Is your early stage startup planning to fail?

The purpose of this article is to help mentors, coaches, and advisors quickly determine if the early stage startup is planning to fail.  Mentors, et al, may not wish to spend time with founders who are planning to fail.

A secondary purpose of this article is help founders understand whether or not they are planning to fail.

You can download a PDF of this article from: Is your early stage startup planning to fail

What are the 3 greatest contributors to startup failure?1

This research study analyzed 101 startup failures and identified the most frequently cited reasons for failure.  Usually there were several reasons for failure.

  • 42% of the time built a solution looking for a problem i.e. no market need.
  • 29% of the time running out of cash.
  • 23% of the time, not the right team.

How do you recognize a startup planning to fail?

How can you tell they are building a solution looking for a problem, with the market demand unclear?

  • The market analysis contains some information copied from consulting reports or other sources.
  • No documented assumptions, with indications which have been validated, remain to be validated or invalidated.
  • No analysis
  • No validation by interviewing target customers.

How can you tell they plan to run out of cash?

  • No 24+ month cashflow forecast, by month, with key monthly milestones.
  • Assumptions, often undocumented, that angel investors, and pre-revenue funds will provide capital before there is revenue.
  • Assumptions, often undocumented, that little time is required to raise capital and little time is needed between capital raises to demonstrate achievements.
  • Assumptions, often undocumented, that it takes little time to go from a prototype in customers hands to a solution that customers are paying for.
  • Assumptions, often undocumented, that the initial revenue generating solution requires no changes before it can go global.
  • No milestones as to when to cut spending if revenue or capital infusion is delayed.

How can you tell they don’t have the right team?

  • The founders have no experience with the target customers, market place, the requirements of building and delivering the solution.
  • The founding team has major skills and experience gaps and no milestones for closing those gaps.

A red-flag and deal killer for me is:

The founders believe all they have to do is make a few wording changes to the presentation pitch deck to get investors, without having to do any of the foundational work necessary for build understanding through information collection and analysis.  This reflects a common belief that its easy to get money.

How do you recognize a startup planning to avoid failure?

A startup planning to avoid failure has a structure to capture the knowledge and facts arising from learning.  A startup that is not constantly learning will fail.  The reason to document knowledge and facts is to enable the entire team to share knowledge and facts.  The structure outlined below will initially have many assumptions.  Over time, assumptions will be validated or invalidated, and new assumptions will be made. The structure below will also enable the startup to effectively gain value from mentors, coaches, and advisors by sharing assumptions, knowledge, and facts.

 How can you tell they are building a solution for a problem, with the market demand clear?

The startup has facts, assumptions, and analysis of TAM, SAM and SOM

What is TAM (Total Addressable Market)?

  • What would be the startup’s revenues with their future solution if 100% of the global customers demanding a solution to their problem bought the startup’s solution? TAM is the case with no competitors.
  • The solution built in the first 12 months is only a subset of the solution which in 5 years time will address TAM i.e. TAM depends upon the specific nature of the solution at a point in time. Note the phrase “demanding a solution”. You must not include in TAM ghost customers who are not demanding a solution.  If customers don’t know they have a problem and are not demanding a solution, the startup is planning to fail.
  • There is a critical difference between customer needs and customer demands. Customers have a large number of needs.  Demand is customers deciding that they will spend time, effort, and money to get a solution for what they believe is an urgent need.  Often this means that customers will spend less money to meet other needs.
  • Is the startup’s TAM large enough to launch and grow the company? For example, the global smart phone TAM is huge, but the global TAM for smart phones that have a keyboard is tiny.
  • The best way to calculate TAM is with a bottom up calculation, starting with a clear description of the target customer segment, its needs, and then considering the subset of customers who will actually provide revenue, and the revenue per customer. Recognize not everyone in every country will be able to afford the solution.

What is SAM (Serviceable Addressable Market)?

  • This is the portion of the TAM that is within the reach the startup’s distribution channels and partners, and your ability to deliver and support your solution. Geography may be a constraint. This still assumes 100% market share of those customers demanding a solution. SAM will change over time, as growth occurs in geography, the number of distribution channels and partners, and the volumes from each distribution channel and partner.
  • How will customers connect with the startup?  If they are seeking a solution, how will they find the startup?  How will the startup make customers aware of the solution?

What is SOM (Serviceable Attainable Market or Share of Market)?

  • SOM will be lower than SAM for two reasons: the startup may have competitors, and every customer who is demanding a solution may not actually buy a solution.

TAM, SAM, and SOM will vary at different points of the startup’s 5-year forecast.  TAM, SAM, and SOM will also change as the startup validates assumptions by progressing through: initial assumptions, customers interviews, feedback from prototype in customers hands, feedback from initial revenue producing customers, feedback from MVP (initial revenue producing customers who are delighted from the initial set of value they achieve from the solution), customer feedback as solution capabilities are enhanced to provide value to a greater set of customers, etc.

