Why Do Start-ups Fail After Receiving Funding?
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.
Incorrect Product-Market Fit
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.
Too Much Interference from Investors
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.
Conflicts Between Cofounders
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.
Speed of Product Development
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.
Run Of the Mill Business Model
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.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Seed Funding - Introduction
- Why is it Difficult to Raise Seed Funding?
- Documents Required for Startup Financing
- How Co-Founders Split Their Equity?
- Proof of Concept
- Minimum Viable Product
- What is Prototyping?
- Asset Light Business Model
- Advantages of Asset Light Business Model
- Disadvantages of Asset Light Business Models
- Cash Burn Rate: The Basics
- Managing the Cash Burn Rate
- Startup Financing and Term Sheets
- Key Terms and Conditions in a Term Sheet of Startup Funding
- Red Flags that Investors Need to Look out for in Term Sheet
- The True Cost of Owning a Property
- Valuation of Early-Stage Startups: The Mindset of Investors
- Pre Money and Post Money Valuation
- Start-Up Valuation: Advanced Concepts
- How Pre-Revenue Companies are Valued?
- Valuation Divergence - Meaning and its Importance
- How Do Option Pools Work?
- What are Capitalization Tables?
- Asset Sale vs. Stock Sale
- Financial Models for Startups
- Key Performance Indicators for Startups
- Restricted Stock Options (RSU’s)
- Veto Rights - Meaning and its Importance
- Financial Benefits of Incubators
- What are Unicorns?
- Why Startup Companies are Staying Private?
- Why Unicorn Companies Fail?
- Building a Startup Team
- Bootstrapping: Meaning and its Advantages
- Disadvantages of Bootstrapping
- Revenue Based Financing
- Convertible Notes and Startup Funding
- Pros and Cons of Convertible Notes
- Simple Agreement for Future Equity (SAFE)
- Keep It Simple Securities (KISS)
- Series A Funding
- Series B Funding
- Series C Financing
- Venture Debt in Startup Funding
- Pros and Cons of Venture Debt
- What is Venture Leasing?
- The Freemium Model - Different Types of Freemium Models
- Pros and Cons of Freemium Model
- Scalability and Startups
- Pros and Cons of Scalable Business Models
- Why Do Start-ups Fail After Receiving Funding?
- Start-ups and Arbitration
- What is a Revenue Model?
- Understanding Investor Focus on Burn Rate
- How Investors Evaluate Start-up Ideas?
- Government Regulations Which Impact Start-Ups
- What is a Start-up Accelerator?
- Managing the Operational Metrics of a Startup
- Different Types of Investors
- The Founder’s Dilemma
- Role of Social Media In Start-Up Funding
- Start-Ups and Public Relations
- Red Flags for Start-Up Investors
- IPO: An Exit Route for Start-Ups
- What is Acqui-Hire?
- How to Build a Start-Up that gets Acquired?
- Legal Issues Faced by Start-up Companies
- Corporate Venturing
- How Reverse Pitching Works?
- Aggregator Business Model
- Marketplace Business Model
- Difference between Aggregator and Marketplace Business Models
- Product as a Service (PaaS)
- Benefits of Product as a Service (PaaS) Model
- Disadvantages of Product as a Service (PaaS) Model
- The Co-Working Business Model
- How Co-Working Spaces Make Money?
- Peer to Peer (P2P) Business Model
- The Instacart Business Model
- The Goodleap Business Model
- The Twitter Story
- How Tesla Reinvented the Automobile Industry?
- How Epic Games Changed the Gaming Industry?
- The SpaceX Success Story
- The Stripe Business Model
- The TikTok Business Model
- Zillow Story - The Real Estate Marketplace
- How Business Cycles Affect Start-Up Companies
- Managing Start-ups During an Economic Downturn