Due diligence for startups: check that cheque
Not all investors are who they say they are. With Themis, we share our insights on financial crime in fundraising and du...
As criminals invent new ways to launder cash, or obtain money or shares fraudulently, startups need to stay vigilant. Unfortunately, many founders encounter potential investors who aren’t who they appear to be.
In this post, we cover the best ways to avoid potential scammers, fraudsters and time-wasters, and hear the stories of founders who’ve encountered them.
Finding investors can be difficult and time-consuming so by the time you find someone who’s keen to invest in your startup, you might be tempted to get the deal signed as quickly as possible. Scammers can be sophisticated and convincing – often it isn’t easy to distinguish between fraudsters and bona fide investors. To increase your chances of spotting and avoiding a scam investor, hone your instincts and carry out thorough due diligence. We explain how in more detail below.
By the time you start to raise a funding round, it’s likely you’ve already built up a strong network of industry peers and experts. Ask your network, advisors, mentors and team members to recommend potential investors. Word-of-mouth recommendations are likely to be far better prospects than someone who sends you an unsolicited message.
Attend events for startups such as pitch sessions, conferences and networking nights to meet potential investors. When you meet in person, you can gain valuable insights into an investor’s character which aren’t as easy to pick up on when you only communicate via email or video call. Networking is a skill that takes practice – the more practice you get, the more you’ll hone your instincts for spotting a great potential investor.
The time-waster in Brazil
We’re listed on a site for finding investors and via the site, we were contacted by a potential investor in Brazil. He was friendly and enthusiastic on video calls, and keen to see our documents, have a demo and so on. Just like any normal investor.
We were in touch regularly and he wanted to put in £300K – over half our round! But when we sent the Term Sheet, the messages dried up. He’d send excuses about being busy but by then, we’d realised he was a time-waster and we’d moved on to focus our efforts on finding genuine investors.
Looking back there were signs that we shouldn’t trust this guy. First, on his investor profile he’d selected $1 – $100,000,000 as his investment size, which suggests someone who isn’t serious. His LinkedIn page disappeared and reappeared, and didn’t look professional. And when I looked up his address on Google StreetView, it was just a small, ordinary flat. It all didn’t feel right for someone with that much to invest.
While sometimes a simple Google check will uncover clear signs that a potential investor is not who they claim to be, unfortunately this is not always the case. Sometimes a professional scammer will have built up a very convincing online profile at first glance. This is why it is so important to conduct thorough due diligence even if things look great on the surface, and especially if there is any initial worrying or unusual behaviour.
When building network connections and reaching out to potential investors, spending even 5 minutes on Themis Search will help ensure individuals are who they claim to be. Through our self-serve Search Function, founders can screen potential investors for bad press or a history of litigation, among other potential connections to previous scams and other fraud attempts. It is also important to look beyond fraud when screening investors, as conducting business with a bad apple could present links to other financial crimes such as money laundering, sanction evasion, and corruption.
When you have an interested potential investor, encourage open and transparent discussion with them. Ask about their expectations, how much they want to be involved in your startup, and the role they see for themselves.
Make sure your values and vision align with those of the investor. Even if the investor is bona fide, misaligned values can lead to conflicts in future.
Read more: Top 10 questions to ask potential investors
If something doesn’t feel right, don’t ignore the warning signs. Maybe there’s something about a potential investor’s behaviour that makes you suspicious or uncomfortable. Talk about what’s happening with your co-founder or co-worker – if they feel similar, then it’s a red flag.
Learn to trust your instincts and intuition. You already know what to avoid in terms of payment frauds, identity theft and bogus charities – apply the same principles to investors. Classic red flags are investors who try to rush you to make decisions, pressure you into unfavourable terms or avoid giving clear answers to your questions.
The famous investor imposter
We already had some money committed for our £500K pre-seed raise when the representative of an apparently well-known Thai investor got in touch. We met the ‘investor’ on a video call and after he told us about the sectors he invests in, he wanted to sign the term sheet and commit half the round. We were astounded.
But the guy didn’t put his camera on. He said his lawyers had told him not to show his face. We were suspicious but worried we were ignorant about foreign practices.
For due diligence, we contacted Themis who needed his details to run their checks. When we asked the investor for his address, we got an angry response: “I don’t appreciate being interrogated, I just want to support startups.” A bona fide investor will always be happy to comply with your due diligence requests and be pleased your startup does things properly.
The bogus investor went off-radar for a fortnight and then told us he was coming to the UK and wanted to meet. But of course, his trip was repeatedly ‘delayed’. At this point we knew he wasn’t the famous Thai investor he claimed to be, he’s a time-wasting scammer. Trust your instincts – if something sounds too good to be true, it probably is.
Co-Founder & CEO,
Due diligence is an important step in your fundraising but it can be easy to overlook when you’re excited about a deal.
