Top ten reasons why startups fail

Entrepreneurship is for those with thick skin, and sheer tenacity to be able to hear lots of “no’s” but not be deterred.

Jolly’s Volley

I think most people are aware of the fact that very few startups actually succeed. That’s precisely what makes entrepreneurs a rare breed. While knowing the risks, entrepreneurs follow their passion, try to change the world and hope for wealth creation for themselves and their shareholders.

It’s the potential for that proverbial home-run (or a Sixer in cricket talk, I suppose) that drives entrepreneurs, especially technology entrepreneurs (and VCs) to get into the game in the first place. But, for a combination of reasons both within and outside one’s control, startups fail. The list below is one compiled by my colleague, Tim Draper. I have tried to add my own little twist to give it some Indian spice and colour. So, here goes…

1. Startups run out of cash: One can argue whether that’s the cause or effect of failure. Often, startups are too optimistic about when their product is going to be accepted by the market (the hockey stick that entrepreneurs and investors alike often talk about). I used to have a professor in Business School who was a turnaround specialist hired by large corporates in the US to help float a sinking ship, and actually have them become viable businesses.

He used to say, “You can run out of wives and girlfriends, but make sure you never run out of cash”. I am guessing the latter will automatically lead to the former in most cases. But all kidding aside, there are often times when the entrepreneur is either too naive or highly arrogant when dealing with the situation of “cash crunch”.

On the former, he/she is busy fighting other fires that he/she simply underestimates how long the cash will last (sales cycles are longer than expected, for example, or customers are more price sensitive than expected). I have also seen the latter, where an entrepreneur will not heed advice from Board or advisors (in terms of cutting the burn) simply because he/she thinks that his/her company is too valuable for the investors and other stakeholders to let die, and they will bridge the company. More often than not, the entrepreneur is wrong. In tough times, investors become a lot more disciplined about letting go of the non-performers, and not putting good money after bad.

2. Founders don’t have complete faith in each other: They fight instead of delegate, trust and verify with each other. This is a tricky one. I often tell entrepreneurs that great companies are founded not by an individual but teams (2 or more founders). Gates and Allen, Brin and Page, Yang and Filo, Jobs and Wozniak and the list goes on and on…It’s important to have one founder who is outward facing (customer/business centric) while another who in inward facing (operations centric).

But there has to be a clear delineation in roles and responsibilities, so that one doesn’t step on the others’ toes. The other aspect is to be brutally honest with each other, and actually have a transition plan, as a company scales. More often than not, founders are great at the early stages of a company, but a new seasoned management team is necessary to scale the business to tens of millions of dollars and beyond in revenue.

Sometimes, I have found myself in situations where two buddies who founded the company are no longer capable of running the company (i.e. the company has grown to a size beyond what the founders can handle). The truly remarkable founders/CEOs are ones who realise when they are no longer right people to be at the helm of the company.

They often step aside, or take on a role of a chairman/evangelist and let a more seasoned CEO steer the company forward. But for a variety of reasons, ranging from “giving up control”, to “title creep (still needing to be CxO)”, to sheer ego, founders end up in a tiff with each other or with the Board. Let me give you a specific example. There is a company where two co-founders (Founders A and B, close friends for many years) started a company with operations and market in India, while they were still in the US. The plan was for them to move to India. But for a variety of personal reasons, Founder A simply could not make the move to India. Founder B, as a result, ended up doing most of the work.

Even though founder A was no longer contributing, founder B did want to let him go due to the long personal friendship. Founder B, as a Board member, has a fiduciary responsibility to do the right thing, and let his buddy go (since he was no longer actively contributing to the company). The unvested equity held by founder A was no longer working towards creating value for the company. Founders often have a hard time choosing between a fiduciarily responsible decision and an emotional personal relationship. By having a detailed conversation around roles and transitions at the onset, founders (who are also good friends) can avoid awkward situations downstream.

3. CEOs hire weak team members: This is partially related to the previous point. Strong CEOs sometimes try to carry everyone with them rather than hiring people who stand up on their own. Again, there may be team members who are dear friends, but may actually not be the best person for the position. CEOs need to do what’s optimum for the company and the shareholders, not their friends or their ego.

Most successful CEOs will utter the following words “always surround yourself with people smarter than you”. Again, if entrepreneurs are honest with themselves and actually adhere to that mantra, they will build a strong company, and an equally strong culture of hiring better and hiring smarter. Many CEOs or executives, due to either ignorance or arrogance, end up settling for weaker team members.

