Five red flags investors look for in evaluating startups

In a more competitive funding landscape, angel investors are critically evaluating startups with a more ruthless lens than ever. It is crucial that founders don’t get their fundraise off to a false start by having something that is a fundamental red flag for a potential investor. Understanding and addressing these common concerns can significantly boost a startup’s chances of securing funding.

We spoke to angel investors and experts on our network to get their take. From a lack of passion and commitment to inadequate industry knowledge, we delve into the key indicators that may raise doubts in the minds of angel investors.

1. Lack of passion and commitment

Angel investors want to see founders who are deeply passionate about their business idea and are committed to making it a success. If a founder appears disinterested, lacks conviction, or demonstrates a lack of dedication, it can raise concerns.

According to Xavier Ballester, Director at Angel Investment Network’s Startup and Property Divisions: “Investors want founders that are passionate and committed to their startup. This comes through so clearly from the investors I speak to and is more critical than ever in today’s tougher funding landscape. Investors want to see that the founders they back are willing to work hard, make sacrifices, and persist through challenges.” 

2. Inadequate industry knowledge

Investors expect founders to possess a deep understanding of their target industry and market. If a founder demonstrates a lack of knowledge about key industry trends, competitors, or customer needs, it may raise doubts about their ability to navigate and succeed in the market.

According to experienced investor Noel Duigan: “The lack of experience of the founders, or their team is the main red flag for me. Often you are investing in the founders rather than the company. If the founders don’t have any skin in the game, that’s pause for consideration.”

Noel Duigan
3. Not having your finances in order

Founders asking for too much money can be a red flag for investors. Similarly overly optimistic or unrealistic financial projections can also set alarm bells ringing. If the numbers don’t align with industry benchmarks or seem too inflated without a clear justification, it may indicate a lack of understanding or a willingness to mislead. 

 According to Ballester: “It it really important to be realistic about valuations, particularly in the present climate. Many businesses are now needing to re-evaluate their plans and potential funding pathways. What was 8x last year may now only be 5x. It is vital valuations are rooted in fact, not fantasy. You will be far more likely to gain the interest of prospective investors with this approach.”

According to angel investor and acclaimed author David Pattison: “Some pre investment red flags for me include: When the opening conversation is just about how much and when? Also if a team that is rewarding itself too well on other people’s money.”

David Pattison
4. Lack of traction

Investors look for evidence that the startup’s product or service has market demand and validation. If a founder cannot demonstrate any customer traction, industry interest, positive feedback, or a well-thought-out go-to-market strategy, it may raise concerns about the startup’s potential for success.

Duigan says: “Lack of traction in their space will often mean stalled growth and is a red flag.  Have a look at their runway and burn rate, you don’t want it short and wide. That could spell either bad margins or high overheads.”

5. Poor communication skills

Effective communication and active listening are essential qualities for startup founders. If a founder struggles to articulate their ideas clearly both in person and through vital communication tools like the all important pitch deck, this is a big red flag. Similarly if they fail to actively listen to feedback or input from others, or exhibit poor interpersonal skills, it may hinder their ability to build relationships with investors and stakeholders.

According to Marla Shapiro, CEO of HERmesa – a UK based angel syndicate: Investors want a super clear, concise story that gets us excited to ask more questions and set up the first call.  As one of our members says, “pitch decks are meant to be commercials, not novels!”   

Marla Shapiro

According to Addy Windsor-Clive, investment manager at Regenerate Ventures: “A pitchdeck that isn’t in a suitable format asking the typical questions a VC would ask is a red flag for me.”

Ultimately people buy people and Shapiro puts it succinctly:  “We really try to invest in nice people.  We are putting our own money into the business and we are going to be with these founders for the next 3, 5, 7 years.  Life is too short to invest in jerks!”

While these red flags can raise concerns, it’s important to stress that they are not necessarily deal-breakers. Founders can address these issues and improve their chances of securing investment by being transparent, receptive to feedback, and continuously learning and improving.

The reality is many won’t learn. But by recognising and proactively addressing any red flags, startup founders can ensure they can have a head start in attracting angel investors. Putting rocket fuel into their fundraising strategy and turning entrepreneurial dreams into reality.

Join the world’s largest angel investment network, where global angel investors meet the great businesses of tomorrow.