Companies Seeking Funding Need to Know Origin of Potential Investors

PROBLEM

At the dawn of the spam industry, a client developed a proprietary software product designed to keep spam out, while allowing parents to monitor and regulate their children’s Internet access.  Beta testing was going well, a good number of version 1.0 packages were given out to consumers with excellent feedback and this start up company was gaining interest from potential investors. 

To move forward from seed funding and partial market distribution, a Series A Placement effort was planned with a goal of raising an additional $1.2 million.

One potential investor sought out our client after reading a press release about the technology [or so he claimed] introducing himself as an accredited investor interested in tech companies.  After reviewing the business plan over several days and a few follow up meetings facilitating the warm-up period, the potential investor advised the client that the company’s $1.2 million ask was not nearly enough.  He suggested they needed $5 million to properly capitalize and build the company’s infrastructure to reach out and address a ready to buy global market – he also told them he was willing arrange all the funding they would ever need.

After signing a simple one page Memorandum of Understanding: X% of equity for each X$ downstroke etc., the first funding installment of $250k was delivered by the investor [half, a cashiers check drawn on a local bank, and the other half in cash = Flags everywhere].

The investor then insisted that he be given the software codes, historical testing logs, and other IP to review before moving ahead and providing the next installment payment.  The client told him he’d have to get the engineers together to prepare a full package for him.  Following this move, the client put the $250k in a safe deposit box; then called me and his attorney – smart move, finally.

I worked with the attorney to begin what we call the reverse due diligence process.  As the research progressed, we learned that this investor did indeed have access to several million dollars from both U.S. deposits of record and offshore sources.

However, we also learned that he was a broker for the porn industry (the anti-spam technology could threaten his business planning – lot of money has been made from spam, especially in this area); he was a convicted felon in the U.S. and Canada, he shopped Eastern Europe for young women, supplied lap dancers in Toronto, and along with a few partners of dubious credibility and character, operated not only two brothels, but also three very active film studios.

Be keenly aware that there are people masquerading as investors who simply want to outright steal your technology, reverse engineer a method to get around what you’re trying to protect, or set up convenient money laundering covers.

We don’t want to read a headline declaring, “Start up Company Principals Co-indicted Along with Key Investor on Federal Racketeering Charges.”  I’ve seen it happen and it’s an expensive and life changing event.

It took a bit of legal untangling, but we returned the $250k to the investor, obtained a signed release from him dissolving any interest held, and completely severed the relationship.  A full briefing was also provided to the U.S. Attorney to assure our client wasn’t on anyone’s radar screen.

Lessons Learned

Think things through, trust but verify, and stay clear of Faust’s rationale – from the beginning of time, dancing with the devil has never worked.

Thanks To

Greg George
www.gti-advisors.com
greg@gti-advisors.com

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