Angel Investing Case Study: When to Walk Away from a Deal

Neil here.

Yesterday, I explained a little bit of the reasoning behind my decision to hold off on featuring new deals for the past several weeks.

And while I’m excited to announce that the “dry spell” will be over soon, I know you probably have some more questions about what exactly goes through my mind when I’m analyzing a deal that I ultimately pass on.

So today, I want to go through a case study of a company that I recently decided not to feature – and exactly why I did it. I won’t name names, of course – I’m not in the business of shutting down aspiring entrepreneurs or dragging people through the dirt.

Still, my hope is that it’ll help you understand more about the inner workings of our due diligence process… and that you’ll be able to apply some of its lessons to your own due diligence in the future.

Let’s dive in.

Perfect on Paper: What Initially Caught My Eye

This is how it always goes: when you first encounter a company seeking funding, you immediately experience a kind of gut feeling, good or bad.

75 percent of the time, my gut feeling says “no,” right out of the gate. The other 25 percent prompts me to dig deeper.

What caught my eye about this company at first was its immediate relevance. It provides both hardware and software to solve a problem that’s been massively exacerbated by travel restrictions and stay-at-home orders.

It also has some pretty good numbers – tens of thousands of customers, over $5 million in revenue last year, and pretty good engagement numbers, too. The founder has multiple exits under his belt; the company has a partnership with a giant in its field; and much of its product is protected by IP.

It sounds perfect on paper, which is exactly why I initially liked it. But a company’s fundraising page is not enough to base an investing decision off of – not even close. You need to get the founder on the phone… or you need somebody else to do it and report back.

And that’s exactly what I did.

The Truth Comes Out When You’re Face-to-Face

Well, we weren’t face-to-face exactly, but we did have a long conversation on Skype. It was going well at first, but as you know by now, it doesn’t take me very long to get to the numbers.

And that’s where I found myself running into obstacles.

The founder I spoke to had a great track record, but he wouldn’t tell me how much his previous company was bought for. In other words, he wouldn’t give me a benchmark as to how successful the venture was.

In Silicon Valley, companies are sometimes purchased for pennies on the dollar – and the founder can still call that a purchase. Personally, I’m not buying that terminology unless I have some good numbers to back it up.

But the withholding of critical intel didn’t stop there. I also was not allowed to know how much money had been put into the company to date, nor how much the founder had personally invested.

These are huge red flags for me. The only reason a founder has to withhold information like that from an investor is because he’s raised too much money and achieved too little with it. And if they won’t even disclose their own investments… It probably means they haven’t made any. In my experience, a founder with no skin in the game is much less likely to succeed.

The Final Straw

By this point in the conversation, I’ll admit I was getting a bit irritated. Because here’s the thing: companies raising money, especially those raising on crowdfunding portals, are asking other people to put their hard-earned dollars to work for them.

That is a big ask, no matter how nominal the investment may seem. The way I see it is: how can you expect hardworking people, many of them complete strangers, to funnel a million dollars your way if you won’t even share the hard facts with them?

As an angel investor, it’s important to remember that all young companies have positives and negatives to them. One bad number isn’t, and shouldn’t be, a dealbreaker. But a founder who’s secretive before they even have your cash in hand? That’s another thing entirely.

When I did get to the heart of some of the company’s numbers, I found something discouraging. This startup was proudly boasting about a massive boost in their numbers recently – a boost they saw as a direct result of the coronavirus outbreak.

Emotions aside, here’s what I don’t like about that: it basically means their recent success could be fleeting. If the only thing boosting your numbers is an extraordinary and unprecedented situation the world hasn’t seen in more than 100 years… well, that doesn’t give me a lot of confidence that it’s sustainable in the long term.

How We Left Things

It’s always disappointing when a promising lead doesn’t turn out as you’d hoped. This was especially true in this case, because I hadn’t come across a great opportunity in a while and was really hoping I’d come away with something amazing to show for it.

But that’s just the way things go sometimes in the angel investing world. And at the end of the day, I wasn’t going to feature a startup on our Network if it didn’t check all my boxes.

So I did what every angel investor has to do from time to time… I thanked this founder for his time and moved on.

And you know what? I could very well be wrong about this one. There’s really no telling this early in the game. Think of all the investors who passed on Airbnb… On Uber… On billions of dollars in returns. It happens all the time.

But when you’re looking at a truly incredible company, you’ll know it. When I hold up this company against one that recently passed the Research Team’s rigorous criteria… it really doesn’t compare. Again, on paper, they weren’t so different – star founder, cool product, the works.

The difference is that the startup we did feature shared every detail they could with us. I immediately felt that there was a sense of mutual trust and respect – which, to me, is incredibly important. And the best part is that their product caters to an audience that’s not going anywhere. Their numbers shouldn’t fluctuate wildly based on current events.

Trust and stability go a long way for me. Combine them with an awesome founding team, and I’m pretty much sold. Incidentally, the startup we decided to feature is about to close down their raise – there are just two days left. Click here to learn more.

What this all boils down to is this: The best way to move forward and max out your batting average is to stick to a strategy, do your due diligence, and above all else, trust your gut. This time, my gut said no – but only after I’d spent multiple hours digging deeper.

The lesson to take away is, as always, to do your homework. Even if you pick a few bad apples along the way, you’ll most likely come out in the positives – and there’s a good chance you could come out with life-changing wins, too.

That’s all I have for today – but we’ll talk soon.

Until next time,

Neil Patel