5 Reasons Startups Fail

Reason 1: Market Problems

A major reason why companies fail, is that they run into the problem of their being little or no market for the product that they have built. Here are some common symptoms:

  • There is not a compelling enough value proposition, or compelling event, to cause the buyer to actually commit to purchasing. Good sales reps will tell you that to get an order in today’s tough conditions, you have to find buyers that have their “hair on fire”, or are “in extreme pain”.   You also hear people talking about whether a product is a Vitamin (nice to have), or an Aspirin (must have).
  • The market timing is wrong. You could be ahead of your market by a few years, and they are not ready for your particular solution at this stage. For example when EqualLogic first launched their product, iSCSI was still very early, and it needed the arrival of VMWare which required a storage area network to do VMotion to really kick their market into gear. Fortunately they had the funding to last through the early years.
  • The market size of people that have pain, and have funds is simply not large enough

Reason 2: Business Model Failure

As outlined in the introduction to Business Models section, after spending time with hundreds of startups, I realized that one of the most common causes of failure in the startup world is that entrepreneurs are too optimistic about how easy it will be to acquire customers. They assume that because they will build an interesting web site, product, or service, that customers will beat a path to their door. That may happen with the first few customers, but after that, it rapidly becomes an expensive task to attract and win customers, and in many cases the cost of acquiring the customer (CAC) is actually higher than the lifetime value of that customer (LTV).

The observation that you have to be able to acquire your customers for less money than they will generate in value of the lifetime of your relationship with them is stunningly obvious. Yet despite that, I see the vast majority of entrepreneurs failing to pay adequate attention to figuring out a realistic cost of customer acquisition. A very large number of the business plans that I see as a venture capitalist have no thought given to this critical number, and as I work through the topic with the entrepreneur, they often begin to realize that their business model may not work because CAC will be greater than LTV.

The Essence of a Business Model

As outlined in the Business Models introduction, a simple way to focus on what matters in your business model is look at these two questions:

  • Can you find a scalable way to acquire customers
  • Can you then monetize those customers at a significantly higher level than your cost of acquisition

Thinking about things in such simple terms can be very helpful. I have also developed two “rules” around the business model, which are less hard and fast “rules, but more guidelines. These are outlined below:

The CAC / LTV “Rule”

The rule is extremely simple:

  • CAC must be less than LTV

CAC = Cost of Acquiring a Customer
LTV = Lifetime Value of a Customer

To compute CAC, you should take the entire cost of your sales and marketing functions, (including salaries, marketing programs, lead generation, travel, etc.) and divide it by the number of customers that you closed during that period of time. So for example, if your total sales and marketing spend in Q1 was $1m, and you closed 1000 customers, then your average cost to acquire a customer (CAC) is $1,000.

To compute LTV, you will want to look at the gross margin associated with the customer (net of all installation, support, and operational expenses) over their lifetime. For businesses with one time fees, this is pretty simple. For businesses that have recurring subscription revenue, this is computed by taking the monthly recurring revenue, and dividing that by the monthly churn rate.

Because most businesses have a series of other functions such as G&A, and Product Development that are additional expenses beyond sales and marketing, and delivering the product, for a profitable business, you will want CAC to be less than LTV by some significant multiple. For SaaS businesses, it seems that to break even, that multiple is around three, and that to be really profitable and generate the cash needed to grow, the number may need to be closer to five. But here I am interested in getting feedback from the community on their experiences to test these numbers.

The Capital Efficiency “Rule”

If you would like to have a capital efficient business, I believe it is also important to recover the cost of acquiring your customers in under 12 months. Wireless carriers and banks break this rule, but they have the luxury of access to cheap capital. So stated simply, the “rule” is:

  • Recover CAC in less than 12 months

Reason 3: Poor Management Team

An incredibly common problem that causes startups to fail is a weak management team. A good management team will be smart enough to avoid Reasons 2, 4, and 5.  Weak management teams make mistakes in multiple areas:

  • They are often weak on strategy, building a product that no-one wants to buy as they failed to do enough work to validate the ideas before and during development. This can carry through to poorly thought through go-to-market strategies.
  • They are usually poor at execution, which leads to issues with the product not getting built correctly or on time, and the go-to market execution will be poorly implemented.
  • They will build weak teams below them. There is the well proven saying: A players hire A players, and B players only get to hire C players (because B players don’t want to work for other B players). So the rest of the company will end up as weak, and poor execution will be rampant.
  • etc.

