The trust-fall that is post-investment VC startup funding
To secure funding startups endure an extensive due diligence process. Take the example of a startup courting a VC and vice-versa. The startup is put through its paces with accountants, lawyers, and even the investors themselves trawling through everything from corporate records to business plans, financial agreements to bank accounts, employee contracts, intellectual property, insurance policies and more… It’s normal for this process to take months before all shareholders are happy.
To be considered viable for investment, a startup must “pass the test” of due diligence with facts and figures. But the minute actual investment is made, and money has left the investors bank account, the VC does a trust-fall into the startup’s plans, continuing to fall without looking – hoping and praying the startup catches them and their investment makes a return. All the hard work of due diligence is tossed out of the window to be replaced by quarterly slide decks with inaccurate figures and encouraging WhatsApp messages from founders.
We recently asked 100 Venture and Private Equity firms behind closed doors how often they check a portfolio company's bank statements or access the account data post-investment? The answers were 5% every quarter, 5% every six months, 39% Requested Statements but never checked them, and 51% said Never, only checking when making initial investments. These responses show how portfolio managers struggle to keep up with the demands of swollen portfolios and workloads. Shocking? Yes. But surprising? No.
With EU startups having already raised $13.7 billion in Q1 2024 alone, but with 1 in 5 startups also failing in their first year, why is there not closer monitoring of investments? Why is the post-investment relationship based on trust when the funding is all about facts? In a world where financial data is more easily accessible than a flat-white, VCs should not be relying on good faith and blind trust with their startup partners. The number of startups failing in their first year would be significantly less if investments were better monitored and issues resolved before turning chronic and fatal. Leaving investments unsupervised is not trusting, its reckless.
VC funding for early-stage startups jumped 99% from 2020 to 2021 amidst a dangerous culture of hedging bets and hoping for the best. Not wanting to be left out, VCs have been blindly throwing investment darts hoping to hit the bullseye and land themselves a unicorn. Although sometimes they miss the board completely leading to poor money management by portfolio businesses, a lack of control from the investors, and a total loss of shareholder value for all parties involved. Take the obvious examples of startup fraud, the likes of HeadSpin, Mos, FTX, Theranos, they should all have been spotted sooner and the list continues to grow.
These issues compound further when you learn LPs reasonably assume the Funds and the Boards they sit on are monitoring portfolio companies properly. However, more frequently than not, investors discover that in the liquidation of a business, that informed governance is far from the case. It is not just financial losses, but reputational and trust value being destroyed unnecessarily.
In 2023 European VC raised $59.1 billion in total, with thousands of startups bidding for their chance at success. The stream of money is not slowing, but today there is growing scrutiny on investments. As we head into a time when raising capital is more challenging than any time since the dotcom bubble, funds are thinking carefully about how they can best manage and add value to their portfolio while providing the visibility and certainty that their LPs demand to part with their cash. Terms like value add are being bandied around boardrooms and both startups and VCs alike are exercising greater caution in their relationships.
New technologies like real-time due diligence platforms enable investors to track the financial standings of their portfolio live. Acting like an early-warning system, these technologies allow investors to act before trouble starts and potentially save those struggling investments before they crash, which would otherwise be swept under the rug.
Investors are looking for startups that go above the norm, demonstrating that they take governance and financial controls seriously. Startups want to work with investors whom they trust to offer ongoing value beyond the initial funding stage. We are calling for the industry to take a stand against the trust-fall that is VC startup funding and challenge the lack of financial due diligence post-investment.
