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Adam
August 1, 2021
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The Three Most Common Reasons Why Startups Fail: In-depth Analysis and Stories

Success is not final, failure is not fatal: it is the courage to continue that counts.

Winston Churchill

In startup land, there are so many things that can go wrong. By default, startups die unless founders constantly steer the company away from demise. There is a lot of luck involved but luck alone is not nearly enough. If the founders don’t react to reality and fast they’ll run out of money. It’s a dangerous place to be the startup land. May this writing help some of us reach the promised land, the land of success, the land of product-market-fit.

There are many articles out there about why startups fail and I found most of them inaccurate. For example, you read that a well-known blog identifies the most common reason for a failure in a startup as “running out of money”. Running out of money is not the root cause. It’s the very last thing that’ll go wrong before shutting down the company. The main killers are in the works far before the company runs out of money. For example, if there is no demand for a cool product like a VR headset, the company will run out of cash, but the root cause is not running out of money. The root cause is that the market for VR is not where founders and investors think it is. It is the lack of market research.

Below, is one of the better Pareto charts that I found on the internet [Forbes article, data from Statista]. This is not a mutually exclusive Pareto. In other words, the summation of those percentages does not add up to 100%, but it still gives us an idea of which causes are more important than others.

Let’s dig in. The number one reason why startups fail on the Pareto is “No market need”. In other words, it goes back to the idea behind the product. Again in this Pareto, we see “running out of cash” as the second most important reason. How often do we see a startup with a product that people are dying to use die? I’m sure there are corner cases, but they are extremely rare. So, in my view, “Running out of the cash” mostly translates to “no market need” or “Lack of market research”. Here, I’ll list the items on the Pareto and break them down into common root causes.

