How to help investors with „Zombie“ start-ups?

Definition of a zombie start-up

Even the best investors in the world aren’t right all the time. Investors typically apply a portfolio approach to spread their risk and increase the chances for backing an opportunity. In any investor’s portfolio you have therefore what investors have come to call “zombie start-ups”. Zombies are start-ups that make revenue, perhaps enough to break even, but not enough to generate a valuable return for investors and as turnover is not enough, they are constantly raising capital. As a successful financing round always needs an attractive start-up, and zombies are by definition not attractive to investors, there is only one way to raise capital or secure an investment by covering up unwanted negative sides of the start-up. For clarification, this is mostly not about fraud, more about ignorance, omittance and/or deception:  

1. ignorance: most often the start-ups themselves are not conscious about essential facts for the success of their business, be it out of misinterpretation or just not knowing.  
2. omittance: cutting out the ugly non-obligatory information.
3. deception: providing a positive interpretation to the ugly obligatory information 

Along this train of thought, both new as well as committed investors are provided with a “dressed-up” version of the start-up’s story which will make investors believe in the rightness of investment decision. Typically, new investors fall prey when they fail on performing a profound due diligence and rely solely on business analysts whose interest are in achieving a deal. There are numerous reasons for the due diligence process not being done in a comprehensive and profound way. However, after an investment an investor is defined by the legal binding of his investment which usually impedes a drawback of the commitment other than by buyout or exit. Moreover, there is sometimes also an emotional relation to the Start-up Team or the idea itself, so often an investor still will provide with follow-up investments in the course of future financing round in addition to increasing investments to avoid dilution of shares. Despite investment reasons, such a situation is best described as a stalemate, where the investor has seemingly no real option to change the situation substantially and to lose his investment, what most investors want to avoid. So, either investors just accept it and let their investment quietly fade away or investors struggle on, trying to help the team with whatever resources they think could help, be it money, market insight, own time and work to achieve a desired turnaround. 

Regardless the path an investor will seek, a true insight into the ordeal of the start-up is missing and thus a zombie start-up proceeds its way. 

Problem statement of investors

Investors that have invested in underperforming start-ups need a basis to decide future actions and support. Investors seek information they will not receive resulting from conflicting interests with the start-up’s management. To reiterate earlier interest of zombie start-ups is to achieve success in financing their operations by deferring and deflecting unwelcome parts of the start-up for  upcoming rounds of financing.  

So how can investors find true insights to a start-up’s health? Information sought after is how the start-up is really performing on the market as well as assumptions about future potentials and performance on the market, thus a realistic valuation.  There are two approaches to get information about a start-up’s performance. On the one hand, there is the obligatory public information, as the balance sheets and the profit & loss and other key performance indicators that are published for regulation reasons. This information is produced internally and depict how funds were used. This information can lead to deception, strongly pointing towards a solution in how to find the economically right interpretation. On the other hand, information about the performance of the start-up that is produced externally, by partners and customers and community that lead to answers in how the start-up is perceived in the market, its status quo and its future potential. This information is only used when there is an advantage for the start-up and thus can be ignored or omitted if found to harm the overall picture. 

Solution for getting investors better insights

A team can provide true insight to the status and the prospect of the investor’s investments. The team would scrutinize the investment opportunity without bias from close relation, conflict of interest or deal based performance pay. The team focusing on the market perception of the start-up’s performance taking into account all stakeholders and their feedback. True insights would be provided by a three-level analysis. The first analysis will be to compare the initial due diligence and start-ups vision with current reality. The second analysis will provide a deep insight into problem areas that were identified in the first analysis. The deep dive will provide with potential solutions to overcome the problems. The third analysis will provide an insight into which solutions have which impact for a potential turnaround. The third analysis can be conducted via a conjoint analysis.

Methodology to obtain true insights

First meta level analysis

The meta level analysis will look at external and internal factors involving the product service or solution of the start-up. Internal competencies and external influencing factors are analysed through a quantitative survey. This survey will be conducted in at 360° approach, so that start-up employees, investors, customers and clients are invited to participate. Quantitative feedback will provide with a score and provide insights to further qualitative deep dive analysis.

Vision and evaluating its “Back casting”
Best case	realistic case	worst case
Initial Vision
Current State

internal competencies:	score	external potential:	Score
Management	%	Technology	%
Culture	%	Market	%
Skills	%	Finance	%

A further correlation matrix provides understanding about which problem areas have a correlation effect on other areas.

Secondary deep dive analysis

Problem finding with 360-degree interviews towards stakeholders. These interviews will be qualitative interviews and provide more profound insights into what problems exist. Qualitative interviews can also point towards potential solutions for problems. These solutions can then be compared with other interview feedback and ranked based on our previous correlation matrix and scores. An effective deep dive analysis and qualitative interviews will require a throw stakeholder mapping and access to clients and customers that are not biased by the start-up. 

Tertiary conjoint analysis

The final analysis would be to provide a weighting average on the proposed solutions from the deep dive analysis. It might be obvious to be able to rank the most important solutions to problems. In cases where it is not obvious, such as price or enhancements, a conjoint analysis can help to provide true insight on the impact and effect a proposed solution will have on the start-up’s turnaround. Thus, with the final analysis the investor can estimate the required recourses for a potential turnaround. 

Financing of a true insights service

In order to omit any performance related fees, a flat fee for each of the analysis stages is ideal. The variable costs are the amount of interview partners required to provide a true insight analysis. Thus, larger start-ups will require more interviews to be conducted and essentially cover the operational costs for interviews. Teaming up with market research companies and universities will also help to streamline and standardize the methodology so that future evaluations can be compared with previous analysis.