Most startups fail. The majority of these failures are avoidable and caused by poor planning – the entrepreneurs not understanding the risks they face. This post will bring you up to speed on the major ones.
Around 25% of all startups go out of business in their first year. Officially, 71% of all startups launched today will go bankrupt in 10 years. That’s bad although it omits the full picture. It doesn’t take into account the companies still limping along with little to no sales and taking losses.
Murphy’s Law hits entrepreneurs harder than they hit people in other professions. Ex post analysis show that most of these startups could have avoided failure if they were more careful with their planning. And it’s true – most entrepreneurs fail to recognize all the risks they face.
The following is a list of common risks that most startups face. Think them over before launching your next great idea.
Product risks are those dealing with the product itself, or the procedures for making and selling the product.
The first kind of product risk is one of inadequate planning. Did you address things the following:
- Target market – who is going to buy your product/service and why?
- Competition – how many companies are providing similar offerings and why your company’s offerings will be more appealing?
- Pricing – how much your competition is charging and how do they justify that price and is your own pricing justifiable to the market?
- Market control – how do you prevent competitors and new entrants from copying your advantages, or worse improving upon them?
The next risk comes from your channel partners. How do you keep them in line? Can you guarantee the stores carrying your products will continue to carry your product after 6 months? What happens if they give your competitors better retail space than you? What happens if your manufacturers start selling your products under their own brand name, or your design firm starts designing similar products for your competitors?
Some businesses require huge support or administrative infrastructures. Want to launch your very successful streaming service in India? You’ll likely fail because they don’t get the kind of bandwidth you do. Want to launch a grocery delivery service in Thailand? They have 41.6 road deaths per 100,000 people per year, so your operations might not be as smooth as you think. Most operational risks are easy to figure out during planning but some don’t show till operations actually begin.
Needs vs. Wants
Is there an intriguing enough value proposition to cause buyers to commit to purchasing your product or service? Is your product a “nice to have” or a “must have”? Figuring that out will let you decide whether or not it’s worth going forward with your idea.
Pricing is an art form. Price too high and no one can afford you. Price too low and no one takes you seriously, or worse, thinks your products are cheap and low quality. Get a picture of a celebrity with one of your handbags, and suddenly a handbag that costs a $100 to make is selling for thousands. Be associated with the wrong image, and suddenly your multibillion dollar enterprise is losing sales (case in point: MacDonald’s, Coca-Cola and others).
Market risks arise from situations in the marketplace – competitors, customers, and the environment in general. You need to know the routes to market, and if you can build and maintain them effectively within your budget. There’s also timing to consider.
Poor business model
We’ve seen far too many entrepreneurs who are overly optimistic about gaining customers. A good product or service, an interesting website, and 500 followers on Facebook helps, but none of these things make you money by itself. They’re all important, but these are just the start of a successful business.
You need to acquire customer dollars, and balance the cost of acquiring a customer (CAC) to his/her lifetime value (LTV). A lot of businesses fail because this balance if not in their favor. It all comes down to having a profitable, scale-able business model. Having a solid business plan, one that covers every aspect of the business, goes a long way towards this.
I talked about not knowing enough about your competitors before. Competitors are people and businesses who are chasing the same consumer dollars as you are. Don’t neglect to consider “good enough” solutions and hacks when researching competitors. If you’re selling a new kind of door stop, remember that a book, a pair of heavy boots, or even an upturned chair can get the job done. It’s not pretty, but it serves the purpose, and it’s cheaper than your designer doorstop.
Technology and Obsolescence
If you’re not a tech based startup, we always recommend going with the technology you already know. This is because any new technology may have long, expensive acceptance cycles, have unpredictable performance issues or manufacturing problems. This gets worse the more “disruptive” the technology is. Look at how long it took WordPress to become the most popular website platform, and how much tweaking, improving, and apologizing they had to do before it happened.
