Investors are putting their money and that of their co-investors at risk when they invest in your company. Investing in an early-stage company can be both a wise and unwise move. Thus, as you are seeking funding, you need to understand that investors may not invest in your business because of various factors. Apart from your company’s financial and business characteristics, there are three communicational issues that will result in a rejection from the investor.
1. You don’t understand the investor’s problems
The investor runs huge risks when investing in your company. Investors might lose their entire investment. The entrepreneur has to consider risks when talking to an investor. When you do not understand the risks the investor faces, you will not be able to persuade the investor to fund your company. The disclaimer of Manhattan Street Capital e.g., a premier American online fundraising platform, shows which risks investors face when investing in early-stage companies.
Investment Risks
Principal risk: Investing in startups will put the entire amount of your investment at risk. There are many situations in which the company may fail, or you may not be able to sell the stock you own in the company. In these situations, you may lose the entire amount of your investment. For investments in startups, total loss of capital is a highly likely outcome. Investing in startups involves a high level of risk, and you should not invest any funds unless you can bear the entire investment loss.
Returns risk: The amount of return on investment, if any, is highly variable and not guaranteed. Some startups may be successful and generate significant returns, but many will not be successful and will only generate small returns if any at all. Any returns that you may receive will vary in amount, frequency, and timing. You should not invest any funds in which you require a regular, predictable, and/or stable return.
Returns delay: Any returns may take several years to materialize, and most startups take five to seven years to generate any investment return, if any at all. It may also take many years before you know if a startup investment will generate any return. You should not invest any funds in which you require a return within a specific timeframe.
Liquidity risk: It may be challenging to sell your securities. Startup investments are privately held companies and are not traded on a public stock exchange. Also, there is currently no readily available secondary market for private buyers to purchase your securities. Furthermore, there may be restrictions on the resale of the protection you are buying and your ability to transfer. You should not invest any funds in which you require the ability to withdraw, cash-out, or liquidate within a certain period.
Security Risks
Instrument risk: You may be investing in preferred equity, common equity, or convertible notes. These securities instruments all have different inherent risks caused by their structure. It would help if you took the time to understand the nature of the securities instrument you are investing in.
Dilution: Startup companies may need to raise additional capital in the future. When these new investors invest in the company, they may receive newly issued securities, and these new securities will dilute the percentage ownership you have in the business.
Minority stake: As a minor shareholder in the business, you may have less voting rights or ability to influence the company’s direction than more prominent investors. In some cases, this may mean that your securities are treated less preferentially than more oversized security holders.
Valuation risk: Unlike publicly traded companies valued publicly through market-driven stock prices, the valuation of private companies, especially startups, is difficult to assess. The issuer will set the share price for your investment, and you may risk overpaying for your acquisition. The price you pay for your investment may have a material impact on your eventual return if any at all.
Business Risks
Failure risk: Investments in startups are speculative, and these companies often fail. Unlike an investment in a mature business where there is a track record of revenue and income, the success of a startup often relies on the development of a new product or service that may or may not find a market. You should be able to afford and be prepared to lose your entire investment.
Revenue risk: The company is still in an early phase and maybe just beginning to implement its business plan. There can be no assurance that it will ever operate profitably. The likelihood of achieving profitability should be considered in light of the problems, expenses, difficulties, complications, and delays usually encountered by companies in their early stages of development. The company may not be successful in attaining the objectives necessary for it to overcome these risks and uncertainties.
Funding risk: The company may require funds in excess of its existing cash resources to fund operating expenses, develop new products, expand its marketing capabilities, and finance general and administrative activities. Due to market conditions at the time the company needs additional funding, it is possible that the company will be unable to obtain additional funding when it needs it, or the terms of any available funding may be unfavorable. If the company is unable to obtain additional funding, it may not be able to repay debts when they are due or the new funding may excessively dilute existing investors. If the company is unable to obtain additional funding as and when needed, it could be forced to delay its development, marketing, and expansion efforts and, if it continues to experience losses, potentially cease operations.
Disclosure risks: The company is at an early stage and may only be able to provide limited information about its business plan and operations because it does not have fully developed operations or long trading history. The company is also only obligated to provide limited information regarding its business and financial affairs to investors.
