Why Startups fail

tl;dr - summary of interesting articles

The most likely outcome for a startup is failure.

Most seasoned investors and founders operate under the above assumption. There are several risks that skew the outcome towards a failure. Understanding these and mitigating these risks can tilt the scale.

Failure rate for startups. Varies wildly across industries. For example failure in consumer internet is way higher than say mobile hardware

• 30-40%  - If failure means liquidating all assets, with investors losing most or all the money they put into the company
• 70-80% -  If failure refers to failing to see the projected return on investment
• 90 -95% - If failure is defined as declaring a projection and then falling short of meeting it

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Why Startups fail. Not in any particular order. (Carmen Nobel)

1. Lack of foresight or strategy
• Start-ups often fail because founders and investors neglect to look before they leap, surging forward with plans without taking the time to realize that the base assumption of the business plan is wrong. They believe they can predict the future, rather than try to create a future with their customers. Entrepreneurs tend to be single-minded with their strategies—wanting the venture to be all about the technology or all about the sales, without taking time to form a balanced plan.
2. Lack of flexibility in the business plan
• And all too often, they do not give themselves wiggle room to pivot midstream if the initial idea doesn't jibe with customer demand.
3. Bad timing
• timing can determine whether a company gets funding and whether it achieves the start-up's elusive measure of success: an exit that involves going public or getting bought.
4. Lack of funding.
• A company could have a great idea and a great team, but still fail to achieve traction due to lack of funding and, consequently, lack of time to let a good model mature.

Despite these failures, why do entrepreneurs continue to start companies? naivete, hubris..  or can running a doomed company can actually help a career, yielding experience and networking opportunities with venture capitalists and other entrepreneurs.

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CB Insights 'top 20' list of most common reasons why technology startups fail.. 

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9 reasons why most startups fail (Entrepreneur)

1. Their entrepreneurs live in a vacuum
2. Their idea doesn’t uniquely solve a big problem
3. They run out of cash
4. They invent concepts, not complete products.
5. There are big gaps in the strategy.
6. The team does not have what it takes.
7. Competitors with existing solutions don’t give up so easily
8. The market moves on them, or moves in an unexpected way
9. They listen to bad advice from the wrong people.

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Top 20 Reasons Startups fail (Businessfinder)

1. No revenue from customers
2. No input from customers on R&D performed or on the product or service being developed
3. Misreading of markets (e.g. overestimate size, delay market entry)
4. Product not needed or not simple enough for the application
5. Poor sales and marketing decisions (e.g. distribution channels vs. direct sales, delay going global or going global too quickly)
6. Timing wrong; the product or service was too early or too late.
7. Unaware of competitors and changing market conditions

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Forbes -  The Unlucky 13 Reasons Startups Fail

1.  Market positioning
2. No Competitive Research–Wrong Market Positioning
3. No Go-To-Market-Strategy
4. No focus
5. No Flexibility – Know When to Cut Losses
6. No Passion or Persistence
7. Wrong or Incomplete Leadership
8. Unincentivized or Unmotivated Team
9. No Mentors or Advisors
10. No Revenue Model, Ever
11. Less Capital Than Needed – No VC Experience
12. No Long Term Roadmap to ROI
13. Bad Luck or Timing

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Top 20 Reason Startups Fail ( Chubbybrain.Com )

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http://franchising.clubztutoring.com/reasons-start-ups-fail/

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References 

1. Why Companies Fail--and How Their Founders Can Bounce Back Author: Carmen Nobel
2. http://thenextweb.com/insider/2014/09/25/top-20-reasons-startups-fail-report/
3. http://www.entrepreneur.com/article/231129
4. http://www.businessinsider.com/the-top-20-reasons-startups-fail-2011-5
5. http://www.forbes.com/sites/georgedeeb/2013/09/18/the-unlucky-13-reasons-startups-fail/

Angel: Some Facts, Figures and Myths

FAQ for Wannabe Angel Investors (USA)

These represent my reflections only and are in no way a criticism or endorsement of any community or school of thought

·        Who are Angel Investors AKA Business Angel, Informal Angel?: Generally wealthy professionals such as doctors or lawyers, former business associates -- or better yet, seasoned entrepreneurs interested in helping out the next generation.

