3 Most Common Financial Mistakes When Building a Startup
Launching a startup can be a very exciting yet challenging and frustrating time for entrepreneurs. One of the most difficult components of building a startup is the financial side. This proves to be difficult for a great number of entrepreneurs because of its complexity and the amount of time involved in figuring all the different pieces out. First, you need to figure out who your target market is and from there, figure out how large your addressable market is. You also need to identify all your costs (one-time and annual, fixed and variable), your break-even volume and price, and projected revenues, profits, and annual growth for the future. Not only do you need to identify all these pieces of information, you need to know the precise dollar amount for each piece. As a result, it is very easy for entrepreneurs to make a small financial mistake that snowballs into a catastrophic blow to their business. Here are three of the most common financial mistakes entrepreneurs make when building a startup.
1) Running Out of Cash
When creating a startup, there will be a lot of expenses to deal with. No matter how long your company is around for, there will always be annual expenses such as salaries, taxes, utilities, and rent for office space. But when a company is nascent, you also have to deal with additional expenses, such as purchasing equipment, acquiring legal protection for your company and products (e.g., copyrights, trademarks, and patents), and heavier-than-normal advertising. As a result, it is very easy to fall into a spending trap early on in the process. However, if you do not adjust your spending once these one-off expenses are dealt with, you may quickly find yourself having serious perpetual cash flow problems. Startups that do not rectify this and fail to receive additional funding wind up burning through all their cash. According to research done by CB Insights, 29% of the failed startups they examined reported running out of cash as one of the primary reasons for their failure, which was the second most common reason found for why startups fail.
Flud, a newsreader for mobile devices, learned this lesson the hard way. The company was founded in 2010 by Bobby Ghoshal and Matthew Ausonio. In its first year of existence, the company was off to a roaring start. They were able to secure a round of seed funding worth $2.1 million, Google and Apple promoted the app, and the company enjoyed a lot of positive press early on. But while more competitors focused on acquiring users started to pop up and thrive, Ghoshal and Ausonio were hung up on the addition of new features to the app as well as making technical fixes. Additionally, they were seeking an $8 million round of funding from investors. While they were hung up on those two things, Ghoshal and Ausonio became oblivious to another serious problem: they were quickly burning through their cash and were in danger of running out. Unfortunately, the problem was never fixed and in August 2013, the company shut down after they were unable to receive additional funding from investors.
When Flud was launched in 2010, it was believed to be one of the next big things. Indeed, the company garnered more attention in its first year of business than many startups do in their entire life. Just before shutting down, they had $500,000 in bookings for the product and were very close to getting an additional $8 million in funding from investors. These factors alone would have led people to believe that Flud would not only be around for the foreseeable future, but would have thrived in the online news space for years to come. However, because Flud was unable to properly manage its cash, it had to shut down after just three years. Had Ghoshal and Ausonio ensured that the company’s cash flows were stable, the company would likely still be around today. As the case of Flud demonstrates, it can be quite difficult to fix this after it initially spirals out of control. Therefore, it is important that you properly control your company’s cash flows from the start in order to avoid the possibility of burning through all of your money.
2) Improperly Pricing your Product
When launching a startup, several financial analyses must be done to determine what the selling price of your product will be so that you meet your financial goals, namely breaking even, and later on, making a profit. To determine this, you need to know several financial factors, such as market demand, costs (fixed and variable), and consumers’ price sensitivity/elasticity of demand. However, if you do not price your product properly in accordance with these factors, your product will not be successful on the competitive market and therefore, your company will quickly start losing money. If your product’s selling price is too low, you may find yourself unable to cover costs and will lose money on each sale. On the flip side, if the selling price for your product is too high, you will not bring in customers as projected and therefore; revenues are likely to fall short of costs. In either case, improperly pricing your product could result in the demise of your business.
In 2014, Thomas Pun, CEO and founder of Delight IO, learned this the hard way. Initially, Delight IO, which set out to provide users with data captured during interactions between mobile users and helps visualize it (mobile analytics), received lots of positive feedback on its services. These initial responses led Pun to believe that’s what subscribers to the Delight IO platform desired. However, contrary to what Pun believed, the product-market fit was not fully there for his company’s product, as many users who desired this type of service wanted actual information and not just raw data. Additionally, the high price point of $300 for the product and services that fell short of subscribers’ expectations eventually caught up with Delight IO. Sales started to slow in early 2013, resulting in Delight IO incurring thousands of dollars in losses for several consecutive months. Unfortunately, after just two years of existence, the company shut down in January 2014.
