Monday, May 2, 2011

4 Ways Startups Fail

1. Run out of money
The number one reason a company fails is it runs out of money.  Many of the "acqua-hires" by Facebook and Google are teams who ran out of cash looking for a home.  They did not sell their company as a talent buy.  They literally just get hired in with standard employment packages.  One common variant of this are the various seed companies that raise a $1 million seed round and hire up a 6-7 person team prior to getting to product market fit.  The company burns through the cash in a year, and then tries to shop itself to Google, FB, etc.  If the sale falls through, the company shuts down and the employees get hired individually by various companies.  This scenario is most common on teams with a large number of business founders - e.g. if you have 3 business founders and 3 engineers, the engineers may leave early on with trouble and the residual value of the team is low or none which means the company does not get an exit at all and the founders disperse to look for jobs.
Ways to mitigate:
  • Run lean.  Only hire up the team when you are confident you will be able to make money or raise more money.  
  • Raise more cash then you need when you can.
  • Bootstrap the company or charge for the product from day one.
  • Focus on having an engineering heavy team from day 1 to increase the odds of a talent buy if all else fails.

2. Team implosion
Lack of clear decision making?  Founders constantly fighting?  Hiring a bunch of jerks that irritate everyone?  A lot of companies end up imploding due to bad team dynamics leading to a lack of clear direction, internal infighting and backstabbing, and a terrible working environment.
Ways to mitigate:
  • Make sure you and your co-founders have clearly defined roles and there is a single person ultimately in charge who can call the shots.  
  • Make sure you and your co-founders can communicate openly, have mature and frank discussions (can you give each other constructive feedback?), and are aligned on where you want to take the company (does one person want to sell early and the other wants to build a long term global business?).  
  • Have a high bar for culture and team fit for early hiresCorrect hiring mistakes quickly.

3. Living dead company / lifestyle business.
Depending on your perspective this is either a great outcome (a small, lifestyle, tech business) or a terrible outcome ("living dead" startup with little or no equity value).  VCs and hyperambitious founders think of companies that reach a certain scale, but never become a breakout success as the worst form of failure. Rather then fail fast and be able to move on to something else, the entrepreneur is locked into a company on a slow to nonexistent trajectory.  The company spins off enough cash to stay alive and pay salaries, but not enough to grow at a meaningful rate.  Additional funding is not available as the company is viewed as a small cash business.  The entrepreneur feels like she can never leave ("I owe it to the employees and investors to stick around") and the VCs are stuck with a board seat that takes up a big chunk of their time.
Ways to mitigate:

4. Bad board / investors.
Stupid things a bad board member or investor may encourage a startup to do:
  • Raise and burn lots of unnecessary cash leading to too high a valuation to exit and too much dilution for the founders to be incentivized.
  • Fire the founders and hire a "professional CEO"who takes the product/company down the wrong path.
  • Block an exit even when it makes sense, and watch the company get crushed by the larger player who tried to buy them 6 months before.
Ways to mitigate:
  • Do due diligence on your investors.  Ask other entrepreneurs, angels what their experience with the investor or board member was like in the past.
  • Don't add people to your board until you know them well.
  • Bootstrap your company or raise angel money without giving up a board seat (harder to do with a venture round).

Let me know in the comments what other failure modes you think are common for startups.

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