Venture capital (VC) is one of the most popular ways for early stage businesses to access capital. Venture capital (VC) firms provide much-needed funding to help startups get off the ground.
However, venture capital is not a silver bullet for every startup. The venture capital space can be a soul-suckingly lucrative, but it can also be extremely challenging. One reason is that it is extremely competitive to obtain venture capital (5% chance of success for startups). Moreover, venture capitalists put a lot of pressure on startups to grow and to succeed once they get on board.
Venture capitalists are so eager to invest in startups that they’ll do anything to make their money work for them instead of against them. However, each year there are so many venture backed startups fail before they even have the chance to succeed.
This is surprising because one might think that your success is guaranteed once you raise VC funds. However, according to this article by inc.com 65% of venture backed startups fail but the rates could be even higher depending on your definition of failure.
First, let us briefly define venture backed startups and their features.
Venture Backed Startups and Their Characteristics
Most startups need external funding to grow their business and venture capital is very popular among startups to approach to raise capital. However, only a minority of startups, after several rounds of pitching and meeting with potential VC funds, receive funding from venture capitalists.
You can read in this blog post about the main reasons venture capitalists reject startups according to numbers and to our experience of working with startups.
You need to understand investors’ priorities and “logic” and know how to satisfy them. By focusing on the characteristics of your competitors and understanding the needs of your investors, you’ll be able to create a product that addresses the challenges your competitors are facing and be able to secure funding from the right sources.
Raising capital from venture capitalists is certainly a major milestone for a startup because venture capitalists do not only bring money but also their expertise, experience and their professional networks to help the startup growth.
venture backed startups are typically more ambitious, more innovative and tech-savvy than average startups and serve a larger market with a scalable product.
However, many venture backed startups take high risks that bring them to their knees as they do not yet have the resources and slack to make too many risky bets and mistakes.
Below we will elaborate more on five prime reasons why many venture-backed startups fail each year.
1. There’s a lot of money to be made, but not a lot to lose
This is the No. 1 reason why many venture backed startups fail. The best part of being an investor is the sense of satisfaction that comes with success; but it becomes a lot more difficult when there’s no guarantee that either party will make money.
If you’re in the business of finding and funding new and early-stage companies, there’s a chance you could lose everything you invested in them. For startups, even if they are venture backed, despite the advantages explained in this blog post, the cash flow is limited and they typically have 1-2 years runway at best.
If startups do not manage their cash flow well and do not scale their business on time and fast, they risk to go bankrupt and lose everything. Even venture backed startups might face difficult economic conditions or unable to finish their product on time or find enough customers to cover their costs.
Even if startups are venture backed, there is no guarantee that other stakeholders, specially customers, are going to trust them blindly. They should keep in mind that they still have a long way to go.
This means that there’s a very real chance that investors could lose money on any given deal.
2. VCs don’t have a lot of success stories to point to
Not only do venture capitalists not know whether their investments will make money, but they also don’t have many success stories to point to. We mentioned that only a third of VC deals will survive to witness moderate success and perhaps one in five or one in ten venture backed startups show massive success, like a unicorn.
This does not provide enough evidence to analyze for venture capitalists to understand the success formula. Of course, they have some valuable clues, specially the best ones, to help startups but they cannot claim they know everything.
After all, every deal is different. What has worked in the past and perhaps in another industry perhaps does not work today in this specific deal. So even taking advice from VCs should be done cautiously as the landscape of startups are ever changing.
But it’s also important to keep in mind that not every investment leads to a huge return. In fact, only about 25% do. And the majority of the time, the return is somewhere between 6% and 15%.
This is another reason venture backed startups fail. VCs bring a lot of managerial and growth expertise but they certainly know the startup and its opportunity less. Due to their loud voice in the board meetings, the startup founder might listen to their suggestions that might work every time.
3. There are too many hands in the pot
Investors are less likely to invest if they think they’re too early or too late to the game. They prefer to see some competitors in the market but not too many. They certainly do not want to see larger competitors that address the same position and the same customer needs.
But regardless of which side of the line you end up being on, the competitive landscape is very dynamic. It is not only the VC backed startup that has seen the opportunity and tries to capture it, it is also other entrepreneurs or competitors who might have seen this opportunity.
This is especially the case for venture backed startups because there is usually a lot of attention and media coverage to those startups and what they actually do. This can backfire if larger players and other entrants start noticing the VC backed startup market and activities.
And when this happens, the majority of the time, it’s because there was a massive shift in the market that benefited the entire industry but it also intensifies competition for the venture backed startup. This could be one of the reasons such startups fail in the long run or cannot reach their full potential.
4. Can’t find an exit strategy
The goal of investing in early stage companies is to generate high returns. But when the average return on an investment is between 6% and 15%, it doesn’t take a genius to realize that this won’t lead to a comfortable lifestyle.
This is why more and more investors are going after certain milestones – like revenue, customer growth and profitability. This can make it a lot more difficult for startups to find an exit, but it also gives those investors a lot more information to rely on.
On the other hand, many VCs request startup founders to exit the business after a while because founders may destroy value after certain stages rather than create value. This is also mentioned in a new article by Harvard Business Review.
If founders do not exit on time, there may be a lot of issues not only with the startup growth and survival but also between investors and the founder. Founders who do not give up control in time can lead to the decline of a venture backed startup.
5. Lack of leadership and communication are weak points
This final reason is a combination of the others and is often where most ventures fail. It’s often a combination of the other reasons that were listed above.
For example, you might have a great business, but no clear path to growth and no clear leadership. This is often the case with early stage companies, and this is where many venture capitalists fall short.
These investors often see a great idea and think they have a chance to make a quick buck. They don’t understand that building a successful business takes time and effort.
It’s important to have a clear vision for your business, and it’s also important to have a clear plan for growth. This will allow you to develop a long-term strategy that will help you navigate the short-term bumps in the road.
Moreover, good communication and stakeholders’ expectation management by founders can solve many issues mentioned above or at least mitigate their impact. This soft skill should be nurtured among founders particularly venture backed startups who deal with multiple stakeholders.
Final words: It’s a long and unpredictable road to success
Success is often measured in terms of short-term gains, but it’s also important to take a step back and remember that it takes time to build a successful venture backed business.
This means that there’s a real chance that you won’t see any short-term gains. This can be frustrating, but it’s important to remember that success takes time. The best way to manage this frustration is to have a clear exit strategy and a growth-oriented business that is focused on long-term results.
This will allow you to let a few deals fall through and let some other startups fail, but it will also ensure that you have a strategy in place for the next round of funding.