Personnel risks: An investment in a startup is also an investment in the management of the company. Being able to execute the business plan is often an important factor in whether the business is viable and successful. You should be aware that a portion of your investment may fund the compensation of the company’s employees, including its management. You should carefully review any disclosure regarding the company’s use of proceeds. You should also carefully consider the experience and expertise of the management team.
Fraud risks: It is possible that certain people involved in the company may commit fraud or mislead investors. If fraud or misleading conduct occurs, then your total investment may be lost. You should carefully review any disclosures regarding the company’s management team and make your own assessment of the likelihood of any potential fraud.
Lack of professional guidance: Many successful startups partially attribute their early success to the guidance of professional investors (e.g., angel investors and venture capital firms). These investors often play an important role through their resources, contacts, and experience in assisting startup companies in executing their business plans. A startup company primarily financed by smaller investors may not have the benefit of such professional investors. You should consider the existing professional investors in the company and whether or not they or any other professional investors are participating in the current round.
Growth risk: For a startup to succeed, it will need to expand significantly. There can be no assurance that it will achieve this expansion. Expansion may place a significant strain on the company’s management, operational and financial resources. To manage growth, the company will be required to implement operational and financial systems, procedures, and controls. It also will be required to expand its finance, administrative and operations staff. There can be no assurance that the company’s current and planned personnel, systems, procedures, and controls will be adequate to support its future operations. The company’s failure to manage growth effectively could have a material adverse effect on its business, results of operations, and financial condition.
Competition risk: The startup may face competition from other companies, some of which might have received more funding than the startup has. One or more of the company’s competitors could offer services similar to those offered by the company at significantly lower prices, which would cause downward pressure on the prices the company would be able to charge for its services. If the company is not able to charge the prices it anticipates charging for its services, there may be a material adverse effect on the company’s results of operations and financial condition.
Market demand risk: While the company believes that there will be customer demand for its products, there is no assurance that there will be broad market acceptance of the company’s offerings. There also may not be broad market acceptance of the company’s offerings if its competitors offer products that are preferred by prospective customers. In such an event, there may be a material adverse effect on the company’s results of operations and financial condition, and the company may not be able to achieve its goals.
Control risks: Because the company’s founders, directors, and executive officers may be among the company’s largest stockholders, they can exert significant control over the company’s business and affairs and have actual or potential interests that may depart from yours. The company’s founders, directors, and executive officers may own or control a significant percentage of the company. In addition to their board seats, such persons will have significant influence over corporate actions requiring stockholder approval, irrespective of how the company’s other stockholders, including you, may vote. Such persons’ ownership may also discourage a potential acquirer from making an offer to acquire the company, which in turn could reduce the company’s stock price or prevent you from realizing a premium on your investment.
https://www.manhattanstreetcapital.com/faq/for-investors/what-are-risks-investing-early-stage-companies
2. You are unable to explain your innovation
Many of our clients are unable to define in one short sentence what their product is. The investor will not waste his time trying to figure out what you mean. As a research professional, you may be naturally inclined to focus on the technical details of your company’s core product offering and what makes it so innovative. However, investors will care more about the application and ramifications of your product. Connect with the investors’ priorities by explaining how your innovative solution will solve a real-world problem and how you will scale it to generate revenue and profit.
3. Your attitude towards the investor is not appropriate
A recent study by the Academy of Management finds that entrepreneurs who show humility are nearly twice as likely to get funded. In short, humble entrepreneurs are attractive to investors and teams. The popular image of an assertive, boastful entrepreneur who swaggers into a room does not match the personality type of people who win over investors. In fact, the 57 venture capitalists (VCs) in the study said that ambitious entrepreneurs who do not show humility come across as arrogant, overconfident, and stubborn–not the type of people investors were interested in backing. We have seen that these arrogant and stubborn entrepreneurs also reject very attractive investors offers, thinking the world is waiting for them.
Conclusions
One of the toughest parts of the entrepreneurial journey is seeking funding from angel investors and venture capitalists. The aforementioned 3 points show the main reasons why investors will not fund your business. However, you can convince them by showing the bright side of your business. You can back your presentation with accurate data about your business, competition, and industry.