THE FIVE MOST COMMON MISTAKES MOST STARTUPS MAKE
In working with startups and early-stage companies for two decades, there are a few common mistakes I have seen these companies make that can be highly damaging to their chances for success. Statistics show that more than 90% of all startups fail within their first year. While there are many reasons for failure, these common mistakes are heavy contributors to the percentage probability that a startup will fail. On the plus side, if startups are aware of these pitfalls, and can avoid them, they will dramatically increase their chances of success.
This one is, by far, the most common and most potentially damaging common mistake startups make. I have personally experienced this in multiple engagements as a CFO, and it can destroy a company’s potential. Frequently, founders become the CEO of startups because they started the company, they often do not have money to attract and compensate a professional CEO, and they believe they are the best person to run the company. While founders have many positive personality traits that make them excellent early-stage CEOs, at some point in a company’s development, the business needs a professional CEO to take the business to the next level.
Founders tend to have difficulty delegating, collaborating, and listening to their team. While the very characteristics that made the founder capable of starting the company and getting it through the early stages of product or service development, funding, and staffing are absolutely critical during the founding stage, they are often the most formidable barrier to the long-term success of the business. Founders can be dictatorial, stubborn, petty, selfish, and utterly incapable of nurturing an environment conducive to a team dynamic that promotes a productive company culture. For startups to have the best chance for success, founders need to know when to say when, and to step aside and bring in an experienced professional CEO to take the company forward.
FAILURE TO SECURE ADEQUATE FUNDING
All too often, CEOs of startups are overly optimistic about the timeline for company success. That optimism is one of those positive characteristics mentioned above. Without that optimism and willingness to take significant risks, there would be no startups. However, unrealistic expectations about the timeline to profitability can destroy an otherwise viable business model due to inadequate funding. While raising money is difficult, time-consuming, and distracting, it is vital to the survival of every startup. Strategic decisions about the timing and structure of funding rounds is highly complex and deal-specific. If using equity for funding, the timing of stock sales in terms of the stage of development for the company will drive valuation. While no one wants to suffer dilution from selling “too much” equity, “ ”too early,” it is far better to have too much cash than not enough. There must be a balance between the risk of raising significantly more money than needed, and the risk of running out of money, thus requiring one or more subsequent funding rounds to take the company to profitability.
It should be clear at this point that these common mistakes overlap significantly. The reader will note that funding decisions are highly dependent on who sits in the CEO role, and on whether a qualified CFO has been engaged to support fundraising efforts (see more on this below). The key point here is that overly optimistic expectations can result in ongoing funding shortfalls that can restrict growth, distract the team, and prevent the company from being proactive with regard to product or service development, staffing, inventory build, and many other key requirements that can make all the difference in a company’s survival and success.
FAILURE TO HIRE A QUALIFIED CFO
Since I often serve as a CFO for startups and early-stage businesses, I will freely admit that I am biased when it comes to discussing the need for a CFO for companies in the early stages of development. With that stated, a good CFO can make a substantial positive impact on the probability of success for a startup. All too often founders fail to see the value in having a CFO. The typical perception of the CFO role is that of an accountant that simply “keeps the books.” While the development and implementation of accounting policies and procedures is one of the key benefits of bringing on board a qualified CFO early in the company’s development is important, this is not the real value add of a good CFO. The kind of CFO that startups need is one who can spearhead the funding strategy, provide strategic planning expertise to include financial discipline and perspective to that process, and serve as the interface between the company and investors.
Startups will typically require multiple funding rounds before they reach profitability. Even after profitability, companies will often need to raise additional capital to expand into new markets, products or service, and to scale their manufacturing operations, etc. A qualified CFO that can not only “crunch the numbers” to create realistic financial forecasts to determine the correct amount of necessary funding, but who can also structure funding rounds, write funding documents, complete the required SEC and state document filings, and actively participate in the fundraising process is absolutely vital to successful fundraising activities. Next to the CEO, the CFO position, from the investor’s viewpoint, is the most important C-level management position. Investors want to know that someone experienced and qualified to serve in the CFO role is watching their money, ensuring that it is spent wisely, in the way that was represented to the investor when they wrote their check. Far too often, founders grossly underestimate the importance of a good CFO, and this hurts the company’s chances for success.
FAILURE TO ADEQUATELY COMPENSATE KEY EMPLOYEES WITH EQUITY
One of the smartest things Silicone Valley startups tend to do is to properly, adequately and fairly compensate their employees. While this is not a given, we see technology startups building powerful and successful teams by providing significant equity stakes to key employees, to tie them to the long-term success of the business, and in many cases, even granting equity to every employee, right down to the receptionist. Unfortunately, this is not always the case. One of the most common mistakes I see with startups I work with is a failure to compensate employees with equity.
Founders typically control the equity of the firm early on, since they founded the company, and more often than not provided some or all of the seed capital to get the business off the ground. While this is very common and appropriate at that early stage, as key employees are brought on board, founders often fail to recognize the value in tying these employees to the company with equity. In the typical startup, if it later becomes successful meaning that the company secures a favorable exit at an attractive valuation, founders are lucky to retain 20% of the equity in the company.
Founders, especially those that invent or create technologies or products, tend to grossly overvalue their early contributions, and to discount the hard work and creativity their key employees bring to the table. Additionally, founders often believe that the hard part of building a successful business is creating the product. While a good product or service is certainly a critical element to building a successful company, once there is a product, a company still must be built around that product. Building a successful organization including sales, manufacturing, customer experience, accounting systems, staffing, marketing, human resources, and everything else that goes into creating a successful business must be built from scratch to commercialize that product. This is the hard part of building a valuable company. To attract and retain quality people, the company must provide incentives. Since most startups do not have sufficient cash to compensate employees on par with larger, more established employers, they must make up for the shortfall, along with compensating the employees for taking the added risk of working for a startup, with equity. All too often, founders refuse to acknowledge or adequately compensate key employees with enough equity to secure their engagement for the long-term.
FAILURE TO SEEK LEGAL COUNSEL
Startups face a multitude of legal issues, from drafting employment agreements and supplier contracts, to intellectual property issues such as filing for patents in various countries and protecting trade secrets. Most startups cannot afford full-time legal counsel, and most do not seek legal counsel to draft or review documents, follow proper procedures for cap table changes board and shareholder meeting activities, negotiating contracts, and the like. The results can be devastating. Without proper legal counsel, CEO often sign contracts without understand the implications for the business, which can result in extensive legal problems down the road, including costly and detrimental litigation. I see this happen quite often immediately prior to exit, when the company is about to be sold or is about to conduct a public offering. Patent disputes, shareholder disputes, lender disputes, supplier contract disputes, and the like can block a lucrative exit many years and hundreds of thousands of manhours in the making. The strategic use of a good attorney can be the best money a startup spends. All too often founders can be “penny wise and pound foolish” when it comes to legal counsel, and this can have profound consequences for the company.
While startups make all kinds of mistakes, these are the top five most common I personally see repeatedly in my role as CFO. While every business is unique, and the accompanying challenges can also be somewhat unique, if founders can actively work to avoid making these five mistakes they will increase their chances of success dramatically. Building something great and valuable is always challenging. My hope is that this information will at least provide some positive direction for startup management teams. I wish you great success!