Why Startups Fail
An entrepreneur recently asked me why startups fail. Startups fail because they run out of money. You’re probably thinking, “Tell me something I don’t already know!” Read on and you’ll see that statement is deceptive in its simplicity
This post is based both on my experience as an investor and as entrepreneur (when I’ve boot-strapped and venture-funded).
They spend too much on sales and marketing before they’re ready. Many venture companies move to a high burn rate too quickly and it’s hard to go back. Sometimes even a frugal entrepreneur winds up spending too much either because he doesn’t manage the money or is tempted by having money in the bank. This often happens when a startup raises too much money too early.
Other times, this occurs with entrepreneurs who are accustomed to having lots of resources. They ramp up sales before the product is ready. Of course, there’s a lot of work required to get sales early on. But a product with a truly great value proposition that delivers in a measurable way will practically sell itself. Companies that ramp sales and marketing too soon waste a lot of money.
Sometimes even when the product is great, the sales process itself isn’t understood to a point where it can be scaled: who are you selling to, how much will they really spend, and what profile of sales person does the company need to hire who will succeed at selling that particular product. All of this has to be understood before sales can efficiently scale.
Spending on the sales and marketing operations means there is no return if customers don’t bite. When you spend money on the product that work can be leveraged in future versions. (In fact, the key to effective product delivery is to try a lot of things and see what sticks.) For every venture dollar invested, I estimate that more than two-thirds go into sales costs and only a third into product development. Once you up the burn rate, there’s no easy way back.
The market outpaces the startup’s ability to execute. When you’re in a race, the only thing that matters is winning. To win a race, you have to be the fastest.
In the case of the startup in a hot sector that means how fast do you make critical decisions, hire key personnel, and manage limited resources. If, on average, you’re slower or less efficient than your competitors, you’re very likely burning more cash than they are as well. The chief executive sets the pace. If the CEO dithers on important decisions — let’s say making key hires — it slows the whole operation.
Take Company X (a composite). Entrepreneur X caught a case of what I call “analysis paralysis.” He took 14 months to hire for a key position. At Stanford, my professors would ask: “Would you choose X or Y, or do you need more data?” Students often wanted more data. The professors would chuckle and call them on it: “There is no more data.” A simple, but valuable lesson: In the real world, you rarely have a complete picture. You have to work your hunches, draw on past experience and the available information. Unlike solving engineering problems, there is no perfect answer when it comes to hiring — you need to get all the data you can through references, interactions, and simulated projects, but ultimately it’s very subjective.>
There is no Entrepreneur. I know what you’re thinking, “Every startup has an entrepreneur.” What I mean is an entrepreneur with a capital “E.” Let me explain: A lot people have good ideas and some are even able to execute on them. But rare is the man or woman who can take an idea and transform it into a sharply defined product and then sell it to top-level prospective hires, investors and customers. An Entrepreneur as opposed to his lower-case counterpart is a product picker and a market visionary.
Company Y (a composite) was a startup with near-flawless execution but no clear vision. CEO Y tried his last company’s strategy and when it failed found himself at a loss for what to do. The company ran out of money and was forced to sell out for a pittance. Meanwhile, CEO Y’s main competitor was more nimble. He reacted quickly to market changes with a viable contingency plan and as a result sold his startup for many times that sum.
Without strong product and market vision, a startup will burn through cash as its team collectively struggles to define its position.
The market takes too long to develop. Often, entrepreneurs are ahead of their time. Customers are not ready to spend money on or change habits for unproven benefits. The company runs out of money waiting for the market to develop or it tries to start over, but it’s too late.
Company Z (a composite) had a compelling concept, but customers weren’t ready to buy in. CEO Z proposed a restart: Rather than sell to the market segment he was in, he would target a different market segment. As a result, he would significantly reduce Company’s Z’s sales and marketing expenses. Company Z was mildly successful with its new plan, but burned through lots of cash before it re-configured. My guess is that it will be bought for little more than the amount that’s been invested.
Risky Business
VC’s play a high-risk game. We have to identify opportunity and risk and then accept that a certain amount of that risk will result in failure. Venture capitalists lump failures into one of two categories.
A failure like Company Z’s: A startup that struggles for reasons beyond the entrepreneur’s control. Things look good, but ultimately mainstream customers or a large volume of users were unwilling to take a chance on a new concept. Skilled execution and a reasonable backup plan won’t compensate for a market that fails to develop as quickly as originally anticipated. Some entrepreneurs are able to switch markets completely early on — if they haven’t raised and spent too much cash. But in this scenario, all companies in the given market flounder or fail. It isn’t a desired outcome but it’s not for lack of trying.
The painful failures — those that keep me and other VCs I know up at night - are the investments that fail due to self-inflicted wounds. A competitor winds up owning what turns out to be a very large market. The other company simply moved faster and out-executed.
It’s not just how fast you run the race that matters. It’s how fast the race is run. When it comes to startups, speed wins. But if you’re still early, don’t increase your burn and overspend on sales and marketing before you’re ready. Sometimes you have to slow down to speed up.
Thanks, Dave, for an insightful article. The following is my own experience to share.
http://www.lovemytool.com/blog/2007/09/why-startups-fa.html
Comment by Denny K Miu — May 23, 2008 @ 7:31 am
Excellent article, I love the point about being an entrepreneur with a capital “E”. Thanks.
Comment by Work Post — May 23, 2008 @ 8:48 am
Great post. From personal experience, definitely agree with you about the pitfall of expanding sales and marketing too early.
