Llew Claasen | The 3 most important reasons why startups fail and what can be done about it | Fin24 Innovation

Llew Claasen discusses three reasons why startups fail, and what entrepreneurs can learn from this.

Early-stage startup investors are always looking for ways to identify the reasons why startups fail, so that we’re able to increase the likelihood that our own startups will achieve product-market fit, non-linear growth and ultimately, succeed. I recently came across a new report on the reasons why startups had failed and thought it would be useful to explore how these compared to my own experience. Here are my top three reasons why startups that we invested in failed, and what entrepreneurs can learn from this.

Out of cash

One of my favourite startup mantras is: “You can’t win if you’re no longer in the same.” It’s obvious but nevertheless worthwhile repeating that the worst thing that can happen to a startup is for it to run out of cash. While you still have cash, you have time, strategic options, and negotiation leverage. Once you’ve run out of cash, you have none of those.

This quickly turns into a vicious cycle whereby you have no time to come up with new strategic options, no time to pivot or prove new hypotheses, and no leverage to negotiate favourable financing terms. This quickly spirals, results in a loss of investor confidence and founder demotivation, dramatically reduces the likelihood of raising new capital, and increases the likelihood of failure.

Startup entrepreneurs often misunderstand this issue and believe that existing investors will rather bail them out than write off their original investment. This is called the sunk cost fallacy. Most sophisticated startup investors create a portfolio of investments and fully expect that a high percentage of the startups that they’ve invested in will fail. Most startup investors will write off their investment in a startup in a heartbeat if they lose confidence in the founder’s ability to navigate the opportunity.

A startup entrepreneur should never ever run out of cash. Raise capital well in advance of the need and assume that every fundraising will take at least six months to complete. Fundraising is a journey, not a destination. If you’ re not constantly raising money as a startup entrepreneur, you’ re not working hard enough on this.

No market need

The Lean Startup is an indispensable guide for managing a startup. The core principle is that a startup should iterate and test go-to-market assumptions until they achieve product-market fit – a state where their product is capable of economically addressing a large and growing addressable market.

Unfortunately, it’s also been misinterpreted as suggesting that it’s not necessary for startup entrepreneurs to apply any market research to an opportunity before they raise seed capital and rush to put an early version of the product into the market and iterate from there. In my experience, an enormous amount of time and venture money is wasted on startups that address no specific market need.

I feel very strongly that any startup entrepreneur should do some research on how large their addressable market size is and what their value proposition is expected to be before they create an early version of their product or raise capital. A Serviceable Addressable Market (SAM) of less than $100 million that is growing less than 5% pa, is not large enough for a venture-funded startup to address. No amount of hypothesis testing or pivoting can overcome that constraint.

Disruptive innovations (the most typical type of venture-funded opportunity) rely on addressing a relatively underserved market segment and gradually moving upmarket to address large market spaces occupied by incumbents. If the addressable market size is not large enough, there is not enough space for a startup to grow into and attract the large forward revenue valuation multiples needed to raise venture capital in successive rounds.

Wrong team

I’ve made this mistake a few times when I’ve felt that the market opportunity was so compelling that even a set of monkeys could create the works of William Shakespeare under these circumstances. I can confirm that although startup success from the wrong founding team has a non-zero probability of occurring, it’s still so low and requires so much time from an investor, that I’ll never intentionally do it again.

There is enough research out there to suggest that about 50% of the early-stage startup investment decision is weighted in favor of the founding team. On a probability-weighted basis, the founding teams with the highest likelihood of success have relevant skills (including education), experience, and business networks. They’re typically two founders – one with operational and business development skills (CEO) and another with technical skills (CTO). They complement each other’s personalities and they behave in a trustworthy manner towards each other, which is conducive to mutually beneficial effort.

In my experience, the likelihood of the success of a startup is dramatically improved when founders are constantly developing investor relationships to raise capital, there is a clear need in a large and growing addressable market for the product and the founding team is well matched to the challenges that lay ahead of them.

* Llew Claasen is the managing partner of Newtown Partners, a venture capital firm founded by him and Vinny Lingham. The firm invests globally in early-stage, emerging technology and disruptive business model startups. Views expressed are his own.

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