Nowadays, we can see a tendency to overuse the word startup. Almost every newly established business falls under this category. Why? Because a startup sounds proud. Modern. Perhaps even a little intriguing. However, it is worth realising that there is something else behind this word, in its original meaning.
R i s k.
Startup. Is this really a good idea?
Eric Ries, the author of the book “The Lean Startup”, created one of the first definitions of a startup, which was: “a human institution designed to create new products and services under conditions of extreme uncertainty”. And of course, building any new business is burdened with a certain amount of uncertainty, but startups grow out of this uncertainty. The uniqueness of the business model can be both a huge advantage and a great disadvantage for the entire venture, and verification of the idea comes with time. That is why it is so difficult to predict whether even the most innovative and thoughtful startup will turn into a company or… will collapse.
And quite a lot of them fail. In 2012, a lecturer at Harvard Business School, Shikhar Ghosh, in an article for the Wall Street Journal said that approximately 30-40% of potential American startups fail (if we assume the total loss of investment funds as failure; with a variable definition of failure understood, e.g., as a negative return on investment, this figure can go up to 95%). Whereas, in 2014, Fortune revealed that, according to their data, as many as 9 out of 10 startups will fail! That same year, CB Insights began digging into the stories of failing startups, discovering that 70% of tech companies typically fail around 20 months after receiving their first funding, according to their ratings.
March 2020 brought another grim reality. The outbreak of the pandemic and fear of the unknown dampened consumer demand, with global Venture Capital funds in the first quarter of the year falling by 17% compared to the same period in 2019. It seemed that Covid-19 would only exacerbate the problems that startups have faced so far, but meanwhile, what has become a tragedy for humanity has turned out to be a gateway to growth for companies with a technological twist.
Mass lockdown, forced remote work, rapid growth of e-commerce, forced digitization of products and services – all this resulted in the emergence of new needs on the market, and thus an opportunity to create new business models (tested in undoubtedly risky conditions). Investors could feel the potential and in the first half of 2021 Venture mutual funds grew by 95% compared to the previous year, reaching USD 288 billion and constantly growing.
The new reality is an indispensable opportunity for new business investments. How many of the startups will turn into unicorns, and how many will encounter difficulties on their way that will affect their continued existence?
What really leads to the collapse of startups, and is it possible to effectively defend against it?
Why do startups fail?
As we mentioned, since 2014 (last update 9/02/2022) CB Insights has been analysing stories of failed startups. On this basis, the report “The Top 20 Reasons Startups Fail” was created, which clearly shows that there are many startup problems. Importantly, their sources to look for the very basis of the business, namely in the very idea for a product or service, in the created solution, business model, price and even in the founders or investors of the entire venture.
Why do startups fail?
Top 5 Reasons:
No market need | 42%
One of the most common declarations of startups is the willingness to solve problems and thus improve the lives of their customers. A beautiful assumption, but the question remains whether the chosen problem is real or just… interesting sounding.
When opening a company, building a business model and creating a product, it is easy to succumb to certain illusions that this will provide a panacea that solves all problems. When asked for details, we begin to reel off an endless list of benefits. Benefits that may turn out to be completely uninteresting to the target audience or not very effective in practice.
The latest technology, access to data, an experienced team, charismatic leader, reputation – all this is not enough if our product and business model will not solve the real problem in a scalable manner.
Ran Out Cash | 29%
Acquiring start-up financing can be difficult, but – as practice shows – the real difficulty turns out to be proper financial management in the subsequent years of the startup’s operation.
Startups fail for financial reasons most often when the product turns out to be unsuited to market needs, requires time-consuming and costly changes during development, its technological debt increases or there are problems with effective monetization of the solution.
Not the Right Team | 23%
Running a business is a difficult task. It requires simultaneous concentration around business and technological issues. If any of these aspects fail, it quickly takes revenge on the entire project.
A frequent issue faced by startups is difficulties in building an MVP (whether it is due to the lack of an appropriate team within the company or a trusted external partner). As a result, a good idea does not translate into good technology, and owners lose the feeling that they are able to properly verify their business and technology decisions.
Get Outcompeted | 19%
As the saying goes? Competition never sleeps. If you want to develop a startup in the future, your product should be so unique and exceptional that competing companies cannot immediately react to it and copy it almost one-to-one. On the other hand, even when starting with the most innovative idea, you have to reckon with the fact that, over time, competitive offers will appear on the market.
Customers will quickly verify which product is easier to use and which company responds better and faster to their needs. They will not be interested in who was the first and from whom the idea came – they will primarily be interested in quality and effectiveness.
Therefore, if you are not able to quickly develop your product (each change takes months or requires the reconstruction of a significant part of the solution), there is a good chance that users will leave for more efficient competition.
Pricing/Cost Issues | 18%
It may seem that starting with an innovative product, it is easy to overestimate it. The high cost will scare potential recipients who do not yet trust the brand and do not know whether it is worth investing in the solution. Practice shows, however, that the real problem runs much deeper: people start to leave when the price does not match the quality.
Startups rise up fast and sink down just as quickly if the product doesn’t grow with them. Solutions that are good at the beginning may turn out to be outdated in two or three years’ time. And thus unprofitable from the point of view of customers.
Of course, rarely, is there only one reason. Most often it is the accumulation of many difficulties, or one main one that generates more. Other specified cases are: poor product, ill-considered business model, poor marketing, ignoring consumers, too late or too early release of the product, distraction of business concentration, lack of agreement in the team or among investors, failed Pivot or no idea for changes, loss of passion, challenges legal, failure to listen to advisers or burnout.
How you can avoid falling?
As you can see, entrepreneurs face a real challenge. How to approach creating a startup so as not to fail in the first year in operation? Or – which is even more important – how to avoid mistakes that will resonate only in the following years?
And most of all: is it possible to do something when technological problems are already leading your startup to the edge of an abyss?
We invite all interested parties to the second part of the post: “A startup is like walking off a cliff – how to avoid a painful landing?” in which we divide startup issues into 4 main categories and show that you can effectively protect yourself against at least three of them.