Why do most Venture Capital Investments fail?

Venture Capitalists are playing a crucial role in providing employment indirectly .The investments they are making in startups actually helping lot of youngsters to find lucrative jobs in startups. A decade ago a qualified Chartered Accountant or Cost Accountant used to get around INR 20-30 K per month in the corporate on the successful completion of difficult courses . However with the emergence of multiple Venture Capital firms and subsequent startup boom, it became extremely easy to find highly paying jobs even for college drop outs. However there are many Venture capital firms whose investments are not really leading to return on capital rather leading to erosion of capital . So the humble attempt is to highlight some of the controllable factors in the hands of Venture capitalists to safeguard their investments.

 This transitional change in the sources of capital also led to the change in value assessment and feasibility assessments of corporate world, Notional future value potential assumption started replacing the realistic quantitative cash flow potential based on current actual returns in decision making of Venture Capitalists.

 Till very recently, no one in venture capital world was asking is the company making profits or is the company have visibility towards profitability in the next two years?. Rather every VC firm was eager to fund such ideas which burns more and more money while on the face of such idea it is evident that they never make positive cash flow returns. The idea was to drive more and more customers to the concept or business platform and eventually use such platform to generate positive cash flows.

But the cost of acquiring the customer and retaining the customer on the platform was much higher than the revenue and this gap never reversed for many years of existence too in most cases. While every Harvard returned VC professional felt it will happen unfortunately it never happened till date. There was no honest attempt to see if at all the customers stick to the platform if the company start charging premium to the customers and start booking profits on sales.

So metrics of measuring successful ventures moved from Profitability, Market share, Growth in profitability, Reduction in costs to further improve profits to Reduction in Cost per Order, Reduction in Cost of Acquiring a Customer, Number of persons visiting the website, Number repeat visitors to the website, Number of cities from where people visited the website, Number of clicks, etc.

 All this led to shift in perception in assessing valuation from earnings and profitability to Market share expansion in terms of visitors or users as a focal point irrespective of profitability from transactions.

Also it became quite difficult to trace the transaction journey or visitor journey on the websites of portfolio companies of the Venture Capital firms due to the complexity of coding and bots .This also resulted in difficulty for Venture capitalists to trace the accuracy and genuinity of visitors to the site.

This has complicated the play for Venture capital firms and also made it easy for promoters to raise funds.After seeing the valuations few startups were fetching in VC world, there was mad rush of Venture Capital firms to encash the so called opportunity in Indian market, Instead of waiting and asking for detailed picture, the venture capitalists started pumping in money at extremely insane and unsustainable valuations. The fear that they may loose an opportunity to make billions by investing millions has resulted in driving abrupt behavior in Venture capital firms to invest in few companies even without proper understanding of the business. In most cases Venture capital firms started giving Term sheets at higher valuation than ongoing current valuation which promoted promoters to raise funds from all those who want to invest rather than what is ideally required in the business. So this resulted in to a case of excess supply of cash than required cash.

 So now the promoters sitting on cash that they don’t need ideally. With more cash in bank the startups started rolling out retail outlets or marketing spent through online platforms in to new territories, new product categories , bigger offices, professionals with lucrative job titles and compensations, while all these was happening, interesting to note the company was not even close to cost recovery in their primary and initial market segments. So the funds were deployed in areas which are yet to be proved feasible to the company precisely. Over time these expansions not supported by customer needs or market availability lead to erosion of invested money in the form of Discount offering and business losses.

 The investors who already invested the money at this level have two options in front of them- 1. Write-off the Investment already made or 2. Find someone who can bring further investment to the startup.

In normal circumstances, both of them are difficult to execute. But in a situation where too many Venture capital firms siting with massive LP money want to deploy somewhere. Like how professional network on LinkedIn, all the Venture capital firms and their partners too have very effective network among themselves. So it became easier to sell the loss making, cash burning start up story to a fellow in the VC world by the existing Invested VC. All that he / she wanted to show increased traffic on the website, some paid stories in media. Like this the story continued for many startups irrespective of genuine buyers, profitability and market presence. The comfort that some other known VC invested in a company gave more comfort to many Venture Capital firms than the business convincing them. This is the result of networking on the negative side.

 Networking in VC world is quite extensive. This makes it easy for existing Venture capitalist to pull another VC. Most investments in startups do happen based on references and not straight reviews. So it becomes extremely easy for an already invested and struggling VC to pull in new VC in to the existing portfolio company and together both aim to grow or bring another VC in the next round.

I have myself experienced in my corporate journey, that Venture Capital firms suggested me to show them ideas which has scale and not profitability. One of the biggest VC firm in India suggested me once very recently profitability is not the criteria for their investment and rather asked me to present ideas with potential for high valuation at each round in terms of visitors to site.

 In easy times like pre COVID 19, most of these things were never acknowledged and if at all one would have mentioned these to any VC, the chances are higher that they brand you as“Ignorant”. But thankfully COVID-19 has opened up many Venture Capitalists to reality.

