If you have managed to launch a successful business, Congratulations!  As your business grows and you seek additional capital, you will most likely run across both individuals and potential transactions that you should be wary of.  These include:

Shysters (fundraising advisors):

First, there a large number of advisors out there that can be extremely beneficial partners to your business and can be a great resource for you to obtain adequate financing for your business.  Unfortunately, there are also a number of individuals and firms who will take advantage of your business in the hopes of getting a quick fee.  These shysters will often leave a business in a position where the Company can not succeed, either due to cash constraints, or a capital structure which prevents future investing.  Here are several warning signs of a potential shyster:

Compensation: A typical advisor will take a percentage of funds raised (usually between five and ten percent), and warrant coverage (the ability to invest later in the financing round at the same terms as the investor they brought in).  If you don’t or can’t understand how an advisor is going to be compensated for assisting you in raising money, or you believe their compensation is too high, they probably fall into the shyster category.

Investor List: A reputable advisor should be able to give you an idea of who they are going to contact as potential investors.  This list will most likely evolve as the process goes on, but there should be an initial list.  If the advisor can not give you initial names, they have probably not been successful in raising capital in the past.

Proposed Transaction:  If you don’t understand the transaction the potential advisor is proposing and they can’t give you a clear picture of what the capital structure of your Company will look like after the transaction, it is a good sign to stay away.

Success Rate: Every advisor has had a failure in their career, either a Company that they couldn’t get funded, or their career is not all that expansive.  If a potential advisor says that they have been successful 100% of the time raising capital at terms attractive to the company, you should stay away.

Scams (investment transactions):

As there are bad advisors out there, there are also a number of bad transactions out there, here are a number of bad transactions (from a company’s viewpoint) to look out for:

The Reverse IPO:

Several years ago there were a number of reverse IPOs out there.  A reverse IPO is when a private company buys an essentially defunct public company (often referred to as a public shell), and merges the private company into the public shell, creating a public company with operations.  These are often pushed as a cheaper alternative to going public, and to provide all of the benefits of being a public company.  There are several things an entrepreneur should look out for in regards to a reverse IPO, including; you will now need to deal with the regulations of being a public company, there is no cash infusion with a reverse IPO (as opposed to a traditional IPO), and even though you may technically be public, no one knows about you, so there will be no one trading your stock and no equity analysts covering your company.

Promise of Future Investment:

A number of investors will make an initial investment with the promise to invest future amounts.  This is either done through a simple promise or a more formal equity line.  The two things an entrepreneur needs to keep in mind are that those future investments may not always be there and the amount of control you are giving up to the investor.  If a Company puts an equity line in place with an investor, it may be difficult for the Company to get out of, and the existence of the equity line may limit the Company’s ability to sell equity to other investors (who will see the potential for future dilution).

Too Good to be True:

A company will often come across a proposed investment which appears too good to be true - keep in mind it probably is.  Ensure you understand what position the investment will leave the Company in, in addition to how both the investor and investment advisor or getting compensated (and at what level).

Purchase Option:

A number of investments will often come with a purchase option attached.  This is where the investor can purchase the Company at some point in the future either a pre-determined price, or at a discount to any other future offer.  Although this may be something a Company is willing to give up to get an investor on board, it will limit the Company’s future ability to attract other suitors and may limit the ability of getting the best price for a company if it ever decides to sell.