Neil here.

The harsh reality of startup-land is that the majority of companies fail. In fact, 90% of startups won’t make it much longer than their first or second raise.

However, it’s my belief that most startups fail because of completely preventable errors in their business models and management. And startups that can circumvent these problems have the biggest shot at success in the long run.

If you’re thinking of investing in a startup, and it has any of these red flags, it’s best to pass and use your investment capital elsewhere…

Mistake #3: A startup that’s capital-inefficient

I only invest in startups with business models that scale well… because scalability points to one key characteristic of every successful company I’ve ever backed: capital efficiency.

The most important requirement of a company that scales well is that it does not need proportionally more capital as it continues to grow. In fact, you want to look for companies that need less capital as they expand.

Of course, every early-stage startup will need to raise more money as it grows larger. But if that company’s profit margins aren’t growing steadily alongside the capital it’s raising, that’s a huge red flag.

You see, a company with razor-thin margins will inevitably have to hand off equity to more and more stakeholders to keep the cash flowing.

For you as an investor, that’s a problem.

The more people who own shares of a company, the more diluted your own shares (and your prospect of substantial returns) become.

That’s why I like to bet on startups producing technology like apps and software… companies that exchange significant up-front costs for wider margins in the long run.

This type of tech doesn’t require massive sales forces or manufacturing capabilities to run. The product can expand rapidly without taking on long-term overhead costs, ultimately giving investors the biggest bang for their buck.

Mistake #2: A startup that’s teetering based on a single point of failure

As an angel investor, you want to make sure that you back companies in big markets with massive growth potential.

The companies that exist in these spaces are the ones with the most room to grow… which is good news for your investment.

Now, sometimes a company can exist in a successful market but still not make the impact it had intended. This can happen when a startup’s business model is too heavily dependent on one particular point of failure. If that one thing goes wrong, the company is done.

That’s a bad sign for any investor assessing a company’s risk profile… because losing your money on company whose success hinges on one singular assumption is a costly mistake.

Personally, I’d rather invest in a company that can identify multiple ways it could fail and develop ways of adapting and pivoting their strategies successfully if their original plans don’t work out.

Mistake #1: A startup that’s not humble

Above everything, the one thing that really drives me up the wall is a startup that’s not humble about its successes and cognizant of its mistakes.

No entrepreneur wants to fail… I get it. But mistakes are a part of the game, and the most successful founding teams will have the foresight necessary to predict and tackle inevitable missteps.

Many companies lack this judgment for a couple different reasons.

The first is that many founders are so focused on their product that they fail to solicit any sort of critical feedback from their potential stakeholders. A startup that only seeks praise and avoids criticism will go nowhere… because criticism is what tells a founding team how their product can improve.

The second reason is that many companies block out their competition with the idea that their product is the best of the best.

And maybe that’s true, for now. But one day, a startup could be smooth sailing along and the next, their entire business model could be undermined by an even better product.

That’s just the way it works out here.

Simply put, founders should consistently ask themselves, “What could go wrong here? And are we prepared to fix it?” If the answers to those questions sound anything like “I don’t know,” you should stay far, far away.

I’ve pulled together a list of seven questions that you should always ask a founding team to figure out if they’re on the path to success (or not). Because even when an idea looks picture-perfect, what lies below the surface may be far from it… and you don’t want to waste your time or capital on an idea that’s just not going to work from the get-go. Click here to see the list.

And make sure you keep up with me on Facebook, Instagram, and Twitter for all the latest Network updates and trends in the startup world.

I’ll be back soon with another update.

Until next time,

Neil Patel