Walking Away from Potential Investors

Fundraising is hard – and, for fundraising entrepreneurs, walking away from an interested investor is a tough choice. However, sometimes it is the right choice.

Investors in a startup can be a great blessing or cause significant damage. As a result, fundraising entrepreneurs should consider carefully whether to accept an investment, even when spending a tremendous amount of precious time and effort to raise money. In other words, entrepreneurs should remember that walking away is always an option – and sometimes it is the right path.

Decades of raising money has exposed me to scenarios where I walked away from a potential investment or later wished that I had. So, let’s review some scenarios that fell into this bucket as a learning exercise for those who may not have run into these situations yet in their own fundraising journeys. I have learned from others’ experiences – and I hope others can learn from mine.

Here are examples of situations where an empowered entrepreneur should consider saying “no” to certain investors, even when it seems to make the fundraising journey longer and harder:

• An Investor Whose Relationship Matters to the Entrepreneur: Tradition has it that the earliest money raised by a budding entrepreneur is from “friends and family.” While it is undoubtedly the case that many entrepreneurs have raised money from those who are willing to support them, perhaps regardless of the strength of their plans, it helps to remember that a high percentage of startups fail, and that losing money invested can damage the relationship between the entrepreneur and their friends and family. I have chosen to consider carefully the startup industry sophistication of my relatives and friends before approaching them for investment because I value my relationships with these special people in my life, and I do not always find it appropriate to ask them for investment if my startup world is not their scene.

• An Investor with a Bad Reputation: Once, to my horror, I learned that an investor I had allowed into my earliest fundraising round had a bad reputation amongst many other investors in my local ecosystem. This became clear when potential investors who were getting serious about investing in later rounds and who started asking about who else was already invested began passing when they learned that this investor was already in. Their words were variations on “While I like what you are doing, I won’t invest alongside that investor due to my other past experiences.”  After losing several investors that way, I became much more careful in checking on potential investor reputations with some of my trusted insiders before accepting them onto my companies’ cap tables. Later, I discovered the same bad reputation problem can happen with VCs who do not collaborate well with other investors.
  
  
• An Investor Inexperienced in Early-Stage Investing:  While everyone must start somewhere, I am careful to listen for the experience level of a potential investor just beginning the path of early-stage investing. Are they collaborating with other experienced early-stage investors to get up the learning curve? I started applying this test after a painful learning experience with an investor who thought taking an early-stage startup with virtually no hard assets through bankruptcy was wise because they had invested in a convertible note and were “higher” on the cap table than the equity investors. This is a terrible misapprehension that evolved from their experience in real estate investing – and they would not listen to other experienced investors who tried to help them understand the differences. This cost my startup a great deal in legal fees to navigate.
  
  
• An Investor with a History of Violating SEC Rules: When a potential investor from another state who did not have close relationships with my other investors’ was expressing excitement about investing substantially in our open round, we did some Google searching (an investor due diligence practice when meeting new potential investors) of his and his firm’s names. We were concerned when we discovered that he had been convicted of violating SEC securities regulations, and, as a result, we wound down those conversations since we did not want to end up with questionable investors on our cap table since I had already learned how damaging investor reputations can be to other fundraising efforts.
   
• An Investor with a Consistent Propensity for Swapping Out Startup CEOs: Some VC investors demonstrate a pattern of swapping out CEOs. While sometimes this is appropriate and done in collaboration with the founding teams when a VC has a consistent pattern of initiating CEO changes across their portfolio, that raises questions the founding team should consider when evaluating potential investors. Sometimes, this is difficult information to find, but asking about investor reputations from others in the startup community can be revealing. It is not only the startup team that should provide references!
  
  
• An Investor Demanding Complex and Punitive Terms: Sometimes, I have had the opportunity to compare competing term sheets from different VCs. Similarly, when negotiating a terms sheet, I always seek to avoid complex or punitive terms, opting for the simple, plain vanilla set of terms whenever possible because that positions the company well for future fundraising rounds. Complex terms tend to create the conditions for additional complexity in future rounds.
  
  
• An Investor Failing to be Transparent About Who is Making Decisions: We had a VC managing partner who was deep into due diligence but kept changing the terms after talking to his primary investor. After several go-arounds like this, we opted to decline the term sheet because it was becoming clear that the VC was not in a position to make commitments, and we were not allowed to talk to the actual decision-maker. Not a good foundation for a long-term partnership!

• An Investor Who Does Not Understand the Risks of Early-Stage Investing: Sometimes, a potential angel investor has given me reason to politely refuse their investment, such as when one asked if they could liquidate a rental house they owned to invest in a startup. Clearly, these investments had very different risk profiles, and the ask raised concerns about how well the potential angel understood the risks of what they were undertaking with an early-stage investment.

The risks associated with accepting investors like these can far outweigh the benefits of taking their investment. Remember that once investors have invested in your company, they will be part of your journey until exit because there are very few ways for investors to liquidate their investment in a closely held private company. That reality can have substantial negative consequences that may be unforeseen. So, if you spot red flags like in the examples above or other red flags, consider whether the wise course would be walking away. You are not required to accept an investment just because someone wants to invest.