Reason 4: Running out of Cash

A second major reason that startups fail is because they ran out of cash. A key job of the CEO is to understand how much cash is left and whether that will carry the company to a milestone that can lead to a successful financing, or to cash flow positive.

Milestones for Raising Cash

The valuations of a startup don’t change in a linear fashion over time. Simply because it was twelve months since you raised your Series A round, does not mean that you are now worth more money. To reach an increase in valuation, a company must achieve certain key milestones. For a software company, these might look something like the following (these are not hard and fast rules):

  • Progress from Seed round valuation: goal is to remove some major element of risk. That could be hiring a key team member, proving that some technical obstacle can be overcome, or building a prototype and getting some customer reaction.
  • Product in Beta test, and have customer validation. Note that if the product is finished, but there is not yet any customer validation, valuation will not likely increase much. The customer validation part is far more important.
  • Product is shipping, and some early customers have paid for it, and are using it in production, and reporting positive feedback.
  • Product/Market fit issues that are normal with a first release (some features are missing that prove to be required in most sales situations, etc.) have been mostly eliminated. There are early indications of the business starting to ramp.
  • Business model is proven. It is now known how to acquire customers, and it has been proven that this process can be scaled. The cost of acquiring customers is acceptably low, and it is clear that the business can be profitable, as monetization from each customer exceeds this cost.
  • Business has scaled well, but needs additional funding to further accelerate expansion. This capital might be to expand internationally, or to accelerate expansion in a land grab market situation, or could be to fund working capital needs as the business grows.

What goes wrong

What frequently goes wrong, and leads to a company running out of cash, and unable to raise more, is that management failed to achieve the next milestone before cash ran out. Many times it is still possible to raise cash, but the valuation will be significantly lower.

When to hit Accelerator Pedal

One of a CEO’s most important jobs is knowing how to regulate the accelerator pedal. In the early stages of a business, while the product is being developed, and the business model refined, the pedal needs to be set very lightly to conserve cash. There is no point hiring lots of sales and marketing people if the company is still in the process of  finishing the product to the point where it really meets the market need. This is a really common mistake, and will just result in a fast burn, and lots of frustration.

However, on the flip side of this coin, there comes a time when it finally becomes apparent that the business model has been proven, and that is the time when the accelerator pedal should be pressed down hard. As hard as the capital resources available to the company permit. By “business model has been proven”, I mean that the data is available that conclusively shows the cost to acquire a customer, (and that this cost can be maintained as you scale), and that you are able to monetize those customers at a rate which is significantly higher than CAC (as a rough starting point, three times higher). And that CAC can be recovered in under 12 months.

For first time CEOs, knowing how to react when they reach this point can be tough. Up until now they have maniacally guarded every penny of the company’s cash, and held back spending. Suddenly they need to throw a switch, and start investing aggressively ahead of revenue. This may involve hiring multiple sales people per month, or spending considerable sums on SEM. That switch can be very counterintuitive.

Reason 5: Product Problems

Another reason that companies fail is becuase they fail to develop a product that meets the market need. This can either be due to simple execution. Or it can be a far more strategic problem, which is a failure to achieve Product/Market fit.

Most of the time the first product that a startup brings to market won’t meet the market need. In the best cases, it will take a few revisions to get the product/market fit right. In the worst cases, the product will be way off base, and a complete re-think is required. If this happens it is a clear indication of a team that didn’t do the work to get out and validate their ideas with customers before, and during, development.

About the Author

David Skok

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  • http://www.forentrepreneurs.com David Skok

    Sorry – I don’t know enough about it to answer your question.

  • Ankush Katiyar

    Sharing my personal experience, what I believe is ideas never fails, execution fails. People when get started are full of enthusiasm but with the passage of time they get low and at last they shut it down such some excuse.

    I have published a post on my blog. Link is here http://www.conhacks.com/2014/07/11-reasons-why-most-startup-fails-startup-problems.html

  • Sherry

    Is it possible to figure out if an idea will work before taking the money? I have bootstrapped the company http://www.carmelosystems.com to get a couple of customers deployed. But made some mistakes along the way and have not being able to get more deployed. An angel investor is interested in putting money, but I am now worried about let him down by losing the $1M he wants to invest. Have not tried your inbound marketing ideas. Could you give some advise? Am I facing the Market Problem?

