Why do most of the startups fail?
We've all had the perfect idea to start a startup once in our lifetime. It was the next Facebook or Google.
But, according to this article from FastCompany, roughly 75% of startups fail. 75%!
But you're not one of them, right? That's what everyone thinks at first.
In another study by Statistic Brain, the rate of failure in the US after five years was 50%, and over 70% after 10 years.
The Statistic Brain, the main reasons why startups fail are:
- Lacking the focus
- No enough motivation and passion
- Too much pride
- Unwillingness to listen or see
- Lacking mentorship
- Raising too much money too soon
There are a lot of reasons why startups fail, and we've listed the top 5 you should definitely avoid.
1. Market problems
Probably the major reasons why most startups companies fail is that they're little or no market at all for their project.
You've built your product, but you can't seem to sell one thing. After all, you shouldn't just build a product without first thinking who you're going to sell it to.
Here are some symptoms that tell you beforehand that you've got market problems
- There is not enough interest in your value proposition to cause the buyer to commit purchasing. Most sales reps will tell you that in today's condition, you have to look for buyers that have their “hair on fire”, or are in “pain”. You will hear people talk about your product whether it's a Vitamin (good to have), or an Aspirin (desperately must have).
- Market timing. Can't stress this enough, market timing is one of the most crucial parts of your startup. The most common problem with market timing is that your product could be ahead for a few years. A good example is when EqualLogic launched their product (iSCSI), it was way too early. It required VMWare for storage area network to do VMotion to really bring it to market. Fortunately for them, they had funding to wait.
- Simply said, the market size of people that have “pain” and have funds is just too small.
2. Business Model Failure
“After spending time with thousand of startups, I realized that the main problem is that they're too optimistic about how easy it will be to get customers” – David Skok
It's really a beginners mistake to think that you will build such a great product easily. Never assume that your customers will beat a path to your door because your product is great. Not to state that this never happened to anyone, but it's not that much likely to happen. Maybe 1 in 20 cases.
In many cases, the cost to acquiring customers (CAC) is actually higher than the lifetime value of customer (LTV).
A great amount of business plans you will see that they have not given any thought to this critical number. After realizing this, you will begin to see that your business plan will not work either. Unless the CAC is lower than the LTV.
Basically, the essence of the business model is to simplify the way of focusing what matters. With a good business model you can easily answer these two questions
- Can you find a scalable way to get customers
- Can you monetize those customers at a higher level than you're getting them (CAC < LTV. Always)
There is a rule called “CAC/LTV” rule, and it's pretty simple.
Cost of acquiring customers should always be less than lifetime value of a customer.
To calculate this, you take the entire cost of your sales and marketing, and divide it by the number of customers you got in that particular timeline. For example, if you spent $1M, and you got 1000 customers, your average CAC is $1,000.
To calculate the LTV you have to look at the gross margin associated with the customer. This includes net of all installation, support and operational expenses. For companies with one-time-fees this is pretty simple. But, for companies with recurring revenues, this is calculated by: monthly recurring revenue/monthly churn rate.
There is another rule you have to take into account, and it's called the “Capital efficiency” rule.
If you'd like to have a capital efficient company, it's important to recover the cost of acquiring customers in under 12 months. Stated simply, recover cost of acquiring customers in less than 12 months.
3. Poor management team
A tremendously common problem why startups fail is a weak management team.
A great management team will know how to avoid 2, 4 and 5. But, a weak management team will often make these mistakes:
- They often use weak strategies, and build products no one really wants. They fail to validate the ideas before and through development. This can carry through to poorly thought marketing strategies and waste your product.
- They're usually poor at execution. This leads to the product never getting build correctly or on time, which leads to a poorly implemented go-to market execution.
- A poor management team will build poor teams below them. It's like a chain of bad teams. There's a great saying that goes here perfectly. A players hire A players. and B players only hire C players (because B players hate working with other B players). This way, the rest of the company will end up as weak, and a poor execution is inevitable.
4. Running out of cash
A fourth and major reason why startups fail, is running out of cash.
The key job a CEO has to do is to understand how much cash is left, and if that will carry the company to a milestone.
The valuations of a startups will not change in a linear fashion over time. Just because it has been a year since you raised your Series A round, it doesn't necessarily mean you're now worth more money. Sucks, right?
To reach an increase in value, a company has to achieve certain key milestones.
In terms of a software company, these are the key milestones:
- Progress from Seed. The goal here is to remove major elements of risk. This can include hiring a key team member, proving that a couple of technical obstacles can be overcome, or building a prototype.
- Product in Beta testing and having customers feedback. Keep in mind that if the product is finished, but there's no feedback from the user, valuation will not increase that much. This is because customer validation is worth more.
- Product is shipping now, and customers are using. You even got some positive feedback!
- Market fit issues that are perfectly normal at the early releases has been eliminated. These are early signs that a business is starting to ramp.
- Business model is finally proven. It's clear to see how you're going to acquire users, and it's proven that this process can be scaled. The cost of acquiring users is far less than the lifetime value of a customer.
- Business has scaled great, but it still needs additional funding to accelerate expansion.
What usually goes bad and leads the company to bankruptcy is that management failed to achieve each milestone before running out of cash. Most of the time, it's still possible to raise cash, but the valuation will be lower.
5. Product problems
Another major reason why startups fail is because startups fail to develop a product that meets the market needs. This can be either due to simple execution, or it can be far more strategic problem, which can be a failure to achieve Market fit.
Most of the time, the first product a company brings to the market won't meet the market need. In the best possible scenario, it will get a few revisions to get the market fit right. Additionally, in the worst scenario the product will be far off base, and a complete re-think is necessary.
If this happens to your startup, it's a clear indication that your team didn't do the proper work. They didn't go out and validate their ideas with customers before or through development.