  • No market need: This is a classic one and it simply means the idea was bad. Why was the idea bad? It breaks down to one root-cause:
    • Lack of market research
  • Ran out of cash: Running out of cash can kill the startup, but it’s not the main root cause. Did founders have product-market fit and ran out of cash building the product? Does this mean they miscalculated their runway or no one needed the product and they kept burning money? Could they build an MVP with fewer features that could sell? Or this was because the founders could not raise money because they did not appeal to investors?
    • Miscalculating the runway
    • Lack of market research
    • Lack of founders’ sales skills
      • We all know some founders can sell. They can convince investors to give them money even if they don’t have anything to show for it. Being able to sell the dream is definitely a skill.
  • Not the right team: Sometimes, the team lacks the skills needed to build the product. Sometimes the team does not have a passion to build the product.
    • Lack of founders sales skills: charismatic founders with good sales skills can overcome this issue. Convincing the right people to join the team in the early days is hard and requires extraordinary amounts of salesmanship skills and charisma. Some of these skills can definitely be learned and some people are born with them. The truth is that life is unfair and we should get over it fast. We may still do great learning the know-how from the experts.
  • Competition: It is rare that a startup fails solely due to competition. Startups have many more reasons to worry about than competition. If the startup is founded based on an idea that already has a strong solution, customers will have a hard time choosing a new product over a well-known and effective product. In my opinion, the majority of these items falls back on the lack of market research. In their customer discovery interview, founders are supposed to ask interviewees about how they currently solve their problem and start building only after they make sure there are no good solutions out there. Another thing to watch for is developing a feature as opposed to a product. If we are developing something that does a good job of solving something, but someone with a lot more resources can simply add it to their established product, it’s not a good place to be. I’ll add a root cause item for that here.
    • Building a feature, not a product. So many companies fall into this trap. Usually, savvy investors are good at pointing this out because they see so many cases like this and develop an accurate feeling for it.
  • Pricing/cost issues: if the idea is strong, it delivers enough value to keep the startup afloat or attract investors. We can break this down into two items:
    • Lack of market research
    • Slow response to market
  • Poor product: We’ll talk about this later, it’s true that a poor user experience repels customers, but it has a limited effect. How often do we hear that a product that was absolutely needed was abandoned just because it was hard to use? I agree that a bad product will increase retention and it’s dangerous, but if the idea is great, the startup may still survive. We can break down this item into two sub-items:
    • Lack of market research
    • Bad UX
  • Lack of business model: A business model is simply about who the customers are, what value we deliver to them, how much the cost is, and how much we make? This one is a little too vague and we can’t really learn anything meaningful from it. “Lack of Business Model” as the reason for the failure of a startup is like saying “this car failed becuase the engine didn’t have drawings”. A business model is like the engineering drawing for a product that may or may not work. Not having the engineering drawing is not good, but it cannot be identified as the root cause of a failure.
  • Poor marketing: We’ll talk about this item more! There are definitely cases that the idea is good, but the team fails to deliver to the right audience. If the founders came across a good idea, but do not know their customers, it’s a classic case of lack of market research before launch. If the founders validate their idea with the market before launch, they’ll have a good idea about their customers and how to find them.
    • Lack of market research
    • Founders lack of sales skills
    • Slow response to market
  • Ignore customers: This item could reduce to slow response to the market. If there is a strong market demand and the founders ignore it, it can kill the company.
    • Slow response to market
    • Founders lack of sales skills
  • Product mistimed: It’s funny how we founders come up with excuses to blame things other than ourselves when things go wrong. I can imagine those founders in the VR space had reasons like that, but if thorough market research was done, people would have found out that the time is not right for the space to grow. They certainly are more qualified to call this as a root cause for their startup failure more than many others. In the case of VR headsets, the technology was/is not there either. Most VR headsets cause dizziness after a little bit of use. I acknowledge that market research is very challenging in this space. Building a functioning MVP is expensive in the hardware space and by the time the MVP is built, hundreds of thousands of dollars to millions are spent. If the market is not ready for the product, the startup will fail. So, we can break this down into two items:
    • Lack of market research
    • Miscalculating the runway
  • Lose focus: I heard so many stories of founders following the next shiny thing and forget what they already have that might be working. This could be identified as pivoting too fast. Individuals who get excited about technology or a new product are in danger of falling into this trap. I personally love technology like most of you and I’m an optimist like most of you and I have fallen for this one in the past. Having a cofounder definitely helps with this syndrome. Solo founders are more prone to this.
    • Lack of cofounder
  • Founder/investor dynamics: Again it is rare that a company has a product-market fit and is making money and investors have problems with the company. If the company is making money for the investors, they won’t have a problem with the founders wanting more ownership or increasing their salaries and so on. In my opinion, the real problem lies somewhere else like many other items on this list.
  • Legal challenges: Yikes! Patent disputes, founder fights, etc. These are serious problems in startups and are among a few items that are truly orthogonal/unrelated to product-market-fit.
  • Didn’t use network/advisors: Not sure what founders meant by this one, but this is strongly related to “Founders lack of sales skills
    • Founders lack of sales skills
  • Burn out: This is a serious issue that people are talking more about recently. Before, it was taboo to talk about founders’ feelings. Starting a company is not for everyone. And I don’t mean this in a lesser way. I don’t think if I’m exaggerating when I say Founders lose several years of their life building a new company. Once, I had a cofounder who was telling me “what’s wrong with all these startups failing?! We should be able to do this in six months. This is really straightforward.”. It’s needless to say how quickly he burnt out and left the company even though I tried to warn him about the rocky road ahead, he did not listen. He was not primed for the journey, probably for the best. This could be a stand-alone item or be related to many other items. For example, the lack of a founder’s sales skills combines with his/her persistence leads to burnout. However, I don’t think this is a leading item on our list.
  • Failure to pivot: This is the last item on our list and I believe it simply goes back to two items that we already touched on:
    • Lack of market research. If founders do a thorough job researching the market in the beginning, the likelihood of pivoting decreases dramatically.
    • Slow response to market: If the founders see that there is not a market for their product, or it’s extremely hard to find the right customers for, maybe those customers don’t exist. The slow response simply results in fast depletion of funds and an inevitable shutdown of the company.

