Startup Funding Scams

Startup funding scams

When I told my daughter that I’d scheduled a Skype interview with a Nigerian entrepreneur, she had a predictable reaction: it’s probably a scam. Which made me think about how startup funding scams are all too frequent here in the US, let alone globally.

It happens on all sides of the table. Con artists posing as entrepreneurs promise breakthroughs and fantastic investment returns to gullible investors. Con artists posing as investors promise millions for gullible startups, but first some fees must be paid. And in the middle are scamming “investment bankers” who promote mythical opportunities to lonely senior citizens, and brokers who promise entrepreneurs they can make introductions to lenders or investors – for an upfront fee.

Investment scams are a big reason the Securities and Exchange Commission (SEC) was set up in 1934 in the US, and why there are similar regulators around the globe. And it’s one of the reasons investors’ “due diligence” process includes at a minimum reference checks on founders, site visits, and sometimes more extensive background checks.

See also: Due Diligence Overview

Silicon Valley’s Biggest Startup Funding Scam

Entrepreneur frauds can fool even the smartest investors. Perhaps the biggest Silicon Valley fraud ever was Theranos, which promised its technology could perform a raft of medical tests with only a few drops of blood. Elizabeth Holmes, founder and CEO of Theranos, raised $700 million, and was heralded as “The Next Steve Jobs” on the cover of INC magazine.

Elizabeth Holmes on covers of magazines

But she took “fake it till you make it” too far. Her fraud was slowly uncovered beginning in late 2015, when a Wall Street Journal investigative journalist broke the story – despite WSJ owner Rupurt Murdoch investing $125 million in Theranos. Eventually there were formal charges of fraud and a settlement in 2018.

Beware Of Foreign Investors

I recently helped an entrepreneur who had received a funding proposal from someone in Denmark. This person had seen the entrepreneur’s listing in Gust, an angel investment platform. The Danish con artist had built trust through email exchanges over time, leading up to the proposal.

But the investment “offer” the entrepreneur shared with me had a number of highly suspicious components, including a reference to the need for some upfront payments. Here is a slightly redacted version of what I emailed the entrepreneur.

This doesn’t make sense to me. It smells, actually.

To say that the offering is debt, and shares, is a contradiction.

The title of this guy in real life is Chairman, not President/CEO as listed in the proposal. And the spelling of his last name is slightly different from what’s publicly listed for this company: [URL of a big Danish investment company’s board of directors]

The whole “security bond” stuff they are proposing doesn’t make sense to me for an early stage company. It sounds like a way to charge you money before you get money.

An exit in year three also doesn’t make sense. How does that work?

The reference to 4% doesn’t make sense – 4% of what? 4% annual interest on the debt? 4% ownership of common shares? 

This feels like a proposal written by an imposter in fake foreign English. These folks at the big Danish investment firm would speak English just fine, and they would have lawyers drawing up much more detailed and coherent proposals than this.

Even legitimate investment bankers can seem like scams sometimes. One later stage company I worked with had spent $150,000 on a fundraising effort with a local investment bank that led nowhere. In 20/20 hindsight the company had lots of work to do to clean up their financial house before they were ready to fundraise. But the investment bank didn’t tell them that!

Desperation and Naiveté Create Vulnerability

It’s not uncommon for entrepreneurs to find themselves in desperate financial straits. Nor is it uncommon for entrepreneurs to feel totally lost in the world of fundraising – it’s a foreign language and a foreign business culture for many.

Plus, entrepreneurs tend to be optimists, which often means they want to believe others are acting in good faith. And they want to believe that someone else believes in them and their vision, just the way they are now, no changes needed.

Add in a lack of time to do research, plus just enough cash to entice a scam artist, and you have a highly vulnerable situation.

But of course, most startup fundraising interactions are not scams.

About That Nigerian Entrepreneur

It turns out that Nigerian entrepreneur is not only legitimate, he was recognized as a success story by one of the most prestigious grant making organizations in Africa.

I made sure to do some research – and not just a cursory Google search – before our Skype call. There were signs to make me suspicious – he had different names listed on his Yahoo email versus Skype. But in the end I chalked that up to some cultural differences.

You can hear the interview on Season Two of The Funding Coach.

Do Your Due Diligence

There is no substitute for checking on potential investors. The best investors and investment bankers or brokers will be checking up on you; make sure you turn the tables and do homework on them. This includes:

  • Online searches in multiple media – web, Facebook, LinkedIn, Twitter and others outside the US if appropriate
  • Go beyond cursory checks: deep web “crawling,” Facebook and Twitter post reading, check out employees listed on LinkedIn at relevant investment companies
  • If you are close to a deal, talk to other entrepreneurs who have worked with the investor. Don’t take online testimonials at face value!

On that last point: I was looking into business loan brokers, and thought I’d found some shady ones. I received an email from a broker with a supposed customer testimonial. I dug deeper and found dozens of different brokers that all shared the same set of video testimonials. They were all from a template provided by their broker franchise provider. It looked like a scam to me!

As they said in Hill Street Blues, “Let’s be careful out there.”

Don Gooding

1 comment

  • After posting a link to this article on a Facebook group for “angel investors,” I got a private message asking: How do you know investors are real? I suggested the following as part of your homework. In conversations with them, after you have told a bit about your story, turn the tables. “Do you mind if I ask you a few questions? What types of investments have you been doing over the last two years? What was it about those investments that made you decide to invest? How much did you invest in each one? Do you just invest once, or do you make follow on investments? How actively are you involved with your investments?” A real investor can easily and readily answer those questions, and will respect the fact that you are shopping for the “right” investor. Then, before you sign on their terms, talk to two previous investments.

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