New Investor? Here Are 4 Investing Red Flags To Avoid

Investing in a small, regular business is tough.

You need to consider lots of factors.

If you overlook any factor, you could lose all your money.

In 2016, I nearly lost ₦500,000 to a friend’s small business.

But proper due diligence saved me just before I committed funds to the new venture.

As you read my story, take heed of the lessons.

The best people learn from what other people have already mastered.

A New Business Opportunity

My friend had acquired a school for ₦3,000,000.

The previous owner sold because she wanted to travel abroad.

And my friend wanted partners to help him get the school up and running.

The profit percentages offered were the best I’ve ever seen.

Though, I’d be more like an Angel investor, I’d get a profit share of 17% at year-end.

To get a hand in the pie, I had to make a one-off investment of ₦500,000. Only ₦500,000 . . .

So, I took a three-day leave from work and went down to Aba, Abia State.

I wanted to tour the school myself. To see and to believe.

The school had several strengths.

• Choice location.
• Student population of 270 across Creche, Nursery, Primary and Secondary school.
• Conducive school building with lots of space (though rented).
• My friend was the school principal, and he had over 18 years teaching experience

After my visit, I made a conscious commitment to my friend . . .

“I’d make the transfer as soon as I returned to Lagos.”

But I got skeptical after I got back to Lagos.

Later that day, I called him to say I had lost interest in the business.

I’ll not invest any money in the school again.

My friend got mad. And we didn’t speak to each other until recently.

Why Would I Call Off the Partnership?

Red flags…

Putting the red flags in words at the time was above my head.

Maybe I couldn’t find the right words. Or I didn’t see it as necessary.

Today, looking back, I think I have a better understanding.

I can now say why I couldn’t bring myself to make that transfer, to invest in that school.

Here are the screaming red flags that wouldn’t let me invest then.

1) Reputation

My friend looked very genuine.

He was a pastor in a new generation church, and didn’t look like he’d deliberately scam me.

But when I thought hard about him and his actions when I was around him, I wasn’t very comfortable investing.

One time when I visited his house, he insisted we follow another road on my way out.

This was because he didn’t want to see someone.

When I asked why, he said the man he was avoiding was quite unreasonable.

They had done a network marketing business that didn’t go well.

The man now wants a refund, but it’s not in his place to give him his money back.

He said the cash went to the networking company, not him.

So, there was no way he’d pay the man out-of-pocket.

I urged my friend to find a better way to engage the man who had lost money, to make him see reasons.

Avoiding the man made him look all guilty. He brushed off my suggestions.

The heuristics I used for my judgment to not invest in the school have become more apparent today.

What if the business failed? Would my friend not do any of the following?

• Avoid me in person
• Not take my calls
• Not want to have a difficult conversation about the way forward, even in the face of failure.

Lesson: Action, not words, is a perfect measure of reputation!

2) Experience

My friend has been teaching at various levels of education for 18 years. He had taught in Creche, Nursery, Primary and Secondary Schools.

Being a pastor also means he could easily influence people and get them on his side.

In my mind, I knew this was not all. All of these attributes are good. But they’re not the only skills needed to run a school.

I asked myself:

“Has he ever handled the business side of education aside making side money from home lessons?”

The answer was a resounding No.

There’s more to business than delivering a service.

Managing a company to turn a profit requires a mix of skill and experience.

You know how important business strategy is if you have done it before.

For me, business strategy boils down to two key strategic choices: cost leadership and differentiation.

In a cost leadership strategy, my friend will run the school as the cheapest around Aba. Because parents are paying less, the school will have lots of students. And with lots of students, the school should be able to turn a profit.

In a differentiation strategy, my friend will try to make the school as different as possible from other schools. The goal is to make parents and students see the school as a very different kind of school. And in the end, they end up paying more. Because the margin is high, the school should be able to turn a profit.

One clear reason jumps right out when I look back at why I didn’t go through with investing in the school.

The school had no clear business strategy. It was a go-with-the-flow or go-by-the-Grace kind of school.

Lesson: Solid and clear growth strategy wins. Luck and excitement wear out.

3) Finances

When I visited the school, I looked at its financial records.

What I saw left me unsatisfied. I asked a few questions. The responses were off.

i) Is there a bank account registered in the company’s name to which checks and balances must be applied before funds are withdrawn?

None. My friend ran the school through his personal account to make sure no one was stealing from the school. Money is released when the expense is justified.

ii) How is school fee payment tracked to know if parents pay on time and in full?

My friend keeps an old 40-leave note where he records school fee receipts and other revenue streams. The payment is made into his bank account or handed to him in cash.

iii) Is there a level of control to make sure some teachers and my friend are not gaming the system by collecting school fees through their personal accounts or letting some students attend the school without paying anything?

My friend collects the fees himself. He couldn’t possibly cheat himself. No teacher is allowed to collect fees. My friend can also offer scholarships to brilliant and indigent students as he deems fit.

Lesson: Financial record keeping and controls built around one person are signs of inefficiency.

4) Drive

You can measure how far a business will go with the owner’s level of drive

When I think about small, regular businesses, I try to separate owners with a long-term drive from owners with initial excitement.

Long-term drive stays with you forever. Initial excitement wears off.

At the core of what drives a business owner must be an intense desire to have the business succeed.

Nothing but the business should come first. My friend was a busy pastor, and I knew his “calling” could have him be away from the school for long hours at a time.

This is not good for a small business with little seed capital. Owners should be all in or all out. In-betweens are not acceptable, especially at the early stages.

Lesson: Committed owners have a “we die here” mentality. Profiteers have an “I can’t kill myself” mentality. Commitment always trumps profit.

Closing

During the pandemic, I got a call from my friend. The school had failed. All investors had lost their money, and he was dead broke. I encouraged him, telling him failure is part of the journey.

After I ended the call, I didn’t instantly scream, “I-Knew-It’ll-Fail.” Or “Thank God I didn’t put a dime there.”

My first reaction was a deep sadness. I failed my friend.

I felt sad because a part of me kept telling me that if I had advised my friend on what to improve after I pulled out, the outcome would have been different.

Don’t know if this would have been the case. But I’ve got to live with it anyway.

So, for other young people who might be working hard on a small business or pondering investing in a small business, do you think these red flags could help?

You can share your thoughts in the comment . . .