The Venture Capital Funnel
CBInsights[1] have gathered data out of 1098 venture-backed startups that raised their seed money in the period 2008–2010, and they presented it in a very interesting visualisation. Once I saw it I wanted to analyse it a little further, although the 2 years after the financial crisis might not be representable.
First of all a little background information. Venture capital firms follow the model of staging[3]. This means that all venture startups are in need of new funding rounds every few years. There are many reasons for the staging model but the most common is the uncertainty for the future, especially when the company is in its early. The period between rounds is usually 12–18 months. If the startup does not perform as expected, the investors may decide to cut their losses and not further invest in the startup. If the startup does well or better say if investors believe that the company does well then rising is a little bit easier. Both entrepreneurs work around this main concept and are focusing on one round at a time, with sometimes some funny results [4].
The CBInsights study shows that out of 1098 companies, 40% failed to raise additional funds after their initial seed round. The seed round failure has created an infamous effect, commonly called “Series A Founding Gap” or “Valley of Death”, mainly because of the volume of the companies that are cut of in the Series A round. The failure rate improved in the next two rounds (23,6% and 31,6%) but after Series C the chances of failing got even bigger, reaching 55% in series D.
What is striking about the figures in this table is that failure is a function of “not exiting” (IPO or Acquisition) or “not advancing” at the specified time (Round). A different side of the same coin is that success is a function of either exiting or advance to the next round in order to find a better opportunity to exit. An interesting fact is that in order to advance a company has to keep the investors optimistic about the promised returns on investment while the probability of failure increases every round, reaching at 70%.
These numbers are matching a well-known saying[2] of the venture capital community that seven out of the ten (“10”) “Series A” investments will fail, two (“2”) will recover their money back, and only one (“1”) will be successful. In this report we don’t have data about the returns on the Exit or the amount raised in each round but the 70–30 split of failures and exits shows that even with a venture push the chances are not with the startup.
Note: This article has been appeared first in www.whydotheyfail.com and is based on the project and dissertation named “Venture Capital failures. Why VC backed start-ups fail and how can we improve the failure rate” that was submitted to Warwick Business School on 05/03/2018 by Kostakis Bouzoukas
[1] https://www.cbinsights.com/research/venture-capital-funnel-2/
[2]http://online.wsj.com/article/SB10000872396390443720204578004980476429190.html
[3] Sahlman, W.A., 1990. The structure and governance of venture-capital organizations. Journal of financial economics, 27(2), pp.473–521.
[4] Cornelli, F. and Yosha, O., 2003. Stage financing and the role of convertible securities. The Review of Economic Studies, 70(1), pp.1–32.