Early-stage startups must go through a sanity-check process as early as possible. The definition of a sanity check varies, but the basic one is as follows: a sanity check is a basic test to quickly evaluate whether your business plan makes sense by verifying that your assumptions are supported by evidence.
Why is this process so important? A recent CB Insights study indicated that the top 3 reasons startups fail are:
These risks should be addressed EARLY, and the best way to do it is to engage in a sanity-check process, with the objective of reducing risk and increasing the startup’s chances for success. I recommend using a scorecard and not just asking and answering questions, because the numbers may tell you a story that a discussion won’t.
Later on, I’ll share an example I’ve used several times with great success.
Let’s review these top 3 failure factors one by one.
1. No market need (42%)
Ask yourself some of these questions to make sure you’re not trying to sell something the market doesn’t really need:
Market opportunity: Are you really solving a real pain? Do customers really need your product? Is your product a “nice-to-have” or “must-have”? Is the pain big enough to justify spending money on solving it? What is the addressable market size, market growth potential, and segmentation within the market? Is this the right time to approach this market? Have you used both a bottom-up and a top-down approach?
Customer dynamics (B2B): Is the potential customer/decision-maker aware of the problem and your solution, or do they need to be educated? Is solving the problem you are addressing a top priority for them? Is your champion in the organization a decision-maker, or will they need to bring in others? Did the organization allocate a budget to address the problem you are solving?
Competition: What is the competitive landscape? Who are the competitors, and what are they doing better than you? What is your added value and “unfair advantage” compared to the competitors? How will you beat the competition?
Go-To-Market Strategy: What stage is your product development at, and what is the roadmap? Current customer acquisition rate? Partner relationships? How will you sell your product? How will you get early adopters and make them happy so they will serve as references for new customers? How will you address the rest of the market after you get the early adopters, and long will it take? How will you reduce their perceived risk of buying from a startup? What will your sales organization look like? What is your marketing strategy? What is your initial target market? If you succeed there, how will you penetrate subsequent markets? Are you realistic about your expansion assumptions?
Financial Projections: How much money will you spend, and how much money can you make in the next few years? What will your cash flow look like, and what kind of funding will you need going forward? How much funding? What will you use it for?
Exit Scenarios: What is your endgame? If you succeed, who will buy you? When? Are your objectives aligned with the objectives of potential investors (especially VCs)? If you don’t think of an exit, what is your growth strategy?
Comparables: Are there any comparable companies that can be used as evidence for all your answers to the above questions?
2. Lack of cash (29%)
I will not elaborate much on this one, as I think this reason for failure doesn’t always stand on its own. It is the result of failure to address other areas such as market product fit, time to market, the right team, and many other success factors, and not necessarily the cause. However, there is a significant planning and forecasting factor in the sanity-check process that should be professionally addressed. Many startups underestimate what it will cost to achieve success. It is crucial to evaluate the resources required and to prepare a realistic, even if somewhat aggressive plan. Then sanity check it against a comparable company. Underestimating costs and showing ridiculous growth will not impress investors who know better and may kill your startup.
3. Wrong team (23%)
This is a major risk that founders usually tend to neglect.
Founders: In many startups I’ve worked with, the founders got together due to an opportunity, not due to much thought or planning. So what should the founding team look like, and must each of them bring to the table? There are two core challenges that matter in a startup: building the product and selling the product. It’s important that, among them, the core founding team will have the skills to do both, for their specific product, and in their target market. For example, if a startup has a very complex technical challenge to solve, one of the founders should be very technical. If the technical challenge is small, but the marketing and sales challenge is huge, maybe a very technical founder is not a must. The technical founder will need to iterate on the product and eventually get it right — or you won’t be able to sell anything or raise any money. The sales or marketing founder must sell the product — or your customer base will not grow.
First employees: In my first startup, my first employee (a team leader) eventually became the VP of customer success and stayed with the company for 10 years. These are the people you need as your first employees. Talented team players who see the career opportunity and are here for the long-haul. Kind of like “mini-founders”.
Hiring additional talent: Don’t underestimate the importance of marketing. Everyone thinks they know how to market. Most don’t. Finding the marketers who can help you grow is a critical, yet often-neglected part of early-stage success.
I promised you a self-evaluation tool, so here it is. All you have to do is give yourself a grade from 1 to 10 on each of the tests in the table. Then see your overall score (download the Excel sheet here).