The world is full of ambitious people with big ideas. Unfortunately, often the big idea is to separate you from your money. Don't get scammed.
If you're considering making a significant investment in a start-up or early stage company, follow these nine tips to avoid becoming a victim:
1. Understand the business plan.
You need to understand the business you are investing in. If you don't understand it, don't invest in it.
Before you think about writing a check, ask:
- What is the company going to do with your money?
- Does the company have enough money to do what it says it's going to do?
- What does the company sell?
- Who is going to buy?
- Who is competing in this market?
- How does the company make money?
- When do you get to see some profits?
- If the company succeeds, when do you get to sell your equity?
The business plan should make sense to you. If it doesn't make sense, don't assume that you're not smart enough to "get it." Here's a secret - most business plans don't really make sense when you dig into them. That's why most new business ventures fail.
Again, if you don't understand it, don't invest in it.
2. Don’t get stampeded into investing before you're ready.
Show me a guy who is insisting that you've got to invest RIGHT NOW, and I'll show you a scam. Promoters of legitimate ventures will encourage you to take your time, consult your lawyer, and ask questions. They should want to have savvy, sophisticated investors as part of their circle. If a business wants your investment today, it will probably want it in two weeks.
It's your money. Invest it when you're ready and not a moment before.
3. Talk to other investors.
Ask the promoter to put you in touch with other investors. Pick up the phone and have a conversation. Here are a few questions to get you started:
- How do you know the promoter?
- Can you tell me about the business?
- When did you invest?
- Do you have common stock (or membership units)? Preferred? If preferred, what are the differences between common and preferred?
- What about this company convinced you to invest?
If the promoter won't let you talk to other investors, or if the other investors seem sketchy, run away!
4. Talk with the Company's lawyer.
If an emerging company is taking money from investors, it should have a lawyer. Ask for the name of the lawyer, and ask permission to call him or her. Then, really call. The purpose is to find out some valuable information:
- Does the lawyer really exist?
- Is the lawyer a bona fide experienced attorney with a deep background in business?
- Do you get a good vibe from the attorney?
Nothing can kill a start-up faster than incompetent legal advice. Even if all of the other fundamentals are good, a company with poorly drafted corporate documents and agreements is a disaster waiting to happen. If the company does not have capable and reputable legal counsel that is a big red flag.
5. Ask common-sense questions.
When a promoter tells you about the fabulous returns his venture is going to earn, ask some common-sense questions:
- Why haven't 100 other companies rushed into this market?
- Why haven't the big private equity firms snapped up this deal?
- Why doesn't the promoter simply borrow the needed funds from a bank, so that he only has to pay interest and can keep the fantastic profits for himself?
Scammers tell stories that you want to believe. Sometimes the best question is: "why do I deserve this generosity?"
6. Don't get shamed into investing.
The scam artist's best trick is often to make you feel insecure. If you ask an uncomfortable question, the scammer will make you feel naive and foolish for asking such a "silly" question. It is human nature to crave the admiration and approval of others. No one wants to be thought a rube. Scam artists prey upon basic human nature.
Always remember, when someone wants your money, you get to ask any questions you want. If you get the sense that the promoter is trying to make you feel stupid for asking questions, you're probably about to get scammed.
7. Resist "Fear of Missing Out."
We've all heard the stories (many apocryphal) of the guy who passed on an opportunity to be an early investor with Warren Buffett. Or Sam Walton. Or Bill Gates. And yes, sometimes that probably happens.
Scammers prey upon this fear. They’ll convince you that this is a “once in a lifetime” chance to get rich. They want to create a sense of psychological urgency - that sense of: "Oh my God, this will change my life!" Before long, in your fantasy, you're already spending the profits.
When you start to feel that sensation in the depths of your soul, CHECK YOURSELF! Most scams, in retrospect, are painfully obvious. (That Nigerian prince who just needed $10,000 to unlock $100 million? Yeah, I guess that did seem a little fishy.) Scams work because they cause your brain to shut off for just long enough to write a check.
Resist the fear of missing out and you'll probably avoid getting scammed.
8. Meet the promoter in person.
For God's sake, don't invest based on a phone call, or worse, an email. Meet the promoter in person. Have lunch or a drink. Talk to him and find out what his story is. Have him tell you about himself. Does the story make sense? Does he know the kinds of things that a person with his background ought to know? Do you get a good vibe? Do you trust him?
This is not 100% fool proof because scammers are quite persuasive. However, in my experience, if you use a meeting to tease out a lot of biographical information, it will put you in a position to go back, do some more diligence, and see if the guy checks out.
9. Engage a smart business lawyer to kick the tires.
If you're going to invest a meaningful amount of money, paying for a few hours of a lawyer's time can save you from a very expensive mistake. You want a lawyer who has seen a lot of deals, who has the capability to investigate the promoter and make inquiries into his background and reputation, and who knows how to spot a scam. It's amazing the number of successful people who invest without legal counsel.
Don't be one of them. Follow the above steps and chances are good you can avoid getting taken by a charlatan peddling fools gold.
If you're considering making an investment in a private company and want to enlist experienced counsel to help you kick the tires (or if you're worried you've already gotten scammed), call John H. Snyder (212-856-7280) or Thomas C. Sima (212-796-6661).