Why start-ups fail
- 2. Why Startups Fail • Nine out of ten startups will fail. This is a hard and bleak truth, but one that you’d do well to meditate on. Entrepreneurs may even want to write their failure post-mortem before they launch their business. • Why? Because very optimistic entrepreneur needs a dose of reality now and then. Cold statistics like these are not intended to discourage entrepreneurs, but to encourage them to work smarter and harder. • Startups are far more likely to succeed when their founders understand, admit and compensate for their personal limitations.
- 3. Reason 1: Market Problems A major reason why companies fail, is that they run into the problem of their being little or no market for the product that they have built. Here are some common symptoms: • There is not a compelling enough value proposition, or compelling event, to cause the buyer to actually commit to purchasing. Good sales reps will tell you that to get an order in today’s tough conditions, you have to find buyers that have their “hair on fire”, or are “in extreme pain”. You also hear people talking about whether a product is a Vitamin (nice to have) or an Aspirin (must have). • The market timing is wrong. You could be ahead of your market by a few years and they are not ready for your particular solution at this stage. • The market size of people that have pain and have funds is simply not large enough.
- 4. Reason 2: Business Model Failure • After spending time with hundreds of startups, I realized that one of the most common causes of failure in the startup world is that entrepreneurs are too optimistic about how easy it will be to acquire customers. They assume that because they will build an interesting web site, product, or service, that customers will beat a path to their door.
- 5. •That may happen with the first few customers, but after that, it rapidly becomes an expensive task to attract and win customers and in many cases the cost of acquiring the customer (CAC) is actually higher than the lifetime value of that customer (LTV). •The observation that you have to be able to acquire your customers for less money than they will generate in value of the lifetime of your relationship with them is stunningly obvious. The vast majority of entrepreneurs fail to pay adequate attention to figuring out a realistic cost of customer acquisition. Most have no thought given to this critical number and as you work through the topic with the entrepreneur they often begin to realize that their business model may not work because CAC will be greater than LTV.
- 6. The Essence of a Business Model • A simple way to focus on what matters in your business model is look at these two questions: • Can you find a scalable way to acquire customers? Can you then monetize those customers at a significantly higher level than your cost of acquisition? • Thinking about things in such simple terms can be very helpful. There two “rules” around the business model, which are less hard and fast “rules, but more guidelines. These are as follows: 1. The CAC / LTV “Rule” The rule is extremely simple: CAC must be less than LTV where: CAC = Cost of Acquiring a Customer LTV = Lifetime Value of a Customer
- 7. • To compute CAC you should take the entire cost of your sales and marketing functions, (including salaries, marketing programs, lead generation, travel, etc.) and divide it by the number of customers that you closed during that period of time. So for example, if your total sales and marketing spend in Q1 was Kshs 1m, and you closed 1000 customers then your average cost to acquire a customer (CAC) is Kshs 1,000. • To compute LTV, you will want to look at the gross margin associated with the customer (net of all installation, support, and operational expenses) over their lifetime. For businesses with one time fees, this is pretty simple. For businesses that have recurring subscription revenue, this is computed by taking the monthly recurring revenue, and dividing that by the monthly churn rate. • Because most businesses have a series of other functions such as G&A, and Product Development that are additional expenses beyond sales and marketing, and delivering the product, for a profitable business, you will want CAC to be less than LTV by some significant multiple.
- 8. 2. The Capital Efficiency “Rule” If you would like to have a capital efficient business, I believe it is also important to recover the cost of acquiring your customers in under 12 months. Wireless carriers and banks break this rule, but they have the luxury of access to cheap capital. So stated simply, the “rule” is: Recover CAC in less than 12 months. Reason 3: Poor Management Team • An incredibly common problem that causes startups to fail is a weak management team. A good management team will be smart enough to avoid Reasons 2, 4, and 5. Weak management teams make mistakes in multiple areas. • They are often weak on strategy, building a product that no-one wants to buy as they failed to do enough work to validate the ideas before and during development. This can carry through to poorly thought through go-to-market strategies.
- 9. • They are usually poor at execution, which leads to issues with the product not getting built correctly or on time, and the go-to market execution will be poorly implemented. Reason 4: Running out of Cash • A fourth major reason that startups fail is because they ran out of cash. A key job of the CEO is to understand how much cash is left and whether that will carry the company to a milestone that can lead to a successful financing, or to cash flow positive. • They will build weak teams below them. There is the well proven saying: A players hire A players, and B players only get to hire C players (because B players don’t want to work for other B players). • So the rest of the company will end up as weak, and poor execution will be rampant.
