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The reality is that a very high number of startups fail. What you are working on now will statistically, most likely fail. Well done for getting this far. From those who have studied startup failure in detail, the quantum of that failure is estimated to be anywhere between 75 per cent and 90 per cent plus of all businesses starting. The timing of when they fail depends on the circumstances of the business although there are some important trends.
The reasons for failure are complex and varied. In this series of articles, I will bring together all considered thinking into one place to present a holistic view. There is no one single answer as to why startups fail. Also, different people have different viewpoints based on their own experiences. Experts working in the space, whether investors or entrepreneurs may even contradict each other on reasons for startup failure. That’s not to say someone is wrong and someone else is right, just that why startups fail is a very complex topic and there can be any permutation of reasons for ultimate failure.
There are a few over-arching themes that you need to watch out for the best chance of success. This is evidenced by extensive research as well as guidance by authorities on the subject. You will look at some of the reasons for failure and think that it’s an obvious reason for startup failure. But what this article will do is give you the context of why a particular reason causes startup failure. Often some of the bigger reasons of failure don’t just happen. Lots of small problems start to occur in the business first that lead to a large cataclysmic failure.
But even more than understanding potential causes of failure in your startup are the things you can do right now to have a better chance of success. If you are already running a startup read on to see what sounds familiar and what you should do. If you are just starting out, identify what you need to get right from the outset.
What the data shows
Fortunately, a lot of research has been done trying to understand more about why startups fail. Given that all startups are different, it is important to review the results to identify what the research shows and to understand how we can use it.
CB Insights published the most comprehensive recent research on 101 startup failure post-mortems to get beneath the surface of startup failure. The chart below shows key findings.
Note: many startups offered multiple reasons for their failure, hence why the percentages for each reason total more than 100 per cent.
Clearly there are three key reasons that resonated with founders of failed startups more than most. Having no market demand, running out of cash, and having the wrong team are perhaps the most obvious reasons one would expect for a startup to fail. Due to the complexity of startup failure, unless you are unlucky, no one thing will result in the failure of your business.
More likely, it will be a number of things that ultimately cause failure although it may start with one catalyst. Having said that, the three reasons at the top of this list above – lack of market demand, no cash and poor team are likely to be the reasons that ultimately kill your startup.
Obviously understanding if you have a poor product doesn’t immediately alert you to the fact you have a problem. But if any of the things in the grey box below are materially wrong or if enough of them in tandem are not working, then you should be concerned.
Similarly, running out of money would kill any business. But if your startup is burning up lots of cash or has pricing issues with customers then you can believe your business is at risk. Having a business model from day one is not essential for your startup. In the early days, you should be focussing on your product and market. But if no business model has been identified for a long enough period of time, then cash flow will increasingly be a problem for you to the extent that it is fatal.
Inability to raise funding from investors will limit the cash runway you have and is a problem many startups face. This in turn, limits anything else you can do with your startup. That’s not to say you are dead and buried. It just means you need to change your criteria to have any chance of surviving in your current circumstances.
The third most popular reason startups fail, according to CB Insights research, is because they don’t have the right team. You’ll see from the diagram below that many of the factors for wrong team are personal characteristics that can derail a startup such as lack of passion and focus, and burning out through poor management. However, not fully utilising your resources such as your network and poor decision-making can also materially harm your startup.
Of course, disharmony in the camp will cause untold damage to your business. There will be some startups for who, based on their circumstances, having a legal challenge, for example, is the straw that breaks the camel’s back. But this is not exclusive to tech startups and is an operational risk feature in any business.
Fundraising and why startups fail
Running out of cash has already been cited as one of the primary reasons for failure. But what impact has funding raised had on startup failure according to the research?
The median amount of funds raised is a better indicator of the funding failed startups secured as it eliminates outliers. This research showed that dead tech companies raised US$1.3 million before failure. This makes sense in that startups are most vulnerable in the earlier stages when the proposition is still being formed and you are still trying to understand your customers.
That initial level of funding of US$1.3 million for most startups is not enough to get to some meaningful milestone to encourage the investor to support you further. Stewart Butterfield, CEO of Slack which has itself raised US$340 million in funding, is amongst a large contingent of people who believe raising money for startups has never been easier.
