7 reasons why startups struggle to raise venture finance
VCs play an important role in funding high-potential, high-growth companies.
THERE’S NOTHING EASY about raising venture finance for your startup – only a handful of founders that pitch to a particular fund are successful.
It’s worth remembering that venture finance is just a small part of a startup’s story. The vast majority of new businesses are funded through other sources like bank loans or initial cash injections from friends and family, or better still, from customers.
A lot of companies that achieve an exit either via trade sale or the public markets never raised venture capital. But venture capital does play an important role in funding a particular class of high-potential, high-growth company.
Here are just a handful of the reasons why startups struggle to raise venture capital:
1. Too aggressive
It’s easy to pitch amazing hockey curve sales numbers, trillion-dollar market estimates and Facebook-sized valuation possibilities. Rationality is the key here.
You need to have a model and a rational argument to back up your pitch for the size of the opportunity.
The model – of sales growth, number of customers, lead pipeline, pricing growth and so on – is the basis for the conversation. You’ll debate it with your VC target, and unless you can back up your assumptions with good intuition and occasionally some facts, then it’s hard to believe it to be credible.
I’d say the model is more important than the final number it underpins. With a good model, both sides can ask “what if” questions, and it gives scope for optimism bias to push deals across the line.
2. Not aggressive enough
You often find that entrepreneurs do not fully appreciate the fundamentals of venture financing. The model really only works if the venture firm finds super hits; the big exits that ‘return the fund’.
This usually means the founder must have a big vision and an ambition to build a big company and push for a big exit.
You’ll hear VCs say they need to believe you can be a €250 million or €500 million exit. They’re not just spinning a yarn; the model of venture funding literally does not work unless you can find some of these companies in your portfolio.
This means your plans need to align with this big exit potential.
If you show nice, steady revenue growth, getting to €5 million annual sales after five years, and pitch a potential exit of €50 million then this is not a VC-backable company. It’s a great business, no argument, but it’s just not VC-friendly.
3. Can’t articulate the customer value proposition
This goes to the very heart of every business, and it’s surprising how often founding teams have difficulty in really understanding the pain point of the customer and how their solution solves it in a meaningful way.
You need to be able to put yourself in the place of your customer, feel their pain and have sufficient understanding of the customer’s business and processes to be confident your solution is appropriate, effective and deployable.
Sometimes the pain point isn’t really a pain point, or is not a priority for the proposed customer. Other times, the proposed solution would bounce off the organisation, requiring too many changes to existing systems to adopt it.
4. Lack of clear leadership and delegation
There’s no greater turn off during a pitch by a founding team where the founders are talking over each other, fighting to be heard or contradicting each other.
If that’s the way it is in a pitch, then that’s likely exactly how it is day to day in the company. Founding teams need to draw clear lines of responsibility and authority and demonstrate their understanding of the need to grow a team, bringing in top talent into a structure built to scale.
During a pitch you quickly get a sense for this. You like to see a clear leader who drives the narrative but who also defers to others on the team for their specialist input.
You also like to see this interplay between the team members to be free-flowing and clear, illustrating a team that already has a good dynamic where each individual takes ownership but understands their role.
5. Pitching to the wrong VC
There are many shapes and sizes of VC firms and partners. It’d be a real mistake to assume that they all behave similarly and are looking for the same types of companies.
The reality is that VCs typically invest in about one in every 100 companies they see. This is not because the other 99 are bad, it’s simply that they do not fit what the VC is looking for.
Before choosing firms to approach, make sure you’ve done your homework on the stage of company they invest in, the geographic areas they are looking at, that they have money to invest, that they are specialists in the type of business you are building and the sector you’re operating in.
Once you’ve established what you think is a good potential fit, then research the partners and find that partner who sounds like they would be most interested in your company.
6. Bad advisors
Bad advisors at best slow down deals and at worst can cause funding rounds to collapse entirely.
It’s always a mistake to use your family’s trusted lawyer to represent you when negotiating a deal with a VC firm. Use a lawyer that has done it before, that knows what is standard and what is unusual and that can guide you through the process based on their experience.
There’s a real pattern to investments, and it’s a real waste of everyone’s time and money when industry norm terms are disputed by inexperienced advisors.
This extends to financial advisors using esoteric or just plain wrong accounting practices, to mentors who’ve never experienced running or growing a business and basically anyone you rely on for their judgement.
7. Not raising enough
The number one killer of companies in the early stages is running out of cash. The number one reason for running out of cash is you spent too quickly. The number one reason for spending too quickly is being over optimistic about sales and prematurely scaling the company.
The unfortunate reality is that the vast majority of companies are overly optimistic about their sales, and as a result, a general rule of thumb is to always raise more than you need when you’re in a position to do so.
It may be very invigorating to bet the shop on everything working out exactly as you’ve planned, but the smart bet is to build in a healthy dose of contingency. Shit happens.
Try to ensure you operate at a cash level that gives you some optionality, some ability to take corrective action, when things inevitably do not go according to your plan.
There are hundreds more things that could be listed, but hopefully some of these resonate and will be helpful to you if you’re planning to raise venture capital. I wish you every success if you are.
Steve Collins is a partner at venture capital firm Frontline.
