The Relationship With Your Investor During The Death Valley Curve: The Risk, And How To Survive

In an uneven investment scene, things get difficult when investors and founders are unfamiliar with the startup culture — case from UAE

Photo by Felix Russell-Saw on Unsplash

Sultan Hamid crossed the doors of the elegant yet practically-designed building in Dubai Silicon Oasis where he just had a stormy meeting with his investors. There was only one item on the agenda: why his medical diagnostics app startup isn’t generating revenue, despite a $500k seed fund.

The scene is still fresh in his head: him trying to explain that startups don’t work that way, and the investors dismissing his passionate appeal as a lame excuse for his failure. And with his high burn rate, who could blame them?

As he moves toward the designated smoking area, he catches a glimpse of the buildings adorned with names of big tech companies he long dreamed of joining someday. Suddenly, Sultan realizes that he doesn’t need a smoke.

He needs to breathe.

Sultan’s story isn’t uncommon. Things get difficult for startups when investors and founders aren’t equally familiar with concepts such as the startup lifecycle. As a founder, you end up working under extreme pressure to live up to the investor’s expectations of short-term profit or breaking even quickly. And in the process of appeasing the investor, you end up increasing the complexity of your business model, which dilutes your core value propositions, all while you struggle to get your startup past its early stage.

The tragic scene of a bloated startup with matrix organization, overstretched resources and high headcount that is always burnt out, for the sole purpose of securing a follow-on deal, just to repeat it all over again, is a sign of something gone horribly wrong.

As you float with no clear direction, closing your eyes and hoping for something to change, you get a distant memory of the product idea that you started this venture to turn into a reality, and you wonder: what is it exactly that went wrong?

It all begins with funding

Unfamiliarity with the startup lifecycle isn’t limited to places where the startup culture hasn’t been widely embraced yet.

In UAE, where where Sultan’s story takes place, a friendlier startup ecosystem is progressing with increasing support from the government and private sector. This provided an appealing investment target for VC’s, as well as other players who hail from a more traditional business cultures, such as some family businesses, corporations and wealthy individuals.

Numbers support the appeal of the scene. With over 199 investors in the scene, it is expected that ~$1.5 billion of startup funding will be raised in MENA in 2018, with UAE having a share of over $1 billion ($106 million have been invested by May). That is up from $560 million in 2017 for MENA.

How could such positive indicators factor in our problem?

Well, access to fund isn’t equally available at all VC funding stages. According to Magnitt, early stage investments make up 76% of reported deals in Q1 2018. ArabNet’s State of Digital Investments in MENA 2013–2017 report, published in partnership with Dubai SME, puts early stage deals worth less than $500k at 61% of total investment deals in 2017, compared to 25% for the next ticket, which includes Series A.

This reflects a trend which Idriss Al Rifai, founder and CEO of Fetchr, puts succinctly, “If you need $500k to $1m, there are many options. However if you need between $3m and $50m, then it is still hard because the VC’s here are not willing for that level of risk.”

Moreover, Dubai SME, the government arm for SME development, announced that they will focus on the early stage in their plan to join the investment scene.

Risky business

This is actually quite normal. Startups are high risk ventures by definition. In other words, you may enjoy huge ROI if the startup proves to be a feasible business opportunity to sell to other companies or push for an IPO. And yet there is still a high chance that you may lose your investment. In fact, the reported failure rate among startups is 90%. In UAE, only 50% of SME’s in the service sector survive their third year.

This makes investors prefer to risk lower amounts on early stage funds, usually under $1 million, rather than the millions required in later stages. And investors from the more traditional business cultures follow the same logic.

Two interesting things happen at this point.

1. Fewer fund is available to startups as they near the end of the early stage. A staggering 79.4% of startups fail to raise Series A fund, and as high as 70% of loan applications get denied to SME’s by banks. As a result, startups often have no choice but to rely on angel investors and other early stage players for funding. And among them we find investors from the more traditional business cultures.
2. In the startup scene, the usual deal between startups and investors isn’t limited to finances. VC firms like 500 Startups and Wamda Capital, accelerators like Sheraa and Flat6Labs, and incubators like Hi2 and Dtec, all provide education, mentorship, networking and understanding to support startup growth.
   
   Investors from the more traditional business cultures cannot offer that, simply because they are not familiar with the startup culture. And you can’t give what you don’t have.

