Find out the key reasons for why startups fail and how you can avoid making the same mistakes in this article.
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There is a lot of hype about startups nowadays. From Uber to Twitter to Airbnb, stories of startup success are inspiring a new generation of entrepreneurs. However, what we don’t often hear about are the stories of startup failures. According to Fortune, 90% of startups fail. Here we will outline the key reasons why startups fail and provide some case studies, drawing on an extensive study by CB Insights. If you want to create a successful startup, make sure you avoid these errors.
1. Lack of Market Demand
According to CB Insights, the number one reason for why startups fail was a lack of demand for the startup’s product. Out of 101 startups analysed by CB Insights, 42% cited ‘no market need’ as their reason for failure. Certainly, the product may be well-made and some customers may seek it. However, if there isn’t enough demand, this limits the extent to which the startup can grow and meet investor expectations.
Case Study: Patient Communicator
An example of a failure to gauge market demand is Patient Communicator. This was a startup for a product that allowed patients to access their doctors through an online portal. Despite being backed by Blueprint Health, a prominent healthcare tech incubator, the startup failed to raise money from investors to expand production. This was because there was a lack of demand for the product in the healthcare industry. Doctors were not really interested in a high-tech, efficient office. What they wanted was more patients, which this technology did not necessarily guarantee. Additionally, doctors tended to stick to traditional ways of running their office, and were generally resistant to adopting new technologies. Despite numerous meetings with stakeholders and money spent on marketing, the startup failed to secure enough interested parties. Ultimately, the startup decided not to proceed with further production and closed the business.
Moral of the story: study your market and carefully assess whether there is sufficient demand for your product.
2. Poor Team Composition
Twenty-three percent of startups cited ‘Not the right team’ as the reason for their failure in the CB Insights study. A team without the right balance of skills and experiences can result in a lack of leadership and poor decision-making. As many first-time entreprenuers create startups, putting together the right team may be particularly difficult.
Case Study: Zirtual
A significant example of this failure to create the right team is Zirtual. Founded in 2011, CEO Maren Donovan raised $5.5 million in funding through heavy-weight investors such as Tony Hsieh and the Mayfield Fund for its virtual assistance business for professionals. Within 4 years, the company grew exponentially, with 500 employees and a $11 million run rate. However, all of this came crashing down due to fundamental flaws in the executive team composition.
For one, Zirtual did not have a full time Chief Financial Officer on its board. They outsourced the CFO to another firm. Secondly, it only had two people on its board of directors. These factors resulted in short-sightedness in the directors’ decision-making capacity and miscommunications between the board and the outsourced CFO. Ultimately, errors in burn-rate projections were discovered, meaning that the business was using up more money than it was making. This resulted in the company letting go of 400 employees and being acquired by Startups.co under a different CEO.
Moral of the story: make sure your startup has a diverse team, composed of people with essential experiences and expertise.
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Nineteen percent of startups noted being outcompeted by other businesses in their market as the reason for their failure. This can result from startups’ failure to take away customers from similar businesses and add value to products already in the market.
Case Study: Sidecar
Sidecar is an example of a startup that failed to outperform its competitors. While it was the first startup in the ride-sharing market, Uber and Lyft soon overtook it. Its failure to beat its competitors came down to a weak business strategy. First, Sidecar failed to raise as much capital ($35 million) as its competitors, Uber ($6.61 billion) and Lyft ($1.26 billion). Second, widespread adoption and use of ride-sharing apps depend on both drivers and members of the public knowing about and downloading the app. Uber recognised this and spent almost a million dollars on aggressive marketing in its first 6 months. Sidecar did not place as much focus on marketing. It also had little to offer to customers that was different to Uber. Sidecar became increasingly sidelined as Uber took off and dominated the market. Ultimately, funding dried out for Sidecar and General Motors acquired it.
Moral of the story: have a strong business strategy to outperform and differentiate from your competitors
4. Run out of funds
Due to a combination of the above and other reasons, many startups fail as they simply run out of money. Twenty-nine percent of startups noted this as the reason for their failure in the CB Insights study. Lack of demand for the product or failure to beat its competitors can result in a lack of funds to continue operating the business and difficulty attracting additional rounds of funding. There are other factors that should also be considered.
Failure to control spending
Startups may run out of funds by failing to strategically control and manage its spending. As entrepreneur and venture capitalist David Skok notes, a grave mistake that startups make is not achieving milestones before running out of cash.
For example, after raising a lot of capital through first-round investments, founders may become too eager to grow quickly. They may then hire a lot of employees or pursue risky ventures, thinking they have enough money to do so. However, this is problematic if this is done before the product is adequately tested on the market to gauge viability and demand, and to smooth out technical or design issues. As a result, the company may burn through too much cash by rapidly expanding before profit is guaranteed. This can then make it more difficult for startups to attract further investments, resulting in the business running out of cash.
Therefore, spending could be restrained at the beginning while the product is thoroughly tested and its scalability is proven. After this, startups will be able to attract a second round of investments and spend more money on expanding the business.
The CAC-LTV balance
As David Skok also notes, businesses may also run out of cash if the cost of acquiring a customer (CAC) is more than the lifetime value of a customer (LTV). For example, a lot of money may need to be spent on marketing in order to win a new customer. However, the customer may only be a one-off customer, by buying your product once. In this case, the CAC will be higher than the LTV. Failure to project such numbers can result in the business running out of cash.
Case Study: WOW Air
An example of this failure to spend money strategically is WOW Air. This was an Icelandic budget airline founded by Skuli Mogensen in 2011. As economics professor Kerry Tan put it, the startup’s issue was that they “tried to grow a little bit too quickly”. WOW Air had around 10 planes which flew to 30 destinations in the US and Europe, which was already demanding for a small fleet of planes. The airline then decided to add 15 destinations to Asia, and bought highly expensive widebody planes in order to service these routes. When it failed to turn over profits due to intense competition in the budget airline market and high oil prices, it returned the planes, incurring massive debt. The airline failed to secure further investments to keep them afloat. In 2019, WOW Air became bankrupt.
Moral of the story: don’t get ahead of yourself and expand the business too quickly. Make sure you’ve done all the numbers and expand strategically.
Despite the stories of success, startups are tricky business. Make sure you understand these key reasons for why startups fail and take heed of the cautionary tales. If you make the right moves, your startup may well flourish. You can start by establishing the legal basics of your startup.