Why founders lie
We are lucky enough to live in a world where when an entrepreneur has a business idea, and they can find VC and angel investors who are willing to make a bet on them and their business idea and hopefully succeed. Sadly there is a problem that comes up, which hurts the entire world of investing and entrepreneurship. These are the half-truths that are told to investors to keep their worries at bay but suddenly snowball into an avalanche of lies that can hurt so many. We will look at how and why this happens and what can be done to prevent them.
Why does it happen?
This is usually quite a simple answer. The entrepreneur is afraid of the repercussions if they tell their investors the truth, and there is not enough oversite of a startup to discover the falsehood before it is too late. The investors don’t demand more information when they should (from the very beginning), and the entrepreneur initially looks at reporting requirements when not required as an annoyance and thus does not provide the information that could have identified a problem earlier.
There are a few red flags that seem to be common among the famous start up deceptions.
· Extreme Secrecy- When it comes to business, secrecy is essential. You don’t want potential competitors to know what you are doing and beat you to the punch. However, investors need to know what is going on. Investors don’t want secrets getting out either; it is against their own best interests.
A company that is too secretive is a red flag that something nefarious may be going on.
· The Math Doesn’t Add Up- A simple gut check of the math behind any investment should be performed. If someone is claiming that billions can be made in the future, the question should be asked, how much upfront capital needs to be invested first, or what volume of sales are required before those billions can be obtained? This number should be relatively easy to identify.
Also, if there is any physics, biology, or other science related to an invention, such as how much blood is needed to conduct tests, how much energy is required to remove water from the air, how much sun energy/meter hits the earth, etc. it is worthwhile to make sure these numbers add up as well.
· Only One Source of Info- SImilar to secrecy if there is only one source of info that an investor can rely on, usually a charismatic leader, about a project, then concerns should be heightened. This will usually be talking about glowing terms for the future rather than the hear and now of the company.
Most Common Deceptions
Most of the time, entrepreneurs are not trying to con their investors; they have a genuine belief in the product or service they are promoting. They are only looking for help to make their dream a reality. However, there are exceptions to these good people:
· The Fantasy- Selling the dream is a common tactic of a fraudster. Something bigger than life being offered to the investor who wants something better (money, fame, or sex) than what they currently have, if it si too good to be true it usually is.
· Big Names- Be weary of the name-dropper. Just because they know someone does not mean their idea is a good one, and when they are driving a Mercedes/Ferarri and asking for your money, be even more concerned.
· Fear Of Missing Out(FOMO)- Making hasty decisions to jump into an investment is the wrong thing to be doing. If the entrepreneur is pushing you to invest now or miss out, it may be better to miss out or wait until the next round of funding. Usually this is the sign of a Ponzi scheme trying to get money fast before the house of cards tumbles
Best Practices for Prevention
We want to help keep any investor safe, and these actions can be taken to prevent most of the bad mistakes in startup investing.
· Never risk more than you can lose- Even the best ideas can be unsuccessfully implemented, or the unforeseen can happen. As with all investing, make sure you never make an investment larger than you can afford to lose. When you risk too much you can lose everything and this is never the right way to invest.
· Always ask questions and demand answers- From the very beginning, make sure to get all your questions answered to your satisfaction. If there are projections or current expenses/sales, make sure to check those and find out where the numbers come from and how they were obtained. Just this simple procedure will allow you to be on top of most issues as they arise.
Angelspan.com, a startup research firm, conducted an online survey of 46 US investors and advisors who cover 7,612 startup companies, 83% of the investors agree that companies that communicate regularly perform better; however, only 18% of early-stage startup companies provide monthly updates, demand regular updates. Information should be required consistently with a schedule that depends on the company’s maturity, size, sales, and new funding rounds. Reporting should be easy for both the entrepreneur to produce and the investor to monitor, and be straight to the point.
· Independent testing- Many of the start up frauds that were perpetrated could have been realized sooner if independent testing had been conducted. These can be demanded as part of an investment.
· Make sure to have access to all the team members- If you are making a large investment talk to all of the people on the team and make sure to continue this communication as the project progresses. This will help you to confirm progress and be a gut check to any charismatic leader who may be trying to deceive.
· Don’t fall for flash or make rash decisions- Big names and impressive leaders should be questioned on a regular basis. There may be a reason why they are driving an expensive car or have high priced dinners with your money. Don’t let them convince you into an investment that is a bad choice.
If you are an entrepreneur or an investor, as soon as the investment is received, there is an obligation to report; these reports allow investors to know how the company is performing and how their money is being used. If things are bad or going in the wrong direction, it is much better to let investors know early; the course can be corrected, and the issues are more likely to be solved, or the decision to shut down the project may be chosen. It is much better for both the entrepreneur and investors to abandon a bad idea than to throw more money after a bad investment or for the entrepreneur to end up in jail.
Honesty is the best policy.