Why Do Some Startups Fail?

It’s a common phrase that failure is part of life—especially when it comes to new businesses. According to serial entrepreneur and venture capitalist David Skok from Matrix Partners, there are many reasons why startups fail. Knowing a bit more about the typical reasons for new venture failure can help your to avoid them in the future. This is the first of a two-part blog series to address some of the reasons for failure.

WomanwithBookonfaceMarket Problems

You might not realize it, but one of the most common reasons for businesses failing is that there is little or no market for the product you have created. Given the tough economic situation, people wait until it is absolutely necessary to buy a product. Market timing may also be key. You could be a pioneer of a certain product, but perhaps the market is not ready for your idea.

Business Model Failure

Another common reason for the failure of startups is the overly optimistic mindset of business owners about customer acquisition. By looking at your initial few customers, an entrepreneur may feel they have an interesting enough product for people to start following them (and buying from them). The cost of acquiring (CAC) is higher than lifetime value (LTV) of the customer. Most of the time, entrepreneurs forget to factor in the realistic CAC. For any business to thrive, the cost of customer acquisition should be lower than the value of the lifetime of your relationship with them.

A simple way to focus on your business model is to look at following two questions:

  • Can you find a scalable way to acquire customers?
  • Can you monetize them at a significantly higher level than your cost of acquisition?

To compute CAC, take the entire cost of your sales and marketing functions (including salaries, marketing programs, lead generation, travel, etc.) and divide by the number of customers that you closed during that period of time.

To compute LTV, look at the gross margin associated with the customer (net of all installation, support, and operational expenses) over their lifetime. For businesses with one time fees, this is pretty straightforward. For a recurring subscription revenue, compute by taking the monthly recurring revenue, and dividing that by the monthly churn rate.

To have a capital-efficient business, it is also important to recover the cost of acquiring your customers within 12 months. In other words, it is necessary to recover CAC in less than 12 months.

Poor Management Team

Having a weak management team is also a very common problem with startups. Do not simply hire people you know—hire people who are skilled at tasks you may not excel in. Weak teams have a higher chance of making multiple mistakes, such as lack of market research, weak go-to-market strategies, poorly built products, poor marketing plan, etc.

Be sure to hire a strong team of individuals who all have different skill sets that will contribute to your company’s overall success plan and long-term strategy.

For more information, please visit: http://www.forentrepreneurs.com/business-models/why-startups-fail/

Thanks for reading, and until next time… stay WISE!


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