If you are a tech based startup remember to collect a lot of market feedback. Do we even need a “better” technology (I honestly can’t tell the difference between a 450ppi and a 500ppi display on a 5 inch screen), do we already have something better than what you’re proposing (this butter stick vs. whatever you currently use to spread your butter), and is this new technology worth whatever price you’re asking for it (Dropbox/Drive vs. La MaisonShawish’s USB Mushrooms)?
And finally remember that if you do truly have a whole new class of technology, it won’t be long before regulators start changing things around, which might make your business easier or harder.
Political and Economic
Some startups are just in the wrong place at the wrong time, and don’t realize it. Ernesto Sirolli talked about how they tried to set up a tomato farm in Africa, but hadn’t accounted for local conditions (hippos). Be sure to get a complete picture of the market you’re thinking of stepping into. Pakistan has had 5 major floods in the last 10 years. They really need a flood protection system, but probably can’t shell out a thousand dollars per meter for a high tech flood barrier. And therein lies the reasons you should look at the economic situation of your market, because right now Pakistan is the country that needs that product the most. Equally important are tax rates, tariffs, expropriation (the act of taking of privately owned property by a government to be used for the benefit of the public), and risks associated with bringing profits back to your own country (e.g. inflation, exchange rate, etc.).
Timing is crucial, and often one of those few business variables you can’t really control. Your idea could be so great that you might be years ahead of your market, meaning your potential consumers just aren’t ready for your product or service. Bill Gates made the first tablet PC in 2002, before the market was ready for it, and Steve Jobs ended up stealing the market with the iPad in 2010. Nokia came up with the first smartphones (Nokia 9000 Communicator). Guess who stole the show almost 10 years later?
If you’ve launched too soon, you run the same risks. If the market can be ready in a few years, and you have the money for it, stick it out. If the market will take a while to get ready, or if you don’t have the money for it, see if you can pare your idea down to fit the existing market better. If you know it’s too soon, don’t launch, make a prototype and get a patent, but don’t launch. Wait till the opportune moment and you’re sure to succeed. At the same time don’t wait too long. Your patent won’t matter if everyone thinks it’s your competitor who came up with the idea.
Location affects you in a number of ways, even for businesses that don’t really need a physical location to serve its customers. Lots of startups in Europe end up moving to UK because the tax structure there is much better for businesses. It’s the same reason iPhones and iPads are manufactured in China.
Location also affects the kind of support and infrastructure you get, not to mention the culture around you. Why are most innovations made in USA, and why do most tech startups come out of Silicon Valley?
Location also affects sales. Rowland H. Macy once started a store in Massachusetts, but didn’t get enough sales. He tried again in Sixth Avenue, New York. This time he ended up creating Macy’s. How many purses do you think Chanel or Gucci would sell if they were based in Somalia?
And there’s another reason which doesn’t get as much attention because no has looked into it much until now. Paul Graham observed that most venture capitalists fund startups that are located about an hour’s drive away. If you are planning on getting venture funding, it literally pays to be where the money is.
And finally, you don’t want to build a nuclear reactor on an earthquake fault line. When all is said and done make sure there aren’t environmental problems (or legislations) that can affect your business.
Dependence on Government Regulations
Unless you are a political heavyweight, or have equivalent political connections, investors won’t be interested in any idea you pitch that is really dependent on government regulations, or political connections. Consumer pharmaceuticals, oil and gas, and utilities don’t start out below a certain size because there is no room for small businesses in these areas are a few sectors that would require some political backing.
This one is quite self-explanatory. Financial risks are those involving money.
Not Enough Money
This is one every single entrepreneur has faced at some point. Not having enough money to get off the ground. You need money for making your product and marketing it. Each is useless without the other.
So what do you do when you don’t have enough money? Don’t try to bootstrap, lean startup, guerrilla market or do any of those other business buzz word things. Get the money you need and do it right the first time. There’s a lot of ways to raise money for your ideas, which we’ve explored in another post.