  • http://www.forentrepreneurs.com David Skok

    Hi Sherry, the key to figuring this out lies in meeting with as many prospective customers as possible and figuring out if you have built something that they want to buy (i.e. do you have Product/Market Fit). You should watch out for the difference between real intention to buy, as evidenced by them talking about placing orders, versus polite positive feedback. I would also be looking for evidence that this is a repeatable sale with many customers fitting the same application usage profile. If you can demonstrate that to the investor by allowing them to talk to those customers, you should be able to get the investment and use the money to expand your sales and marketing.
    For more on Inbound Marketing, visit the HubSpot blog pages, as they are great at educating people on this topic. Best, David

  • http://www.carmelosystems.com Sherry

    The investor has talked to customers who rave about the product, I am the one who is anxious about why there has not been 3 more customers and where/how to find them. Your post and response made me walk away from the keyboard and think through a few things. Time well spent. Thank you.

  • sree

    wat u mean

  • Chris Marshall

    Hi Sherry, take a look at http://www.agilovation.com/home. I have worked with Zac Lyons in the past and his agile approach to driving innovation through deep customer insight will work really well in a situation like yours. He really can help to very quickly understand if there is a market for your idea. In addition, his results will give you deeper insights to the target customers pain points and a better understanding of how to talk to/target your messaging to your potential customers in a language they understand. Regards, Chris

  • Minh-Hoang Nguyen

    Thanks for great posts. Full of information about failures. If anyone wants to figure out why failed and tracking failures in lifetime, check the FailED app at https://itunes.apple.com/us/app/failed-manage-your-failure/id894438205?ls=1&mt=8 . It’s really great and helpful for everyone!

  • Shahin Khani

    Check out my conversion with Lawrence Pingree on why startups fail


  • http://www.forentrepreneurs.com David Skok

    Thanks for adding. Interesting!

  • Sunil Kumar

    Hi Everyone, i have one query on product based startup. I have IT based idea and i am not technical guy. What should i do ? Outsourcing would be good idea or consider a technical partner. Or should i drop the idea? Could you please guide me? Many many thanks to you all in advance.

  • http://www.forentrepreneurs.com David Skok

    I’d strongly advise getting a technical co-founder.

    Best, David

  • Sunil Kumar

    Thanks a lot David for your suggestion. what happens i wont be able to find technical co-founder. in that case i should not be thinking of start such project.

  • http://www.forentrepreneurs.com David Skok

    Yes – that is the advice that I would give you.

  • http://www.topchart.io TopChart

    What we have found so far is that it is simple: startups either have a market or not. Weigh in on it here: http://www.topchart.io/projects/reasons-why-startups-fail

  • Nimish

    David can you please tell what strategies to adopt for research and development?
    I am tryin to develop an app for the construction industry in India.

  • http://www.forentrepreneurs.com David Skok

    The best recommendation I can give you is to find a technical co-founder who knows how to build such a product, and can help you hire a technical team. Best, David

  • Reece Larkin

    I must echo point 4. Running out of cost. Once you’ve figured your business out you need to make a financial plan. Otherwise down the line, your business will fail, and you will run out of funding.

    A few more points that wasn’t mentioned in this article are; One Man Show. Most startups are run single handed, and startup founders think they can do this all by themselves, however the real facts are that it will effect your business quite a lot. So, you need a mate and some men to sail your ship more smoothly and safely.

    Some extra points can be found on this article: http://www.spellbrand.com/5-tips-overcome-startup-problems

  • http://www.forentrepreneurs.com David Skok

    Thanks for adding to the discussion.

  • Reece Larkin

    There are a couple of issues in terms of conquering the majority of your startup issues. These are; Funding, Product Nature, Time Management, One Man Show and Running Costs.

    I’ll quickly say these over, these will inconclusively help you to succeed in your startup.

    How about we begin with Funding. Most and each startup needs funding to get some place. Most startups will close because of money issues. This is the reason funding is fundamental to any startup. There are more than 500 crowdfunding stages over the web that help you group finance your startup. Some of which incorporate; Kickstarter, IndieGoGo, CrowdFunder, RocketHub and significantly more!