So, before we jump into a story about the importance of market research, let’s recap and build a list of three key reasons why startups fail:

  • Lack of market research: This is by far the most important reason why startups die. It’s surprising how many times founders build things that don’t have a market. Ideas that seem neat in the beginning, but are too niche or don’t solve any problems in the real world. Don’t rush your product to market. Do your research first. There is an adrenalin rush when you release something, but that initial excitement can soon turn to disappointment and god-forbid depression if you don’t research the market.
  • Founders lack of sales skills: Founders need to be able to sell. They need to be able to sell family members on the idea, they need to sell to early employees, they need to sell investors and finally customers. It’s such an important skill to have in the team. If you can’t sell, don’t start a business or find someone who can do it for you.
  • Miscalculating the runway: It goes without saying, but this happens more often than not. Always know your numbers. Founders who get into product too much tend to forget how much money they have in the bank and when the runway ends. It’s very simple, just find the net losses every month which can be seen in the monthly bank statements and divide the remaining money by the monthly loss. That’s how many months you have money left. I know it’s simple, but so many founders forget to do this or get too fancy with their calculations and miss simple things. It’s not because they can’t do math. Our minds trick us sometimes and make us not see the upsetting facts. Denial is a defense mechanism that our brain uses to avoid emotional pain.
    • Expensive MVP: In the hardware space, expenses tend to be higher than expected. When I started my IoT company, I thought I had all the costs down. The real costs turned out to be twice as much because things break, mistakes happed, etc. So, raise twice as much if you can and be incredible savvy. Don’t get spendy. People want to sell you services to help your business left and right. Unfortunately, many are scam. Be careful with advertising agencies. They make their real money from a large number of failed advertising campaigns and make their name from a few successes.

Here’s a story that highlights the importance of customer interviews and market research before launch

I have been reading the stories of dead startups for a while now. Read about how they died and how they suffered and how they might have been saved. Premature starts are the most common reason for the death of startups. Most of the startups that die at this stage don’t even get a chance to be heard or be included in the statistics. They silently die alone without much press or others knowing about the suffering that the founders go through.

These startups are at the idea stage, and the founders think that they have a solid idea with millions of customers to reach and millions of dollars to make. They jump ahead and start building without knowing that no one wants what they are building. The urge to build is so strong in engineers that they don’t spend enough time validating their market. In other words, they don’t test their market before launch. They assume that if they want something, others want it too. They are not completely wrong about that, but the problem is they don’t know who their customers are. They think they know, but when it comes down to marketing their product, they can’t find customers.

Let’s begin our story by looking at a startup called Triangulate. According to Harward Business Professor, Tom Eisenmann, most startups claim that they fully subscribe to the Lean Startup methodology. But the devil is in the details. Most startups only follow some instructions and neglect others. We’re about to see just that in the painful story of Triangulate’s death.

Triangulate - Triangulate develops profile matching platforms for social  networks, enabling users to associate with other users with similar  profiles. | Startup Ranking
triangulate’s logo

Neglecting to research customer needs before starting the engineering effort, is a serious startup crime. Most founders understand the value of an MVP and its function. But, building and iterating MVPs is expensive. We, technical founders, are too eager to get the product out and have customers. The lean startup methodology is filled with sentences like “Launch early and launch often” and “Fail fast”. We can’t launch too many products. There is not enough time to build hundreds of MVPs and see which ones live and which ones die. The public expectation of MVPs is much elevated compared to a few years ago and people expect better products right off the bat.

So, we can’t just throw the dice until we hit the jackpot. The stakes are too high. Our time and money are limited. The founder of Triangulate, Sunil Nagaraj, initially wanted to build a dating engine that automatically collected user’s data from their social media apps and other online profiles such as Netflix and matched them using its algorithm. He wanted to market his engine to dating sites like Match and eHarmony. It certainly sounds like a great idea, but investors wanted Sunil to close a deal with one of these sites and come back for raising money.