And so the chances become larger for the startup to land a deal with this investor. And with it we face the potential for critical miscommunication even on the most basic concepts: the nature of startups, and the role of the investor.

Business culture miscommunication

In the context of startup culture, startups exist to help assess a high risk business opportunity. It does so by validating the scalability of a business model that revolves around a product or service.

Startups conduct numerous and incremental experiments to test the assumptions about the product. From the success and failure of each experiment it gains validated learning. What is learned is then used to further develop the product and the business model.

This eventually reduces the risk of the final decision to a more manageable level. In other words, it is a systematic approach to managing extreme uncertainty.

But to the investor, this becomes more of a typical SME-shareholder private equity relationship. Here the SME exists to maximize ROI, either by generating revenue at an acceptable pace, or through SME’s value when it is re-sold.

It is a question of placing the SME on the investor’s portfolio matrix and resolving its uncertain value to their business as quickly as possible. As long as the investor is confident about this value, they will continue to support the SME, even if they don’t get their returns now.

In short: startups adapt a version of the scientific method to deal directly with extreme business uncertainty. This requires patience, resources and a lot of failures. Investors, on the other hand, hate such high uncertainty about their investment, and want to resolve it as quickly as possible.

It can be tempting to think that “pace” is the subject about which the two sides disagree — after all, it is a frequent topic of discussion between investors and founders.

But “pace” is, in fact, only a symptom.

The real problem is uncertainty — the compulsive feeling of doubt that prevents you from trusting your ability to make the right decisions, because you don’t have enough information to make predictions. As uncertainty increases, so does fear about the future.

It is understandable how investors panic when they see the startup take their money, and then proceed so unceremoniously to put its head in the mouth of uncertainty, even though that is exactly the function startups exist to do in the first place.

As the startup burns through fund, moving ahead in its natural course with negative cash flow (a phase known as the Death Valley Curve), the investor loses confidence and shifts to plan B: push to break even quickly.

An entrepreneurial wasteland

It isn’t uncommon to see investors at this point asking the startup to find other ways to generate short-term revenue. Indeed, the founder may try to explain the nature and purpose of startups, but let’s face it: it only comes across as an excuse for failure, and usually makes the situation worse.

Eventually, with no alternative fund options available, some startups resort to economies of scope to appease the investor.

From this point on, things can spiral out of control. Tech startups start reselling B2B software license, do third party deployment and even bespoke web development projects to generate short-term revenue on the side, using its core product resources.

This may seem like a reasonable trade-off to survive the phase; however, it gradually leads to a complex matrix organization, overstretched resources, ever growing headcount, and stressful workplace environment.

As time passes, and with the sweet taste of revenue, resources get completely reallocated from the core product operations to cover the scaling costs of the new operations. In a moment of irony, these operations cause an even higher burn rate and increases waste everywhere.

With resources at full capacity, the work needed for the core product is deprioritized for the sake of satisfying the needs of the new operations, which hinders the progress on the core product itself. And with little to no progress, everyone starts losing faith in the product — even the core team starts having second thoughts.

Suddenly, the product manager becomes the only person left who cares, or even remembers, that there is a product around which the startup was founded in the first place.

Little by little, the startup loses its vision, and it is only a matter of time before management applies the 20/80 rule to reallocate resources based on short-term revenue contribution, and the product is placed on the 20 side. This completes the transformation into a startup that doesn’t care for its core product.

When layoffs are introduced to reduce headcount, the product team will be the first on the list. After all, who needs a marketing executive to carry product hypothesis tests in a job shop? Better yet, who needs a product manager?

When the dust settles and we see a startup that has lost its way, it all points to one simple fact: investors in the startup culture provide support to push the startup forward in its lifecycle. Investors who are unfamiliar with the startup culture on the other hand can push it out.

It takes two to make things worse

Founders can contribute greatly to this problem.

Founders who themselves are unfamiliar with the lean startup framework and startup lifecycle wouldn’t have the necessary knowledge to identify the crucial moments to pivot, greatly increasing the chances for the problem to occur.

Another scenario is when founders with limited access to fund resort to promising unrealistic projections and over-optimistic timelines to secure fund. This creates the perfect conditions for miscommunication later in the relationship.

How can this be solved?