·        Are Angel Investors millionaires? - Contrary to popular belief, most angels are not millionaires. Typically, they earn between $60,000 and $100,000 a year.

·        Typical Profile of an Angel Investor

o   Years Investing – 9

o   Number of Investments – 10

o   Total Exits/closures – 2

o   Years as an Entrepreneur – 14.5

o   Number ventures founded – 2.7

o   Age – 57

o   Percent of Wealth in Angel Investing – 10%

o   Education -  Master’s degree

·        What motivates an Angel? - Unlike VCs, angels are not motivated purely by profit. Many are passionate about helping entrepreneurs esp if they have been one themselves. Some are in for the thrill, some to overcome boredom and some who believe in a cause but the bottom-line is that they have the money and willing to invest. As an entrepreneur it is absolutely important to understand what motivates the Angel and vice versa

·        How do I as an individual qualify to become an Angel?

The federal securities laws define the term accredited investor in Rule 501 of Regulation D as: ·        a bank, insurance company, registered investment company, business development company, or small business investment company; ·        an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; ·        a charitable organization, corporation, or partnership with assets exceeding $5 million; ·        a director, executive officer, or general partner of the company selling the securities; ·        a business in which all the equity owners are accredited investors; ·        a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; ·        a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or ·        a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes. For more information about the SEC’s registration requirements and common exemptions, read our brochure, Q&A: Small Business & the SEC. o   http://www.sec.gov/answers/accred.htm

·        How can I become a certified accredited investor?

SEC has laid down reasonable guidelines but this is neither a legal interpretation nor a policy. However, Investors should expect that you verify you are an accredited investor.

Sec has adopted “Safe Harbour” to provide some certainty that issues are complying with reasonable steps. Read more here - SEC.

Third party angel groups, wealth management companies can securely and anonymously certify you

o   EarlyIQ

o   Accredited Investor Solutions

o   Halbert Wealth

·        Mentoring for Angel Investors

o   Best Practices

·        Reports for Angel Investors

o   Quarterly Halo Report

·        What Stage do Angels invest in?

1.      34% Seed Stage

2.      39% Startup

3.      18% Early Growth

·        Industries they invest in

o   19% Software

o   18% Health/Biotech

o   16% Business Products & Services

o   15% Consumer Products & Services

o   12% Hardware

o   12% Other

o   7% Media/Entertainment

45% of the companies that received financing from angels had no revenues when they received the angel investment.

·        Returns for Angel Investors –

 Returns to Angel Investors in Groups – Robert Wiltbank, Warren Boeker (Our findings in this study are based on the largest data set of accredited angel investors collected to date, with information on exits from 539 angels. These investors have experienced 1,137 “exits” (acquisitions or Initial Public Offerings that provided positive returns, or firm closures that led to negative returns)

Note: Study has severe survivor bias and self-selection bias. Actual results should be less favorable.

o   The average return of angel investments in this study is 2.6 times the investment in 3.5 years approximately 27 percent Internal Rate of Return (IRR). This average return compares favorably with the IRRs of other types of private equity investment. (In the UK it is 2.2 times the invested capital.

o   Three factors that appear to impact these angel investors’ outcomes

1.      Due diligence time: More hours of due diligence positively relates to greater returns.

2.      Experience: An angel investor’s expertise in the industry of the venture in which they invest also is related to greater returns.

3.      Participation: Angel investors that interacted with their portfolio companies at least a couple of times per month by mentoring, coaching, providing leads, and/or monitoring performance experienced greater returns.

4.      One factor—angel or venture capital investors making follow-on investments in their portfolio companies—is related to lower performance, although additional research may be needed to better understand these results and the factor that affect them.

o       The most likely outcome in any one angel investment is failure, but ‘winning’ investments are very attractive.

·        Read more: Interesting Articles

o   Mistakes when pitching to an Angel

Whatsapp Acquisition

As the dust settles on the news of the acquisition, the focus will shift from focusing on the outrageous $19B price tag to understanding the rationale for the purchase. To put it in perspective, it's $600m/engineer, 50X returns for Sequoia or $42 for every user. Is it irrational exuberance? 