Just as you’d ask for references for a potential employee, ask your investor for the details of several referees: entrepreneurs they’ve worked with previously. Get in touch with the referees to ask about the investor’s attitude, behaviour and values.
Carry out a comprehensive background check on potential investors. Look into their past investments, business history, and reputation in the industry. Use a professional service like Themis to verify an investor’s credentials, financial status and expertise. Themis even offers the ability to do a quick initial check yourself, so you don’t waste any time getting the due diligence process started.
Read more: Due diligence for startups
The non-paying time-wasters
We’re a cross-border fintech so our investors are an eclectic mix from diverse countries. We’ve had two instances recently with dodgy investors.
Firstly, a VC in India signed with us but never came through with the money. Then a syndicate committed to funding us, and again the money never appeared. Both the VC and the syndicate claimed the money had been delayed or run out. We don’t believe these people are simply disorganised – instinct tells us they’re frauds. Why do it? We think it’s because they want all the upside of being a shareholder, but without actually investing.
I’d like investors to be rated, so founders can vet them like doing a credit check on a customer. Dealing with these timewasters is incredibly frustrating. It delayed our fundraising and ultimately, the growth of our business.
Fundraising is truly global in nature. It is crucial therefore to conduct due diligence on potential investors and other business partners that goes beyond your own jurisdiction, screening for potential risks from anywhere in the world. At Themis, we’ve designed our products and services to reflect this global need, pulling from over 230 different jurisdictions and 37 languages to provide a deeper-dive for our clients.
As well as using a service like Themis for due diligence checks, you might need other professional help to navigate your fundraising deals.
At SeedLegals, you can complete your deals entirely online by yourself with our automated legal documents. But many founders chose us because our support team is on hand to help. While we can’t do due diligence for you, we’ve guided thousands of startups through their rounds and one-off investments. We review your Term Sheet and legal documents, identify red flags and, for more complex funding rounds, our Advisory service can help you negotiate the best deal for your company.
Doing your raise on SeedLegals? You and your investors will sign a Shareholders Agreement. This sets out the rights and duties of shareholders. If you issue shares to an investor without signing a Shareholders Agreement, you could run into unresolvable conflict in future.
Your funding round documents also include Warranties – these are your promises to investors about the state of your business. The Warranties set out the penalties you face if it turns out you’ve (knowingly or unknowingly) misrepresented facts. Importantly, Warranties limit your liability. Even if you believe everything is fine, make sure your deal documents include Warranties.
The good investor turned bad
We were introduced to an investor by a friend of a friend. He’d sold his company and was keen to invest some of the proceeds in startups to get SEIS tax relief. We were delighted he put in 30% of our round and for three years, we didn’t hear from him. Then it got weird.
He suddenly started asking for more updates and details about our accounts, then began texting me at all hours asking for a loan from our company. He insisted that because he’d backed us, now we should return the favour. It started to feel threatening so I enlisted our CFO who helpfully is also a lawyer.
We explained to the investor that because he’d signed our Shareholders Agreement, he had no legal basis for a claim against us. We also explained that even if we repaid his money, HMRC would claim back his tax relief. After that, it went quiet.
Running a startup is risky so protect yourself, even if at the moment everything seems fine. If you’re facing a situation like ours, keep all the evidence. Even if you’re feeling overwhelmed, don’t delete messages. Save, file or export everything and ask an expert for help.
When you sign SeedLegals documents for your fundraising, if an investor signs but doesn’t pay, terms in the documents allow you to cancel the agreement. And on our platform, you’ll need to confirm the investor’s cash is in your account before you can issue shares to them. (You can’t click the Issue Shares button until you’ve marked the funds as received.)
If you’re doing a funding round on SeedLegals and an investor signs but hasn’t sent their funds within 15 business days, then it’s straightforward to remove them from the round – No Pay, No Play is built into your documents. If you need help with this, get in touch with us by tapping the chat button (bottom right of your screen).
To make it easier to protect your business, you can integrate due diligence as a standard business process with the help of a tech-driven solution such as Themis Search & Monitoring.
The Themis platform makes it easy for startups to check all investors, as well as any other business associates and third parties, for red flags and potential criminal behaviour. The software is a simple way to carry out screening, KYC onboarding, risk mapping, enhanced due diligence and automated monitoring.
Raising investment? Want to know more about how to do your round on SeedLegals, or how to take a one-off investment before your round? Book a free call with one of our experts for a demo.
Any specific due diligence questions? Themis helps clients manage their financial crime risks, including through tailored due diligence reports from a team of investigators. Feel free to reach out to Eliza Thompson to find out more.
A note from our lawyers
This post is not intended to provide specific advice for any business. If you suspect a potential investor is bogus or if you’re in conflict with a shareholder, we recommend you seek qualified, independent advice.