The reason for hiring strong team members is simply that they will question the status quo, and the traditional way of thinking. They will be a resource for the CEO and the Board to help determine the company’s overall strategy. For startups with constrained resources and continuous threat from incumbents, there needs to be a team with a combination of smart out –of-the-box thinking/questioning, scrappiness and uncompromising tenacity. Often founders, who are junior from an experience standpoint, do not want to let go of a lofty title. My recommendation is that one would often be much better off working at a director or manager level for a seasoned VP or CxO from the outside, than try to learn on the job as a CxO or SVP themselves.

4. They want to do too much: Usually, successful start-ups figure out a narrow niche that they can dominate and then expand from there. This is where the bowling pin analogy is helpful. Often entrepreneurs face a dilemma of “appearing big enough” to a VC especially during a fundraising discussion, but at the same time being able to focus on a particular segment of a market. There is also a balance between being flexible/nimble as a startup, but at the same time not looking completely lost or defocused.

Often, startups have to experiment and try a variety of approaches to products, channels, business models, but they also have to make sure that there is discipline and analysis behind the decision making. Bottom line: stay focused, become dominant is a very targeted segment or vertical, and with that success as foundation, expand into adjacent areas. Entrepreneurs should paint a long term big picture, in terms of a game changing vision, but be laser focused in their execution, especially when starting up. Admittedly, this is easier said than done (as with most of my articles).

5. They go after too small a market: Selling ice to Eskimos is a trivial but poignant example. You may have the best customised ice sculptures, but it doesn’t mean a whole lot if the market is either too small or non-existent. This is often the case when entrepreneurs develop a technology looking for a problem, rather than developing a product having researched a market and determining that the opportunity exists, it’s large and customers are willing to pay for the right product or service.

Another way of looking at this is to see how much “better, faster, cheaper” one can make a solution compared to something that already exists. Trying to improve existing solutions by 10 or 20% doesn’t usually have an impact. Order of magnitude impact in terms of price/performance is a lot more interesting. Having said that, companies often are created not to address an existing market, but one that is anticipated to emerge.

In India, for example, several companies were created and funded prematurely relying on broadband penetration that was supposed to happen in India. Examples around mobile video or location based services are other areas where current market is tiny, but they will emerge. A very tough question to answer is one of timing – Should a startup wait for a market to be ripe, or build a solution while guesstimating market maturation. I am more a proponent of the former, since there is quantifiable opportunity that often does not require behaviour change, and complete customer education. There is a reference in terms of incumbent products/technologies against which the startup can measure its own offering, in terms of being significantly better, faster and/or cheaper.

6. They don’t charge enough from their customers to survive: They often think their VCs are their customers and that a nice VC pitch is all they need to make to get more money. There is no better cash source than happy, marque price-insensitive customers. Just like many other challenges faced by a startup, determining a business model and more specifically pricing is one of them. Although it’s ok to provide a discount for the early alpha/beta customers, it’s usually not the right move to compete based simply on pricing.

Also, it’s crucial to have a very good idea of costs of creating and delivering one’s product or service, so that pricing and margins are enough to sustain a growing company. The aforementioned is an obvious statement, but one would be amazed at how often entrepreneurs don’t actually have a good handle on their margins. In India, which happens to be a more price sensitive economy than most, it’s extremely difficult to start with a low price and raise it over time. The reverse will likely be true.

Bottom line: base the pricing on a quantifiable ROI to the customer, and have an incredibly capital efficient production and distribution base. Margins tend to shrink, not expand, as offerings get commoditised over time.

7. They hire too many people up front: Too many mouths to feed too early can sink a company. Keep a low burn until you have your business model in place. In some businesses it is crucial to have a team in place to be able to deliver the product or service. There is usually training involved, so people do need to be hired slightly ahead of revenue. But often, especially in good times, startups hire too many people prior to having clarity of the business model or revenue visibility.

Having a high burn without either having a product/service to sell, or a process to deliver that particular product or service, is the number one reason, in my mind, why startups fail. Startup investments happen in tranches or series of funding that are usually tied to a company hitting specific milestones. But if the burn is high, those early product milestones are not hit in time, and companies have an incredibly difficult time raising additional capital.

