Reason 1: Economy Problems
A significant reason why companies fail is that they run into the problem of being little or no market for the product which they have built. Here are some common symptoms:
- There is not a compelling enough value proposition, or compelling event, to cause the buyer to really commit to purchasing. Fantastic sales reps will tell you the way to get an order in today’s tough conditions, you need to locate buyers that have their “hair on fire”, or are “in extreme pain”. In addition, you hear people speaking about if a product is a Vitamin (nice to have), or an Aspirin (should have).
- The market timing isn’t right. You may be ahead of your marketplace by a couple of years, and they are not ready for your particular solution at this phase.
- The market size of people that have pain, and have funded is simply not large enough
Reason 2: Business Model Failure
As outlined in the introduction to the Business Models section, after spending some time with countless startups, we understood that among the most common causes of failure in the startup universe is that entrepreneurs are too optimistic about how easy it will be to get customers. They assume that because they will build an interesting website, product, or service, clients 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 oftentimes the cost of obtaining the customer (CAC) is actually higher than the lifetime value of the customer (LTV).
The monitoring that you need to have the ability to acquire your customers for much less money than they’ll create in the value of their lifetime of your relationship together is stunningly obvious. Yet despite this, I see the vast majority of entrepreneurs failing to pay sufficient attention to figuring out a realistic cost of customer acquisition.
— The Essence of a Business Model
As outlined at the Business Models introduction, an easy way to focus on what things in your business model is look at both of these questions:
- Can you locate 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 these simple terms can be very helpful. We have also developed two “principles” around the company model, which can be somewhat less hard and fast “rules, but further guidelines. These are summarized below:
— The CAC / LTV “Rule”
The rule is very easy:
- CAC has to be less than LTV
CAC = Cost of Getting a Client
LTV = Lifetime Value of a Client
To compute CAC, you should take the entire cost of your sales and marketing functions, (including salaries, advertising programs, lead generation, travel, etc.) and divide it by the number of customers that you closed during that period of time. 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 installation, service, and operational expenses) within their lifetime. For businesses with one time charges, this is pretty straightforward. For businesses that have recurring subscription revenue, this is computed by taking the monthly recurring revenue and dividing that by the monthly churn rate.
— The Capital Efficiency “Rule”
If you want to have a capital-efficient company, we believe it’s also important to recoup the cost of getting your clients 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 under 12 months
Reason 3: Poor Management Team
An incredibly common problem that causes startups to neglect is a weak management group. A fantastic management team will probably be smart enough to avoid Reasons 2, 4, and 5. Weak management teams make mistakes in multiple areas:
- They are often weak on the plan, developing a product that no-one wishes to buy as they failed to perform enough work to confirm the ideas before and during evolution. This may 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 assembled correctly or on time, and also the go-to-market implementation will be poorly executed.
- They’ll build weak teams under them. There’s the well-proven expression: A players hire A players, and B players just get to hire C players (because B gamers don’t want to work for additional B gamers). Hence that the rest of the company will wind up as weak, and inadequate execution will be uncontrolled.
Reason 4: Running out of Cash
A fourth major motive that startups fail is because they ran out of cash. A vital job of the CEO is to understand how much cash is left and whether that will carry the company to a landmark that can lead to successful financing, or to cash flow positive.
— Milestones for Raising Cash
The valuations of a startup do not alter in a linear fashion over time. Simply because it was twelve months since you raised your string around, does not mean that you’re worth more cash. To achieve a rise in evaluation, a corporation must achieve certain key milestones. For a software company, these might look something like the following:
- Progress from Seed round valuation: the aim is to remove some major element of risk. That may be hiring a crucial team member, demonstrating that some technical barriers can be overcome, or building a prototype and getting some client reaction.
- The product in the Beta test also has customer validation. Note that when the product is finished, but there’s not yet any customer identification, evaluation won’t likely increase much. The customer validation part is a lot more significant.
- Product is shipping, and some early clients have paid for it, and are using it in production, and reporting favorable feedback.
- Product/Market fit issues that are regular with a first release (some features are missing that prove to be required in the majority of sales situations, etc.) have been mostly removed. There are early signs of the company beginning to ramp.
- The business model is proven. It’s known how to get customers, and it’s been demonstrated that this procedure can be scaled. The cost of acquiring customers is acceptably low, and it is apparent that the company can be rewarding, as monetization from every customer exceeds this price.
- The business has scaled well but needs additional funds to further accelerate growth. This capital may be to expand globally, or to accelerate expansion in a land grab market situation, or might be to fund working capital needs as the company grows.
— What goes wrong
What often goes wrong, and leads to a business running out of cash, and unable to increase more, is that management failed to achieve the next milestone before cash ran out. Many times it is still feasible to raise cash, but the evaluation will be significantly lower.
— When to hit Accelerator Pedal
One of the CEO’s most important jobs is knowing how to regulate the accelerator pedal. In the early stages of a company, while the item has been developed, and the business model refined, the pedal needs to be set quite lightly to conserve cash. There is not any point in hiring a lot of sales and marketing people in the event the business is still in the process of completing the product to the point where it actually meets the market need. This is a very common error, and will only result in a fast burn off, and lots of frustration.
But on the flip side of the coin, there comes a time as it eventually becomes evident that the business model has been demonstrated, and that is the time when the accelerator pedal should be pressed down hard. As tough as the capital resources available to this business permit. By “business model has been proven”, we suggest that the information can be obtained that shows the cost to acquire a client, (and that this cost can be maintained as you scale) and that you are able to monetize those customers at a rate which is considerably higher than CAC (as a rough starting point, three times higher). And that CAC could be recovered in under 12 months.
Reason 5: Product Problems
Another reason that companies fail is that they neglect to develop a product that meets the market demand. This can either be a result of simple execution. Or it can be a far more tactical difficulty, and it is a failure to achieve Product/Market fit.
Most of the time the very first product a startup brings to market won’t meet the market demand. In the best cases, it will take a few revisions to get the product/market match right. In the worst instances, the merchandise will be way off base, and also an entire re-think is required. If this happens it is a clear indication of a group that didn’t do the work to escape and affirm their ideas with customers before, and throughout, development.