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Pros and Cons of Merchant Cash Advance
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The Harshad Mehta Scam in India (1992)
Harshad Mehta was the son of a peon. He was born in abject poverty and when he migrated to Mumbai, he had a mere Rs 40 i.e. less than $1 in his pocket. However, over the years Harshad Mehta rose meteorically to become one of the most influential and powerful brokers on the Bombay Stock […]
Are Index Funds not a Good Investment in India?
The Indian equity markets are at an all-time high. This can be largely attributed to the large inflow of savings which is being channelized from the economy to the stock market. A lot of these savings are regularly routed via the mutual fund route. The Indian market is still developing. Hence, a lot of money […]
Cash Burn Rate: The Basics
The startup and entrepreneurship game has undergone a lot of changes in the recent past. Earlier, having a free cash flow was the hallmark of a successful business. All businesses including startup businesses were valued on the basis of the profitability or the free cash flow which they generate. To date, most startup valuation models […]
It is common knowledge in the investing world that almost 90% of the start-up companies which come into existence shut down within the first couple of years. However, it is also assumed that if a company is able to gain funding from professional investors, its chances of surviving become astronomically high. This is because it is assumed that professional investors are very good at picking companies they want to be back. Hence, if a particular company has been picked, it would be fair to assume that the company must be doing a lot of things right. If one also accounts for the guidance and the deep pockets that investors bring in, failure starts to sound like a distant possibility.
However, a study of empirical data related to start-ups tells a different tale. It is common for start-ups to fail even after receiving funding from professional investors. In this article, we will explore the various reasons which are commonly associated with such failures.
The number one reason which is associated with the failure of start-up companies that have been able to receive funding is a poor product-market fit. A lot of times, start-up companies start developing a very good product. They undertake extensive studies in order to find a pain point for their target market. Then they begin developing the most viable solution in the form of a product or a service. However, if these same companies receive funding very early, then they tend to stop focusing on creating the product.
Many times, founders have lost focus and started focusing more on the commercial and operational aspects of the business. This leads them to neglect the product or service which is the very reason for their existence. Ironically, professional funding can prove to be a detriment in such cases instead of being a boon.
A lot of the time, companies that receive funding tend to shift their focus more towards the investor community. For such companies, customers cease to be their number one stakeholder, and more preference is given to the interests of the investor community.
Now, it needs to be understood that the interests of the investors may not be aligned with the interests of the company in the long term. This is because investors want to maximize the value of their portfolio in a three-to-five-year period before they liquidate their investment. Hence, it is possible that the investors might want to maximize their benefits in the short run at the expense of other stakeholders.
Start-up companies which have a weak relationship with co-founders are more likely to fail. This is because when investors get onboard and start infusing large amounts of capital, it is possible for the cofounders to feel that the roles and responsibilities have not been divided equally.
It is possible for the co-founders to believe that they are doing too much work or getting too little credit for success. It is also common for the co-founders to believe that this is being done on purpose in order to oust them from the enterprise. Even companies like Facebook have seen high levels of co-founder conflicts. Such conflicts can lead to the organization losing focus. The organization may also lose a lot of money to expensive litigation.
In the case of start-up companies, it is not only the idea that matters, it is also the speed of execution that matters. When start-up companies do not have access to a large amount of capital, they tend to develop products at a faster pace. This is because it is important for them to complete multiple rounds of testing and bug fixing before they approach the investors to raise more funds.
Hence, receiving funding in a delayed and phased manner keeps the company on its toes. On the other hand, if the company has already secured a lot of funding, it can suffer from low motivation. This is because there is no urgency to raise funds at a high speed. As a result, it is common for start-up founders to slow down product development. In many cases, this can be detrimental since it can lead to the company losing market share because of complacency.
Having a good product is not enough to survive in the hyper-competitive marketplace of today. It is important to build a good system of execution and governance to support the product. Sometimes, companies that have received funding at an early stage tend to become complacent when it comes to developing their overall business. This complacency often becomes the reason which causes the failure of such start-ups.
The bottom line is that even though obtaining funding can drastically reduce the chances of the start-up failing in the long run, it still does not eliminate the possibilities. There are plenty of case studies wherein well-funded companies have spectacularly crashed causing grave losses to founders as well as investors.
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