Risky Business: All startup investments come with risk, but that doesn’t erase the need for strong founder fundamentals
Anyone familiar with the venture capital industry knows that it is a high-risk, high-reward business. A startup that succeeds can make a lot of money for themselves and their investors. However—as the common VC proverb goes—for every one startup that hits it big, another nine will fail.
In reality, the numbers probably aren’t quite that stark. As a general rule of thumb, The National Venture Capital Association estimates that only 25-30 percent of venture-backed business fail completely. That means out of every 10 startups an investor backs, 2-3 will go out of business and 4-5 might return their original investment (or something close). This leaves one or two startups that will drive the vast majority of a funds financial returns.
Still, it’s clear that more startups lose investors money than produce returns, making the work of a venture capitalist inherently risky. Of course, investors build this risk into their business model, relying on the large successes to make up for the more numerous (but smaller) failures.
Investors do their best in diligence to try to make good choices and mitigate their risk—but it’s not easy to do. If it were, then every investment would be a winner.
So, when a startup doesn’t get funded, it’s tempting to an entrepreneur to blame the investors who denied them for not having a healthy enough appetite for risk. However, this is often a flawed assertion. That’s because most investors are not averse to taking “calculated” risks. It’s the unnecessary risks they are looking to avoid.
As a startup entrepreneur, what is most important for your long-term success is that you’re being honest with yourself about the difference between the risk factors you can and should be mitigating, and the ones you simply cannot control.
For example, startups are rarely able to anticipate future market factors, customer churn or sales costs as well as more established business that have a track record to lean on for their predictions. Savvy investors are comfortable with the fact that early stage companies can only validate their numbers to a certain extent. That said, they will need to be very comfortable with the depth and quality of the assumptions you’ve used to frame your business case.
No matter how young your company is, you still need to have solid support for these key costs and potential revenue assumptions. You can start by simply asking yourself how much it costs you to acquire a customer. Begin with an estimate based on a small sample size, or even the result of some simple beta testing on social media, but don’t underestimate how important it is for investors to know that how you reached your conclusions.
Again, smart investors realize there is no way you will know every single answer to every single question about your market, especially in the beginning. But part of being a savvy entrepreneur is knowing enough about the fundamentals (customer insight, competitive advantage, sales strategy, cash flow management, etc.) to show those investors that you aren’t exposing them, or yourself, to unnecessary risk.
If an investor tells you that you are falling short in this department, it’s likely that they simply aren’t buying into the assumptions and rationale you have presented to justify your vision. And if you start hearing this same message over and over, it could be time to consider whether you are doing enough to clearly and convincingly communicate how you plan to mitigate the risks that are in your power to control.