05 Jul 3 Ways Investors Can Destroy Your Startup
When a startup begins to raise venture capital, the last thing on their mind is the thought of an investor destroying their startup. Though it is rare, and in the majority of cases is not on purpose, it does happen; and you as an entrepreneur need to be aware of it. Here are the top three ways an investor can ruin your startup.
Take Control of the Product
We’ve seen it time and time again, an investor asks the startup to do certain things with the product. Maybe it is moving production to a different manufacturing plant, or changing the structure of the offered service. Either way, these changes might not be in the best interest of the startup. Once the change is made, the investor will ask for another item, maybe the product designs or an exclusive look at the next service coming to market. From there, the investor may have an idea to bring it to market sooner, however, they will probably say to you the entrepreneur, “You just needs to change these few items first”. You make the changes and the next thing you know is that the product or service is very different from what you initially planned. While this may not be a bad thing from a business perspective; the company generally loses sight of their initial goal. At this point, the founding team is not longer needed to drive the innovation of the company. When this happens, the majority of startups fail. With no drive to innovate or develop more products, the company and the team behind it fizzles. The entrepreneurs behind the MVP move on to different products to meet their innovative needs. And as soon as you can say “Success!” the startup has been dissolved. Reduced to a smouldering pile of failed promises and broken dreams.
Create a Loss Leader
Investors can act as strategic partners in many cases. They can drive sales and make introductions to keep the startup innovating and succeeding. The problem arises when deals are made that are not in the best interest of the startup as they grow. Let’s say for example a mattress company signs a deal with a strategic partner, in which the strategic partner agrees to buy 500 mattresses a quarter for the next 5 years at a price of $200 a mattress. When the company is starting to see revenue, a guaranteed purchase of 500 units a quarter for 5 years is great! It is impossible to say “no” to. However, as the company grows, they begin to realize their cost to make each mattress needs to increase from $150 a mattress to $250 a mattress to stay competitive. When this happens, the $50 in net profit they would receive from each mattress sold to the strategic partner decreases to a net loss of $50 a mattress. For a new company, this change from a net profit to a net loss can be catastrophic. If the strategic partner is not willing to negotiate the terms of the deal, a loss leader is created. If there are not ways for the company to navigate with this loss leader the startup can fail. While this seems counterproductive for an investor in a startup, it is quite common among startups with physical products. The best way for startups to negate the potential of a loss leader is to sign terms in the deal that are flexible as the company grows. Having terms against creating a loss leader is ideal, however, startups rarely consider these items at the time the deal is signed.
Force Decisions
The most common way an investor can destroy a company is by making decisions for the company. While they might not seem forced, in many cases they are. An investor typically will force a company into doing something by saying it is for the benefit of the company or that something will come out of it. The forced decision that is being seen more frequently is the investor requiring the startup to move to a more “productive” location. They do this via terms of investment or by social pressure. In the first, but less common situation, an investor will require the startup to move to a location nearer the investor (typically the San Francisco bay area) if the startup wishes to receive funding from them. In the more common scenario, the startup will receive funding, but will always have to travel to the investor’s area for meetings and introduction. While this can be productive for the startup. When the bloated prices and cost of operating a startup in the bay area are considered, it is often detrimental for the startup to leave their ‘home’ region in favor of the bay area, even for the capital and introductions. While this is just one example, there are many other ways investors can force decisions to be made by startups. Whether it be partnership deals or strategic hires, there are always deals to be made. Though they are rare and generally are in the best interest of the startup, these forced decisions can be destructive in the short and long term.
These forms of destruction are rare, but they do happen. The best way to stop them from happening is being aware of what is going on in and out of your startup. Quarterly calls with investors is a great start, understand what the investor wants for your company and how they plan to achieve it. This can give you great insight into their end goal with you as a company.
Saying “No” is also a great way to stay on top of your company. In many cases, it is hard for entrepreneurs to say “No” to an investor in their startup. However, saying “No” is just as important as saying “Yes”. If you feel an investor is trying to guide you down the wrong path take a step back. Fully understand what they are trying to do, and if it is not in the best interest of the company, feel free to say “No”.
Finally, consult with a third party. Five23’s reports and services not only look at the company with fresh eyes, but we are also experts in discovering the needs and intentions of investors and startups alike. Therefore, if you are unsure about a decision, we can guide you in making the correct decision for all parties involved.
If you have any questions or would like to learn more about the ways investors can ruin your startup. Feel free to contact us via email: contact@five23.io. If you think you might be partnered with an investor that is trying to harm your business, intentionally or unintentionally, please contact us. We’d love to discuss your options to make the best decision.