And so given that it’s not the case startups aren’t getting funded, the problem seems to at the ‘continued proof’ stage for startups. Companies fail to achieve on set milestones which prevents investors from following up on their initial money. This is evidenced from the chart below.
After having secured funding, on average, companies survive around 20 months before dying. The above charts demonstrate in the 20-month period following a fundraising, startups are unable to progress further in their development, so much so that they are written off. This is a good example of how running out of cash would have caused the startup to fail but the underlying reasons may be something else. For instance, not achieving a key milestone of securing x million users. If we iterated further using the Five Whys technique, we would get down to what is the root cause for the startup failing.
In their analysis of 3,200 companies, Compass(formally know as Startup Genome) discovered that the principal reason startups performed worse was because they scaled prematurely, that is, grew too quickly. These startups lose the battle early by getting ahead of themselves in scaling their team, their customer acquisition strategies, or their product build. Key findings from their report highlighted the following reasons for success and failure of startups as shown in the infographic.
Compass identified that 70 per cent of startups scaled prematurely from their sample of 3,200 and that premature scaling goes a long way towards explaining the 90 per cent plus failure of startups cited earlier.
This prematurity is usually along one of five dimensions according to Compass: customer; product; team; business model; and financials.
A big part of the development of the business model, which ties up a number of the other points outlined above, is around customer acquisition. Getting initial customers who help you develop a product that solves a pain point is one thing. But acquiring real customers is quite another. The point in the diagram above that reads ‘finding out you can’t get costs lower than revenue at scale’ is an example that your customer acquisition cost is too high.
Customer acquisition cost is something that entrepreneurs grossly underestimate in their business. This is the cost for the business to acquire a new customer. Acquiring customers is not easy. Acquiring customers at a rate where the economics work is even harder.
What do I mean by this? ‘Build and they will come’ is a foolish strategy to grow your business and will very quickly be proven wrong. Customers won’t be banging down your door because you have a great product or service. Especially when you are trying to grow at scale. Given that the customer acquisition cost can be very expensive, having a customer acquisition strategy in place is sensible to help with this.
A customer acquisition strategy works on the basic principle that you need to acquire customers at a cost that is less than the lifetime value of that customer. The lifetime value is the projected revenue that a customer will generate during their lifetime. Firstly you need to calculate the lifetime value of your customers. This will then inform you about the right approach to attract new customers. That approach will be one where the customer acquisition cost is less than the lifetime value you have calculated.
This is an important cornerstone for your startup that will give you confidence that you are building your business in the right way. It will also ensure that you don’t get into problems with running out of cash due to excessive customer acquisition spend. Having a customer acquisition strategy in place is extremely important.
1. Spend a lot of time with potential customers to understand what works and what doesn’t.
2. Develop the most basic minimum viable product (MVP) then iterate based on customer feedback.
3. Stay attuned to key metrics for your business and use them to identify the right time to pivot.
4. Always be fundraising and get the basics of your pitch right.
5. Implement a customer acquisition strategy off the back of calculating the lifetime value of a customer. This will ensure your customer acquisition cost is sustainable and allows you growth without breaking the bank.
6. Manage cash burn carefully.
7. Reduce the number fixed costs in your business (i.e. rent) and increase variable costs (i.e. marketing effort) to allow you to leverage variable costs and preserve cash when needed
8. Scale back on milestones to preserve cash. This will also help you reach milestones and raise subsequent funding more easily.
9. Technical factors are important but integrity, honesty and fit are more so.
10. Get a vesting schedule with a lawyer to ensure everyone is aligned.
Key factors to remember while starting up
Customer & Product: Get out of the office and spend time with your customer. Feedback, iterate, feedback, iterate. Build an MVP and only add features that are essential from customer feedback.
Team: In the early stages of your startup, resist hiring until absolutely necessary. Outsource non-essential operations to the extent you can (i.e. accounting)
Financials: Look to raise 50–100 per cent more than you think because software takes longer to write and deals take longer to close. Ensure you include a contingency.
Business model: Keep iterating the business model based on customer feedback. Build the business model gradually into your startup based on what you are seeing in customer behaviour
The views expressed here are of the author, and e27 may not necessarily subscribe to them. e27 invites members from Asia’s tech industry and startup community to share their honest opinions and expert knowledge with our readers. If you are interested to share your point of view, please send us an email to writers[at]e27[dot]co