Why Startups Fail

A survey done by the U.S. Commerce Department stated that of every 10 small businesses, seven will survive their first year, three will still be going after three years and only two will remain after five years. These are quite startling numbers and really beg the question: “Why do startups fail?”

The answer is amazingly simple and can be reduced to three main causes: lack of working capital, a poorly conceived business model and a poorly constructed business plan.

Lack of Working Capital

Lack of working capital is usually the “last straw” that sinks the already troubled ship. One might argue that it is not really a cause but the effect of another cause — poor planning.

Listen to Ted di Stefano (7:12 minutes)

Philosophically, I can’t take exception to that argument, but list it as a separate cause anyway, due to its critical importance in the planning process.

As an entrepreneur, I can certainly understand the enthusiasm and aggressiveness that are needed elements to starting a new business. However, my experience tells me that this enthusiasm and aggressiveness must be tempered with a large dose of realism.

We should always be asking ourselves “what-if” questions. What if our business model takes longer to execute than we planned? What if our bank or other finance source were to cut off our funding? What if we are sued and need a large amount of capital to defend that suit?

What I have done with working capital intensive businesses over the years was to prepare a “rolling” cash flow budget. This budget is projected over a one-year period and should be updated on a weekly basis or, at the minimum, on a semi-monthly basis.

One of my businesses had a payroll of over US$100,000 per week, not including fringe benefits. You can rest assured that I had a detailed cash flow budget that predicted where I would be on a weekly basis. At the end of each week, we would record our cash receipts and our cash disbursements and take those actual numbers into consideration in order to update our annual, rolling cash flow budget.

Poorly Conceived Business Model

How is a business model defined? Simply stated, it is a relatively short document that describes who a company is and how it will distinguish itself from its competitors by offering unique value in its goods or services.

The term business model, though coined in the 1950s, really didn’t achieve mainstream usage and acceptance until the 1990s. Some businesspeople still, believe it or not, aren’t sure of its exact meaning. This is somewhat discouraging because the business model, in my opinion, is the critical starting point to the serious consideration of starting a new business.

You must be absolutely certain that what you offer is unique and will be readily accepted in the marketplace. Or you must be certain that there is ample “room” for your new company if there already exists a robust market for its intended product or service.

To make my point, I note that at this writing, SunRocket has shut down VoIP (Voice over Internet Protocol) service to thousands of their customers, leaving them stranded for phone service. Other customers were apparently given notice that their phone service could be disconnected at any time — not a pretty scene.

What happened? I’m really not sure. But I wouldn’t be at all surprised if SunRocket’s business model didn’t work out as planned, leading to a severe shortage of working capital — thus the discontinuance of service.

In SunRocket’s case, there already existed a VoIP market. This is a difficult market to profit in. In fact, I wrote an article for the E-Commerce Times entitled “VoIP Here to Stay.” In that article, I talk about an upstart phone company called “Vonage” that had as one of its chief competitors AT&T. Today, it appears that Vonage is struggling.

Though a business model is certainly one key element for the survival of a company, even with a well-thought-out business plan, business models are no guarantees. I have no doubt that the people at Vonage gave a great deal of thought to its business model because of the experienced principals involved in the company, yet it appears that they are really struggling.

Poorly Constructed Business Plan

The business plan is your business’ guidebook. If it is properly written, it will contain all of the key elements that will guide you in the formation and running of your business. For a complete discussion of business plans, please see my article, “A Great Business Plan: The Key to Raising Capital.”

Simply described, a business plan should start with a business model, then go on to describe how you are going to execute that model. It must have a good amount of financial information, including current financial statements and a budget that is projected over at least a three-year period.

Additionally, it should have a detailed description of how you will market your product and include therein a description of your competition and how you intend to not only survive, but also actually thrive, given the competition that exists in your field.

Certainly, there should be some mention of personnel: how you will attract and retain the necessary individuals for your company to succeed in executing its business plan.

Being in business can be both exciting and scary. The fear factor can be greatly reduced by adequate, detailed planning. There is no substitute for it.

Good luck!

Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].

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