Write-Off, why not?

6th July 2018  

by Francesco Terraneo, Marketing Assistant at U-Start



A write-off is a type of liquidation event, which provides the cancellation of an investment, after the failure of the company.”

Introduction

The bitter reality that the investment industry, let alone VC, has to face is that their portfolio companies can make an exit as much as they can slip into failure. Unfortunately, the latter scenario occurs way more often, however instead of seeing it in only negative light, one should see through the learnings. Yet considering the VC point-of-view, start-up mortality in their portfolio is seen as business-as-usual. As a matter of fact, the success of a VC comes from its ability to offset losses with gains, while having a small number of exits returning the entire fund. 

Reasons for Failure

Why do start-ups fail? According to CB Insights' report “Top 20 reasons why start-ups fail”, the main reasons are:

  1. Lack of demand: if the company’s market is filled and does not have any need or interest towards the product/service offered, the company will not sell its goods and, thus, grow to profitability.
     
  2. Lack of liquidity: scenario in which a business ends its cash reserves and does not make revenues big enough to cover the financial needs for further growth. Lack of liquidity is often the result of poor internal management, which is unable to structure an appropriate financial plan.
     
  3. Team: as pointed out by the father of modern venture capital, Georges Doriot, one of the main factors that push the investor to invest in a start-up is the team at its disposal. If the team is not sufficiently prepared, it is very difficult for the company to survive. 
     
  4. Get Outcompeted: once the start-up has entered the market, it must pay particular attention to its competition. Be it direct (i.e. offer the same type of product), indirect (ie they can potentially enter the same sector in which the start-up operates), as well as producer of similar goods (ie they offer goods different from the product offered by the start-up but which could still satisfy the same clients’ needs). Underestimating the competitors and not implementing a strategy to deal with them, involves a very high risk of failure: to date, about a quarter of start-ups fail for this reason.
     
  5. Pricing: the products’ price is a very delicate issue. Implementing an unsuitable pricing strategy, in fact, leads to the collapse of sales and the consequence, and obvious, failure of the company.

Top 5 Write-Off

According to the American business magazine, Forbes, less than one out of ten start-ups are able to continue their journey, avoiding failure in their first years of life. However, in the VC industry, the risk is part of the game, and even a well-established company may one day have to face a sharp change of course.

In the following paragraph, we propose an analysis of five write-offs occurred in 2017 to companies operating in the VC world that have raised capital for over 100 million dollars:

  1. Jawbone: a tech company developing and selling wearable technology and portable audio devices, founded in 1997 in San Francisco. After becoming a unicorn (ie having exceeded one billion market valuation) and raising an amount of 983,9 million, in June of the last year it faced serious liquidity problems that led the company to several lawsuits with its investors. After all, it had to close the business.
     
  2. Quixey: founded in 2009, it provided better access and engagement with apps. After raising $165 million, it had to declare failure as it was no longer able to repay the debt with its main financier: Alibaba.
     
  3. Beepi: founded in 2013 in California, it has been a P2P online marketplace for the purchase, sale and lease of used cars. In January 2017, after raising around $140 million in four funding rounds, due to a high burn rate and a poor management, it had to declare bankruptcy.
     
  4. Guvera: an online platform for free download, streaming and music sharing, founded in 2008. After nine years of activity and around $130 million raised, Guvera finished its funds available and had to declare insolvency.
     
  5. Juicero: founded in 2013 in San Francisco, Juicero was producing a system for vegetables and fruits’ juicing. After raising a total of $118,5 million it declared failure in September 2017, as the market was unwilling to pay what required by the company for the purchase of its product ($400 - $700).

What we can learn from the failure of a business.

As mentioned above, from an entrepreneurial point of view, the failure of a start-up is not a rare event and it can be exploited to learn from past mistakes in order to not replicate them in the future. According to the magazine Entrepreneur, entrepreneurs, from failure cases, should first and foremost learn an important lesson of realism: they must always remain realistic and attentive to the business and market needs, even when the company seems destined to succeed. Being careful observers involves identifying threats in advance, and implementing the right strategies to avoid them. It is, for example, the case of the competitors who should be identified and fought on time rather than underestimated as it happens in 25% of the cases. Realism should also be declined in the relationship with the company’s investors. The entrepreneur must not exaggerate with the promises made at the time of raising capitals. In fact, unattainable promises lead to a decline in confidence on the part of investors who will be less likely to provide new funds in the future.

Conclusion

In conclusion, the failure of a start-up, even if it is a situation certainly not pleasant for both the entrepreneur and the investor, falls entirely in the VC’s world routine. An entrepreneur should not be discouraged by a failure, but instead, he should take some important lessons, useful to undertake new businesses in a more conscious and careful way. An investor, on the other hand, should not worry about how many companies in his portfolio fail but, instead, he should consider how many companies do exits that can offset losses. The fundamental key to this lies in diversification: owning a diversified portfolio means facing the risk of failure rather than passively enduring it. Thus, the fear of a potential Write-Off is constrained. 

 

 

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