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Forward This To Your CFO: 3 Reasons Startups Bleed Out Before Making It

As founders, we often hear fear-inducing statistics like more than half of all startups don’t make it past their 5th anniversary, or that 90% of all startups fail. 

Startups don’t fail for the same reasons, but research from content marketing agency Fractl revealed that the number one cause of failure for funded tech startups is: running out of cash.

This problem is not new.

In early 2000, Boo.com famously burned through $185M of their funding in 18 months before they crashed. The experience prompted even the startup’s co-founder, Kajsa Leander, to call themselves “the poster child for the failure of e-commerce on the Internet.”

Theirs is the story of financial mismanagement, and despite co-founder Ernst Malmsten thinking at the time that the world will not see “the madness around the new economy” ever again, startups continue to make huge money-burning mistakes.
 
“When you raise a lot of money easily, it’s easy to try to solve your problems by spending money.” - Justin Kan, Co-Founder, Justin.tv


The good news is we can learn from the past, and from those who have been there, done that.

Here are 3 reasons startups waste money, and ways to stop the bleeding.

Reason #1: They Hire Too Soon.

Don’t buy into the myth that you need more people to create more value for your business. The Lean Startup author Eric Ries says this kind of thinking can lead to waste and additional overhead costs. An influx of new employees without verifying their necessity can even make existing hires less productive.

Instead, Ries suggests that founders try out all new roles themselves first. You’ll be able to identify which roles are crucial, and which actually require more skilled employees for proper execution. If it can be done by the talent you currently have, there’s no need to hire extra people.

Paul Graham of YC Combinator also warns that “the main way to spend money is on people you don't need. The more people you have, the harder it is to change directions.”

As an example, Singapore’s wildly successful real estate platform Property Guru’s Co-Founders Steve Melhuish and Jani Rautiainen took over all key departments in the early days of their company.

They identified their first key hires where they needed specific expertise, and then split the rest of the tasks and departments between themselves: sales, marketing, and business development were done by Melhuish. Rautiainen took care of the product, tech, finance, and operations.

Scaling too early

When you decide to scale and you are scaling too early, this can bring in costly senior management before it’s actually necessary. Vacation rentals company Roomorama learned this lesson early on. “Bringing on senior management should be a revenue-driven move,” says Co-founder Jia En Tao. For her, these positions should generate “enough sales to be paying for themselves.”

Roomorama’s revenue-driven hiring strategy has also been helpful when it comes to delegating to non-founders, “...founders need to ensure that the business model is sound and sustainable, before passing on the reigns to non-founders (whose goals may not be revenue-maximization, but other things).”

So what are the triggers to hiring specific types of roles?  Carrie Simonds from game developer Pocket Gem looks to headcount as an indicator of the type of employee you need. "The ideal employee for a 3-person unfunded incubation may not be the best fit for a 50-person company looking to expand overseas." 

Reason #2: They Spend It, Because They Raised The Money.

So, if you’re not spending on hiring until absolutely necessary, what should you be spending on?

One of Paul Graham’s rules for raising money: Don't raise money unless you want it and it wants you. “Such a high proportion of successful startups raise money that it might seem fundraising is one of the defining qualities of a startup. Actually it isn't.”

“The reality of fundraising is a lot of times, a lot people think its some sort of metric of success. But really the metric of success is if you can quickly process that capital and turn it into new, better and more improved metrics that you’ve agreed upon with your investor.”
- Matt Tillman, CEO & Co-founder of Haven, speaking at a recent Startup Grind event in Singapore.

Graham goes on to explain that you should only raise money if it is going to help you grow faster and you can  - and if it won’t, don’t raise it.  Aside from damaging your ability to increase your valuation at future rounds, the biggest danger is the money itself, because spending too much can be disastrous for an early stage startup.

For Jia En Teo at Roomorama, the spending needs to be directed squarely at customer acquisition, even more than product. “Product is important, but it does not need to be perfect from the get-go. I believe in iterating and improving product over time, with customer feedback,” says Teo.

Reason #3: They Spend on “Startup Culture” Instead of Their Own

While it may be true that in-office privileges and expensive employee perks have become part of the so-called startup subculture, there are many who have started to challenge these new “norms.” 

Sujan Patel, Co-Founder of Web Profits, advises ditching expensive office equipment and to spend money only on the equipment necessary to operate the business.

And rightly so, because spectacular examples of overspending on offices can sometimes seem like there is a focus on “startup culture” vs. your actual culture.  Examples abound: like $3 billion Powa that went bankrupt last year due to “overspending on lavish offices and partying”. Or the even bigger wake-up calls, like Dropbox, who in 2016 cut down significantly on lavish perks.

The important thing to realize is that when it comes to engaging employees in a startup, its not a one size fits all solution, and not everything that builds a great culture costs a lot of money. Burpple Co-Founder and CEO Dixon Chan learned that what engages one team may not interest the other. Let’s face it, there are really different types of people on tech startup teams - from developers to marketers - and very different personality types. Offering different--yet congruent--activities can yield better results.

What Dixon does at Burpple is he encourages different teams to build their own communities. For example, Burpple’s Co-Founder & CTO, Daniel Hum, has a regular “tech tea time” with his engineering team, where engineers discuss and share the latest tech innovations in the industry over tea.  

Similarly, Jayne Tan, VP of Content & Community leads her own version over lunch where she and her team explore and share about the latest F&B trends and community campaigns. He stresses that culture takes time to build, and you have to put in the work from the top. 

“It's the interest among people, built over time, that will sustain them. This becomes part of the company culture. You know it's part of your culture when people share ideas anytime.”
- Dixon Chan, CEO & Co-Founder, Burpple.

Best of All

Best of all, it's not about spending huge sums of money - it's about finding what matters to people, and operating within a culture of openness that allows people to find and pursue what matters to them.

Blanket spending on big-ticket items - like game rooms or elaborate offices - may appeal to some at a superficial level, but it doesn’t help people develop their careers.  Spending is an easy cop out, an attempt to “fast track” culture.  According to Dixon, “there is no such thing as instant culture.”

“The benefits of running lean are innumerable,” says Brennan White, Founder and CEO of Watchtower. This is crucial, especially for startups not only in an early stage but those who are not profitable yet and “living” off of venture funds. It’s never too early to think long-term, and curbing unnecessary expenses should be top of mind for all founders and their their teams.

Comments

Very helpful advice in this particular post! It’s the little changes that make the largest changes. Thanks for sharing!

happy wheels @ https://happywheelsreview.com/

Reply 0

Patrick nails the problem, and it's one of the reasons my partner and I stressed the three most critical startup factors are: Cash Flow, Cash Flow, Cash Flow. As both an entrepreneur and as an angel investor, I've also advised others "Don't hire a CFO, be one" - you need to understand your business at a financial level. Too many entrepreneurs, especially in tech, understand the technology, maybe even their market, but not money management.

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