How To Protect Yourself From Crooked Founders

Most people in the startup ecosystem feel that it is the funders who have all the clout – after all, they’re the ones who have the money. There are far more entrepreneurs who are chasing money as compared to the number of deep-pocketed investors looking for startups to fund, which means that the balance of power is in the hands of the investors, who can pick and choose whom to give their money to.

It is often perceived that they’re the big bullies in the room, because they’re the gorillas, and who can make entrepreneurs dance to their tune.

When Entrepreneurs Fail

However, the reality is quite different after the cheque has been signed. Once the money has been transferred to the founders, things change dramatically. Since it’s the entrepreneur who is running the company, the investors have very little control. The only information they have about how the company is performing is what the entrepreneur chooses to share.

The trouble is that when things are going badly, entrepreneurs will not share information; or will repackage it in such a way that they don’t tell you what’s actually happening. Sometimes this is because they’re ashamed of the fact that they’re not being able to deliver.

They will gloss over the inconvenient truths, which means you often have absolutely no idea about what’s actually going on in the company.

When Entrepreneurs Choose To Be Secretive

This is what makes startup investing such a risky business. No matter how much you talk about the role of governance and the importance of openness and transparency in sharing information, it’s pretty much up to the entrepreneur to choose to do this – or not to.

We now have three founders who have taken us for a ride, but you only realise this after the event, when the company is on the verge of having to shut down, and this can be a painful lesson.

Once you realise that the founders have been hiding information from you lose trust in them, and the company is then headed in a downwards spiral. It’s very hard to repair the trust deficit, and things usually become progressively worse, because founders and funders start blaming each other and begin talking at cross-purposes.

Just because I’ve burned my fingers doesn’t mean I am going to stop investing in startups. Yes, I’ve been cheated by founders, but this doesn’t mean that all founders are crooks.

Just like I’ve had bad experiences with these entrepreneurs, I’ve had some extremely good experiences as well.

Learnings

For me, the important lesson is to learn from these mistakes and try to incorporate safeguards, checks, and balances, so that the chances of this happening will go down in the future. Now, I understand that not all of this is in my control and that quite frankly, if a founder does want to take me for a ride, it’s always going to be possible for a crooked entrepreneur to do so.

However, founders also need to understand that if they do this, their actions will have consequences and that investors can and will fight back. Yes, we will pull the plug on the company; and will also make sure that the world becomes aware of how crooked that entrepreneur is. You may have cheated me, but I won’t let you cheat someone else.

So how can I prevent this sad state of affairs? How can I check the integrity of the founder? How do I stress test it? This is the million dollar question, and is a tough nut to crack!

As angel investors, we want to be supportive, and we assume positive intent, but this can be an error because it’s always possible to fool some of the people some of the time.

In any case, there’s little point in recriminating over mistakes. Rather than blame the founder for taking me for a ride, I blame myself for allowing myself to be taken for a ride. After all, it’s my money, and it’s my responsibility to invest it responsibly!

In Conclusion

So what have I learned? I need to spend a lot more time, checking and counterchecking personal references, before agreeing to back a founder. When investors fund a startup, in effect we are hiring the founder to run the company, and we need to learn to use the same techniques which HR departments use to hire Grade A CEOs.

Often you will need to go by your gut feel. Do you trust him? Do you respect him? Will you happy to have him over for dinner ? How does he respond when you challenge him? Is he coachable?

And if the answer is no and something smells bad, then I’d suggest you walk away, no matter how attractive his business plan may be; or how polished he seems; or how great his resume looks.

As Warren Buffett said, “In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.”

[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]

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