A related problem is having enough startup cash, but not enough to keep you afloat. Plenty of startups fail because they either run out of cash or can’t find the funding to stay afloat in the market. Assuming that your startup company will gain instant profits will lead to you bankruptcy.
What you should do is plan for the worst, and have enough cash to stay afloat for 2 years with zero profit. Then add another 50% to be on the safe side. Obviously these amounts vary with your product, business model, and industry, but it’s a pretty good rule of thumb if you’re unsure of how much cash you need.
Revenues are great, profits are even better, but cash is cash. A small cash shortage can disrupt your business in the early stage. A million dollars in profits won’t save you when your supplier hands you the $50,000 bill due July, and you can’t collect anything till December. Remember to work out your cash cycles before you launch.
This section includes risks associated with your partners, your employees, and you trying to manage everything yourself.
Doing It All Yourself
Don’t even bother trying. No single person can handle every single issue that crops up in trying to run a business, and boy will there be plenty. That’s why it’s important to have a great team supporting you. This includes partners to help with the decisions, employees to handle the workload and customers, consultants to act as sounding boards, and consultants, mentors, or even an incubator to help prepare for every challenge.
Customers pay for your core competencies. Figure out what they are and focus on being great at them. Then hire people that are also good at your core competencies. Everything else can be outsourced, but your competencies have to remain in house. Your team is an investment, quite possibly the most important one you will make. Hire and develop employees who believe in your mission and care about growing your company. When hiring outside of your core competencies, stick to people who fit your culture and believe in your organization, but aren’t as expensive to retain.
Your experience is another area where you face risks. Most startup founders that have little to no management experience face significant challenges in running a successful company. Startups that hire incompetent managers hurt the business through poor sales efficiency, quality control and customer service. Whatever money you’re saving on salaries hiring fresh graduates isn’t helping the profits you’re losing.
Carl von Clausewitz said “No campaign plan survives first contact with the enemy”, and that’s true in the case of business as well. In 1865, Nokia had a paper mill. Then they started making rubber boots, then cables, plastics, aluminum and chemicals. Now they make phones. You may well face risks that requires you to change direction. Being able to pivot, or adapt to the situation is an integral part of the game. And your team has to be able to pivot right along with you. Successful businesses plan for every worst case scenario, and have highly flexible backup plans for pivoting if the original plan doesn’t seem to be working.
No matter how small your business, you will eventually need to start hiring people. Timing is crucial here, you don’t want to start too early or too late as they both cost money. More important is to hire the right people. Too many startups have had to fold (including one by yours truly) because the people hired just weren’t right for the company. It could be a friend you hired who just didn’t have the skills, it could be someone with the right skills who just didn’t fit in, or it could be a personality mismatch that kept getting in the way.
So how do you hire right? There are many ways. Martin Gardner developed a theory (Optimal Stopping) in the 1960s: “an optimal strategy — a way, not to guarantee success, but to maximize the likelihood of satisfaction”. It works for larger firms, but can become expensive for smaller firms where each mistake can cost a big portion of your budget. If you’re a small company and you’re unsure get professional help.
And finally make sure everything is documented properly, and not running on vague verbal promises and handshakes. You don’t want to get sued 2 years down the line because someone thought you promised them a quarter of your company in return for services.
Remember when Steve Jobs ignored every single industry standard and common knowledge when he designed the first Apple computer, then the iPhone, then the MacBook, then the iPad. He understood one simple psychological aspect about people – they don’t know what they want. They only know what they don’t have. It’s your job (as an entrepreneur) to figure out what it is they want and to give it to them.
You should absolutely listen to your customers to find out their needs and pains. After that though you need to cut off outside influence, be it advice, feedback, or criticism. The Simpsons did a great job of showing what happens when you let customers design your products in the episode “Oh Brother Where Art Thou”. If nothing else, it keeps you from being pulled in too many directions, and losing your original idea in the process.
