Why is it difficult to raise finance for start-up and early-stage companies?

Due to the riskiness of businesses – especially start-ups and early-stage businesses – only a small number of businesses get funding from investors.

Entrepreneurs need to first understand whether their business fits into what external investors want before pursuing them. Otherwise, it is simply a waste of time, money and energy on an elusive goal.

What are the main reasons for such a low success rate?

Lack of experience

Smart investors will check whether the management team has the relevant experience to run the business before they read the rest of the business plan.

A team without the right experience is highly unlikely to get the attention of investors. Potential investors will look closely at the management team.

Flawed business model

Entrepreneurship is not just about market share; it is about a strong and sound business model. You need to have a product or service that customers truly value and for which they will pay a premium. The product or service needs to be some combination of better, cheaper and faster. Cheaper does not mean it has to be cheap or priced lower than the competition. It means that you must have a cost advantage that adds value for your customers.

Requested investment is too high

The key is to get just enough money to get started and test your business model, but not so much that your business is insulated from market tests. It is important to learn early whether your product or service has the potential to be profitable. In order to test your product or service, it is not necessary to spend a large amount of money.

During the Dot-Com bubble many start-ups received vast sums of money that insulated them from market tests. Boo.com spent more than $130 million trying to launch its business in 18 countries and failed. Webvan spent about $1 billion trying to set up an online grocery business and failed.

Illusion of first mover’s advantage

Basing the business only on first mover’s advantage is just an illusion. The first mover’s advantage rarely works in isolation from other competitive advantages.

Many examples illustrate that the first to market is rarely the industry leader in the long run.

For example, Google was not the first search engine, but it now dominates the search market. Apple was not the first to market portable music players, but it leads the market.

  

No exit route

Investors will not put money into a start-up unless there is a way for them to get their money back within about five years.

But most start-ups are not suitable for an IPO, thus preventing investors' ability to sell their shares.

Low sales growth

Investors look for rapidly growing markets mainly because it is easier to obtain a share of a growing market than a mature or stagnant market. Smart

entrepreneurs will try to identify high-growth potential markets early.

Start-ups need to generate at least $30 million in sales within five years for most investors to consider investing. Only a small number of companies can achieve such sales growth.

Low return

The business opportunity must have a realistic chance of achieving a high return on capital – Internal Rate of Return of 40% per year is a good starting point. It may seem high, but it is commensurate with the risk – investors lose money on more than 45% of the deals and need to do very well on the ones which are successful to show an overall positive return. Very few new businesses have the potential for generating a 40 percent a year return.

Rather than searching for investment they are unlikely to get, entrepreneurs would be better off redesigning their business models so they can pursue their opportunities without outside investment. Once they have a proven business model that meet investors’ requirements, they can approach them for funding.