 So the first reason for the failure of VC Investments in India, is the reason for investment. The reason here is not compelling profitable and scalable idea but rather availability of funds and influence from existing players in the VC world.

Secondly, once investment is made these Investments are monitored by analysts and partners from VC are generally managed by the Promoters. However from my experience I can tell, most of these analysts due to excessive work load or due to lack of understanding of the company in detail, they don’t even ask the questions that they are supposed to ask. This makes it even easier for startup to continue to cover up the inefficiencies. It’s very important to assign an analyst with thorough understanding of the functioning of the industry and company that helps the Investor to uncover the truth and support the real growth. If there are any deviations from the plans, they can be rectified and improved provided the analyst identify them in time and inform the Venture Capital Firm appropriately.

Thirdly, I can tell based on my experience most venture capitalist firms are not open to receive any negative and realistic information about their portfolio companies. They live in their own world and always want to hear that their portfolio company is doing something great eve though that is not the reality. At times even burning more money month on month seems to be thrilling news for few. This is the level of either the blind level of love or over confidence in the portfolio, lead a psychological state that you will not able to even acknowledge a sinking ship in front of your own eyes. As per my understanding this comes from the fact they always interact only with promoters and as usual promoters keep sharing perceived positive information only. So this gap between reality and perception over a period of time grows to unbridgeable level and ultimately the investment sinks.

Fourthly, after investments are made, in most cases the relationship is not collaborative. The Investors are heavily dependent on the promoter. So the promoters also block the involvement of Venture Capitalist on the functioning of the company irrespective of whether at strategic level or at transaction level. While it is very important to allow at strategic level, it may not be advisable at transaction level. This makes the business also closed to external reviews and feedback and over a period it reaches a stage of impossibility of coming back to right path. It becomes extremely difficult to rectify by the time investors start involving.

Lastly, I never heard of any Venture Capitalist who on his or her own meets randomly the customers. Most of the time they never meet customers to validate the promoter version. Some cases they do meet the customers selected by the promoter which obviously provides the feedback the promoter want. This again leaves the Venture capitalists to live in their own world away from the reality. Its only when the things are far away from their control, they understand the reality and make an attempt to correct knowing it’s too late already.

 So here are the key points for a VC to safeguard its Investment;

 ·        Never invest in a startup because someone already invested or some other VC recommended. Business idea , its potential in terms of scale and profitability and competency and integrity of leadership team should be the reasons for investment and not because other VC invested.

·        You can take inputs from existing investors, but do your own unbiased review on the potential and prospects of the company.

·        Please note if the existing opportunity is so attractive, the existing investor will not inform you in most cases as he himself can increase the stake. Since availability of funds is not a constraint. So someone referring a company where he already invested and company still burning money, then you need to be all the more careful to review the opportunity.

·        Having competent analyst is the key. Competent just mean some one with depth of experience and subject knowledge. Don’t mistake this as “Alumni” status. You could see many Harvard returned struggling but many Bangalore University MBAs delivering exceptionally well. Qualification or Institutional background is not the hallmark to select analyst. Most VC firms commit the blunder of selecting analysts by their Alumni tag .

·        Be open to feedback whether it’s negative or positive. If it’s negative try to understand what led to this and how to correct the path from there.If its positive , be happy and just authenticate the reality of that and support the growth further.

· Frequent separation in leadership team is a clear indication about the direction of the company. So stay away from such companies to safeguard capital.   

· Promoters with vested interests and insecurity would like to have only restricted access to the Investors.They would like to be present in every meeting when the team talk to the investors and they want to control what is shared with investors. Stay away from such companies in subsequent rounds if already invested. One of the key to successful investment in startups is the operational freedom to leadership to able to share uncensored information with the investors.

·        Never invest in a Promoter alone. Invest in Business idea and Leadership team including the promoter. Promoter is just a face and it’s the team that executes idea.

·        The profitability is key in business. Subsequent round investments need to be clearly depends on the plans submitted earlier and their execution.

·        Path to profitability and Customer experience are two areas where highest transparency need to be obtained before deciding investment.

·        Always note that bringing another VC to a startup that is burning money where you already invested your money will not safeguard your investment. Rather both sink together. So ensure the issues in the company are rectified and company start performing. That saves your money and not your friend’s investment.

·        Spend time in meeting leadership team and customers randomly in your portfolio companies and collect their experience and feedback and review them periodically and start taking corrective actions.One need to have this figured out from database without the involvement of promoters. So independent profiling of with whom to talk should be done by the investor himself / herself without the Promoter role.

·    Extend the confidence to the leadership team to bring unethical issues upfront to them without any fear or favour. This saves lot of pain to the Investors if attended in time with proper attention.

These are some of the measures which saves your investments from sinking. Multiple rounds of investment and valuation on paper is not the real metric of success bur rather profitable growth and scale and ability to generate true returns should be the measures of measuring progress .

Trust you find this useful.

Note: While there are many environmental and economic factors that may impact the investments and performance of those investments, the attempt was only to review internal or controllable factors in the control of Venture capitalists that influence the outcome of VC Investments.

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