Execution risks are the kind that really come up only after you’ve launched the business. These are the most difficult to prepare for, because most entrepreneurs don’t see them coming, but again, you can plan for these.
Balance and the Big Picture
You’re the founder/entrepreneur/owner. Your job is strategy, not the day-to-day activities. A lot of companies end up folding because the owners get too tied down with the details and lose sight of the big picture. Other companies crash and burn because the owners couldn’t be bothered, or were too good for checking up on the production floor and missed crucial details. What you need is to have a balance between the micro manager, and the strategists who works from geosynchronous orbit.
Not Handling Money Correctly
This is more of a common mistake than a risk, but now is as good a time to bring this up as any. Money needs to be handled properly. One very common mistake we see entrepreneurs making is spending too much. The founder becomes overly eager and hires a ton of specialized programmers. The founder wants to let everyone know about his new startup and buys a truckload of polo shirts with his brand name on them, forgetting that no one, not even your employees, ever wears those outside of events.
If a VC just handed the company a big, fat check, it’s because they’re expecting a big fat result very soon. And what happens if the business suddenly has to undertake a costly change, or the original plan must be scratched in favor of a backup plan, or an investor backs out, or a client doesn’t pay? Bad things happen, prices change, and markets go up and down. Is there money to handle such scenarios?
Patent trolls, formally known as “Non-Practicing Entities” (NPEs) or “Patent Assertion Entities” (PAEs) are people or companies that enforces patent rights against other people or companies in an attempt to collect licensing fees. They’re trolls because they don’t use the patents they own to produce anything, they’re simply hustling startups for cash.
The way it works is, the NPEs know that patent attorneys typically charge in the range of $500 per hour and so the NPE will settle for (a little) less than the cost of a court battle. According to “Startups and Patent Trolls” by Santa Clara University, 55% of defendants have less than $10 million in annual revenue.
So how do you defend against patent trolls? Maintain documentation. Keep records of every asset that matters — source codes, legal documents, and multimedia assets. If you know exactly when each asset was first checked in, when a new version was created, who made the changes, etc. you can take the troll to court and win. Christopher Seiwald of Perforce Software suggests you “Track your ideas and your assets as you develop them”.
Keeping up with Growth
Most startups aren’t typically sitting on billion dollar investments from VCs. When you have a great idea, and are able to deliver results on your promises, it’s often hard to keep up with the work that’ll flow in. More work means more sales, but that might translate into another payroll slot or a raise rather than profit.
If you’re smart about it, it usually pays to outsource. You can get professional contractors, who are as good as your regular people or better that cost a lot less than the latter, not to mention the amounts you save from office expenses. If you don’t want to outsource, your other option is to raise morale and reward exceptionally productive employees. This usually isn’t worth it in the long term though, so be prepared to cut costs from other areas or raise prices.
So What Do I Do?
Most of the risks we’ve talked about here can be controlled, but some can’t. Let others help you mitigate risks, but never allow one person to have 100 percent influence in the decision-making process. Work together to identify, evaluate and manage risks, and don’t be afraid to pivot if the situation calls for it.
Other than that, you can:
- Keep an eye on similar businesses: Study your competitors and similar startups to see what risks they faced and how they dealt with them. Learn from their mistakes.
- Do your research: Information is everything. Do as much research as you can, as thoroughly as possible before any major decision. You don’t know how your customers think until you ask them. Your business is not as efficient as it can be.
- Be Prepared: Take nothing for granted. Investors may back out, customers may stop paying, and team members may leave. Be ready to adapt.
- Always have a backup plan. Have a plan B, C, D, and all the way down to Z if you have to for every single strategy you implement.
- Redundancies are worth it: Have a B-Team, a B-plan, a B-product, etc. that can fill in when the A grade is having a bad day. Have a constantly updated list of backups ready for whenever something changes, and believe me it will. Redundancies are how the big players prevent major losses in unexpected circumstances.