In this week’sInvestment Roundtable, we dive into the red flags and yellow flags that every investor should be aware of when evaluating startup investments. From low runway risks to unclear valuations, our team breaks down the top challenges seen in 2024’s equity crowdfunding deals.
Topics include:
- 🚩 Top red flags: Low runway, active lawsuits, and high revenue multiples.
- ⚠️ Yellow flags: Insider share sales, repurchase rights, and unclear valuation terms.
- 🛠 Practical tips for identifying and navigating risks.
What is a “low runway,” and why is it a red flag for investors?
A low runway means a company has fewer than six months of operational cash. This increases the risk of bankruptcy, especially if the raise doesn’t meet its goal. Investors should ask founders about contingency plans and explore their funding strategies to assess risk.
Why are insider share sales considered a concern?
Insider share sales can indicate that founders or early investors are cashing out, rather than reinvesting in the company. If the percentage of insider sales exceeds 15%, it’s often a red flag, as it suggests reduced confidence in the company’s future growth.
What are repurchase rights, and how can they affect investors?
Repurchase rights allow companies to buy back early investor shares under certain conditions, often at unfavorable valuations. This can lead to missed future appreciation and alignment issues between founders and investors.
Why are unclear valuations problematic in startup investing?
Unclear valuations make it difficult for investors to assess whether an opportunity is fairly priced. This is common in Regulation A+ offerings where valuations aren’t prominently disclosed. It’s crucial to read the offering circular to calculate the true valuation.
How should investors think about outrageous revenue multiples?
Revenue multiples above 25x can signal overvaluation, especially for industries with historically lower multiples, such as consumer goods. A high multiple limits investor returns and could indicate unrealistic growth expectations.