What Is Causing Startups to Go Bankrupt?
Many startups have a great product that’s viable, marketable, and ripe with potential. But if that was the only indicator of success, then nine out of 10 startups wouldn’t fail. The annals of startup history wouldn’t be littered with instances of companies like Friendster or Color that had fantastic products, but eventually sank.
The truth is that startups often go bankrupt for reasons that extend beyond the viability of their products. Many of them fall prey to missteps that ultimately dry up their cash flow, and cause the company to fold. So what are some of these pitfalls to avoid?
Failures in Compliance
Theranos, one of the most promising Silicon Valley startups, is now struggling to stay afloat after regulators revoked its license to operate a lab in California because of unsafe practices. Meanwhile, Zenefits, once valued at a staggering $4.5 billion, was recently embroiled in a highly public scandal for skirting state insurance training, licensing, and certification requirements. Both companies with tremendous potential – both brought down by their neglect of compliance, among other things.
For years, startups have been so focused on hyper-growth, rapid scalability, innovation, and revenue, that many of them have overlooked compliance. But with regulators increasing their scrutiny, the message is loud and clear – management teams and boards need to ensure that compliance is as integral to the startup’s vision and culture as anything else. Employees need to be aware that preventing compliance violations is just as important as hitting growth or sales targets.
The key is to embed compliance into the organizational culture right from the start. Implement processes and tools to keep track of changing laws and regulations. Institute a chief compliance officer or a compliance champion who understands the impact of regulations that govern your business and industry, and ensure that appropriate controls are implemented. As a startup, you have the unique advantage of being nimble and agile in order to respond to fast changing regulations. By factoring compliance into your product designs and business model, you will not only attract more investors, but also stand out from the crowd long-term.
Inability to Attract and Retain Good Talent
Your business is only as good as its people. Many startups fail because they aren’t able to attract, recruit, and retain the best talent. Others lose quality employees to bigger, more established businesses who can afford to pay better salaries and benefits. So how do you strike a balance, and hire great talent without breaking the bank?
A competitive pay package is important, but when you’re a bootstrapped startup, resources can be limited. The good news is employees are not all driven only by the promise of big money. Some of the most talented people choose to work at startups because they believe in the founder’s dream and vision. They want the opportunity to make a direct and major impact on the world, to solve problems creatively, to build a product or service that matters – and a startup environment gives them the chance to do these things. So, often, the key to hiring good talent is to build a startup culture that people want to be a part of. Consider asking prospective candidates to spend some time with you and your team, so that they can experience first-hand the culture and impact of your business. Build a vision, a story, and a plan for your business that will excite and inspire prospective employees.
Even if you can’t afford astronomical salaries, you can offer flexible work schedules, location independence, autonomy, and other benefits that matter to people. You could also consider offering equity or a percentage of ownership in the company in exchange for a lower salary. If these options don’t work, consider outsourcing certain functions, and only staffing core positions. You could also hire interns, or explore freelance networks like Elance.com. The bottom line is that attracting and retaining good talent doesn’t have to be hard, but it could mean the difference between success and failure.
Scaling Too Fast, Too Soon
In 2009, Quirky was founded to provide a platform that would enable inventors to pitch their ideas and have their products developed. However, in 2015, the company filed for bankruptcy. One of the underlying issues, it was said, was that Quirky had set their sights too high – instead of trying to build one or two products a year, they were launching 50-plus products a year. And in the process, they were unable to do full justice to each offering.
Many startups fall into the trap of scaling too fast, too quickly. A 2011 Startup Genome report found that 74 percent of high-growth Internet startups fail due to premature scaling. Companies like these end up burning through their cash far too soon by hiring too many people at once, or ramping up sales before figuring how to achieve profitability, or being so obsessed with creating the perfect product that they don’t focus on anything else.
One of the ways to avoid scaling too quickly is to keep your finger on the pulse of the market. Go slow, learn from your customers, listen to their complaints and feedback, and incorporate that data into future product iterations. The key is to constantly refine your product, or understand if you need to pivot and change course. This approach may take time, but it will enable you to develop a stronger and more sustainable business.
Suppliers or vendors can sometimes be the weakest link in your business. If they don’t provide good quality components, or deliver on time, or safeguard sensitive information, then they could severely impact your business. That’s why it’s so important to do the necessary due diligence and ensure that all your suppliers or vendors have been properly vetted, and are continuously monitored. Unfortunately, this is an area that is often overlooked.
A report by Zurich Insurance and the Business Continuity Institute (BCI) found that 72 percent of organizations, including small and medium-size enterprises, do not have full visibility into their supply chains. This could have major consequences – the report also found that 74 percent of organizations had suffered at least one supply chain disruption in the previous 12 months.
We often talk about knowing your customer, but it’s just as important to know your suppliers or vendors, so that you can identify where the real risks lie. Before choosing a supplier, vet them thoroughly – ask for references, scan supplier information sources such as Dow Jones. Categorize the suppliers based on the level of associated risk, and then assess them at periodic intervals to ensure that the risks are under control. Have a backup plan for critical suppliers in case there is a disruption in the flow of goods or services. And finally, invest time and effort in building a good relationship with your suppliers – they are essential to the health and growth of your business.
Building a startup is risky business. The obstacles and pitfalls are many, and not everyone survives. However, by recognizing the risks along the way, and learning how to avoid or overcome them, you can beat the odds of failure, and establish a successful business. So, keep compliance front and center; attract and retain good talent; scale steadily and deliberately; and finally, implement a strong supplier or vendor governance program – and you’ll be well-positioned to not only survive, but thrive.