From excessive dilution to aggressive clauses, corporate investors look for these red flags when scouting new investments.
Pitching their vision to potential sponsors is one of the crucial skills for a founder — never more so than now, as the valuation bubble of 2021 has popped and investors have pulled back from deals. But startup founders still make common mistakes when they showcase their business plans.
Founders are also more likely than ever to be pitching to corporate investors, who are present in around a fifth of all startup funding rounds these days, and who have stayed steadier in the market while the rest of VC has retreated. Corporate investors have their own characteristics, and will be looking for slightly different nuances in startup pitches.
To help startups avoid striking out with this corporate contingent, we’ve put together this list of the biggest red flags for corporate investors when they consider investing in startups:
1. Heavy equity dilution early on
It is a big warning sign when founders have taken on a lot of money from an angel investor early on. It erodes investors’ potential returns in future rounds and can sap founders’ commitment if they only have a small share in their business.
It can also impact how much control and flexibility founders will have to develop their startups.
“Founders getting demotivated because they are diluted is a problem,” says Pedro Rodrigues De Vasconcellos, vice president of ventures, innovation and partnerships at education company Pearson.
Having a large angel investor on the cap table also puts off outside investors because it “can distort the board decision-making process,” says Vasconcellos. This could include pressure to sell the company or change executives.
The outsize influence of a large investor could also lead to a lack of collaboration in future funding rounds, investors warn.
“It’s super common these days to found pre-seed and seed startups that have raised significant money from angels without proper strategic analysis of the consequences of giving up too much stake too early to fund the initial stages,” says Eduardo Amadeo, partner at venture capital firm Overboost.
2. Founders who are unaware of the competition
Founders who haven’t looked into the competition, or who are dismissive of competitors, is more common than you would think. “Not being aware of others in the space or brushing off the issue completely” is a red flag for Alisa Band, senior investment manager at Henkel Tech Ventures, the corporate venture arm of Henkel, a maker of adhesives, sealants and coatings.
Founder who leave out details of how their startup differs from others in the sector and how it will compete effectively in the market is a big no-no.
3. Aggressive clauses in the term sheets
Corporate investors keep a look out for clauses written into financing deals that give other investors too much control over the startup. These include right of first refusal – the right to have first dibs on any sale of shares; call options – the right to buy shares at a set price below the market price; and commercial exclusivity – the sole right to enter commercial agreements with the startup.
There is often a misconception that corporate investors are the ones pushing for clauses that will give them rights over the portfolio company, but GCV’s research indicates that only a minority of corporate investors will ask for any special rights from the startups they invest in. And they take a dim view of others insisting on those rights.
Strategic investors can view these types of clauses as crimping the potential payback they seek from investments.
4. The “part-time” founder
Founders who treat their startup like a side gig will not get much sympathy. Startup entrepreneurs who are not fully committed to their business full time are actually quite common, say investors.
“Usually, it happens when the company has three or more founders, and one is not fully committed,” says Pavlos Dias, head of corporate VC at Faber Castell. He also is wary of single founders who try to build the business on their own without a partner to help.