On the technology front, early hires are usually engineering centric to develop and refine the product. Once the product is getting close to market release (as alpha/beta), that’s when sales, business development and customer facing hires come into play. The aforementioned is a slight generalisation and seems fairly obvious, but one would be amazed at how frequently this particular mistake is made, often by seasoned entrepreneurs. I have had experience with several companies where, due to the economic/market environment, a RIF (reduction in force) had to take place.

What’s more amazing is that in most cases, after the RIF, the company’s performance did not suffer in terms of revenue, and bottom line improved drastically. Lesson learned: companies can be much more capital and team efficient than they realize. Often it’s only after a startup goes through the over-hiring and then laying-off cycle that entrepreneurs realise that they truly can do more with less.

8. Sheer luck (or lack thereof): Startups can and do get broadsided by competitors, new technologies, big companies changing direction, regulatory environment etc. This is one that squarely belongs in the category that’s completely “out of one’s control”. Startups’ success depends on a blend of luck and skill.

One can argue about the percentage splits between the two. In India, this point may be more true than most places, given the regulatory environment that exists in many sectors. And given the mood of large organisations like the RBI, SEBI, or the various ministries and their dynamic mandates, startups can either tremendously benefit or completely get clobbered by the decisions made. In India, there are grey areas around topics like Service tax, which can cause significant burden or relief depending whether a company is liable or not.

Given my aerospace background, I had a chance to see direct impact on technology companies catering to the defense sector getting tremendous benefit when the Republicans were in the White House vs the Democrats. Finally, often cash rich incumbents can simply play a loss-leading pricing game to crush a startup.

9. They don’t work hard enough or fast enough or smart enough: All those little decisions add up to an outcome. Awareness of the market dynamics subtleties are ignored or not analysed/understood as well as they should be. It’s important, for example, in India to realise that this is primarily a cash based economy, and on top of that a pre-paid economy. So, trying to enter the Indian market with a credit card based purely online subscription model, may not work, especially if the product or service is to be delivered to a broad consumer base.

DFJ has companies in our portfolios who have faced the very same challenges, so the nimble startups have to keep their finger on the market pulse and continuously adjust (without throwing darts in the dark) based on market feedback. Although not often the case, there are times when startups get a bit complacent. This could be due to over confidence in the technology, or on the other extreme, due to fatigue, especially if the company has been going on but been relatively flat for a number of quarters or years.

Sometimes technology entrepreneurs get a bit detached from their eventual customers, not realising that the needs of the market are changing, or the customer behaviour is morphing and as a result the product also needs to change. Lack of that adaptation, or not doing so fast enough, can also lead to a dire end. Let me give another hypothetical example. If a company relies on acquiring online merchants to be able to provide a service like search engine optimisation, or an advertising network to an online publisher, then it’s crucial to have a process in place to be able to add those merchants seamlessly and quickly if the business is to scale. Yet, if that company has an Oracle like culture, and the QA process for every merchant addition takes 8-10 weeks, the company is doomed.

10. They don’t take enough risks: Some start-up entrepreneurs think that they should operate as though they are big companies. This is wrong. They will never beat Microsoft or Google at their own game. They must get creative and do things differently, even at the risk of embarrassment. The incredibly successful entrepreneurs are those who thought monumental, not incremental.

11. Bonus point (buy 10, get 1 free, recession special): Entrepreneurs get greedy. This may be ironic coming from a VC. The sole focus of the entrepreneur should be to create a large profitable long term entity. The big pain point for the entrepreneurs, and understandably so, is around dilution that they suffer when raising capital. That concern often leads to sub-optimal decision making.

For example, especially in times of financial uncertainty like today when valuations tend to be lower, founders/promoters tend to take less money to minimise dilution. My advice to entrepreneurs is “when offered capital, take it”. It’s almost always better to take more capital than less because it usually takes longer and more capital to hit key milestones.

Bottom line: Entrepreneurship is for those with thick skin, and sheer tenacity to be able to hear lots of “no’s” but not be deterred. Having said that, passion alone cannot guarantee success and due in part to reasons given above, startups fail. What’s equally important to realise is that it’s “ok to fail”.

I am obviously not implying that one should stride for failure. Silicon Valley is filled with entrepreneurs who failed their first and even second time before they finally had a success under their belts.

The learning involved in going through a rough startup experience can be tremendous. In India, I feel a sense of risk aversion among entrepreneurs where a stigma still lingers (whether real or perceived) around failure. I think only when that viewpoint changes, will we start seeing truly monumental ideas coming out of India, rather than the incremental “low risk, low reward” variety.

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