During my tenure at Red Rocket, I have had exposure to over 500 startups in the last few years. I have seen really good startups and really bad ones. Below is a summary of the recurring problems I have seen in the flawed startups, and where relevant, how venture investors typically react to such problems.
1. A Small or Un-scalable Idea
Investors tend to bias ideas that throw out the largest nets possible, in terms of potential customers. They would much rather back the next Google, whose product appeals to everyone and anyone, than a small niche business that only appeals to a very narrow market (e.g., whitewater rafting business on the Zambezi River). Niche businesses are OK if you are going to run it as a lifestyle business for yourself, but not to attract professional investors. And, investors tend to prefer businesses in sizable industries that are easily scalable, translated as more technology-driven than human-powered, where they can drive higher margins over time.
2. No Competitive Research–Wrong Market Positioning
Often times, entrepreneurs launch businesses they think are good ideas, but they never took the time properly research the market. Investors don’t want to back the 10th startup in a space; they would much rather back one of the first movers. Especially, if one of the others in your space has already raised a boat load of venture capital to fire bullets in your direction. And, in all cases, you want to make sure you are clearly differentiated from the others (e.g., better product, better value, different target client) and that your plan is defensible against future market entrants who may follow you after your preliminary success.
3. No Go-To-Market-Strategy
Entrepreneurs are typically so focused on building their product, that they don’t think far enough ahead to their go-to-market strategy, and how that will help them to achieve a proof-of-concept to attract growth capital. You always need to raise enough capital upfront to not only build your product, but to effectively test your sales and marketing tactics. This will allow you to demonstrate your business is seeing nice preliminary growth and traction, and that you have tested and identified a profitable customer acquisition plan with affordable economics.
4. No Focus
It is hard enough launch one business, yet alone try to launch multiple different businesses all at the same time. As an example, I was working with one software business that was trying to tackle both the B2C and B2B markets at the same time, and within the B2B space they were trying to market to ten different industries therein. What they didn’t realize is that the go-to-market strategies and required team members were completely different by each of those channels. They were trying to be a jack-of-all-trades, but ended up being a master-of-none without a laser-sharp focus to start.
5. No Flexibility – Know When to Cut Losses
If you are trying to paddle upstream, no matter how hard you paddle, the current is going to take you backwards. Many entrepreneurs stay heads-down marching in the same failing direction. They need to know when a pivot is required, while there is still enough capital in the bank and enough time to implement the changes. You need to constantly test and tinker with your startup until you land on a winning direction. Sometimes that is a big pivot, from a B2C to B2B focus, as an example. And, sometimes, it is a small shift by selling into the healthcare industry instead of the insurance industry, as an example.
6. No Passion or Persistence
If an entrepreneur does not exude passion about their product, they will never love their startup well-enough to get through the goods times and the bad. And, they will never attract the best management team or investors, if their passion does not rub off on others too. Furthermore, even if you have the passion, you need to have a persistent mindset that regardless what hurdles get thrown your way, you are going to figure out a way through them.
7. Wrong or Incomplete Leadership
Startup teams need experience thinking, acting and operating like a startup. So, never try to put a Fortune 500 management team inside a startup, because typically they don’t think like startups, with shoestring budgets and roll-up your sleeve mentality around the clock. And, investors do not want to back a person; they want to back a complete team, in case you get hit by a bus. So, make sure your senior team is up and running, and gelling with each other, before reaching out for capital.
8. Unincentivized or Unmotivated Team
If you are going to ask your team to jump through hoops to follow you into battle, you better make sure they are properly incentivized and motivated to help you succeed. Some entrepreneurs try to keep 100% of the equity in their own hands. But, to me, a management team needs to have the same incentives as the founder, and putting 15-20% of the company into the hands of your employees will be a lot more motivating and loyalty-instilling to them, and materially improves your odds of success. And, nothing is more expensive or unproductive to a startup, than having a revolving door in your management team.
9. No Mentors or Advisors
Entrepreneurs should not be “lone wolves”. They need to understand they are not in this battle by themselves. Many cities have established startup ecosystems for them to tap into for mentorship and learnings from battle-tested serial entrepreneurs or venture capitalists. So, make sure you are well networked and surround yourself by people who are best experienced to pass their relevant learnings on to your business, so you don’t repeat the same mistakes they made before you.
10. No Revenue Model, Ever
OK, I understand many startups may not have a revenue model day one, trying to quickly build up a large audience and monetizing it later. But, there better be a clearly communicated revenue plan for when that day happens down the road. And, that revenue plan needs to be material enough, based on credible assumptions, to make it enticing for an investors to get excited and to justify your current valuation. For some products, consumers will never pay for them based on free alternatives available online. So, if you are hoping for advertising to make up the shortfall, you better have a clear and affordable roadmap to millions of users to get the attention of advertisers. Otherwise, a “freemium” or e-commerce drive model would be preferred.
11. Less Capital than Needed – No VC Experience
First of all, make sure you are raising enough money out of the gate. That means raising enough to build your product and to achieve your proof of concept. And, preferably, that amount is large enough to at least carry you 12-18 months. When you fund your business piecemeal over time, you will never get out of fund raising mode (vs. business building mode) and you risk burning out of money before your business has a reasonable chance for success. And, whatever capital you think you will need, double it for a cushion, as things always go wrong. Also, when you first reach out to VC’s, make sure your team and your business is ready, and is well researched and prepared to walk into that meeting with enough traction and a winning-plan that will get their attention.
12. No Long Term Roadmap to ROI
Whether you are investing in your own business, or raising capital from outside investors, you need a clear roadmap to at least a 10x return on your invested capital. With a one in ten odds of hitting it big in the startup world, investors need lots of 10x opportunities to offset the much larger base of zero returns that will be realized. So, when pitching investors, put on their hats. If you are asking for $1MM for a 20% stake, you need to clearly communicate how your current $5MM post-money valuation is going to become $50MM over the next five years with the monies raised, based on reasonable assumptions.
13. Bad Luck or Timing
Sometimes, businesses fail for no fault of their own. They may have had a good idea but some external thing that was out of their control took them down. Imagine being a travel business after 9/11/01 or a new home builder after the mortgage meltdown, or a restaurant on a road that just got cut off by construction, or a startup that just got impacted by an unexpected government regulation. During those times, it is often best to go into “hibernation”, waiting for the conditions to improve down the road, so you can live to fight another day.
This article was originally published on RedRocket VC, a consulting and financial advisory firm with expertise in serving the start-up, digital and venture community.
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