It is common knowledge that roughly 90% of startups fail within the first two years. If you are thinking about starting your own startup, it would therefore be advisable to consider mistakes that failed startups made. Against this backdrop, this article focuses on CB Insight’s recent study on why startups fail and how to avoid the mistakes made by failed startups.
- No market demand for the product / service
According to CB Insight’s study, the main reason for startups to fail is that the product or service that was developed does not make a market. One startup that failed and yet perfectly illustrates that problem is Juicero. The startup was founded in 2013 and received $119 million in total investments. Its founder, Doug Evans, sought to be the next Steve Jobs of Juice-Making trying to sell $699 wifi-connected luxury juicers which required proprietary juice packs. However, when Bloomberg highlighted the uselessness of the actual device by publishing a video which showed that the packets could by squeezed by hand just as quickly as the machine, demand rapidly decreased. Juicero is the perfect example to show that often the visions and ideas of founders deviate from the needs of consumers – simply put, there is no demand for a $699 juice-pack squeezer.
How to avoid not meeting market demand for your product or service
The key to avoid launching a product for which there is no demand, still really lies in conducting market research before the launch. A simple and cost-effective idea is to create an online survey with platforms like Survey Monkey where you can ask specific questions to potential buyers regarding the launch of your product. Once your survey is created you can share it with your friends, family and through your social media networks. Also make sure you ask your friends to share the survey within their network. Simple questions about the price range of a wifi-connected design-focused juicer would have unveiled Juicero’s insensitive price policy.
- Mismanagement of cash flows
The second biggest reason for startups to fail is that they run out of cash. Unfortunately, many startups have great ideas but their founders lack the required financial skills. The key problem is that many startups overspend right from the beginning and/or allow flexible repayment systems. Once investments are secured, startups often invest in unnecessary equipment such as expensive office furniture instead of saving up cash for operations and expansion. However, more importantly, flexible repayment systems are at the centre of poor cash flow management. When startups allow longer repayment terms, the reality is that it drives sales as customers can be more flexible with their payment. Because cash inflow does not equal sales in accounting terms, this will not only look good on the profit and loss statement in form of revenue but also on the balance sheet as current assets such as accounts receivables and inventory will increase. Nonetheless startups will simultaneously purchase more inventory in order to meet future demand – thus using up more of their cash reserves. Over time companies then often expand inventory and accounts receivables thereby constantly decreasing their cash reserves.
How to avoid cash flow problems
There are two key things you can do in order to avoid cash flow problems. First, make sure you forecast your cash inflows and outflows and make sure you hit your monthly targets. If you are overspending, you should analyse whether that overspend was necessary for business expansion and whether you will have enough future cash inflow to compensate for that overspend. Forecasts help you plan your cash flow and support your decisions concerning additional debt or equity financing. Second, make sure you micromanage your spending when short in cash. This especially applies to the first months or even years of operation as you will highly depend on external finance and thus want the best return on your investments. The key thing to remember is that every penny you spend will reduce your profit margin so that constant cost-benefit-analysis is required.
- Choosing the wrong team members
Finally, the third biggest reason for startups to fail lies in the wrong team composition. Often founders want to start a business with their close friends. It makes sense, there is a lot of work to be done plus you can spread the risk over more people. However, what most founders forget is that choosing your friends as business partners does not automatically mean that you have a diverse set of skills which is required to meet the different needs of a startup. Failed startup founders often say that the main reason for failure is that a certain set of skills has been missed within the team. On top of that, wrong team composition often leads to conflicts, especially when there is more than one founder. Here, the problem might be that two co-founders have different views on strategy but they have not yet agreed on an allocation of responsibilities. Without clear tasking, conflicts are likely to arise.
How to avoid choosing the wrong team members
The key to great team compositions is to carefully assess the skills of your potential team members before working together. Do you have a diverse set of skills? If so, who is going to be in charge of operations, finance, marketing etc.? Are these skills aligned with the requirements of the underlying position? One has to carefully analyse these questions in order to determine the right team composition. Finally, once your team members have been defined, make sure you agree on a clear allocation of tasks and responsibilities. By agreeing on this, you will minimise the risk of potential future conflicts.
In conclusion, the three key reasons for startup failure are that there is no market demand for a product/service, that cash is managed poorly and that the team composition is not aligned with the needs of a startup. Against this backdrop, startups should make sure that they conduct careful market research before investing heavily in product development. Furthermore, it is important to implement a cash flow forecast system in order to identify potential cash flow problems at an early stage. Finally, startups should assess potential team members by their skills and define clear responsibilities and tasks for each member.