Did you know that 90% of Indian startups fail within their first five years? This grim startup failure rate affects thousands of investors annually. If you’re a startup investor, or thinking about becoming one, like Gaurav Singhvi, a top angel Investor in India, you’re probably wondering: What if a startup fails? What actually happens to the investor or VC money in failed startups when they shut down?

Also Read: How to Become a Venture Capitalist?

What Happens Legally When a Startup Fails?

When a startup collapses, your investment doesn’t simply disappear – it follows a predetermined legal startup liquidation process that might leave an experienced venture capitalist with the short end of the stick. Understanding this startup investment risk is crucial for anyone entering the high-stakes world of early-stage funding.

Typically, the company enters liquidation under the Insolvency and Bankruptcy Code. Think of it as a queue where everyone’s hoping to get paid, but there’s rarely enough to go around.

The payment hierarchy looks something like this:

1. Secured creditors (banks with collateral)
2. Workmen’s dues and employee salaries
3. Government taxes
4. Unsecured creditors (vendors, service providers)
5. Preference shareholders
6. Equity shareholders (that’s you, the typical angel investor)

By the time this queue reaches equity investors, the coffers are usually empty. That’s why many experienced investors often mentally write off their investments the moment they transfer funds.

If the startup simply winds up operations without formal startup closure process (surprisingly common in India’s ecosystem), you might never see a paisa returned – just a brief message on WhatsApp announcing the end. 

This reality of startup failure and investor loss is something every startup investor must be prepared for before entering this high startup failure investor risk and high-reward domain.

Types of Losses Investors Face

The journey of investor money in failed startups follows a predictable but painful path that extends far beyond the initial financial loss, which is just the beginning of your woes:

1. Capital Loss

The obvious one – your ₹25 lakhs to ₹1 crore investment might disappear entirely. For high-net-worth individuals and angel networks across India, these losses add up quickly.

2. Opportunity Cost

That money could have been in another promising startup, established companies on BSE/NSE, or even a fixed deposit earning predictable returns. This invisible cost often stings more than the direct loss.

3. Time and Resources

Beyond money, what investors lose when a startup fails includes countless hours mentoring the founder, making introductions, and attending board meetings. This investment of time vanishes along with your capital.

4. Reputation Damage

For lead investors or those who brought friends and family into the deal, there’s a reputation at stake. Your network might think twice before joining your next investment syndicate.

How Investors Can Protect Themselves?

While you can’t eliminate startup investment risk entirely, you can certainly manage it better with these strategic approaches:

1. Diversify Across Sectors

The Indian ecosystem offers opportunities from fintech to agritech. Spread your bets across 10-15 companies rather than concentrating on just one “sure thing” in Bengaluru’s tech corridor.

2. Thorough Due Diligence

Don’t just get swayed by IIT pedigrees or previous Flipkart experience. Examine unit economics, talk to potential customers, understand competitive dynamics, and assess the founder’s resilience during tough times. Proper due diligence before investing can significantly reduce your exposure to early-stage investment failure.

3. Prefer Startups With Clear Exit Paths

Ask directly: “How will I get my money back?” Companies with acquisition potential from larger corporates or international buyers offer better chances of returns. Clear investor exit strategies are essential to help mitigate startup investment risk.

4. Use Protective Clauses

Liquidation preferences, information rights, and anti-dilution provisions aren’t just fancy terms – they’re your safety net. A good startup lawyer in India can make all the difference in providing investor protection in startups.

Real-World Examples of Startup Failures and Investor Impact

1. Stayzilla (2006-2017)

Startup Journey:

• Founded by Yogendra Vasupal as an online homestay booking platform.
• Raised approximately $34 million across multiple funding rounds.
• Primary investors: Matrix Partners India and Nexus Venture Partners

Investor Impact:

• When Stayzilla shut down in February 2017, investors faced substantial losses.
• The company went through insolvency proceedings with an estimated debt of ₹13 crore.
• Matrix Partners and other investors saw minimal asset recovery as debts to operational creditors took priority. This is how investor money in failed startups often yields minimal returns.
• The bankruptcy was complicated by legal issues when the founder was arrested over payment disputes with vendors (specifically Jigsaw Advertising over unpaid dues of ₹1.72 crore).
• Resolution Professional sought expressions of interest for the company in 2018, indicating limited recovery for investors.

2. TinyOwl (2014-2016)

Startup Journey:

• Food delivery startup founded by Saurabh Goyal.
• Raised over ₹100 crores from marquee investors including Sequoia Capital, Matrix Partners and Nexus Venture Partners.
• Expanded to multiple cities before its collapse.

Investor Impact:

• Despite multiple funding rounds, TinyOwl’s dramatic failure resulted in near-total equity loss in startups, epitomising the harsh reality of startup investment risk in competitive markets.
• The company’s aggressive expansion without sustainable unit economics burned through capital.
• In its final days, investors reportedly forced drastic layoffs.
• When operations were shut down in 2016, the remaining assets barely covered operational debts.
• Investors ultimately wrote off most of their investment when the company was absorbed into RoadRunnr (later Runnr) in a distressed merger.

3. Snapdeal’s Near-Failure

Startup Journey:

• It was once worth $6.5 billion, making it a big Indian unicorn.
• Raised over $1.8 billion from investors including SoftBank, BlackRock, Foxconn, and Alibaba Group.
• Almost collapsed under competitive pressure from Amazon and Flipkart.

Investor Impact:

• SoftBank, the largest investor, reported a $1.4 billion write-down on their Snapdeal investment, showing the severe consequences of startup failure and investor loss at scale.
• When a proposed merger with Flipkart failed in 2017, the company’s valuation plummeted to under $1 billion.
• While Snapdeal survived through drastic downsizing, investors suffered substantial value erosion.
• The company’s experience highlights how even unicorns can rapidly lose value, trapping investor capital and demonstrating severe angel investment risks.

The Bottom Line

Startup investing in India’s dynamic ecosystem is like Mumbai’s monsoon – unpredictable, occasionally destructive, but essential for growth. The startup funding risks are real, but so are the potential multi-bagger returns. Smart investors understand that failures are inevitable stepping stones to finding those rare successes. 

Struggling to find your way through India’s dynamic startup environment? Gaurav Singhvi Ventures helps investors build strategic portfolios designed to weather inevitable failures while positioning for outsized returns. Let’s connect!