Stopping at stating a problem and not attempting to find a solution is an invitation to defeatism. Here are 4 clear steps to help you get your startup back on the right track.

1. Eliminate the distraction

There is no way around it: you must decide between keeping your new job shop or restoring your fading startup. There is no wrong answer here; you can pick the job shop, let go of your startup plans, and still become successful. Pick one, and stick with it.

2. Better know the road ahead of you

Refresh your memory about the lean startup framework and embrace it. Familiarize yourself with topics such as startup lifecycle, business strategy and product management. You can start with Eric Reis’s book, The Lean Startup website, and the resources listed here.

Attend events such as startup weekends, competitions and expos, and make use of entrepreneurship institutes and training programs. Invest U.A.E.’s 2017 Startup Ecosystem report lists 16 events and 14 institutes and programs for you to check out.

3. Address your investor’s real concern

Keep in mind that the real problem isn’t your pace or quick revenue. It is the investor’s fear of uncertainty in this high risk business. Fund managers have timeline targets to satisfy their limited partners as well. Try to tame that fear of uncertainty by realigning your startup goals and the investor’s expectations.

4. Take control of the communication

Build a more accessible roadmap and business and marketing strategy, and try to get buy-in from the investor’s board.

George Eiskamp suggest what he used in GroundMetrics, a startup that raised $10 million mostly from angel investors: send out a monthly update with a P&L, in a one-page easy-to-read email, with pictures showing the team in operation. That is in addition to sending annual financial statements and annual budget to shareholders.

Over the time, Eiskamp notices how discussions with the investors revolve around what is in these reports. He is not only leading the conversation, but by just preparing the reports he would have the information needed to answer their questions in the meetings, too.

If you don’t have the time, have someone in your team to be in charge of this. Product managers and strategy managers can be helpful here.

What if you want to end the relationship?

It can be tricky to convince your investor to part ways if you are generating revenue for them at an acceptable rate and they do not care for the core product. You may seek another investor who would provide you with the missing elements and help you reach a deal with your current investor. But it is also difficult to find a new investor if your startup is in bad shape.

Strategic restructuring of your startup could make things less difficult. Examples include:

1. Returning to your core product

By re-focusing on your core product you would restore shape to your startup business model to attract an investor who would help you grow.

2. Separating the job shop operations

If the investor is interested in the short-term revenue generating operations in your business model, move those into a separate SBU and trade your way out. Since this SBU is weighing down your startup, trading it would be a win-win situation.

What if you are the investor?

Familiarize yourself and the founder on the lean startup framework and topics such as startup lifecycle. This would give you a better understanding of the phases your investment is going through, and help you assess its value to your business.

If you don’t have the time, have someone in your team to be in charge of this. Mentors, product/portfolio managers and strategy managers can be of help here.

But why wait for the problem to happen?

These five simple principles could help you minimize the risk of running into this situation.

1. You cannot pivot what you don’t know

Refresh your memory about the lean startup framework and embrace it. This will give you the ability to sense when your startup is about to go off track, and correct its direction on time.

2. Clarity gives you control

Always be clear about your business goals and expectations for the different stages of your startup. Make sure this is completely understood and agreed on by the investor from the get-go.

3. Know where to draw the line for yourself

Don’t sell what you and your startup should never be just to secure fund. Create reasonable estimates with manageable margin of error. Setting audacious challenges for yourself to achieve a goal is one thing, but setting disastrous distractions is a completely different game.

4. Choose your investor carefully

Don’t settle for an investor who won’t help you fulfill the purpose of your startup. Due diligence is important to the founder, just as it is to the investor.

5. Surround yourself with a team of “reliable allies”

Your team compliments your entrepreneurial identity. Choose the partners who will make you stronger with knowledge, clarity, control, and due diligence.

Navigating the entrepreneur’s life can be extremely stressful. The journey is long, with many things that can distract you from your goal and the icebergs in way.

As your startup go through the Death Valley Curve, you will feel as if everything has turned against you. That you are losing confidence and control. That is when you need focus and clarity to keep you on track, and more importantly, to keep your sanity.

In the end you have to remember: in your startup, you are the most important asset of all.

* This article is also available in Arabic.
* See this story in an infographic!

This story is published in The Startup, Medium’s largest entrepreneurship publication followed by 335,210+ people.

Subscribe to receive our top stories here.