Avoiding the Boulevard of Broken Dreams: Why Investors Say NO and How to Prevent It

October 2019 

The ancient Stoics had a practical approach to life: they distinguished between what is within our control and what is not, focusing their energy on the former to achieve better outcomes and greater happiness. Similarly, in the context of startups, there are external factors—such as global macroeconomic trends, the chosen industry, or emerging competition—that can influence the fundraising process but remain beyond a founder’s control.

On the other hand, there are internal factors shaped by the company’s culture, management philosophy, processes, and overall strategic decisions. These are well within a founder’s control and can be diligently improved, refined, and monitored. Investors often prioritize these controllable elements, closely evaluating how management addresses them before deciding to invest.

Below, I’ve outlined some key red flags that frequently lead to a rejection. My philosophy is straightforward: awareness is the first step toward change. Recognizing and proactively addressing these red flags can significantly reduce the likelihood of a “no” and make the fundraising process smoother and more efficient.

1.  Messy Cap Table: A Dealbreaker for VCs

The state of a company’s cap table (capitalization table) is a critical factor for most VCs, as it directly affects their potential returns and fund economics. A "broken" cap table can severely dampen investor interest. Below are common cap table issues that raise red flags and how they can be addressed:

Too Many Small Investors with Diverse Interests: A crowded cap table with numerous small investors can create complications for institutional investors. Misaligned priorities and fragmented decision-making often make it difficult to manage future rounds.

Disproportionate Equity for Early Investors: Founders who give away excessive equity in pre-seed or early rounds signal poor strategic planning. If the founding team and ESOP pool combined hold less than 50% of the equity before Series A, it suggests a structural imbalance, often seen as "rat poison" by VCs.

Aggressive Pro-Rata Rights for Early-Stage Investors: Pro-rata rights that heavily favor early investors can lead to dilution conflicts in future rounds, discouraging new investors from joining.

Dead Equity from Departed Founders: Equity tied to ex-founders or team members who are no longer contributing is a red flag. Dead equity above 3% is particularly concerning, as it represents value that could otherwise be allocated to active contributors or new hires.

Absence of an ESOP (Employee Stock Option Plan): A lack of a stock option plan can lead to friction between existing and incoming investors. Moreover, without a robust ESOP, attracting and retaining top talent becomes challenging, threatening the company's long-term growth.

Esoteric Securities: Cap tables burdened with complex securities—such as various classes of preference shares, warrants, and deal sweeteners—are seen as unnecessarily convoluted, adding risk and reducing transparency.

Convertible Debt with Heavy Discount Provisions: A large amount of convertible debt with steep discounts can erode the equity pool for founders and other stakeholders, creating an unattractive dynamic for new investors.

Unresolved Secondary Transactions: Secondary sales, where early investors or team members cash out significantly, can signal waning confidence in the company's future. While some secondaries are expected, excessive or poorly timed ones can sour investor interest.

Structural Capital Issues: Layers of liquidation preferences in late-stage financings can complicate equity structures, making future payouts unpredictable for new investors.

..and how to Address a Broken Cap Table ?

A messy cap table can deter investment, but there are ways to repair it with creativity and pragmatism:


The Bottom Line...

A broken cap table discourages VCs and signals poor governance and planning. Management must proactively identify these red flags and collaborate with shareholders to resolve them. Doing so demonstrates foresight, leadership, and a commitment to building a sustainable, scalable business.

 2. Red Flags in Corporate Governance: "Back Scratching" Practices That Concern VCs

Strong corporate governance is a critical factor for VCs evaluating potential investments. Poor governance practices, often termed "back scratching," can signal mismanagement, inefficiency, or conflicts of interest. Below are common red flags in corporate governance that tend to deter institutional investors:

Unqualified “Bro” Hires: College friends, childhood buddies, or personal connections without relevant skills or experience in the management team can indicate nepotism over meritocracy.

Romantic Relationships Among Founders: Founders who are dating or married (e.g., husband-and-wife teams) raise concerns about potential conflicts of interest and lack of independent decision-making.

High Personal Compensation Without Justification: Excessive salaries, dividends, or perks for management, especially in early stages or without hitting clear milestones, suggest misplaced priorities.