How can you tell they plan to not run out of cash?

  • They have a one-page 24 month, by month cash flow forecast, with key milestones. 24 months is the bare minimum. Milestones must include some key customer traction accomplishment such as: prototype (i.e. not revenue generating) in customers hands; a revenue generation solution with limited capabilities but which still delights customers, etc. Milestones include capital being raised. For each month show: the revenue driver metric, revenues, expenses, profit/loss, key milestone(s) if any.
  • Very few companies obtain 3rd party funding (i.e. other than friends, family) until there is revenue. Only 3% of angel funded companies are pre-revenue.2
  • If you’re planning to raise capital from 3rd party investors, I suggest that you have a one-page five-year forecast, with the current year shown, and the past 3 years, if there is data. Also include the key assumptions and milestones.  Why do this?  Investors who are focused on making money see if you have at least a high-level road map for major growth i.3. 30 times or more.  Given that most startups fail, the only way for investors to make money is to have some startups with massive success.
  • The average seed stage round takes 12 ½ weeks. 20% of the startup require 20 weeks or longer. 20% of the startups require 6 weeks or less.3
  • A fund-raising round can take a long time. This research study examined 13,916 financing events.4 The average time between fundraising rounds was 20.6 months. The time between rounds ranged from 6 months, to 35 months, 68% of the time.  e. 16% of the time less than 6 months and 16% of the time longer than 35 months

How can you tell they have the right team?

  • Assess the skills and experience requirements implied by: the target customers, the nature of the solution to be built, the needed partners and suppliers, etc. Can the CEO’s communication’s demonstrate that the founding team is the right team with the relevant experience, skills, and network.
  • Many founding teams have gaps. Does the 24-month cashflow forecast have the milestones for when the gaps will be closed?

 What are my criteria for determining whether to mentor a startup?

  • There is a documented one-page TAM, SAM, and SOM with supporting facts, assumptions. There are documented interviews (these are NOT sales calls) with potential target customers. This helps answer the question “Are you building a solution looking for a problem?”  The milestones reflect what is accomplished in order to achieve TAM, SAM, and SOM results.
  • There is a one-page 24+ month cashflow forecast, by month, with key monthly milestones. This helps answer the question: “Are you going to run out of cash?”
  • An executive summary has been completed in gust.com with the PDF available. This helps answer two questions: “Does the startup have the right team?” and “Can the startup clearly communicate the market demand, the problem, and the solution?”
  • The gust executive summary has three benefits to the startup founders: #1 Founders answer a number of questions to complete the summary, saving time in the meeting with the mentor #2 Gust has a free software evaluator to assess your input. #3 Gust will enable you to contact a number of angel groups and other early stage investor funds.
  • The one-sentence pitch in the executive summary follows the format of: “My company (company name) Is developing (a defined offering) to help (a target audience) (solve a problem) (with secret sauce).”5
  • A nice-to-have for the startup is a completed business model canvas.6 This holds all the assumptions, and validated assumption the startup has made.

I recognize that the first version of these documents will have lots of invalid assumptions and issues with clear communications.  That’s OK.  These documents provide the foundation for helping the startup learn to succeed.

Your next steps

As a mentor, coach, or advisor:

  • Determine whether the startup is planning to fail or planning to avoid failure.
  • If planning to avoid failure, they may need help with their planning. e.g. what assumptions to make, how to validate assumptions, how to interview potential customers to validate assumptions, etc.
  • If they are planning to fail, are they willing and able to change?
  • If the startup is planning to fail, you need to decide if you can actually have any meaningful impact.

As a startup founder:

  • The first decision is whether you are planning to fail or planning to avoid failure.
  • If you are planning to avoid failure, do you have all the skills to assemble your plan? If not, do you have the mentors, coaches and advisors to assist?

Footnotes

1 https://s3-us-west-2.amazonaws.com/cbi-content/research-reports/The-20-Reasons-Startups-Fail.pdf

2 Angel Capital Association and Hockeystick, “2019 ACA Angel Funders report “

3“What we learned from 200 startups who raised $360 million”, Professor Tom Eisenmann, Harvard Business School, and DocSend

https://www.slideshare.net/DocSend/docsend-fundraising-research-49480890

4 https://medium.com/journal-of-empirical-entrepreneurship/how-much-runway-should-you-target-between-financing-rounds-478b1616cfb5

5 The one sentence pitch is further described in this link to the Founder Institute:

https://fi.co/madlibs

6 https://koorandassociates.org/the-startup-journey/what-is-a-business-model/