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Warning Signs You May Be Dealing With a Decoy Angel Investor Or Venture Capital Fund

Guest post by: Karen Rands

Article Overview: Decoy Investors are people who pose as an investor usually with an alternative motive to get the unsuspecting entrepreneur to pay them some sort of a fee before closing. Unfortunately, for deceitful people, the easiest thing to sell an aspiring entrepreneur is HOPE. What are the warning signs? How can you spot a scam artist posing as an investor? What can you do to protect yourself and your business? We list 7 different types of Decoy Investors to beware of when trying to find early stage capital.

Warning Signs You May Be Dealing With a Decoy Angel Investor Or Venture Capital Fund

Young entrepreneurs fall victim to decoy investors because of their desire to believe that the "investor" they are talking to shares their same excitement and belief about their opportunity as they do, and being honest and credible themselves, they believe the person on the other side of the table is as well. Unfortunately, for deceitful people, the easiest thing to sell an aspiring entrepreneur is HOPE. 1. The Decoy-Investor expresses interest, gets the documents, talks about their friends who also might like to invest, then turns around asks for a "retainer" or small fee to cover their time to talk with these investors. No real investor or venture capital firm asks for money from the company they are intending to invest in.

NOTE: Exception to this may be an "exec with a check" who WILL be investing and asks for additional shares to cover the time they will spend as an "executive" with the company working to build the company. Then this is understood up front and should not be a surprise and should be a point of negotiation. An "exec with a check" would not collect a salary (at least not initially), because their investment would just be recycled as their pay, therefore they would get additional shares for their time, experience and level of involvement.

2. The Decoy-Investor is introduced to you by a broker or "finder" and you are told you will meet for lunch at a swank restaurant. The decoy-investor then proceeds to order wine, the most expensive meal, appetizers...asking you questions all along the way, stringing you along. At the end of the meal, you are presented with a check....but not a check for the business but a check for the meal. Typically this is the game played by a group of finders that each pose as the investor on different days to get the first class meal and justify the introducing party's retainer....because after all you had got to meet with the investors didn't you?

3. A Decoy-Investor runs a fund and promises to put in more money than is needed or requested on the condition that the company raise 10% or 20% of the total they will put in, up front. The package often is set up with a program that the amount raised from the individual investors will be held in escrow for 90-120 days and will be paid back with interest with the larger investment. This is a red flag because the condition of the Decoy Investment fund isn't based off of milestones or progress made by the company in executing their business model, but rather in the fledgling company's ability to raise funds that will be held in escrow-ed and be accessible by the Decoy-Investment fund.

NOTE: An exception to this is when a company is in their early stage of raising capital and the fund (or super angel) wants to ensure they have the capability to raise money or the fund has a standard program to be "second" in an investment rather than the lead on the investment. Also, this does not apply when a company is raising a "bridge" round to an institutional investment or a small cap IPO, because those bridge rounds typically will accrue interest AND converts into the same term and conditions of the institutional round. The kind of program described in #2 is a common scheme used when the "funds" are from an unconfirmed source and is used to in effect "launder" money or because there are little recognized terms in the MOU that gives them control over exit strategies and other capital raises so that in effect they hold the company hostage when they get ready to make their large infusion and starve the company to get predatory terms or rights to the IP at a severe discount.

4. The Decoy-Investor wants to talk or meet your other investors so they can get comfortable. This isn't always a red flag because it is common for some investors to want to be sure about the reasons or the knowledge level of the other investors. But it becomes a red flag when the Decoy-Investor then tries to structure side deals with those investors under auspices of common interests or being a big roller AND asks the investor to keep it confidential from the entrepreneur. Once an investor IS an investor, it is great for them to form bonds and positive relationships with fellow investors, as long as it DOES NOT impact your ability to raise funds from that incoming investor and WILL NOT damage the entrepreneur's relationship with the existing investor.

5. The Decoy-Investor represents a large off shore investor and they book a hotel room (room with beds) or conduct meetings in the lobby and have a series of companies going through to be "selected". They don't have any traceable history on the web, with a website, with offices that can be verified, etc. They don't have a formal application process or don't want to send you documents electronically to be completed. They require a "small due diligence" fee that is actually $20,000 to $40,000 or more and is not based on any real work output like visiting your facility, preparing a binder that can be used with other investors, conducting real valuation work on the IP etc. The documents they have you sign have nebulous language about investment being subject to "due diligence".

Then, the icing on the cake is that the "closing" will be in the Philippines, Brussels or some far away place. A real fund has investor representatives on staff that is paid by the fund to conduct due diligence. They may occasionally ask for reimbursement of travel expenses prior to closing or say they will pay certain outsourced services, like valuation firm work, from the closing funds, but they rarely ask for "due diligence fees" up front. If they do, they are not an investor, they are an intermediary and you need to make sure any compensation doesn't violate your unregistered offering status with the SEC, and be sure you are paying for real work, not just the opportunity for them to rep you.

6. The Decoy-Investor represents a large fund but they won't disclose the name of the fund, or the source of the funds until you have "qualified" for investment and been scheduled for close, when they will share all that information under non-disclosure. Legitimate funds not only will disclose the source of funds, but will also provide proof of funds before beginning negotiations on a term sheet. If they don't provide a full proof of funds, they will at least provide references to other companies they have funded so you can be comfortable that the time spend in negotiation is worthwhile and moving toward a legitimate potential closing.

7. The Decoy-Investor offers a term sheet that commits to close in 90 days. During that time you are not allowed to go to any other investment sources and they require some deposit against the investment for conducting due diligence to be "returned" at closing. Within the letter of agreement they say that the investment will be made if you "pass due diligence". However they don't provide any guidelines as to what their due diligence criteria is based upon. So about 45 days into it, the entrepreneur stops hearing from the investor and can't locate them or they find out that they didn't pass the due diligence....Sorry!

How do we know about these scams? Sad to say, we know of a company that has fallen victim to everyone of these. In some cases they lost money, and in all cases they lost valuable time and became distracted from pursuing strategies to get them in front of REAL investors. Watch out for scam artists posing as angel investors. Do your due diligence and chose your strategic partners wisely. By understanding the warning signs, you can minimize your business risks, protect your business and position it for future success!

How do you avoid falling victim to Decoy-Investors? First, and the most easy, do a google search on the name of the firm, people involved, and any variation therein. You can also visit sites like "ripoff lounge dot com" to see if anything has been posted. Second, ask for references and verification of funds. If they won't provide references at the very least, walk away. And if they provide references, then call them. You'd be surprised to hear how many scammers will actually provide references that will tell you negative info, just because the scammer isn't expecting the target to follow through on the references. Lastly, listen to your gut...if it sounds to good to be true, chances it is. Think of the most savvy business man or woman you know and call them, explain the deal. If saying it out loud makes it sound unbelievable to you, or you are embarrassed to tell that person you respect and want to keep their respect about the deal, then chances are that is the little voice saying, "Don't be a fool, as much as I HOPE this is legit, it just doesn't seem like it can be". Remember, the easiest thing to do is sell hope. Raising capital is not like the lottery where you can just scratch and win. Good Companies with solid business models and a clear ROI will get the funding they need from legitimate investment sources---but it takes a lot of time and sometimes money to get in front of enough investors to find the ones that will actually invest. An investor who spends time with you and then never invests, is not a decoy, he or she is just not convinced that your deal is better than anything else he or she is considering or where they already have their money working for them.

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Article Tags: angel investor, business finance, business funding, decoy investors, due diligence, entrepreneurs, institutional investment, raising capital, scam investors, venture capital



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