According to Failory, 90% of startups fail, and there are many reasons for that along with several meanings of failure. It can be a failure of not meeting the date to break even or an expected revenue growth rate. It can also be sustaining excessive losses and having to liquidate assets.
As a new business, you must understand the importance of a well-defined investment process and perhaps a funding timeline. Without it, the whole VC funding exercise becomes stressful, and raising money can cost you and your business a lot in different ways.
If your funding round fails, you will need to understand the reasons behind it.
In this post, we will discuss the following:
- Why do rounds fail?
- What to do when your equity round fails?
Let's jump straight in!
Why Do Rounds Fail?
Start-ups will always be handicapped when dealing with venture capital investors who have years of experience in deals. The likelihood of an equity round failing is always there and with VC’s being more conservative more likely to happen too. So, understanding the reasons that can lead to that is essential.
We have selected some of the more common reasons here:
1. Founders Are Too Diluted
New businesses will eventually require more funds, and the obvious option they seek is external financing. It is common for founders to be heavily diluted before reaching the IPO stage.
As an example, consider the case when Pandora Media went public in 2011. Co-founder Tim Westergren owned only 2.39% of the music streaming firm.
But what percentage of founder dilution is acceptable? VCs reportedly rejected Pandora more than 300 times. Finally, the business was able to get investment, but the founders ended up having to give up a significant portion of the company.
So, before you ask for VC funding, study and plan your equity distribution.
These people will be key to collating the information needed and implementing any fixes that need to be put into place.
2. A High Valuation
It is natural to seek a high valuation of your business when you are on an equity round. Still, how high is too high for a venture capital investor to be thrown off it? That's a tricky question!
How do you double the value of your second-hand car?
You fill the tank!
Are you doing something like this when you come up with a valuation of your company?
A high valuation is one of the leading causes of a round failure. Even if you get lucky and secure VC funding, the higher valuation will bring greater pressure from the investors. This becomes more acute when you go for the next round.
3. The VC Want Too Much Equity
When it comes to capital structure, venture capital investors want to have their cake and eat it as well. They prefer a big portion of equity since it provides them with a large portion of the profits if your firm succeeds.
If a VC asks for too big a slice and you have too many mouths to feed, the round will end up as a failure. Before entering the Lions' Den it is ideal to have a number in your mind which reflects the maximum equity you are willing to give up.
Remember, it's not just the equity you are giving away; it is also the control of your business.
4. The VC Want Preferential Shares
If you are looking to secure VC funding, you will encounter a strive from VCs to safeguard their investments by requesting anti-dilution provisions like preferential shares.
An equity round is likely to fail when founders hear the demand for preferential shares. After all, they don't want to get diluted themselves.
VC's fear about the worth of their capital is understandable. At the same time, as a founder, you should carefully analyze these conditions to ensure that they are fair to you and other stakeholders involved in your business.
5. Failed Due Diligence
Due diligence establishes a systematic strategy for venture capital firms to assess and verify start-ups to reduce risks before investing in them.
However, it is often a demanding and time-consuming exercise, which is why founders must be properly prepared and ready to devote sufficient time and resources to guarantee a successful process.
If not, a botched due diligence process can drastically devalue your start-up or, even worse, result in a failed round.
6. Misaligned Incentives
Though VC firms typically operate in ways they feel would help a new business to flourish, their incentives can be different from yours. That's why it is critical to go through the exhaustive due diligence process that we discussed earlier.
Consider a scenario where a VC pushes you to spend money to accelerate going to market so that they can quickly get a return on their investment. It happens a lot!
Venture capitalists often pressure founders to spend more money and more quickly. This can sometimes result in rapid growth. Often, it results in emptied bank accounts. We've seen several businesses decimated by this pattern.
Short Term Actions
If you have reached this point, I am guessing your round has failed. Now what?
There are loads of things you can do. Here we have covered the best short-term actions you can take when your round fails.
Retrospective
There is a lot of clarity in hindsight, and it is important to accept failure. There are several examples of entrepreneurs who endured rejection while pursuing their ambitions. You are indeed not alone.
So, what can you do? Well, start with analyzing what went wrong and put an action plan in place to fix the failure.
Know Your Figures
Knowing your figures is a proactive approach, as it lets you know if you need to reduce expenses or extend your cash runway.
This will delay the need for VC funding, but it may not be practical for a very small business or one with little working capital.
Look for Funding Alternatives
After months of dedication and challenging talks, cash-hungry entrepreneurs forget that there are funding alternatives.
They loosen their street-wise prudence and forget conversations with alternate sources of funding. This is a costly error. Always be open to other options like bridging loans and private debt.
Private Debt
Private debt is generally used by businesses to support growth, expand working capital, or simply give them time after a failed equity round to plan and strategize their next move. Private debt has been more popular among institutional investors as a source of diverse returns. However, SMEs can use it to their advantage as well.
In the fast-moving, ever-changing, and highly competitive tech market, growth is everything. You can accelerate it by funding your growth capital with private debt financing.
Conclusion
The best way to prevent round failure is to go in with prudence and a well-defined strategy. However, setbacks are part and parcel of business. It is what you do after you fail that will define you and your business.
What matters most is having enough money to accomplish a set of objectives, so it's never too late to look for funding alternatives.
