Whilst this story is very much based on a US experience and has US terminology, it’s a useful warning to all new entrepreneurs to watch out for people trying to ‘sting’ you for money to help you raise funds or to get useful information out of you for illegitimate uses.

Always be on your guard and don’t be afraid to do due diligence on your investors, you should check them out as much as they do you.

This is a useful article by Frank Szivos, Editor Angel Investor News. http://www.angel-investor-news.com

When company owners go searching for funding, they need to ask the right questions of potential investors. Entrepreneurs tend to prepare themselves for investors questions, but need to make some poignant inquiries of their own.

When Russell Dodd of Nomad Technologies in the mid-Atlantic region launched his first round of investment recently, he found plenty of potential investors willing to talk and willing to move into the due diligence stage. However, to Dodd’s surprise, some companies were asking hefty application fees and asking him to divulge specific information about patented software and business practices. Dodd expected fees, but questioned handing over his software to a potential investor he spoke to on the phone only a couple times. While most potential investors are honest, Dodd knew of a few instances when company secrets were stolen in scams.

We have had some success in talking to potential investors and have had several companies interested in moving into the due-diligence stage of investment. However, some of the companies are asking for outrageous fees and other application fees, Dodd says. We understand these fees but do not feel comfortable in taking the next step in fear they might try and steal our software or idea. We have heard some pretty bad stories in respect to scams of this sort. Although, we do have a patent for our software and business method, we still do not want to just hand our software to someone we spoke to on the phone a couple times.

Dodd’s concerns are real and a common challenge for every young company that steps into the funding arena. The bottom line is for self-protection company owners need to do their due-diligence before throwing open the most intimate details of their businesses, software or intellectual property.

1. Perform due diligence yourself: You can perform a routine credit investigation for a very modest sum. There are plenty of due diligence and investigative firms that offer these services, often for less than $100, according to Mike Roer, Executive Director of the Connecticut Venture Group, a professional organization committed to connecting leading Venture Investments professionals with high-growth emerging companies in Connecticut. Investigation firms can also check with the local police for a criminal record.

Roer says: My defenses always go up when I hear fees. This may be legit, or the “investor” merely wants to sell you a package of fund raising services. I have heard prices quoted of $1000 to $25,000. I would ask the investor point blank if he can provide the cash you need or if he is merely going to source the funds for you as a broker. Some brokers also invest a token amount of around $50,000. I compare this to selling a house. You can try to do it yourself and save the fees, or retain an agent who knows the ropes and pay fees plus a percentage.

Try to sell the equity interest yourself first. Some investors assume you do not have a choice offering if you need a broker to hawk it.

2. Ask for references. For example, check with CEO’s of other companies to whom an investor has committed funds. Reputable investors are proud of their portfolio companies and often list them on their web sites. Then, call the CEOs and ask about their experiences.

3. Get a lawyer now. You’ll need one eventually anyway. Spend a half hour reviewing the situation now.
You can probably find someone to provide this upfront consultation free.

4. Protect Intellectual Property: Regarding software and inventions, do no turn it over. Invite legitimate investors to see a demonstration. No one needs to know how it works, only what it will do. There is a risk of the idea being stolen. There is also the risk of someone else thinking of it independently. Speed, therefore, is of the essence. This is why you are considering venture capital in the first place.

John Andres, former Chief Patent Counsel at US Surgical and Patent Counsel at Priceline.com, believes that the intellectual property field is complex, and counsel fees are well worth the expense in the long run.

Don’t let intellectual property sit around and collect dust, Andres says. Get good advice early and lock up what gives you an edge in the market and can create valuation for your company.

5. Join a Venture Association where you will meet investors, lawyers, and other CEOs at your stage. Check your local chamber of commerce or state department of economic development for the non-profit nearest you.

A compromise might be to contact investors you know to be reputable, rather than reveal inside information to someone who seeks you out a bit too eagerly, Roer says. Also, check out portfolio companies. Does the investor have an interest in a potential competitor? If so, you may want to avoid that contact. However, if the investor has an interest in a firm that is a potential supplier or customer, it could be a perfect fit. Eventually, you will have to trust someone. The trick is picking the right one.