For a value based investing view, read Aswath Damodaran’s blog.

http://aswathdamodaran.blogspot.com/2014/02/facebook-buys-WhatsApp-for-19-billion.html

tl;dr below

• Value of equity = $19 billion
• Implied required return on equity, given how stocks were priced on 1/1/14 = 8.00% (a 5% equity risk premium on top of a 3% risk free rate)
• Steady state pre-tax earnings necessary to justify value = $ 19 billion *.08/ /(1-.30) = $2.17 B
• Higher the risk or lower the waiting period, larger the implied income.

There are several pathways to delivering these break-even earnings:

1. a)      Continue existing revenue model – WhatsApp charges $1 on an annual basis. If WhatsApp's user base continues to grow at 100% they will have 1B MAUs (monthly active users)  by end of 2014. Combine that with the 1.23B MAUs from Facebook who could potentially use WhatsApp. The user bases are largely complimentary with FB dominant in US/Europe and WhatsApp in India, Latin America and other emerging economies. Given that FB has its cross hairs on user acquisition, the user base will grow to justify the acquisition. Moreover FB could potentially charge more per user by integrating add on features. Say $2/user and 1B users could justify value.
2. b)     Advertising revenue from Ads - Facebook generates $6/user pa worldwide through advertising. If we were to assume that FB can extract the same ad $/user, it will take nearly 7 years to recoup the investment. However, ad revenue per user on mobiles (77% access FB on mobile) is less than PCs but more importantly WhatsApp has stayed away from ads and will likely do so in the near future. This is not to say FB will not be able to onboard these users onto their platform and charge for ads. Moreover FB could integrate add on services into WhatsApp in the near future. It’s no secret that Facebook has executed its mobile strategy flawlessly in 2012 and 2013 and will likely have a combined user base of 2B in the next 2-3 years. With 2B users, it will be easier to justify value.
3. c)      Get more users and revenue will follow – While an acquisition cost of $42 per user seems a lot, it pales in comparison with $130 per user for FB, given the $170B valuation for 1.2B MAUs. Depending on how you model it, the valuations could be wildly different.

Edit – Prof Damodaran’s blog is an excellent source, if you are interested in corporate finance and valuations (esp Beta's and market co-variance)

Beyond the numbers

Several articles explain the relations between valuations and number of users but the underlying theme for WhatsApp acquisition has been irrational exuberance. However there seems to be a method to the madness that can’t be solely explained by numbers.

1. a)      Teenagers – After much denial, FB finally admitted that they were losing teenagers. Capturing, WhatsApp users who are fairly young is vital for FB to stay relevant.  Number of likes and level of activity determines FB’s ability to price ads and compete with television for advertising supremacy.
2. b)     Emerging economies – FB has 50% of the 2B users who have access to internet. Majority of these users are in the developed countries and the remaining users are firmly entrenched in local social networks such as weibo, renren,wechat,vk.com etc. WhatsApp gives FB access to many of these countries that would be impossible otherwise.
3. c)      FB login – The battle between FB and Google for your information has only intensified with these companies offering ‘Login with Facebook’ or ‘Login with Google’. An easy process to log into any participating site but actually an attempt to capture your information to target relevant ads. Arguably WhatsApp opens the possibility for users to log into their accounts using FB login. Nearly a billion users potential logging and the associated network effects needs to be modeleda in the valuation.

So how does this affect Intel?

FB recently announced a consortium (Internet.org) to reach the next 5B users. Heavy weights such as Qualcomm, Mediatek,Nokia, Samsung, Ericsson and Opera are members of this consortium to make internet affordable to the masses by lowering the cost of the device and data. Without a mobile product intercept, Intel unfortunately in not a member of this consortium. Facebook’s WhatsApp deal can jumpstart Internet.org plans and wouldn’t be surprised if Mark Zuckerberg announces plans to introduce devices to strengthen the portfolio. Success of this consortium will preempt Intel’s ability to reach the 5B First Time Buyers in emerging countries where WhatsApp is very popular. Intel has to pay close attention to Facebook’s efforts and view them as market disrupters in the mobile space.   

Tips to Become a better investor TL;dr

• "Pick winners" - Very useful advice by some wise man. Right next to - "buy low sell high." Impossible to pick winners all the time but easy to identify loosers.
• Experts "see" more than novices. Become an expert in a domain or industry.
• Experts use patterns to store central insights - no lists or prose - the more patterns you have, the more you can do. Patterns are a natural link to memory 
• Practice - study startup failures, ask the hard questions, be open to criticism.
• Remember there are other startups to invest. Dont invest if you are not comfortable, no need to invest because the herd is moving in that direction. 

