Last month, we talked about some of the reasons that usually cause new ventures to fail in Entrepreneurs: 10 Mistakes, 5 Lessons And 3 Methods To Learn Wisdom, and also stressed the importance of learning from other people’s mistakes, as recommended by Martin Zwilling and Confucius.
Prof. Noam Wasserman of Harvard Business School agrees with them. Wasserman, who spent decades researching startups and why they succeed or fail, has compiled a database of experiences from 10,000+ company founders, and shares his findings in his book The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. Let us take a look at some of the most common mistakes:
Co-founding with friends or family. Wasserman found out that the most common decision of entrepreneurs is to team up with someone they know socially. While this is understandable, it is the least stable of all teams, because the founders will most likely be of very similar backgrounds and have too many of the same skills, being unable to complement each other’s shortcomings. To fix this, founders should be aware of these collective deficiencies and complement their personal strengths with professionals, either as partners or consultants.
There are also emotional issues, because it is more difficult to decide and say what needs to be done on topics such as compensation, decision making, responsibilities when dealing with friends or family. The solution is to actively pursue the “tough discussions” while building firewalls between the work relationship and the social relationship to protect the social one from harm.
Early equity splits. 73% of the company founders included in Wasserman’s research decided on how to divide the equity within a month of founding. While a decision needs to be made on who owns what share of the venture upfront, mostly because of funding requirements, the equity division should never be permanently fixed. At the beginning of a venture there is a lot of uncertainty. What will the strategy be? What roles will each of the founders play? How much will everyone be able to invest other than money?
Most divisions are equal splits, which assumes that all founders will provide equal contributions. That almost never happens, at least one person will feel that they are contributing more than their fair share, which will inevitably lead to problems. It is best not to set equity stakes in stone, but rather to agree upfront upon a dynamic mechanism that enables a redistribution of equity over time based on performance and contribution of the founders. Something like a vesting plan over time or based on achievements of milestones works well.
I advise my consulting clients to always write and sign a gentlemen’s agreement before starting any venture, a legally non-binding document that lays out the founders’ decisions on issues such as how to redistribute equity over time, how to share profits if and when they materialize, what the overall roles of each founder will be, what the general decision rights are, how the equity will be valued if a founder decides to back out of the venture, which expenses will be reimbursed and so forth. Such an agreement is always useful, as it exerts moral pressure on the founders to be more cooperative, eliminating many problems over time before they arise.
Professional vs. emotional investors. It is quite common for entrepreneurs to ask their family or close friends to invest in their venture when they get started. They do this because it is easy, mostly due to an existing emotional bond and established trust between the parties. However, investment decisions based more on emotional than rational reasons can cause problems. It is essential that the founders have an honest and open discussion with their investors and explain the risks and timelines very clearly to manage expectations. If a founder’s grandmother who put money into the venture suddenly gets anxious and asks for his money back just when the startup is trying to launch a product, there will be management problems due to added stress on top of everything else that is going on.
The emotional investors also lack the scrutiny of professional investors. Professional investors are very rational, caring a great deal about their money and where they put it. They would not hesitate to point out to flaws or weaknesses in the business, maybe even offer suggestions and would not at all care about the feelings of the founders, the way a grandmother might.
Having said that, it is also true that while professional investors add value, they also bring control risk. Emotional investors would not fire a founder because they do not like their performance, but professional investors would, and have. 52% of the company founders included in Wasserman’s research were replaced as CEOs by the time they raised their C round of funding. Of those, three out of four were fired by the board, i.e. professional investors.
Conflicting goals of founders. Sometimes startups are launched without the founders having a shared understanding of why they are getting into the venture. While everyone is intent on “building something” in the initial stages, later on, they may have different ideas on how to proceed. Without a mechanism such as the gentlemen’s agreement, this may lead to significant problems for the founders, both personal and financial. Wasserman talks about what he calls the “rich-vs.-king dilemma.”
“The king is a visionary who wants to bring something to fruition and have an impact on the world without having to sacrifice the idea or have others twist and turn it. This person is more control-oriented and should think about being a solo founder, bootstrapping the venture, and finding inexpensive employees who are going to be more rising stars than rock stars.
The founder who primarily wants to get rich will do what it takes to grow the venture, including hiring the best employees, finding the best co-founders, [and] giving up control to the investors with the best financial resources, guidance, and networks. They don’t mind imperiling control in hopes that the pie will grow a lot bigger—and their slice, while smaller, will be much more valuable.”
How about an entrepreneur’s point of view? Andrew Montalenti is not an academician. He is the co-founder and CTO of Parse.ly, and speaks from firsthand experience as an entrepreneur in Why Startups Die, where he conducts a post mortem on startup deaths, based on patterns he discovered:
- Marriage Trouble: If you [and your partners] can’t work well together and co-motivate each other through thick and thin — then the startup will fail.
- No Bootstrapping Plan: If you have the mentality that “without funding, I can’t work on my startup”, then your startup will likely die.
- Startup is a Career Move: If you are treating your startup as a “career move” — a way to move up in the “startup ecosystem” and end up a C-level executive at some other, VC-funded rocketship, then, in all probability, your current startup will fail.
- Refusal to Change Original Idea: You should be obsessed with your company’s mission, but willing to change your company’s approach given new data or circumstances.
- Pre-Emptive Scaling: Worrying about “scale” in the early days of your startup is simply a bad investment.
- Growing Too Fast: The more your company starts to feel like a big company, the slower you will move, and the more you will spend.
- Scared of Code: Nothing simultaneously focuses your team in its mission and gathers the most useful market feedback like actually building software prototypes… Without concrete, tangible progress toward a product, it simply becomes too easy to walk away.
Montalenti has a general piece of advice for startups: Be persistent and continue moving forward, no matter what. He makes references to Paul Graham, who is known for his work on Lisp, for co-founding Viaweb (which later became Yahoo Store), and for co-founding the seed accelerator Y Combinator. Graham is also the creator of the famous “Startup Curve”.
Graham, an experienced incubator who has seen quite a few number of startup failures, tells entrepreneurs what to do to survive:
“When startups die, the official cause of death is always either running out of money or a critical founder bailing. Often the two occur simultaneously. But I think the underlying cause is usually that they’ve become demoralized. You rarely hear of a startup that’s working around the clock doing deals and pumping out new features, and dies because they can’t pay their bills and their ISP unplugs their server…They may have to morph themselves into something totally different, but they won’t just crawl off and die. They’re smart; they’re working in a promising field; and they just cannot give up. All of you guys already have the first two. You’re all smart and working on promising ideas. Whether you end up among the living or the dead comes down to the third ingredient, not giving up.”
There are many ways a startup can die, but there are also many ways to prevent that from happening. Learn from other people’s mistakes, do the hard work, and most importantly, keep the faith.