The Red Flags VCs Avoid At All Costs

Hey readers! Welcome to EH weekly, where you can look forward to insightful lessons and practical takeaways delivered to your inbox every week.

In this week’s edition, we answer two questions we get all the time:

  • What do VCs look for in a founder? 👍️ 

  • What red flags do VCs avoid like the plague? 👎️ 

Q1: What do VCs look for in a founder?

“I was always so sure I was on the cusp of having a billion-dollar gold mine, they were equally sure I wasn’t, but they were always right and I was always wrong. How?”

The answer turns out to be pattern recognition. Aaron Dinin is now a couple of decades into his entrepreneurial journey and has met thousands of entrepreneurs. He’s learned that identifying the founders who seem like good investments is surprisingly easy.

Here, Dinin lists the three most important success signals venture capitalists are looking for in the founders they ultimately fund:

  1. Significant accomplishment as a teenager — Nobody makes someone build a startup. Everything you do as an entrepreneur, you do because you want to do it. Investors know this, so they look for founders who are self-motivated enough to pursue big, difficult goals on their own.

  2. Obsessed with a specific problem — Many entrepreneurs are building startups because they like the idea of being entrepreneurs and then search for a problem. However, founders who are worth funding are founders who don’t care about being entrepreneurs. Instead, they’re obsessed with solving specific problems.

  3. Disinterested in most “normal” things — The founders who are most likely to succeed tend to naturally prioritize their startups above other things. For them, doing so isn’t some sort of punishment or difficult challenge. The truth is, they’d rather be working on their startups, and that’s a big part of what makes them more likely to succeed.

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Q2: What red flags do VCs avoid at all costs?

“My angel groups typically invest in roughly 1 out of every 100 applications. That means 99% are passes.”

DC Palter has listened to 100s of pitches for early-stage startups, and it’s obvious to him within a minute if they are no-goes. Thankfully, he also knows why so many were instant drops.

Here are 6 reasons:

  1. No product yet — For 99.997% of startup founders, investors want to see a product, not an idea. Getting to the “in-revenue” stage is, without a doubt, the most important milestone for finding investors. 

  2. An opportunity too small — There are a lot of fantastic businesses with revenues under $50M. Even $10M businesses can be a goldmine. Niche products have a much higher chance of success than shoot-for-the-moon venture businesses. But, niche businesses are not viable venture investments.

  3. Corporate structure — LLCs and S-corp structures are perfect if the goal is to build a profitable small business without outside investors. But if you want investors, the company needs to be structured as a C-corp.

  4. Deal structure — The only structures most investors will consider investing in are preferred shares, post-money SAFE with valuation cap and convertible note with valuation cap, discount, interest, and a maturity no longer than 24 months.

  5. No competitive moat — The most common reason startups with a great product in an exciting market fail to resonate with investors is that they cannot protect the business from the inevitable competition once they gain attention.

  6. Valuation is too high — If the valuation doesn’t match the stage of the company, the risk profile, and the market potential, I’ll invest in something more attractive.

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