Funding: Financial Smoothie for Infant Initiative

A startup need finances to grow and execute its operation to commercialize the product coming out from the initiative It is interested to see how it is like a smoothie offered to an infant and the semi solid contents of the smoothie like nuts and seeds act as hurdles which need to be crushed along the growth process. Most startups need capital from external sources to execute their plans. Except for a few sole proprietorships or self-funded businesses, it is very hard for a business to run unless it raises funds through a one or more rounds of funding. Funding can be raised either through a private placement or through public offering depending upon the stage where the company currently is and the overall requirement of capital.

In an article by Neil Patel on forbes.com as mentioned in the appendix, 90% of the startups fail. There are two dominant reasons why the remaining 10% of the startups succeed, as mentioned in the article.

1) The product is perfect for the market (huge demand/new to world product)

2) The entrepreneur does not ignore anything (close integration between departments)

But the real question here is: How many of the startup that did fail, had even these two qualities in their team structure. And now that they failed, what can be done?

Another study done by CB Insights, show a list of 20 reasons why startups fail along with the statistical percentages of the chances of occurrence for a particular reason. Here are the top three reasons out of the list of 20 reasons displayed in the article:

It can be clearly seen from this study that 29% of the startups fail because of lack of funding. They might have survived or might have been one of the best startups of the year if they would have some additional funding either from a Venture Capitalist or any kind of private placement. But just having funding is also not sufficient to make a successful business entity. One of the article in Wall Street Journal by Deborah Gage, explicitly mentions that the National Venture Capital Association estimates that 25-30% of venture-backed businesses also fail.

All this data raises a concern. Are the VCs diligently following the due diligence technique or the shortlisting process in Venture Capital funding? It could be possible that ventures which have the potential to be the best startup of the year in the near future are deemed as “fail” just because they were rejected funding from major VCs in their field, owing to a silly reason of not being able to make through the shortlisting procedure? Were they just a few hundred dollars short in their revenue records? Or it may be they do not meet some criterion like being able to reach out to customers in the way they should have been or something else which was considered by the VC during screening. But that doesn’t mean that the startup should be turned down in an automated screening process analogous to the hundreds of resumes are rejected by potential employers by automating the process of matching “keywords” or as they say “essential characteristics”.

An article published by Tuck School of Business at Dartmouth as a note on Due Diligence in Venture Capital, explains that 10-15% of all the business proposals pass the screening phase. The deals that pass the screening phase are further evaluated with detailed due diligence. In the initial screening phase, various criteria for judging the investment fit are considered which includes geography, size, type of industry and the stage in which the startup currently is. Then, due diligence process is conducted by a VC firm to evaluate the potential of the deal in terms of whether a startup has the potential to do well and generate return on investment for the VC firm as desired. Here comes the catch. Let’s suppose a VC firm plans to invest in 10 startups in Silicon Valley this year. They receive over 250 proposals from diverse startups. The firm shortlists about 30 for the business due diligence check. Out of which there might be 8 very good startups. But the remaining 2 which they choose to fund could be the “best out of the worst”. Instead they could have chosen two startups from the already turned down 220 applications which might have done better in case they received funds.

This explains the earlier mentioned fact that 29% of the start-ups fail because of lack of funding. In fact there are numerous examples of start-ups which were rejected by investors, which can be found in an article on formations factory written by Rachel Craig.

In my opinion, there are two solutions to this problem. A solution from the VCs’ perspective, that the screening process should be made highly rigorous and not completely dependent on a software program to shortlist candidates. They should consider swapping funding proposals later on from the selected lot in exchange for the ones which are rejected in the initial screening. Most important, during the initial screening, when a proposal is being turned down, a short report or summary should be prepared which contains the reasons for not selecting that proposal. The VCs can analyze if they are capable of putting efforts in solving those issues for the startup and actually make it worth that it can be. There are many articles out there, which explain how VCs invest in a team rather than the idea, clearly showing that they are looking for people who can execute well. There are so many for entrepreneurs, which talk about researching on VCs before choosing them. It all shows that a VC firm can widen their horizons when it comes to perform the initial screening of applications. They might keep their selection process which they have right now but additionally select the startups which can do well with VC support and funds and a couple of other startups which are the best from the rejected lot. It might help to finally fund the best startups from this list to improve their success rate and finally obtain the desired return on investment.

A solution from the startups perspective could be, “not to give up”. Persistent efforts are needed in order to make an idea a success. Successful examples such as Birchbox, a subscription service for body products also made it big even after getting rejected from about 50 different venture capitalists. This information is provided by Ashish Walia who interviewed the VC Gary Vaynerchuck, who finally funded Birchbox. I have used it to gift a subscription and found it really interesting. Another company named Pandora faced almost 300 rejections during its initial stages and still survived. The very uncertainty of startups frightens away almost everyone. And so, in starting a startup, as in any bold undertaking, merely deciding to do it gets you halfway there. And may be on the day of the race, most of the other runner’s might just not show up. The key is just utter perseverance.

Editorial acknowledgements: Aarohi Shah