Startup Basics

5 reasons why richly funded startups fail

5 reasons why richly funded startups fail
Image credit: a2gemma | Flickr

Recently, especially in the Indian scenario, we have been witnessing several startups losing momentum, firing employees, not paying salaries, burning out investors’ money and not being able to scale or sustain.

Being a founder myself and having raised funds for my startup BeatMySalary, I would like to share some thoughts and the 5 things which can lead to a startup sinking and sinking so deep that it can never come back.

Less focus on revenues and profits
Generally all the founders have 3 typical traits—To think big; disrupt an existing business model; and latch on to an existing trend. While doing this, they sometimes lose out on the fundamentals of building a successful business.

For example a business can be successful if firstly, it can make revenues in a short time; secondly, revenues are not at the cost of under-pricing a service or commodity; and third, it can retain clients/customers and make them come back again.

Most startups do not only focus on making revenues but entice users to try their products in mass. They believe in being funded more than sustaining through revenue generation. Lastly, startups concentrate on selling a service or a product tactically with deep discounts or offers.

Customer retention is a challenge
Today selling an android phone on a wafer thin margin is easy in India. A typical customer first goes to a high street shop and takes a look at all the phones and chooses the one that he likes the most but does not buy there. Instead, he then looks in 10 different websites for the lowest price for the same phone.

He just buys from the seller who is offering the same product at the lowest price. Now this is a serious problem to the companies who fail to make significant profits (healthy profits) on their sales to keep their businesses running and pay their employees. So the companies (startups for that matter) fill this expense gap using the funds they would have raised through private equity.

This becomes detrimental to the operating model over a long period and leads to adverse implications. They keep repeating this ‘discounted route of selling the product’ open just to keep the momentum alive. In this process, they not only kill a high street business but also shoot themselves in the foot.

Hire rapidly, often without a real need
Today we are building cutting edge products with top-class technology, but it sounds like a shame if we fail to minimize the hiring numbers. I personally believe in a great product with a small team, a team that can work closely with the founders with a common vision and a sense of responsibility.

Startups can cut down a lot of crap when it comes to hiring. Hire less, but hire the right folks. Any new hiring should happen only if the existing work is being spilled over to a large extent and the technology cannot handle it without an additional human intervention.

I have seen most companies hire 80-100 people within one year of their being funded $2-3 million which is unwise.

Why burn more than what you can earn!
Once funds are there, startups completely shift focus on ‘burning’ the funds in a set timeframe to capitalize market rather than focusing on the ‘need based spending’ or innovation tagged spending like research, feature development etc.

Most advertisements today that suck millions of dollars do not even justify why they should exist. If an advertisement campaign costs you thrice as much as the value of a ‘customer’, then this is a problem. During the bootstrap days, founders think ten times before spending a penny on advertisement, but when they get funded, they care least about how much gets spent on which channel of advertisement.

I know a founder of an Indian startup that raised $5 million. They spent Rs 4 crore on roping in a film star, another Rs 1 Crore on post production of a commercial using that celebrity and another Rs 9 crore on airing it in different mediums of advertisements.

Overall, it spent Rs 14 crore on ads within 3 months of being funded - this campaign got them 1.2 lakh customers to buy their products in 3 months and their margins on their products were 8%. Each customer spent Rs 6000 on an average buy. Their overall profits were close to Rs 6 crore but they had spent Rs 14 crore (or close to $3 million) to achieve this sales. Their sales dropped by 60-70% after these campaigns stopped.

The investment made on these campaigns did not take them to a breakeven zone even after 1 year.  Hypothetically, this implied they had not sold anything that year but were paying 80 member staff salaries with the other $2 million funding they had raised. $5 million was completely burnt out in 1 year- time with no real tangible bottomline. From a media perspective, they were one among the unicorn star startup, but internally the investors were bleeding to death with no hopes whatsoever.

Changing vision of the founders
When a founder starts the company, the one and only vision he carries is building a world class product that can disrupt a particular market and lead that space. The moment the funding comes in, vision slightly changes and the founder gets more focused on user adoption, market monopoly, protecting interests of the shareholders and investors, scouting for more deep pocketed investors, being an acquisition candidate and creating all that noise that is required to gain a brand position.

This completely puts the original vision in the backseat and the focus on the product gets lost. Do NOT build companies to successfully SELL, sell companies that you successfully BUILD.