- 10. Milestones for Raising Cash • Business has scaled well, but needs additional funding to further accelerate expansion. This capital might be to expand internationally or to accelerate expansion in a land grab market situation or could be to fund working capital needs as the business grows. • The business model is proven. It is now known how to acquire customers, and it has been proven that this process can be scaled. The cost of acquiring customers is acceptably low and it is clear that the business can be profitable as monetization from each customer exceeds this cost. • Simply because it was twelve months since you raised your Series A round does not mean that you are now worth more money. To reach an increase in valuation a company must achieve certain key milestones. • The valuations of a startup don’t change in a linear fashion over time.
- 11. What goes wrong? • What frequently goes wrong, and leads to a company running out of cash and being unable to raise more is that management failed to achieve the next milestone before cash ran out. • Many times it is still possible to raise cash but with marked difficulties. When to hit Accelerator Pedal? • One of a CEO’s most important jobs is knowing how to regulate the accelerator pedal. In the early stages of a business while the product is being developed and the business model refined, the pedal needs to be set very lightly to conserve cash. • There is no point hiring lots of sales and marketing people if the company is still in the process of finishing the product to the point where it really meets the market need. • This is a really common mistake and will just result in a fast burn and lots of frustration.
- 12. • However on the flip side of this coin, there comes a time when it finally becomes apparent that the business model has been proven and that is the time when the accelerator pedal should be pressed down hard. As hard as the capital resources available to the company permit. • By “business model has been proven”, I mean that the data is available that conclusively shows the cost to acquire a customer, (and that this cost can be maintained as you scale) and that you are able to monetize those customers at a rate which is significantly higher than CAC (as a rough starting point, three times higher). And that CAC can be recovered in less than 12 months. • For first time CEOs, knowing how to react when they reach this point can be tough. Up until now they have guarded every penny of the company’s cash, and held back spending. Suddenly they need to throw a switch and start investing aggressively ahead of revenue. This may involve hiring multiple sales people per month or spending considerable sums. That switch can be very counterintuitive.
- 13. Reason 5: Product Problems • Another reason that companies fail is because they fail to develop a product that meets the market need. This can either be due to simple execution. Or it can be a far more strategic problem, which is a failure to achieve Product/Market fit. • Most of the time the first product that a startup brings to market won’t meet the market need. In the best cases, it will take a few revisions to get the product/market fit right. In the worst cases, the product will be way off base, and a complete re-think is required. If this happens it is a clear indication of a team that didn’t do the work to get out and validate their ideas with customers before, and during, development.
- 14. Reason Six: Arrogance • Successful entrepreneurs are always overconfident and that's a good thing. • Without overconfidence, nobody would ever buck the odds to start their own business.
- 15. •Overconfidence turns into arrogance though when you're so sure of the wonderfulness of your ideas that you don't bother to take the pulse of the market. •Temper your overconfidence with the humility to accept criticism without becoming defensive
- 16. Reason Seven: Shortsightedness • Startups can't afford "paralysis by analysis" and it's simple good sense to realize that can't anticipate everything in an undertaking that inherently involves the unknown. • That being said, there's truth in the corny old quote "failing to plan is planning to fail." • Maintain some reserves so that you don't crash and burn the first time you hit a speed bump. Reason Eight: Hubris • All too many entrepreneurs believe that "if you build a better mousetrap the world will beat a path to your door." That's classic engineering hubris that results in treating sales and marketing as if they were of secondary importance. • Sadly, though, the history of business is full of excellent products have failed due to weak marketing or poorly-planned sales efforts. Pay as much attention to hiring marketers and salespeople as you do to hiring your engineers.
- 17. Reason Nine: Egotism • Startups require talented, experienced and energized employees who have specialized knowledge • However, building a business is always a team effort and all it takes is one prima- donna for a team to fall flat on its collective face. • Read the newly- published book Team Genius, which contains team-building rules based upon actual scientific research.
- 18. Reason Ten: Sloppiness •When big companies do a slipshod job, they can float on their brand reputation or throw money at the problem. •Entrepreneurs must be meticulous and make certain that nothing falls through the cracks. Remember: "genius is an infinite capacity for taking pains." •If you tend to be a "big picture" person, partner with somebody who's detail-oriented. Reason Eleven: Imbalance •Thousands of articles and books have been published about the lack of work/life balance creates stress and leads to bad decisions. And yet many startups try to operate in round- the-clock crunch mode. •Exercise or meditate every day, turn your phone off when you go to bed, eat right, etc. You know the drill; now just go ahead and do it.
- 19. Reason Twelve: Inflexibility • The most important advantage that a startup has over an established firm is freedom to be nimble.However, there's a natural human tendency to continue to pursue a course of action after it's been proven unworkable. • Plan from the start that you'll need, at some point, to radically change direction. Welcome rather than resist the inevitable change when it comes.