Risk and Threat Management – Presented by Greg George

Reverse Due Diligence: Companies Seeking Funding – Know Thy Investor and Origins of Their Money

Posted in Due Diligence by gtiadvisors on May 19, 2009

There is a long history of career criminals creating window dressings to look legit, launder their money and set up with unknowing businesses to support other nefarious activities.

It’s no surprise that since the true realization of the money crash last September, sources of funding have dramatically tightened up.  Most of us understand that desperate times require desperate measures, but be careful – if you’re seeking funding or working with someone who is; there be dragons out there…

I’ve managed investor related due diligence issues over the years primarily by  bringing transparency to decision makers before any deal is made – unfortunately, some call too late and we have to roll in to “how to fix it” mode [far more expensive].  There are two sides of the fence in this work – protecting investors which is our most common engagements, and secondly, protecting the people seeking funding.

In recent months, evidence of increasing “desperate” activities have been coming across the desk here regarding those seeking funding.

My experiences working with diverse company principals operating across several business sectors have sought funding for various purposes – a start up effort, introducing a new patent to market, to complete beta, expansion to support new contracts – you know the drill.

Those of us who have been there or have worked with small business owners, know all too well how frustrating the funding process can be.  From endless practice runs refining the right 37 second elevator pitch just to secure a meeting with a funding group, to agonizing over syntax and the right language to include in the executive summary or a life sciences grant application so it gets noticed.

It’s not unusual for personal credit cards to be maxed out, your father in law has stopped talking to you because he’s tapped out and there is only $2,000 dollars left in the mattress.  Desperation can raise an ugly head.  As badly as you need the money, stop and think it through first and check out your funding sources:

Especially sources who voluntarily approach you.

I’d like to share an older case as a primary example.  The premise here holds true more today than ever – a short synopsis without all the details, but you’ll get the point.

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 your 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.”  It can happen and I’ll share of few of these very expensive and life changing nightmares in a future post.

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.

Greg George is Managing Partner of GTI Advisors; Threat Management Practice Group, a firm dedicated to protecting decision makers from the “dark side” since 1962.  Greg works with clients to develop practices and strategies to best protect their organization including threat analysis, multi-disciplined due diligence review, and training.  For more information, please visit www.gti-advisors.com or contact Greg: greg@gti-advisors.com

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2 Responses

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  1. Dhanie Indrasto said, on June 3, 2009 at 3:44 pm

    Yet, another great article with great examples! cant stop reading this after reading the First in a Series of “Total” Operational Due Diligence Posts: Backgrounds.

  2. Pamala Matthias said, on December 21, 2009 at 9:55 am

    Interesting read. There is currently quite a lot of information around this subject around and about on the net and some are most defintely better than others. You have caught the detail here just right which makes for a refreshing change – thanks.


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