    Presently, the Product Nature. As a startup you must recognize what the product or administration you’re putting forth. Is it a thing or an administration that your client might want to have or is it an unquestionable requirement have product or administration. Having this basic rationale on your product nature you can really tempt your clients.

    Time Management is by a wide margin a super vital thing required by startups. It’s not difficult to ace either! A genuine business person will have the best Time Management, knowing when to complete for the day and when to not. Most marriage breakups are because of mismanagement of time, so don’t simply concentrate on beginning your business! Have a basic calendar you can clear your brain from business for quite a while and go through it with family and companions.

    One Man Show. Most businessmen will startup their business without anyone else, this can be to a great degree unpleasant for yourself and can prompt business disappointment. To prevent this from happening, you require someone to help you, take a portion of the weight off your shoulders. This comes in with the time management above, sparing time and being careful.

    Running Costs relying upon your startup your product might or not over keep running in costs. At that point after all your diligent work, your business to fizzle. To prevent this from happening is to arrange well ahead of time, deal with your needs and have an arrangement to verify this doesn’t happen

    Read in more detail at SpellBrand: 5 Tips to Overcome Your Startup Problems

  • http://www.snapmunk.com/startups/ Snap Munk

    Very Interesting Blog Written by you…Good Your plus point is that You Express in that way that gives you more info deeply about startups fail…good
    Another thing is to know more on why startups fail/startups ideas get all in one click : http://www.snapmunk.com/startups
    thank you..

  • Presentation Guy

    Can I email you please. I need advice

  • http://www.forentrepreneurs.com David Skok

    I have emailed you with that directly.

  • Julius Haralampo

    Fantastic read. Very very insightful.

  • Yashash Dave

    David, what i have experienced in all my time trying to pursue a startup idea is to find a credible way of knowing how and what amount of money the idea can pour into the startup if everything is done correctly.
    Ex – If i have a idea i feel is great enough to pursue will at time give me a lot of doubts whether it can fetch the startup enough money to put everything in the light and whether can it sustain the world for longer times ?

    Please suggest.

  • http://www.forentrepreneurs.com David Skok

    The key to figuring this out is customer validation. Prior to putting any significant money, the recommendation is that you spend a lot of time talking to potential customers asking them very specifically: “if I build this, will you purchase it?” and “how much would you be wiling to pay?”. Many entrepreneurs are too scared to ask these questions, and then discover after spending a lot of money building their product that the customers aren’t willing to purchase it. It is far better to find that out before you spend the time and money building the product.
    Then while you are building the product, keep going back to those customers and finding new customers, and continue to test these same questions, while demonstrating prototypes, and early demos.
    I hope this helps.
    Best, David

  • Yashash Dave

    Hi David, Apologies for late reply.
    Your answer is helpful but what if my prospective customers belong to the same industry? (As in my case!)
    Wouldn’t me asking any such questions reveal my idea & endanger it because what i can do with my idea is possible for them too.

  • Sara

    Very valid reasons! Thanks for sharing, it is very helpful. I know an online course which also talks about start up company failures and success reasons. It is mostly based on entrepreneurship . Take a look into it for more details on this subject area https://www.classle.net/#!/online/course/entrepreneurship-bootcamp-batch-3/coursehome/

  • http://www.forentrepreneurs.com David Skok

    If what you can do with your idea is so easily copied, then it is lacking one of the key attributes for a good startup: sustainable barriers to entry. That should make you stop and think hard about whether it is worth pursuing. That is a significant negative, as you can expect to see a lot of competition as soon as you start to become successful, and that competition will force prices downwards. (Or, as it sounds like in your case, as soon as you show the idea to customers, they may decided to copy it without paying you.) Only you will be able to judge this, so don’t take my comments as being negative.

  • Yashash Dave

    Hi David, my common sense told me the same. Its just like every inspired entrepreneurs i find it difficult to let go of my idea. But your right. I should start scanning my idea for sustainable barriers to entry. Thanks for listening. kudos.

  • http://www.prmention.com/ Taral Patel

    Hello, very well written post. I have my self to tried to list out some of the challenges faced by Startups today.

    While there are some challenges that are tough to address, I have tried to provide solutions for most of through Digital PR.

    You can have a look at how many of the Startup issues can be solved by using Digital PR techniques.