Although on the surface it might feel good to be able to bring on the first sales rep, or spend money on campaigns and PR/sponsorship just after beta or alpha launch - a sign the business is growing up - these are expensive and usually not money well spent at that stage.
For a small startup these are dollars that otherwise could be invested in coding making the product feature rich, scalable, easier to deploy, localize, integrate etc. The net effect being become more efficient and cost of sales goes down once ready to get out and sell - sales folks can cut the sales cycle down with a better product, overcome objections easier, marketing has more tools to attract user interest etc.
Comment by Simon Newstead — May 23, 2008 @ 11:00 am
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Pingback by Articles and links worth checking out - 23 May 2008 | 24 Hours is not enough — May 23, 2008 @ 11:26 am
great post. i would add that the faster the market the more the founder needs to be in charge. Finding a founder with vision, product skill, and deal making is ideal. Venture capitalists need to let the founder run the ship. If VCs run interference then the entire venture slows down. Building a startup from nothing is difficult and navigating the market landscape with imperfect information is key.
Once a venture enters the market it has to be a constant state of reinvention to ‘hit’ the tipping point for the preferred business model. One thing often over looked is the one objective to get the new venture in a position in the market to seize the growth opportunity. Entrepreneurs and VCs need to deal with change as a positive not a negative. If the venture’s position in a growing market is good then the change is a normal characteristic. To me lit’s about letting the founder stay in control til the venture hits calmer waters. Founders know best in the early and creative changes. VCs should just replace founders because a few waves crash on board.
I would share this link with you and your readers
http://www.usatoday.com/money/companies/management/2007-08-21-founder-ceos_N.htm
Comment by John Furrier — May 23, 2008 @ 11:26 am
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Pingback by Why Startups Fail? Entrepreneurs Perspective - Keep the Founder Around « Furrier.org - Business & Technology Blog — May 23, 2008 @ 11:38 am
great post dave.
i’d add one more:
* Startups fail because they don’t get a handle on the metrics that matter, and/or don’t create an iterative process for making decisions & changes based on evaluating those metrics regularly.
this aphorism may fall into several of the categories you mention above, but i call it out specifically because most startups fail to understand what the real levers of their business are about. as a result, the efforts they do make are not evaluated in a manner that enables good decision-making.
the layman version of this is “if you don’t know where you’re going, any road will get you there”.
my further thoughts on Startup Metrics here:
http://500hats.typepad.com/500blogs/2008/04/startup-metrics.html
Comment by dave mcclure — May 23, 2008 @ 11:57 am
great post. I am true believer that “Sometimes you have to slow down to speed up”. Iteration is king on early stage companies…and you cannot do that burning too much cash…
Comment by jon — May 23, 2008 @ 12:01 pm
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Pingback by finette.co.uk : Grown-Up Solutions for Startups » Blog Archive » David Feinleib on “Why Startups Fail” — May 23, 2008 @ 12:42 pm
I think often that capital “E” issue of being an entrepreneur is a very, very personal thing. There’s a small percentage of the population out there who can successfully drive a startup idea to success without going crazy. Part of it is fear, whether conscious or not.
When you’re as smart as some of these entrepreneurs, you’re often too smart for what the marketplace is ready for. Too early, and it can kill you.
http://thekevblog.wordpress.com/2007/10/31/whats-it-take-no-fear/
Comment by Kevin — May 23, 2008 @ 12:47 pm
Or, the capital “E” entrepreneur doesn’t spend enough time being the Entrepreneur, by getting bogged down with accounting or operations. - BC
Comment by Ben Carcio — May 23, 2008 @ 12:57 pm
Why Startups Fail…
From the page: “An entrepreneur recently asked me why startups fail. Startups fail because they run out of money. You’re probably thinking, ‘Tell me something I don’t already know!’ Read on and you’ll see that statement is deceptive in its simpli…
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Pingback by Fred Brunel — May 23, 2008 @ 4:21 pm
“Why Startups Fail?”… Additional Thoughts…
David Feinleib at Mohr Davidow Ventures has a good blog post, “Why Startup Fail?”…
Trackback by Silicon Moon — May 23, 2008 @ 5:12 pm
Thanks for the post.
I would actually disagree that startups fail BECAUSE they run out of money, or because “They spend too much on sales and marketing before they’re ready.”
I would argue that this is a symptom of a larger problem, which is that of not having good advisors or a good board to tell them they’re being stupid. Surrounding yourself with strong mentors/advisors/board should cut this problem (and many others of inexperience) off at the pass.
Money is the classic symptom that is sighted when the real problem is often lack of market or a generalized lack of execution.
Comment by David Cohen — May 24, 2008 @ 8:59 am
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Pingback by Ryan A Graves .com » Blog Archive » Why Startups Fail — May 24, 2008 @ 11:50 am
Thanks for your insightful post.
I agree with you with the cash burn on early sales.
But, I think, it is really important to make a clear distinction between markenting and sales so far. Marketing is a specific know-how that can impact the way to draw or to develop a product toward a specific audience.
Considering this I think early marketing is not really a risk but rather an opportunity to save money.
Comment by stetoscope — May 24, 2008 @ 12:23 pm
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Pingback by How and why startups fail :: fortyplustwo — May 25, 2008 @ 1:10 am
Really insightful, no nonsense article. well done
Comment by Marc Ashton — May 25, 2008 @ 2:18 am
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Pingback by How “Why Startups Fail” Fails - Fred Brunel — May 25, 2008 @ 5:34 pm
I’ll use this as reference to find out which killed the company where I (and all but three of the staff, remaining salary-free) just got laid off.
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