Don't Sink Before You Can Swim: Crucial Steps for Startups to Stay in the Black
People love a good startup story, especially one that chronicles the mishaps of first-time entrepreneurs and their eccentric founding team members. Case in point: HBO’s “Silicon Valley.” The show has been a hit with viewers and critics alike, picking up a Critics’ Choice Award for Best Comedy Series last December and celebrating its renewal for a fourth season.
The show resonates because it offers a hilarious if “close-to-the-bone” take on life at the center of startup culture, but the setbacks portrayed on the show are a lot less humorous when companies encounter them in real life.
Startups are often scrappy and resourceful, two of the best qualities one can find in early-stage companies. But they’re also prone to potentially fatal mistakes. I frequently get calls from entrepreneurs who realize too late that they’ve messed up by skipping critical steps in the development process. By the time they come to me, we need to work miracles to save their companies.
Many founders tend to build solutions first and find problems to solve for paying customers later. All too often, they operate using unproven business models and ignore important questions about who their ideal customers are, how much it will cost to reach those customers or how much of their initial capital must be used to support their own living expenses. Any one of these mistakes can sink a promising startup.
Entrepreneurs can use the following strategies to avoid these common missteps:
1. Verify assumptions about the business model.
All companies make educated guesses in their business models. But those estimations should be grounded in facts, and founders must verify those numbers as they conduct market research. Only a third of new businesses make it to the 10-year mark, and bad business models contribute to the demise of many companies.
Just look at TinyOwl, which shut down most of its locations in May because of a faulty business model. The India-based restaurant delivery service had raised more than $27 million in investor funds, but it couldn’t overcome the costly logistics of running the company or the oversaturation of the restaurant delivery service industry.
It’s also easy for first-time founders to get so caught up in their ideas that they dive in before vetting their concepts. That’s how companies end up with solutions that are looking for problems -- and often how they fail. Inventory costs alone can consume a startup’s budget as its founders search for a fit.
Businesses that try to reach all demographics end up with generic, boring products. Instead, they should identify who will actually be interested in the offering and whether it fills a want or a need -- before they sink serious money into building a product. No matter how excited people are about a product they want, they’ll ultimately prioritize items they need. Responding to urgent demands strengthens the business model and improves the startup’s chances of success.
2. Understand what it takes to reach customers.
Most first-time founders operate under the “If you build it, they will come” mantra. But running a business isn’t like Field of Dreams. Startups need to budget for marketing and lead generation campaigns in addition to product development.
Companies spend five times as much money attracting new customers as they do retaining current ones. And in the beginning, everyone’s a new customer. By the time they’ve accounted for lead generation costs, most businesses just break even on customer acquisition.
Founders who ignore these crucial considerations find themselves out of cash or in deep trouble with their backers. Most investors will catch such oversights, and they’re unlikely to partner with entrepreneurs who miss such an important planning component. But some won’t see the problem right away, and the relationship will deteriorate when the company has to admit its glaring mistake.
3. Account for lifestyle costs.
Our culture glorifies the idea of entrepreneurs who live off ramen noodles while pouring all their energy into their companies. But once you reach the funding stage, that vision becomes less romantic.
Businesses can’t thrive when their founders are stressed about missing mortgage payments or feeding their families. (In fact, a whopping 82 percent of business failures stem back to poor cash management, according to a U.S. Bank study.) Investors know this, and they expect startups to include living expenses in their funding requests. They don’t want founders panicking over their personal finances; they want them laser-focused on their companies.
Based on my own experience, I recommend that startup budgets include at least a year of the founders’ lifestyle costs, preferably two. These costs should be honest, comprehensive and workable for the foreseeable future. It’s impossible to dramatically increase compensation unless the business has undergone massive, consistent growth, and that usually takes at least two years.
Successful startups don’t deal in vague assumptions and unsubstantiated business models. Entrepreneurs must rely on fact-based decision-making to ensure their companies have the best chance of succeeding in competitive markets.