It is difficult to predict how an investment will perform. However, due to mismanagement, financial impropriety, unpreparedness, and a lack of transparency, many startups’ coffers are drying up and businesses are closing their doors.
With venture capitalists investing in startups at an unprecedented rate, it appears like any startup with even a hint of momentum has investors pounding on doors to get in.
It is important to note, however, that receiving money from venture capitalists or private equity firms does not necessarily signify that a startup’s product has found a ready market. Simply put, it indicates that a company managing someone else’s funds is ready to stake a wager on the startup.
How quickly can we set money on fire?
Inexperienced startup executives receive a new round of funding and then spiral out of control with high office space costs, poor business decisions, and sloppy financial management. Growth slows as a result, all that capital vanishes very quickly, and the startup either closes operations or starts looking to sell.
For instance, PayDay, a Nigerian fintech startup, which has recently just secured $3 million in a seed round led by Moneypoint Inc (formerly TeamApt Inc), is actively seeking a buyer.
In August, a blogger on X, had reported that Favour Ori, PayDay’s CEO was taking funds from its unsuspecting Nigerian and other African customers by using deceptive conversion rates, locking up their accounts, and ignoring their complaints.
Ori has also been accused of receiving a $15K income as CEO while withholding customers’ funds and cutting staff salaries, all the while holding down a full-time position as a GitHub employee.
The startup, which allows borderless payment alternatives in major currencies, is also bedeviled by many other problems. In an exclusive by Ngozi Chukwu of TechCabal, employees of PayDay revealed that between 30 and 50% of their salaries had been cut because the expected Naira equivalent did not match their dollar salaries. Employees had also not received the stock options that had been promised to them as further remuneration.
The startup has spent a lot of money on social media promotion in recent months. Many have questioned the benefits.
Not the Only One
PayDay is only one of a slew of African startups that have had to layoff, pivot, sell their business, or close shop in the last few years because their burn rates exceeded their revenue growth rates.
Others include fintech Dash which wound down after raising over $85 million from major investors within five years; Wabi, a Coca-Cola-backed e-commerce startup which shut down operations in five African markets; Hover, which transitioned from a full-time team to an open source community due inability to raise additional funding; and Nestcoin, which was impacted by the 2022 FTX crash losing a significant amount of its $6.45 million pre-seed, among others.
What this portends for investors
When a startup is acquired by another company, it is one of the fastest ways for an investor to recover their initial investment. An investor may then get from the acquiring company cash, new stock, or a mix of the two.
The amount that an investor would receive in return from a merger or acquisition of this kind is contingent upon his ownership stake in the business and the acquisition price.
Equity Financing isn’t the Only Way
As they expand, startups may find it very challenging to wean themselves off investor money, especially if it is their primary source of income.
Upon receiving funding, a startup no longer owns 100% of the company. Investors want a return on their money and have a say in ownership, stock, and important decisions.
The way out? When negotiating with an investor, startup founders can try to keep the percentages or amount of equity as low as feasible. For instance, requesting a smaller initial sum of money as opposed to a lump sum can enable a startup to swap a smaller portion of its business for the capital, leaving them with more as the company’s owner.
A founder may also make a purchase offer for a partner’s ownership stake in the company. They will no longer be required to provide them a cut of the earnings because they would then own the partner’s portion.
Lessons
Many times, the cycle of startups that are run with compromised ethics, mismanagement, and financial impropriety is predictable: They raise a big round, their expenses grow to match their new bank account balance, their revenue does not increase as quickly as anticipated (it usually never does, especially early on), they are hesitant to cut spending as doing so would imply low productivity, and then they raise more funding. This further dilutes their stake in the business and then they begin this process over again. This time, with a larger account balance and correspondingly higher expenses.
A number of African businesses have failed over the years, serving as cautionary tales for business owners and investors. These failures highlight the importance of transparency at every step of a company’s development.
