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Why startups fail

Imagine a start-up that promises to deliver groceries within 30 minutes of receiving the client’s order; a start-up which raised close to $800 million from blue chip VC funds like Sequoia Capital, Benchmark Capital, Softbank, Goldman Sachs and even Yahoo. The company also raised $375 million from its IPO where it sold 25 million shares at $15 each. All this happened within just a few months of the company’s creation. This start-up was valued at 1.2 billion dollars before declaring 830 million dollars in losses and going bankrupt. This is a true story. It happened in 1999. The company was called “Webvan”.

Were you also aware that the solar power tech start-up “Solyndra” filed for bankruptcy in 2011, after burning its way through $1 billion in venture capital funding and, “Better Place”, a start-up provider of battery stations for electric cars, shut down in 2013 after losing $850m?

When we think of start-ups, we usually think about Google, Facebook or Whatsapp. However, these companies are an exception in the world of entrepreneurship. Normally, start-ups do not become glamourous companies with billions of dollars of capital. In fact, it’s usually to the contrary. They frequently fail. According to Forbes, the failure rate of start-ups is around 90%, so what are the main reasons for these failures?

In our experience as start-up mentors and private investors, we consider the following to be the main causes of failure:

First of all, we have problems with adapting to the market. One of the main reasons for failure is that the market is non-existent or inappropriate for the product developed. This shows itself in different ways, for example:

  • Clients are not prepared to pay for the product or pay the price necessary to sustain consolidation and expansion of the company.
  • There are clients prepared to pay for the product but the market is not large enough.
  • Inadequate market timing. In this case, the company must find ways to generate revenue wherever possible. Later on, we will describe some real example of start-ups in this situation and how they resolved their issues.

If the market size and market timing are correct, we can however encounter problems with the business model, specifically problems due to the enormous differences between the CAC – Costs of Acquiring the Customer and the LTV – Lifetime Value of that Customer.

The key to any start-up, and in general to any business, is that the cost of acquiring a customer should cost less than the benefits generated by this customer during his or her relationship with our company. The CAC must be less than the LTV by some significant multiple. Generally, a large number of entrepreneurs are too optimistic regarding the costs of acquiring customers.

Another major flaw is the inability to materialize sales, especially in B2B start-ups. Most start-ups will never exceed $1 million in annual sales. In fact, to overcome this barrier would be a key milestone for most of them. The sale of big deals is essentially based upon the application of specific techniques which allow us to define and implement ad-hoc strategies to create and win big opportunities. The majority of start-up sales teams simply do not know how to do this.

The next reason is usually inadequate management of cash flow and costs thereby causing the start-up to run out of cash. This situation is usually produced due to an inability to comply with a milestone. This non-compliance brings with it difficulties to obtain funding which together with greater non-efficiency in cost management (Strategic Costs Management), leads to bankruptcy.

During the early stages of the business, it is key to conserve money and effectively manage the company’s costs to avoid the “burning expenses” which unfortunately, many start-ups incur. For example, it makes no senses to spend enormous amounts on marketing if the product is not yet finished. The company’s costs must be managed efficiently and money reserved for the right moment when we need to manage the desired “hyper-growth”.

And lastly, on many occasions, start-ups fail due to the inability of the Management Team. Why? Well, amongst other things, a good management team would not commit any of the mistakes we’ve just spoken about.

We are preparing a course to improve the management abilities of entrepreneurs with the aim of greatly increasing the possibility of their start-ups being successful.

Will come soon. Any feedback here is more than welcome

@buildthepipe

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