In order to prove to investors and other dating sites that his algorithm works, Sunil decided to build his own dating app and power it using his engine. He launched a Facebook app called Wings to use the already existing rich user data in Facebook. He was able to raise three-quarters of a million dollars for his project. The website had fantastic features such as enabling people to invite their friends to vouch for them as “wingmen”. This inherently enabled some virality in the website which is great for any app that wants to expand.

Eventually, however, Sunil’s team abandoned these features because they learned that users care most about their match physical attractiveness, their proximity, and how responsive they are to their messages. This meant that all the effort that went into their matching engine was going to waste. Physical attractiveness, proximity, and responsiveness to messages were the features that online dating sites already using for finding matches for people. Another discovery by the team was that people did not feel comfortable mixing their romantic life and their social interactions on Facebook.

All of this could have been discovered before the trouble that the team had to go through. If Sunil interviewed his customers and found the important factors that his majority of customers wanted, Wing might have been alive today. The truth is that for any idea on this planet, there are some customers or potential users. The size of that customer base changes, but it doesn’t change the fact. The difficult part is to find those customers and make sure that it’s a large enough customer base that can sustain a good business. In particular, the number of people who don’t care about mixing their Facebook life and dating life is far smaller than the number of people who do. A simple customer interview would have revealed such a deadly mistake. Of course, everything is obvious in the hindsight and we’re not trying to discount what Sunil and his team achieved, but hopefully, we can learn something from their experience and don’t repeat the same mistakes again.

Sunil and his team pivoted once again and this time they launched a dating website called DateBuzz. DateBuzz allowed users to look at the features of a person’s profile before they could see people’s pictures. In most dating websites, more attractive people tend to get most of the messages while other people don’t get as many hits. DateBuzz was trying to address that problem and make this attention distribution a little more uniform.

When a startup makes a product that doesn’t meet the demand of their targetted customers, their Customer Acquisition Cost (CAC) goes up to a point that it far exceeds Lifetime Value (LTV). DateBuzz fell into the same trap. Sunil tried to take advantage of some network effects to lower CAC without much success. He ended up returning $120,000 back to the investors. Why did Triangulate and DateBuzz fail?

This is a classic case of Lack of market research. Having talked to customers before launch, Sunil’s team could have discovered that despite the cool idea behind the engine and the wingman concept, there was no large demand behind those features. The demand for dating has always been there, but features are expensive to develop and there is so many chances to iterate or pivot.

Ried Hoffman, the founder of LinkedIn compares starting a company to jumping off a cliff and assembling a plane on the way down. We don’t have much time to figure things out especially with a team of expensive engineers working on the product. This is why, VCs and Angel investors are moving a little bit down the stream and fund the startups that have some revenue and traction.

A great lesson for us, founders, is that we should bootstrap our company up to the point where we see some traction and engagement from users. Only then, it makes sense to hire engineers and spend hundreds of thousands of dollars per year developing the product.

Classic impatient entrepreneurs

Why do we skip these interviews? It’s a classic and unfortunate mistake that we make. Interviewing customers is so important that forced me to start IdeaCooker. Did I interview people before starting this website? Yes, I did, but I could have talked to more people. I only talked to a few, but I continue doing so. I asked a few entrepreneurs what the hardest thing about starting their startup was. Here is what one of the founders said:

Getting started and picking a single idea to focus my energy was my most difficult problem. I had dozens of ideas and on any given day I could easily find each one to be tempting to chase. Once I picked the idea to go after, the next most difficult challenge was building a team.

These interviews told me that picking the right idea is a huge pain point. Some ideas seem more appealing to us but may not work so well in practice. Some ideas may be more difficult to reach profitability. Some ideas may never reach profitability even though they seem they would.

Startups are more like art than science. That’s why one artist sells millions of pieces of art and some sell none. But we should bring as much science to startups as possible to cut all the losses due to guessing and black magic. I especially don’t like the fact that some fraudulent founders who can sell, raise millions to billions of dollars and the founders who know what they’re doing and are humbled are crushed. If we had more science behind success in startups, these problems would go away. The path to building a successful startup would be a lot more clear.

I’ll close this section with a nice tweet that I saw today:

So, don’t neglect to research the market. Do it today!

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