Running out of cash is a result, not a cause, of most startup failures

Yet another startup that I invested in closed its doors last week, citing “ran out of cash” as the reason for their failure, blaming investors for not supporting the company.

They had customers. Quite a few, in fact. They had growth, but not hypergrowth. Though they started as an IoT business, they now presented themselves as an AI solution for enterprise logistics.

And yet, they ran out of money.

Their goal, like every other venture-backed startup, was to get to $100M, and get acquired for a billion or two to make the founders and investors rich. Or at least reach $25M for a modest exit that gets founders decent compensation for their time while investors get their money back.

They ran out of money long before reaching those goals.

Of course, they were operating at a loss. Just like every other startup. It takes a lot of fuel to reach orbit.

They built a business for scale, invested in development, hired AI specialists, built a hardware supply chain. To get to the required $100M run rate, they hired sales people and sales managers, business development specialists, and channel sales teams. They had more salespeople than customers.

That’s how a startup works. They lose money for years until sales growth overtakes the fixed expenses. In the meantime, investors pay the bills. Until they stop. And then the company runs out of money and dies.

Running out of money is a symptom, not a cause. If the company is doing well, there’s plenty of fresh investor cash to be had. If the company is struggling, investors flee. Saying a startup ran out of money doesn’t tell us anything useful. The real question is why did investors turn off the money taps?

Here the 5 main reasons why investors stop investing:

Not Reaching Hypergrowth

The model for venture capital is the startup will reach $100M in revenue within 5–7 years and get acquired for a $1B. That’s the plan. Venture funds need to return cash to their investors in that time frame, leaving a short timeline to reach critical mass and get acquired.

Getting from $100K in Year 1 to $100M in Year 5 means increasing revenues 30% every month. If you’re not growing close to 4x year over year, you’re not going to reach orbit.

If you grew 25% this year compared to last, for most companies that would be a great achievement. For a venture startup, that’s failure. There’s no way to reach $100M within the venture timeframes growing at 25%. Or even doubling each year.

At first, the VCs will push you to re-examine everything: your product, your market, your sales strategy. They’ll tell you to hire more sales people and spend more on marketing to accelerate growth. Then they’ll tell you to replace the underperforming head of sales. Then they’ll tell you to find a new CEO.

And if those changes don’t get the company to 10x growth, they’re not going to invest in the next round. Sorry. Their first check was nothing but an admission fee to get an inside seat. They expect to lose it. Cost of doing business. The bigger later checks, the real money, are reserved for the few companies in their portfolio that are on target for orbit.

Market Opportunity Smaller Than Expected

Remember that TAM/SAM/SOM? When you pitched to investors, you convinced them you were solving an important problem for a huge market that would make it easy to reach $100M in sales. But how big is that opportunity, really?

It’s hard to tell until you’re knee-deep in the selling. And not just pilots and sales to the desperate few. It’s not until you start trying to sell to the prospects who haven’t heard of you and may not even know they have a problem that you find out how big (or not) the market really is.

It often happens that the SOM is a lot smaller than projected. Maybe the benefits aren’t big enough for most users to overcome corporate inertia, take a risk on something new, and rip off the bandage of changing operating processes. Maybe there are technical reasons why the product is only suitable for a sub-segment of the market. Maybe there are more competitors, or more entrenched competition than you thought.

Once it becomes clear that the SOM is actually $500M instead of $5B, investors will be a whole lot less excited about doubling down on their investment in the next round. It might still be a nice business, but if it no longer looks like a venture business with 100x returns, that earlier investment becomes a sunk cost and the worst thing an investor can do is invest in the next round. Bye.

Missing Milestones

You promised to reach $2M in sales last year. Instead, you only hit $1M. You said you’d have v2 released by April. Now it’s looking like November. You said you’d sign up 5 new customers last quarter. Instead, you only signed 2, with the others pushed out for a quarter.

At a regular company, these results might be disappointing, but not the end of the world. Contracts get delayed. Customers change priorities. Employees leave. Tariffs, supply chain snaggles, and wars screw up even the best laid plans. You roll with what you’ve got.

But when you’re operating at a loss and you need the next round of funding to pay the bills, and that funding is dependent on meeting the milestones that you promised would be unlocked by the last round, well…the continued existence of the business is tenuous, at best.

To get funding, in the last round you promised to meet optimistic, probably impossible, milestones with the money. You have no room for error. If customers are slower to sign up than you anticipated (they always are) and development takes twice as long as you expected (it always does), you’ve set yourself up for failure.

Loss of Confidence

Let’s be honest — investors don’t spend a lot of time in diligence. A few meetings, a few phone calls, then they write a check. They really don’t know what’s going on inside the company. They don’t know if the founding team is actually competent or just talk a good game.

That’s why venture funds write a small check first. It’s an entry ticket. They get a couple of years watching the company from the inside. On the board, or at least as board observer. And then they know.

First question new investors in each round ask is whether the current investors are re-investing in the new round. If the answer is no, that’s the end of the conversation.

If you’ve failed to be honest; if you’ve hidden important information; if you’ve treated employees poorly; if you’ve had fights with the board; or if it becomes clear you don’t know what you’re doing, you’ll lose confidence of the current investors. And if that happens, you won’t have new investors.

Bad Planning

This is the stupidest reason for a company to fail, and yet I see it happen again and again. Poor financial planning.

How much cash to you have in the bank? How much are you spending? How long will that last? How long will it take to get more?

These are simple questions. Obvious questions. Critical questions. Too many founders ignore them. They think the accountants are taking care of the money. They’re not. They just doing the accounting of the money. It’s up to the CEO to manage it. And make sure there’s enough to make payroll.

That means looking at the financial reports daily. Watching the bank account. Obsessing over cash flows. Because you will run out. The only question is when. And can you fill up before then.

If you think you can raise new funding in 60 days, you’re deluded. A round typically takes 6 months to close, often 9 months, sometimes longer. If you have less than 9 months cash in the bank, you better get started now. Because nobody wants to invest in a company that’s out of cash and looks desperate.

How to Succeed

Want to succeed? Do the following:

  • Get into a market that is truly large with a plan for winning customers quickly.
  • Be prepared for the fast-moving treadmill. As soon as you deposit the first venture check (and yes, that includes angel investors), you’ve triggered the starting gun on a race to the exit. There’s no time for vacations, no time for hobbies, no time for family, no work-life balance. That’s what you’re signing up for.
  • Don’t overpromise milestones. It might make it easier to raise the current round, but it’s only saving up trouble for later. Customers move slowly and development takes 2x longer than expected. Only promise milestones you’re 100% confident in, then make sure you meet them.
  • Be a good manager. Run the business professionally. Be open and honest with your board and investors, even the bad stuff. They can help you through the challenges (that’s their job!) There’s nothing worse than surprises when they find out things aren’t going as well as you’d been reporting.
  • Watch your numbers. Daily. Obsess over them. How much money do you have in the bank and how do much you need?
  • Start your next raise early. It will take longer than you expect. Make sure it doesn’t take longer than you have.
  • Think again about whether the venture model is right for you. If you don’t have a business that’s likely to hit $100M in 5 years, find another way to fund the business instead of venture capital.