Identifying 10 Indicators of Startups that Should Be Avoided as Investments

Investing in startups can be a tricky business, and knowing where to put your money can be challenging. While there is no surefire way to identify which startups will succeed and which ones will fail, there are some clear warning signs that investors should be aware of. In this article, U. Mahesh Prabhu presents ten definitive pointers to identify startups that are bad investments. These include emotional instability, excessive self-obsession and vanity, repeated unquantifiable claims, focus on the future without a grip on the present, unwarranted demands without any promise of delivery, obsession with shortcuts and quick fixes, fixation on valuation instead of value creation, and disproportionate and ever-increasing debt.

1. Emotional Instability & Lack of Clarity

Decisions are crucial to sound and sustainable profitability. And since outcomes of decisions are hard to determine, one must remain intellectually flexible to do course corrections. Intellectual flexibility is a mirage in the presence of emotional instability. Emotional instability is also owing to a lack of clarity. Therefore, it is natural to conclude that any startup founders or leaders, with significant emotional instability or lack of clarity, are bad investments. And while short-term profitability may as well be possible, such investing is in fact gambling.

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2. Excessive Self-obsession and Vanity

Self-obsession, if not narcissism, is a sign of an untamed and unstable mind. Vanity is yearning for appreciation and accolades from people, due to over-estimation of the self. Investments are always in business, but when the leaders of such businesses are obsessed with vanity, including awards, rewards, excessive media, and social media coverage, any investor must be alarmed. If you carefully observe, all the great companies that go bust, often tend to have such excessive vanity tendencies in their leaderships. The focus of leadership is critical in all businesses. Still, when leadership is obsessed with its image and diverts its organization's resources to boost or manipulate the image of the self, it is a clear sign of an investment going South.

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3. Repeated Unquantifiable Claims Coupled with Self-boasting

In recent times, it has become a norm for companies with little, no, and even negative profitability to claim great "valuation" through a process called financial engineering (one that is often bordering on financial manipulation). More than often, such organizations seek to expand rapidly in multiple dimensions, in the hope of greater profitability through debts. In an age where most investments are with impulsiveness, rather than calculations, such tactics tend to impact detrimentally. A lot of people do tend to fall for such stories furthering the stock prices. Nevertheless, blindly investing in such startups without insights, is a recipe for disaster. The infamous financial crisis of 2008, incurred principally because most investors failed to care about or understand the definition of complicated jargon like "subprime loans" before considering to invest in "toxic equities." When there are tall claims without substantiation, it is a clear indication of a bad investment. When a leader of any organization makes boastful claims on their credibility, when asked questions about their decisions, it indicates an irrational behavior with a clear and present danger for any investments.

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4. Focus on the Future Without a Grip on the Present

A sizable number of companies often addressed as "most valuable companies in the world" barely have a product or service with substantial profitability. Given this, it must be fascinating to observe why, not many thinkers, ask intelligent questions about how a company can, without any product or service,?generate adequate revenues – let alone profitability – and make such tall claims. How can those without any substantial a past, in their offering domain, make extravagant claims about the future? While our present is owing to our past actions, the future is owing to our actions in the present. Given this logic, is it fair to blindly believe in companies selling us their stock, product, or service in the future without any credibility in the present?

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5. Unwarranted Demands Without Any Promise of Delivery

When organizations make unwarranted demands for money at regular intervals, from their investors, without delivering any quantitative results with investments made in the past – it is a sign of concern. And yet, we do see such things often happening with "large valuations", startups that tend to "raise money" (read debt) from investors from time to time in the name of "series funding." Most of the funding is often without any substantial addition of value to a product or service that such startups claim to "revolutionize." Organizations that become experts at raising debts, can barely be trusted to deliver profits anytime sooner and therefore are a liability and never a sound investment.

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6. Obsession for shortcuts and quick fixes

Shortcuts and quick fixes are the curses of the present generation. Seeking to incur more debts in the name of "round funding" instead of creating products or services that could generate revenues – albeit modest – can seldom be a good sign. It is evident that an organization that is not creating wealth is incurring debt. And debt-creating organizations can barely be profitable; this remains true irrespective of the "modern wisdom" offered by media claiming over-the-roof valuation or lavish lifestyle of people running organizations, incurring debts instead of repaying them.?

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7. Fixation on Valuation Instead of Value Creation

Value is the price of a product or service in the present; Valuation, on the contrary, is a different ball game. Value is tangible; valuation is not. Therefore, any entrepreneur fixated on valuation can seldom be trusted to create value. They are also a no-go for investing.

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8. Disproportionate and Ever-increasing Debt

While debts at agreeable limits (say 20-30% of net revenues) are acceptable, disproportionate debts exceeding 50% of the organizations' revenues are a clear sign of caution. While most startups these days , tend to raise more debt at multiple rounds of investing, to unburden the previous debts, many such debt-funding startups do tend to collapse eventually. While the rise of such debt-driven startups is vividly made public across the media, their failures are barely made public. Any organization with excessive and ever-increasing debt must be considered to be in the category of a bad investment.

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9. Absence of dignity and respect for people

We live in an era of knowledge and skills; these two quintessential things come from people. And while there are great talks about Artificial Intelligence (AIs), any sensible investor can tell you the importance of quality people, in building a high-tech business including AIs. While pay does play a role in attracting talent, retaining them by pay alone has often proved inadequate. Most studies confirm that people chose to move away from an organization that fails to offer them dignity and respect; this is truer with people with rare skill sets. Therefore, startups with poor or abysmal records, in offering dignity and respect to their employees, are bad investments.

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10. Lack of knowledge

To stake a claim to success without knowledge, in an economy driven by knowledge, is ludicrous. Entrepreneurs who make tall claims with a poor understanding of their domain knowledge; or, worse, extreme predictions of the future, without offering substantial knowledge and reason for extreme predictions, can seldom be sensible. A lack of knowledge is often proportionate to a lack of sensibilities, which is seldom a healthy sign for investing.