.
It was hard, but I walked away. Early-stage startups aren’t liquid public companies with anonymous shareholders. You need to know who’s at your table.
The Inexperienced Early-Stage Investor
Several times I’ve encountered investors whose wealth came from real estate or other traditional assets who fundamentally misunderstood startup investing. In one case, an investor treated our convertible note like actual debt—fixated on being “at the top of the liquidation stack”—and tried to block our next funding round so they could cash out the company’s “assets.”
What assets? Our IP and market opportunity aren’t like selling a building.
Some of these situations I caught early enough to decline the investment. Others absorbed enormous amounts of time and legal fees as we tried to educate someone who simply didn’t understand the asset class. And when inexperienced investors don’t reserve capital for follow-on rounds, it sends a terrible signal to future investors that your existing backers don’t believe in you.
The Investor Who’s Actually a Scam
As a startup CEO, you become a target for constant investor outreach. Most are legitimate prospecting efforts from analysts at real firms. But some are sophisticated scams designed to fleece desperate founders.
Watch for red flags: interest that seems too good to be true, unusually large investment offers with minimal diligence (a couple meetings for a multi-million-dollar check isn’t normal), requests for finder’s fees or commissions (check with your lawyer—these are often legally problematic), and any mention of cryptocurrency in the payment structure. If they want to invest in crypto, they can do that themselves without your involvement.
Be especially wary of investors offering “better terms” than everyone else who is investing at the same time. That’s usually snake oil, although it can happen if you manage to secure two competing lead investors.
Your Investor Vetting Playbook
Here’s how to conduct due diligence on potential investors:
Evaluate Their Questions
Sophisticated investors ask lots of questions. They have a clear investment thesis and dig deep before committing capital. Unless they claim to be following a lead investor you already know has done their homework, if someone’s rolling through diligence superficially—that’s a warning sign.
Do Your Homework Online
Run basic internet searches on potential investors. Check for SEC violations or reputational issues. Look them up on LinkedIn and see if you have mutual connections who can provide insights. Verify what they’ve told you about themselves. No digital footprint at all? That warrants serious investigation.
Ask for References
Once an investor shows real interest, ask them for references from other portfolio company CEOs. Experienced early-stage investors expect this and won’t hesitate to provide them. Then actually call those references and ask questions about what the potential investor is like.
Leverage Your Existing Investors
Your current investors care deeply about who joins the cap table. Ask them what they’ve heard about a potential new investor. Have they invested alongside them before? What’s their reputation? Your investors may also have access to Pitchbook profiles that can reveal whether someone’s track record matches their claims. A suspiciously thin Pitchbook profile is a major red flag.
Be Extra Careful with Cold Outreach
When someone reaches out cold claiming to be an ultra-high-net-worth individual or family office, be skeptical—especially if they cite “privacy concerns” for their opacity. Research every aspect of their presence: scrutinize their and their advisors’ websites for inconsistencies, verify their portfolio companies are real (check LinkedIn profiles, Pitchbook data, and domain registration dates), and cross-reference everything they claim.
If things seem to be moving too fast or too easily, pump the brakes. Ask your investors to investigate. Ask your lawyers to dig. Talk to other entrepreneurs about their experiences. The scams out there are incredibly sophisticated, with multiple players, layered websites, and polished presentations designed to exploit desperate founders.
When to Walk Away
You won’t always catch problem investors before they invest, but you should certainly try. And here’s the hard truth: you need to be prepared to walk away, even at the final hour, if something feels off.
I know how this sounds. When you’re running low on runway and an investor is offering the capital you desperately need, turning them down feels impossible. The pressure is immense. But remember: once they’re on your cap table, they have rights that last for years. They can block future fundraising, complicate acquisitions, and make even a shutdown more difficult. And, if they are a scam, they may steal what precious time and capital you do have and damage your reputation in the process without bringing anything to the table in the end.
Bad investors become the stuff of nightmares that haunt you for the life of your company. The pain of turning down capital now is almost always less than the pain of dealing with a toxic investor for years to come.
Building a successful company requires assembling the right team of stakeholders. That includes your investors. Treat fundraising like hiring: be rigorous, check references, trust your instincts, and don’t compromise on fit just because you’re under pressure.
Your future self will thank you.
