As a serial entrepreneur himself and an investor in dozens of companies through his role as a panelist on Shark Tank, Daymond John -- known as the "People's Shark" -- has seen every possible mistake a start-up can make. The FUBU founder, who built a $6 billion business from the ground up, has perhaps even made some of those mistakes himself -- but his many years as an investor in fledgling companies have taught him what to look for.
John may not get every investment he makes right, but he has identified some red flags that scream for him to stay away. These are mistakes entrepreneurs make over and over again that can be avoided.
These are John's red flags
John named a scenario seen on his television program as his top red flag. It's a sort of flawed logic that countless entrepreneurs use to justify the valuation of their business when they can't use actual sales.
"Red flags are when entrepreneurs talk about theory," John said during a phone interview with The Motley Fool: "When they say this is a $50 billion market, and if I can only get 1% of 1%, I would be a millionaire."
That type of thinking, the Shark explained, tends to stand in for hard data.
"Red flags are people who don't have any indication in regards to sales," he said. "They don't have to have a million dollars in sales, but they haven't sold one item to one person, so they really don't know who their customer is."
John explained that entrepreneurs should not expect investors to do their research for them. That includes having already sold their product or service enough to have an understanding of what the market is and what it wants at what price.
"Does their customer want to pay $39 for this or $42? Do they want it red or yellow? Large or extra large?" he said. "If they don't know and they don't have any understanding of sales, then they are basically taking the investment of my money and using it as tuition."
Be ready when you get your chance
John pushed the idea that it's important to gather sales data without spending too much money. He advocated a sort of do-it-yourself bootstrap approach, where entrepreneurs do as much leg work as they can before seeking investors (at least outside of friends and family), and especially angel investors.
His red flags show the dangers of going to smart investors without fully understanding your potential customer base. Getting 1% of 1% of a huge market isn't easy, and the size of the market doesn't mean your idea will succeed in cracking the code, or winning even a fraction of the available audience.
Have your numbers down cold before you pitch an investor. You may not yet have an enormous amount of sales data, but you need to have enough to make the case that you understand your customers, and to show that enough of those customers exist to meet your revenue projections.