Why Startups Fail: A Top 10 List From Geoff Entress, Seattle’s Prolific Angel Investor
Despite the post-election glow in some circles, the financial reality for most people remains gloomy (along with the weather here in Seattle). As Geoff Entress succinctly puts it, “The economy still sucks…Nobody’s writing any checks right now at all.” I sat down with the Seattle-based angel investor yesterday in between his appearances at the University of Washington—as part of a seminar series for UW faculty—and the “Entrepreneur University” event run by the Northwest Entrepreneur Network at the convention center downtown.
Entress was a venture partner at Madrona Venture Group for eight and a half years before leaving the firm this past June to focus on his own investments. He still works out of his office there. He has invested in about 35 companies in the past decade, including investments in prominent Northwest startups like BuddyTV, Isilon Systems, CultureMob, Sandlot Games, ICanHasCheezburger.com, Elemental Technologies, Geospiza, and Pressplane.
Although Entress actually sounds fairly optimistic about new ventures, I thought his talk at the UW was an appropriate dose of reality. It was titled “10 Reasons Why Early-Stage Companies Fail.” As Entress pointed out, his “top 10″ list actually goes to 11, like a Spinal Tap amp (“when you ‘need that extra push over the cliff…’” he says). The audience of about 50 included folks from UW TechTransfer, as well as bioengineering professor Buddy Ratner (an Xconomist). I’ll give a quick recap of the talk here, in Entress’s words.
The main reason startups fail, of course, is that they run out of money, Entress said. Sometimes they shut down and investor money is returned, as in the recent case of Seattle-based ClayValet for instance, but that’s not the norm. Entress proceeded to drill down into the underlying reasons for startup failure:
1. They spend the money they raise too fast. “Conserve your cash,” Entress said. It’s very difficult to raise more funds, especially these days.
2. They hire too fast (ahead of their product development). The common mistake is hiring sales staff before the product is ready to sell.
3. They fire too slow. It’s better to do one deep, painful cut than to endure multiple smaller cuts, which are demoralizing to the team.
4. They react too slowly to changes in the market. This includes things like not changing their overall cost structure quickly enough, not cutting staff deeply enough, and not adjusting the business model.
5. They don’t hire the right team as the business grows. Startup founders often don’t “scale” to large public company CEOs.
6. They don’t listen to their customers. Customers can be “sold,” but they usually know better than you what they want.
7. They don’t change their business model when it becomes obvious that it is flawed. Be decisive, be flexible, learn what works and do more of it. (Entress gave one good example—Shelfari trying out numerous features and letting users say whether they like them or not—and one bad example, his own startup UrbanEarth.com, which folded in 2000.)
8. They don’t raise enough money. Focus on milestones required for the next financing, and structure the financing appropriately (in terms of preferred stock, convertible debt, common stock, or LLC interests).
9. They raise money from the wrong investors. All money is green, but it is not all the same. Different types of investors (venture, angel, other financial, strategic) have different return and timing expectations.
10. They don’t leverage their board and investors. Communicating via monthly updates (at a minimum) is key. Your board and investors will have contacts and insights that you won’t. Your investors need to agree on key strategic decisions like raising money or selling the company. Existing investors are your backup source of financing.
As a corollary (Entress labeled it 10+ on his list): They don’t sell when the opportunity is right. That means in a period of high growth, high demand in the market, or when they are a strategic “absolutely must have.”
These certainly all sound like good rules for startups to live by. But there is one final reason for failure, as Entress pointed out, and it is a wildcard…
11. They have bad luck. No matter how good your product is, sometimes bad things will happen, you will run out of money, and you will fail.