Fixed Asset Turnover Ratio
Fixed assets i.e. property, plant and equipment represent the single largest investment any company makes in its operations. It is therefore important that a company keeps a close eye on whether these investments are performing well and generating adequate revenue and profit to justify the expenditure. While it is impossible to come up with a […]
Common Restrictive Covenants in Fixed Income Securities
It is important for investors investing in fixed-income securities to be aware of restrictive covenants. This is because restrictive covenants can have a huge negative impact on the valuation as well as the liquidity of the debt. Bond indentures are detailed legal documents that can have many covenants which prove to be restrictive. However, there […]
What is Venture Leasing? – Advantages and Disadvantages
In the previous few articles, we have already learned about how venture capital and venture debt work. We now also know the pros and cons of venture debt. However, there is another form of debt called venture leasing which is commonly used by investors in the marketplace. In this article, we will have a closer […]
Financial and Economic Models used in the Equity and Currency Markets
We often read about how electronic and software based trading is the norm in stock or equity markets as well as currency and other financial markets. Indeed, anyone who is remotely connected with the stock market or for that matter any financial market would know that there are trading systems and trading software that help […]
Conflict of Interest in Investment Banking
Investment banking institutions are engaged in multimillion-dollar transactions. This means that if an investment bank is perceived to be operating in a conflict of interest situation, it could severely damage the reputation of the bank. This lost reputation could end up becoming a financial loss is no time. There have been several instances where conflict […]
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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