As the story of Delight IO demonstrates, fully understanding the desires of consumers and then finding the ideal product-market fit is crucial to properly pricing your product. Unfortunately, Delight IO did not find their product-market fit, failing to realize that many consumers who paid for this type of service wanted real information, not just raw data. Had Pun better understood his target market and therefore had been able to properly price his product so that the company could turn a long-run profit, his company would have been able to excel in the visual analytics market. Instead, he lost his company after just two years. Therefore, it is important you fully research and understand the demand for your product and know your costs so that you can properly price your product, as your company’s survival strongly depends on doing so.
3) Making Poor Hiring Decisions
When you are first launching a startup, there are a lot of items for you to deal with, particularly if you are going solo on the venture. So it often makes sense to hire one or two people to help with managing the company, particularly with finances and marketing. However, the hiring process must be met with skepticism, caution, and delicacy, as two issues can arise. The first is if you hire too many people early on, you may incur an excess of employee-related expenses, such as salaries, training, and legally required employee benefits. The second is if you do not properly screen potential employees for experience, personality, goals, and work ethic, your company may incur costs both in terms of revenues and in terms of reputation due to damage caused by poor-performing employees. A damaged reputation may also pose additional challenges when looking for additional funding from investors. Additionally, internal conflicts, particularly among co-founders and/or other parts of management, could hinder your company’s ability to get stuff done. Any one of these factors could do enough internal damage to the point where the company is unable to survive.
ArsDigita, a former Boston-based tech company, found this to be the case. The company, which focused on web development, was founded by Philip Greenspun, Tracey Adams, Ben Adida, Eve Andersson, Olin Shivers, Aurelius Prochazka, and Jin Choi in 1997. For the next three years, the company saw very healthy growth, earning up to $20 million in revenues and $7 million in profits annually by the end of the 20th century. The company was helped by the ongoing dot-com boom of the late 1990s. However, rifts on the ArsDigita team started to form in 2000 after Peter Bloom (General Atlantic), Chip Hazard (Greylock Ventures), and Allen Shaheen invested in the company and gained control of many management decisions, with Shaheen taking over as CEO. From there, things spiralled downwards. The three men significantly increased the cost structure of the company, which included expanding the ArsDigita team from 80 to 200 employees and doubling everyone’s salaries. Company spending spiralled so far out of control that an additional $20 million was blown just to get the company back to the same revenues it had when Greenspun was CEO. Additionally, the three men made poor management decisions regarding products and partnerships/alliances, namely in passing up a potential product alliance with Microsoft, and often found themselves in conflict with the co-founders. Conflicts continued on for months at ArsDigita. Finally, in February 2002, enough financial damage had been inflicted on the company due to its poor team dynamics that they had to shut their doors and sell their assets.
ArsDigita serves as yet another example of a company with so much potential to succeed. They were earning millions every year, had the help of several investors, and were being pushed along by a booming market. Despite all this, the company failed. Had Greenspun and his fellow co-founders been able to get on the same page with their newly hired investors in terms of financial goals and work towards those goals as a team, ArsDigita’s chances of survival would have been much greater, even once the tech bubble burst in 2001. However, since various members of the post-2000 ArsDigita team were frequently in conflict with one another, particularly surrounding cost structure and spending, the company was torn apart by the rifts caused by the poor internal dynamics and ultimately could not survive .
When launching a startup, it is crucial to have the financial side nailed down because these metrics are often considered the key indicators of the success of your business in both the short run and the long run. The three cases discussed in this post demonstrate just how important it is to manage your company’s finances and financial decisions properly and how damaging making poor financial decisions can be for your startup. In all three cases, the end result of these simple yet avoidable mistakes for the entrepreneurs involved was the loss of their businesses. In order to avoid these mistakes, several steps should be taken before and during your company’s launch. Having a clear and well-defined product-market fit before launching, knowing exactly what your costs are, including properly differentiating between one-time and perpetual costs, and hiring a qualified CFO to help manage your company’s finances are just some steps you can take in order to increase the likelihood of financial success for your company.
Additionally, utilizing platforms that help startups track their financial health can help to ensure your company remains financially stable and continues making progress towards your set financial goals. Doing these things will help you avoid these common financial mistakes, which will allow your company to not only survive, but thrive in competitive markets and increase the likelihood of your company succeeding in the long run. Are you a startup seeking funding during Seed or Series A? Check us out here!
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