Venture Capital Quotes

- To succeed in venture Capital. Learn to pick winners
- The difference between little failures and gigantic failures is the amount of capital raised.
- Advice for entrepreneurs - "Persistence, persistence, persistence"
- "Don't raise a lot of money. Then you'll be on the express train. Take the local train -- it goes slower and there are more places to get off.
- In life you are a motorboat or a sail boat. A sail boat meanders in seemingly winding ways but eventually gets to the destination. A Motorboat takes the shortest route but best of luck if there are icebergs.
- When founders ask for a bridge loan, ensure its not a bridge to nowhere.
- Money for a startup is like oxygen, cant survive without it. However, all money is not the same. Pick investors wisely.
- Business opportunities are like buses, there's always another one coming.- Richard Branson
- You miss 100% of the shots you don't take. 

Frameworks for Business plan evaluation Part 2 - Scott Meadow

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Framework - Scott Meadow/Kaplan - 4M model<br />
<ol>
<li>Money: how does the company make money? revenue model? sustainable?</li>
<li>Management: Capability, Track record, Hubris</li>
<li>Market: competition, market trends etc&nbsp;</li>
<li>Model: Business models, scalable, size of market.</li>
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Venture Capital Valuation

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Valuation terms<br />
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<li>Full dilution: Full dilution counts not only shares that have been issued but also all shares that would be issued if all options and warrants were exercised and other promises or contingent agreements to issue shares were given effect.</li>
<li>Investors’ (initial) percent ownership: The percentage of a company’s full dilution shares that the investors own, at the time of investment, including the shares issued to the investors.</li>
<li>Money: The amount of capital being invested in the round.</li>
<li>Post-money valuation: Post-money valuation is computed by dividing the money by the investors’ percentage of ownership.</li>
<li>Pre-money valuation: Pre-money valuation is computed by subtracting the money from the post-money</li>
</ul>
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Warrants: The investors may get warrants (or non-qualified options) to purchase additional shares. The factors to consider:</div>
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<li>Warrant coverage: How many additional shares the investors can purchase relative to the number of shares they purchase outright—10 percent, 30 percent, or even 100 percent.</li>
<li>Strike price: Relative to the price of the underlying security the investors get.</li>
<li>Stock choice: Whether the warrants are to purchase <b>common stock or preferred stock</b>.</li>
<li>Warrant life in years: This varies but can be, for example, one, five, or ten years.</li>
<li>Kicker versus substantive change: Warrants can provide a small “kicker” (5 percent coverage with a one-year warrant, for example) or can materially affect the valuation (100 percent coverage with ten-year warrants).</li>
<li>Effect on the valuation: You need to consider the time cost of money since warrants need not be exercised (converted to shares) until a much later date</li>
</ul>
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VC industry follows the power curve - s<span style="background-color: white; color: #333333; font-family: ff-tisa-web-pro, Georgia, 'Times New Roman', Times, serif; font-size: 18.1818180084229px; line-height: 23.3766231536865px;">implistically, the best investment returns more money than the rest of the investments combined.</span><span style="background-color: white; color: #333333; font-family: ff-tisa-web-pro, Georgia, 'Times New Roman', Times, serif; font-size: 18.1818180084229px; line-height: 23.3766231536865px;">&nbsp;</span></div>
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<img alt="top1001" src="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1001.jpg" height="374" width="640" /></div>
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<a href="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/toptech3.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"></a><a href="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1002.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img alt="top1002" border="0" src="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1002.jpg" height="384" width="640" /></a><a href="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1002.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><br /></a><a href="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1002.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><span style="background-color: white; color: #333333; font-family: ff-tisa-web-pro, Georgia, 'Times New Roman', Times, serif; font-size: 17.7777786254883px; line-height: 23.3766231536865px;">The next chart breaks down the top 15 investors based on the stage they invested in the companies.</span></a><a href="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/top1002.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img src="http://www.cbinsights.com/blog/wp-content/uploads/2014/03/toptech3.jpg" height="392" width="640" /></a></div>
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