Not All Angels Are From Heaven

The best way to screen for bad angels is to determine the primary underlying motive of the investor as not all angels are exclusively in pursuit of asymmetric upside. Bored professionals, retired entrepreneurs, wannabe venture capitalists and wannabe CEOs often seek to achieve their ambitions or end their ennui through “passive” investments. Moules tags these types as meddling angels: They are manageable and considerably less menacing than the chief executive angel whose “real agenda is to run your company from the back seat. They are very intrusive and will push you to make decisions and commit resources that will put your company at risk.”

No entrepreneur is looking for a shadow CEO and should thus be wary of the shark angel, a bottom-feeder whose underlying motivation is to take advantage of a business balance sheet, poor counsel or negotiation skills, and hopes to inevitably control the company, intellectual property and other assets. Perhaps counterintuitive to some, these investors are the worst to co-invest with as they are likely to have no regard for your interests in their attempts to marginalize management and hijack the company.

Entrepreneurs and syndicate investors alike should be on the lookout for red flags:

• Listen carefully to the investor to determine motive. Warning signs can often emerge in the early meetings and certainly during the diligence and term sheet process.
• Avoid conflicts of interests. It is appropriate and recommended for investors to hold entrepreneurs accountable for performance thresholds, but those who insist on including investor-centric punitive measures in the term sheet for adverse events beyond the control of the company are likely to pounce at the first opportunity as they may be equally attracted to the venture’s downside as its upside.
• Be wary of younger and retired investors. They may consider the target venture to be their new full-time project.
• The larger the investment, the more diligence you should perform on the investor. Ask the angel to name the most recent prior investments he has made and then talk to the company. Consider background checks.
• Consider personality. The marriage metaphor may be mundane, but nonetheless accurate.
• Know-it-alls are an easy red flag, particularly those who don’t abandon their position in the face of contrary evidence. Investors who are persistently wary of the truth are exhausting and poor team members.
• Avoid those who preface their investment commitment by reciting a laundry list of perceived negatives regarding the venture’s business model or investment terms, but nevertheless agree to invest. Ideal investors are partners who invest on the merits of the opportunity—not in spite of them.

Entrepreneurs desperately seeking capital are prone to ignore these red flags. Advisors, though, are likely to be more aware of warning signs as bad angels have personality traits that resemble those of bad clients.