Source: Tien Anh Nguyen, Research & Analytics Team, OpenView
For quickly growing startup or expansion-stage software companies, raising venture capital should be cause for celebration. Champagne bottles should pop, high fives should ensue, and every stakeholder should salivate over the ways in which the business can leverage its cash infusion to scale and drive future growth.
And while most investments start that way, it isn’t long before some companies’ euphoria gives way to disaster.
Unfortunately, starting from the notorious “Webvan” of the dotcom bubble, the high tech “deadpool” is infamously littered with many examples of ventures that either had no business accepting outside capital, or had issues that couldn’t simply be solved by more money. That many startups fail is not ground breaking news, of course, because venture-backed startups are risky investments and have a very high rate of failure, by definition.
The more relevant issue is why they fail. In my experience, it happens for five simple reasons:
1. The product isn’t a must-have in the long run
A lot of nifty, trendy software startups produce nice products that appeal to early adopters. They’re good enough in the first few years, but they might not translate into mainstream appeal as the business begins to scale. And if you haven’t cornered your market or your customers can’t live without your product, then what’s the point of trying to grow bigger with outside capital?
2. The technology architecture isn’t scalable
It’s one thing to support a handful of customers early on. It’s quite another to support thousands (or millions, if you’re Facebook or Instagram) of customers. Unfortunately, far too many businesses assume that their technology can scale with their customer growth. When something inevitably goes wrong and they aren’t prepared to deal with it, that seemingly small issue can sink the entire business.
Imagine what would have happened if Instagram hadn’t been able to support the million new Android users it received in just 12 hours last April. Instead, the popular photo sharing application handled the influx seamlessly and signed a $1 billion acquisition offer with Facebook less than a week later.
3. The business model isn’t sustainable
It’s not uncommon for unprofitable companies to receive very significant outside capital investment (see: Groupon, Pinterest, and Twitter) that let them continue to operate unprofitably for a long time. And while unprofitability isn’t necessarily an issue in the startup and early growth stages, not having a profitable economic model in place for the product you plan to sell is a huge problem.
A lot of founders think that the only reason they aren’t making money is because they aren’t selling enough of their software. But if the economic model that supports the business is ultimately unprofitable, then that assumption is a fallacy. As you sell more of an unprofitable product, after all, you’ll simply be more unprofitable.
4. The senior management team is inept
For almost any business, bad management is bad management. If you haven’t assembled a forward-thinking senior management team that can set the right course for your business, then the company is doomed. Moreover, good management at one point in the company’s lifecycle can be totally inappropriate (or even bad) management at another stage in the company’s growth. So it is essential that the company’s management is always looking to upgrade itself, and be wary of complacency. Ultimately, no amount of outside capital can rectify a senior management team’s failings, as it is the senior team that decides its own fate.
5. The company doesn’t know what it wants to be
Given the right execution and strategy, almost any company can scale once they have avoided the previous four pitfalls. But what is it trying to scale to? Do you want to be a platform? Are you strategically acquiring customers in the hopes that the business will eventually be bought out by a competitor? Too few companies ask themselves what they want to be when they grow up. They lack a vision for the future and, as a result, misappropriate the capital they receive from outside investors. Before they know it, the money’s gone and their investors aren’t willing to pony up any more.
The good news? Failure doesn’t have to be a death sentence.
Twitter is a perfect example. The social network had several catastrophic outages earlier in its early development, largely because the product wasn’t scalable and the competitive landscape was stiff. But the company swallowed its pride and was quick to admit its shortcomings, digging itself out of the aforementioned pitfalls before it was buried for good.
That’s the real key to scaling, after all. Yes, raising venture capital can help you grow your company. But building a great, big business has far more to do with execution and vision. Cash should simply be used to support those two things, not as an alternative to good management and strategy.
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices throughout the southeast including Charlotte, Raleigh/Durham, Greensboro, Wilmington, Washington D.C. and South Florida with a team of more than 30 professionals serving more than 100 companies throughout the region.