Most startups fail – this is the truth you must embrace when deciding whether or not to take the plunge and start investing in early-stage businesses. Now that the 800 lb gorilla is out in the open, we can discuss how to prepare for when things go wrong and what you should do when, inevitably, one of your companies does fail.
Veering off course
A company completely going under is about as bad as it’s likely to get, but chances are there’ll be a few warning signs en route. If the issues are addressed as they arise and the course adjusted, then there’s no reason why (with a bit of luck) the iceberg can’t be avoided.
Things that can disrupt a startup’s rise to its full potential include targets not being hit, key personnel changes and sales not materialising. It may be that the company simply needs additional funds to reach the milestones set out in a previous round. If this is the case, it could try to raise funds at either a lower valuation than the previous round (this is known as a down round), or at the post-money valuation of the previous round (a flat round), depending on how poorly they have performed.
Stay in the loop
The best thing you can do is establish a clear line of communication with the company, either as a direct shareholder or via a nominee, so that you’re aware of the company’s progress and can avoid any nasty surprises.
Should things start to take a downward turn you and your syndicate should discuss the best way to support the business, either through providing contacts or (if possible) sharing your experience of similar situations and ‘lessons learned’. Remember: investors are a startup’s best source for network connections, buyers, suppliers and more.
Keep the pot topped up
Most companies will require more than one funding round, so setting aside cash for future raises isn’t a bad idea. In fact, Business Angel of the Year 2014 Peter Cowley recommends keeping aside two to three times your original investment for follow-on funding rounds.
Down and flat rounds
While down rounds and flat rounds are generally thought of as losses, they are a natural part of the game. Approach them as if you’re reviewing the company for the first time. In an insightful interview for our podcast, Angel Insights, Founding Partner of London Bridge Capital Yenyun Fu reminds us that some of the most highly acclaimed success stories have been through down rounds. In another interview, Peter Cowley, Entrepreneurship Fellow at the Cambridge Judge Business School, talks about what he takes into account before deciding whether or not to invest in a flat round.
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What to do when the ship sinks
Of course, there will be times when you’ve done everything you can to shovel water back overboard and the old vessel’s gone down all the same. It might seem like there isn’t anything that can make the situation worse, but there is: panic.
If the company you’ve invested in ceases to operate, emotions will be running high – entrepreneurs and investors alike will be upset and disappointed. What’s important is that no one storms in with the sole intention of looking out for themselves. Stay calm, level headed, and see if any of the following applies to you.
Some countries, including the UK, offer downside protections for early-stage investors in SEIS- or EIS-qualifying shares. You’ll know if you’ve got them, and you’ll be able to write off part of the loss on your next tax bill.
Liquidation of assets
Depending on the type of company you’ve invested in, a small amount of value able to be returned to investors through a sale of the assets. These assets can be physical (office, equipment, hardware), IP based (patents and such) or derived from the value of the user database. If there’s something of value it will need to be sold and the money can then be distributed.
Supporting the team post closure
Being an entrepreneur is incredibly difficult and going through a failure even more so. Soshi Games Founder Cliff Dennett knows that much firsthand and explains a bit more about the experience in this candid interview.
The best thing you can do when things go wrong is support the team. Remember, while you may have lost out financially, they will have poured their own invested capital together with years of blood, sweat and tears down the drain. Your first instinct may be to get angry, but good entrepreneurs will bounce back – and you don’t want to burn any bridges should their next venture hold more promise. Consider it a learning opportunity.