Unnecessary Staffing Overheads: Management teams with roles like executive assistants or non-essential hires before Series A signal poor resource allocation and could raise concerns about a lack of fiscal discipline.

Undefined Roles and Responsibilities: A lack of clarity in organizational roles and responsibilities indicates weak operational structure, leading to inefficiencies and potential power struggles.

No Technical Founder: In technology-driven startups, the absence of a technical co-founder or equivalent leadership weakens the company's ability to innovate or execute its vision.

No Financial Skin in the Game: Management team members who lack personal financial stakes in the business, essentially functioning as employees of current investors, may not be incentivized to maximize long-term value.

Excessive Board Influence from Founders: Founder-dominated boards with no independent members can limit accountability and create governance imbalances.

Family Members in Key Roles: Multiple family members holding key positions in the company can raise concerns about favoritism, lack of diversity in thought, and potential agency conflicts.

Infrequent or Poorly Documented Board Meetings: Irregular board meetings or inadequate documentation and reporting signal a lack of transparency and governance rigor.

Resistance to Institutional Oversight: Founders or management unwilling to accept external oversight or governance changes typically needed with institutional investment indicate an inflexible mindset.

Implications of Poor Corporate Governance...

These red flags typically give rise to agency conflicts, where the interests of management may not align with those of shareholders or investors. Institutional investors, focused on measurable returns for every dollar spent, will carefully scrutinize such practices. While there may be exceptions to some of these issues, the presence of multiple red flags is likely to erode investor confidence.

3. Red Flags in Investor Communication: Avoiding Evasive Practices

Clear and consistent communication is paramount during the fundraising process. Evasive or erratic behavior can damage trust and leave investors questioning a startup's credibility and professionalism. Below are common pitfalls in investor communication that can hinder a successful fundraising round, along with additional points to consider. 

Inconsistent Messaging: Misrepresentation of metrics, exaggerated market estimates, fabricated customer logos, or overly optimistic growth projections can sow doubt and erode trust. Credibility is difficult to rebuild once lost.

Missed Commitments: The fundraising process can last 3–12 months, and failing to meet deadlines for providing updates—such as trading performance, pipeline progress, or product development milestones—might not kill the deal but can leave investors with a poor impression.

Desperation and Neediness: Demonstrating panic (e.g., revealing that you have only one month of runway left) can push investors away. It signals poor cash management and raises concerns about the startup's ability to plan and sustain itself post-funding.

Premature Exit Proposals: Overemphasizing quick exits or flipping opportunities undermines the perception of long-term commitment and may lead investors to question your sincerity and strategic vision.

Evasiveness About Challenges: Long, convoluted answers about past failures, cash burn, or pivots can appear defensive or deceptive. Be concise, transparent, and focus on how lessons learned have informed future plans.

Prolonged Fundraising Timelines: Allowing news to leak that you've been fundraising for more than six months creates the impression that the startup lacks traction or investor interest, which could discourage others from engaging.

Poor Pitch Demeanor: Being overly cocky, defensive, or dismissive during a pitch does not inspire confidence. Similarly, being too subservient or overly agreeable can signal a lack of conviction. A pitch is a two-way conversation, allowing investors to understand your beliefs, goals, and roadmap through thoughtful dialogue.

…Additional Red Flags to Avoid in Communication

Overloading Investors with Information: Bombarding investors with irrelevant data, lengthy presentations, or overly complex explanations can overwhelm them. Focus on concise, clear, and relevant updates.

Over-Promising and Under-Delivering: Setting unrealistic expectations (e.g., closing deals, launching products, or achieving milestones ahead of schedule) without following through creates credibility gaps. Investors value reliability over exaggeration.

Lack of Preparedness: Coming to meetings unprepared, whether it's failing to answer financial questions or not knowing key metrics, signals a lack of professionalism and readiness.

Inconsistent Stakeholder Narratives: If different team members share conflicting information or contradict each other in investor discussions, it signals disorganization and weak internal alignment.

Delays in Responding to Investor Queries: Slow or incomplete responses to investor questions during due diligence reflect poorly on operational efficiency and could stall the deal.

