Preparation for the investment process is always time very well spent. This is where most people focus. There is almost always no preparation for a failed raise, and certainly no time built in – but having an option going into the process is time well spent, says David Pattison
Most young businesses expect fund raising to be a straightforward and simple process. The reality is that it is never easy and almost always turns into a lengthy, distracting, and arduous process. This usually comes as a surprise to the young business founders.
Funding is a difficult process, so it is very often the case that funding rounds fail. This leaves the young businesses in a range of positions, from being in good shape and ready to go again to desperate for cash and in a very short time frame, scrambling for an alternative source of funds with seemingly little negotiation room.
There aren’t any statistics around how many failed funding rounds there are versus successful completions. My estimate would be that there are more failures than successes, but a lot of the failures are early on where prospective investors waste a lot of companies’ time ‘kicking the tyres’. This isn’t too dangerous as very often there is still plenty of time to move on to an alternative.
More difficult is when a raise fails late in the process. The most difficult being when you have chosen your future investment partner and are in a period of exclusivity to get the deal done. Having rejected all the other interested parties, you are now only engaged with one set of investors.
What do you do if you find yourself in this situation? Here are some things you should consider:
1Try and build in some extra time and have an option
Planning is never perfect. Most fail to build in time to cover a failed raise. Institutional raises take an average of six to nine months. A failure at the end of this time means starting again. As I said it’s a tough process.
- Make sure any process doesn’t drag on. Investors want to get you to a position where you have no option but to go with them and they may well try and renegotiate late in the process. Stick to a timetable and don’t let exclusivity periods or due diligence drag on. Holding to a timetable and pushing back on extensions will buy some time for another process.
- If possible, have an agreed option for when the deal fails. Maybe an agreed deal with your current investors or even a loan option in place. It will give you peace of mind and take pressure off the process. It will also keep the new partner focussed.
2Establish why the deal failed
It’s important to know why the deal failed. Is it something fundamentally wrong with the business, the team, the numbers, or something as simple as the investor just deciding they don’t want to do it? Any future investors will want to know if you have had a failed round and will drill into the reasons. You need to have good answers. More importantly you need to know so that you can put things right.
3Work out how much time you have
The problem with a failed round is that it has taken some of the well-planned time out of the process. This immediately puts the business under pressure and can send out a signal of slight desperation, which is never a good place to be when negotiating. You therefore need to work out how much time you have before the cash needs to arrive. If you are a profitable business this isn’t an issue, if you are burning through cash then this is vital information. How do you buy more time?
- Go back to your current investors and see if you can get them to invest at a lower level than the planned round. You will need to make the offer very attractive. They might also be open to looking at a loan.
- If the business is burning through cash and you are in survival mode then cut costs. Cut hard and quickly. It will buy time and impress any future investor. It will also be painful.
- If you can, get the business to a break-even position. This will buy time even if it does have some long-term effects on future growth.
4Explore all of the options at the same time
When a deal fails, it is tempting to look at one option at a time. Don’t. Look at all the option at the same time. It will be distracting for you and the business, but you are talking about giving the business a future, so it is important. The type of options to look at would be:
- Approach the investors you rejected in the selection process. It will feel awkward but if they liked the business before, there is a chance they can be encouraged to like it again.
- Go to your current investors for help. They won’t want to see their investment disappear and might feel obliged to help. They might not have wanted to invest in the proposed round because it was too much money, but a lower level at an advantageous price might be very attractive to them.
- Approach ‘family and friends’ for loans or investment. They will want to help.
- If you don’t need the money immediately, consider putting off the fund-raising process. Reassess, it might lead you to a different solution. You might not need the funding and if you don’t then you retain a lot more equity and a lot more control.
5What if you are desperate?
Sometimes the deal fails so late that the company is in a desperate position. This will almost certainly put you in the ‘money at any cost’ position. When you are dealing with the institutional investors such as the venture capital sector, they will want to take advantage of your weak position. They will smell the ‘blood in the water’.
There are very few options if you are really desperate. It boils down to the following:
- Take a very hard look at whether it is worth carrying on. Does it look like a tough future with no real upside and little in the way of enjoyment? Too often a business carries on because everyone has got used to a miserable working environment. Having said that, there are very few founders who don’t believe that their businesses have a future. Be very clear on why the business is worth saving.
- If you do decide to continue then try and put a deal in place that gives the management team some upside based around future performance. You are unlikely to get a valuation of any substance and you will almost certainly have to give up significant shareholding and influence. But future success is what everyone wants and being rewarded for this will mean that everyone benefits.
Preparation for the investment process is always time very well spent. This is where most people focus. There is almost always no preparation for a failed raise, and certainly no time built in.
Having an option going into the process is time well spent. Knowing what to do when the deal fails is going to give a lot of confidence to the business, the team, your current investors, and the new investors you will be looking at to fill the gap.
David Pattison is a start-up funding expert, business chair and mentor, and author of The Money Train: 10 Things Young Businesses Need to Know About Investors. The book won best Startup / Scaleup book at the Business Book Awards 2022.