The top five reasons for start-up funding failure

The US is usually an accurate indicator of trends in the Australian startup scene. So, when data from the US tells us that just 4.1 per cent of startups secure seed funding from venture capital firms and just 3.8 per cent secure money from angels, we can expect a similar picture here in Australia. This leaves 92 per cent of startups bootstrapping or borrowing from banks, family and friends.

This year the shifting sands of the economic landscape have changed the way that VC firms are investing. During FY20, our own firm completed more deals compared to FY19, but we invested in a smaller proportion of new companies. These are testing times that has shown some start-ups to be highly resilient, so a new investment may pose a greater risk with many unknowns.

If founders consider these top five reasons for funding failure they may be able to correct their course before they pitch to VCs.

1. Team dynamics

A VC hopes to see a number of key roles filled when they consider investing – namely a technical person, a domain authority and a commercial individual to take the product to market. If there is no tech co-founder in a tech business, this rings warning bells for investors. Conversely, if an idea and the technology is great but the skills are not within the team to take the product to market, then the start-up is unlikely to reach its potential.

2. Company fundamentals

A new start-up that competes with an existing portfolio company is likely to prove too great a conflict for a VC, and start-ups with a complicated capitalisation table or share register can also be a turn-off. Cap tables are problematic if founders have too little equity to be incentivised, non-founders have large proportions of equity, there is one major shareholder who is inactive in the business or there are simply too many shareholders.

ESG issues can also be deal breakers. Like many VCs, we are aligned with the principles of sustainable investment and will decline opportunities to invest in industries like tobacco, gambling or weapons.

3. Missing in traction

If a founding team appears to be slow to reach milestones this may also lead an investor to question the viability of the business. An investor will be looking for an ability to get things done, increasing momentum and proof that a business is scalable and capable of rapid growth.

Founders need to clearly demonstrate early signs of traction and product / market fit.

4. Problems with product

Whilst constant iteration of an MVP is a part of start-up life, a poor prototype can be a fast track to failure. A good prototype will allow founders to engage with their audiences, gain clarity on the product, and assist in planning a roadmap.

Often founders confuse features and products, and it’s easily done. Features perform an action whereas products are normally a package of features that solve a problem.

If there are intellectual property concerns with a feature or a product, then this, too, may prove  too off putting for an investor. This includes factors such as non-exclusive licenses and potential infringements of a third party’s technology.

5. Market factors

Sometimes the greatest ideas fail because the size of the market is too small and the start-up quickly reaches saturation. This business may then operate more like an SME with limited growth potential, but for a VC this isn’t a compelling investment proposition.

A crowded market might pose an issue to start-ups and a lack of differentiation can stall investor interest. Founders in this position, may need to conduct further testing and iterating to develop a unique proposition.

Founders should always ask for feedback to better understand the VC’s decision and if there is an opportunity to resolve potentially problematic issues. A simple course correction might be the difference between funding success and failure.

Benjamin Chong, Partner, Right Click Capital

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