Appearing Overly Secretive: While protecting proprietary information is important, being overly secretive or unwilling to share key details can make investors wary. Transparency balanced with prudence is key.

Most of these points are rooted in basic common sense, yet startups often take shortcuts under pressure. Investor communication is as much about building trust as it is about conveying information. A disciplined, transparent, and professional approach will improve the chances of securing funding and lay the foundation for a positive long-term relationship with investors.

4. Red Flags in Business Fundamentals: Loose Ends That Concern Investors

Investors are meticulous when it comes to evaluating a startup's business fundamentals. Loose ends in strategy, execution, or financial planning raise serious concerns and can jeopardize a deal. Below are key areas where gaps or inconsistencies can deter investors, with insights into why they matter:

Weak Financial Discipline and Unrealistic Financial Models: Financials detached from business reality, such as inflated valuations or misaligned revenue projections: A financial model disconnected from business strategy. Misaligned assumptions—such as inflated revenue projections, Reliance on gross revenue metrics when significant costs are excluded, unrealistic hiring plans, and inconsistent cash burn estimates—signal poor planning. If, during due diligence, it becomes apparent that you need significantly more or less cash than anticipated, it can lead to valuation markdowns or additional protective measures demanded by investors.

Outsourcing Key Competencies: Startups that rely heavily on outsourcing critical functions like product development or marketing risk losing control over core competencies. Investors will scrutinize how you plan to transition key functions in-house and will assess potential issues with intellectual property (IP), such as ownership disputes, patent filings, infringement risks, and potential litigation.

Poor Unit Economics: Startups failing to establish strong contribution margins or sustainable customer acquisition strategies risk undermining long-term viability.

Excessive Burn Rates: Startups raising large funding rounds often face pressure to spend excessively, creating unsustainable burn rates that delay profitability and heighten risk. Indirect factors such as contribution margins, delays in outsourced manufacturing, and seasonality effects heavily influence cash burn. Investors expect a thorough, bottom-up sales plan where metrics like close rates, sales cycles, and hiring timelines realistically tie into cash burn and funding needs. A lack of attention to these details can undermine confidence.

Claiming "No Competition": Startups that claim to have no or minimal competition often worry investors. This may indicate either a lack of market awareness or evasiveness. Investors view competition as a sign of market validation, and the absence of competitors may suggest an unproven or unattractive market.

Poor Use of Previous Funds: Inefficient deployment of prior capital or pivoting too early can result in a valuation gap. If the capital raised doesn’t align with the dilution of existing shareholders, it signals poor financial discipline. Additionally, raising insufficient funds for a runway below 12 months—rather than the typical 18–24 months VCs prefer—can create long-term viability concerns.

Negative Customer References: Negative feedback during customer reference checks is a serious deal-breaker. Investors view these calls as critical indicators of market fit, product quality, and customer satisfaction. Failing to address or mitigate negative feedback will raise questions about your ability to retain and grow your customer base.

Loss of Major Contracts: Losing or being at risk of losing significant contracts can erode investor trust. It is far better to disclose such challenges upfront and explain mitigation strategies than to have investors uncover the issue during due diligence. Transparency builds trust, while concealment creates doubt.

….Additional Red Flags Investors Watch For..

Overestimating Market Size: Inflated total addressable market (TAM) projections without supporting data reflect poor market research and weaken investor confidence in the startup’s strategic vision.

Overly Aggressive Scaling Plans: Scaling plans that outpace operational readiness, such as hiring too quickly or launching in multiple markets simultaneously, suggest overconfidence and inadequate risk management.

Misalignment Between Vision and Execution: A disconnect between the company’s vision and its current execution—e.g., overpromising on future milestones without demonstrating meaningful progress—raises doubts about feasibility.

While a couple of isolated issues may not be deal-breakers, multiple red flags across different categories can compound into significant concerns. Investors prioritize startups with robust planning, transparent communication, and an ability to address challenges proactively. Founders must demonstrate their awareness of potential issues and their capacity to resolve them effectively.

Closing these loose ends and aligning business fundamentals with investor expectations will improve your chances of securing funding and position your startup for long-term success.