Econtrepreneur.com

There are literally a million things that can kill your startup. Worrying about all of them will likely drive you nuts, and distract you from the “holes” right in front of you. So with an eye on the hole right in front of you, let’s take a side eye to the five general categories of risk that can doom your start-up and how you can best avoid them: product risk, market risk, financial risk, team risk, and execution risk.

Product risk is what most early stage founders and investors most commonly fail to measure. It is best framed in the economic measure of consumer surplus (the gospel of which I am an avid disciple). Are you producing something people want because the cost of acquiring it is far less than the value it provides to the user? To answer this question, you’ll need to listen (yes, stop talking) to a LOT of customers. Ask them how they do things, observe how they solve their needs. Question the root cause of those needs. Seek first to understand them before you begin showing off your so-called solution. When you can make something they actually want really badly for a cost far below what they are willing to pay, you have product fit.

Market risks that can doom your startup are most often found in distribution problems, market size, and competition/substitutes. Even if you have a product with massive consumer surplus for a party of one, you’ll never have a massive business if the total size of the market is minuscule, you can’t find a channel to get it to market, or if there is a competing solution that is half your cost. Most companies die because they fail to solve market risk by building effective sales channels. Too often VCs cite a company with a lack of product-market fit when in reality, the company has a great product and zero marketing. To solve this, focus on how you can make purchase decisions easy: convenient location of sale, ease of technology, elegant UI, one-click buy, marketing channel exploration, CAC/LTV ratios, etc. This is why we advocate for maker-founders to seek out help from proven marketing and sales guru investors who put in money and time into your company rather than advisors who both those things out of your startup.

Financial risk becomes a problem when the fundamental costs of doing business generate insufficient returns to sustain your business. Some are short term, like making payroll next week if your runway is going away. Some are longer term, like high upfront capital costs from inventory or equipment required to make or distribute your product/service. The key here is to keep a tight lid on costs and try to get profitable as fast as you can. Avoid splurging on that fancy office when a shabby one will do just fine (and use the savings to add the additional sales person who will help resolve this problem). If your company has significant upfront costs, you’ll need to carefully manage inventory levels and development expenses so that you don’t run out of runway before you’re ready to take off. Too often I hear founders complain that their company failed because they couldn’t get funding, when really, they couldn’t find a way to develop the product and market fit with the resources they had, when it was entirely possible to do so. They just failed to have a financial plan to match their access to resources. Yes, it does take longer to build a company without funding from VCs, and yes, we often don’t understand what we’re doing. So if you’re the smart founder who does “get it”, live within your means to do so.

Team risk is why most seed stage companies with $50k-$100k MRR fail to raise their series A. No one is going to drop $3-5mm on a company that, if the founder is hit by a bus tomorrow, blows into dust with them. Nor will a VC put real money into a team that has only product skills. If you want money to scale, you need to show that you can build a team that is better than the founder and has complete skills (product, marketing, sales, customer support, and finance). This means you not only need a team, but a team that says, “we’ve got this”. Hire folks who’ve done it before or have such impeccable academic qualifications that their abilities are not in doubt. Hire away a key person from a HOT growth company who has experience with the growth challenges you face right in front of you (note: Google is not a hot growth company, it is a stale corporate machine).

Execution risk will be the subject of a post later this month, but to summarize it best, it is when you get to $3mm in annual revenue and think you’ve “made it” when really, you haven’t even started the real race yet. The ability of a company to grow quickly under pressure, hire the right people, put in place proper culture, incentives, and relationships so that the company can prosper and run full speed is far, far harder than anyone thinks. Execution risk is the killer of would-be unicorns and turns them into someone’e distressed asset purchase or family business. Your ability to create a culture of performance aligned with your customers needs and economic value model will be the key to getting things done as you scale. If this is your start-up, DM me, and we’ll talk further. A paragraph here just doesn’t do that sentence justice.

So, overall, start thinking about how you can de-risk your startup by looking at these risks and how your daily activities, weekly and monthly goals help eliminate them as best possible. You’ll never get rid of them, but you can sure sleep better at night if you do.

Some time around 2016, a company that was raising at a lofty valuation pitched to me requesting capital from one of Sputnik ATX’s antecedent funds. The company pitching was WeWork.

The heart of their presentation was a claim that WeWork represented a new model for coworking space that was going to revolutionize coworking from stodgy folks like Regus, a profitable competitor. At the time, WeWork charged less than Regus to use office space and WeWork had significantly higher unit operating costs, customer acquisition costs, higher churn, and a significantly riskier customer base.

I pointed out to their pitchman that they had lower unit revenue and far higher unit cost than their competitors. How could they make money?

They responded with more of the same balderdash. WeWork’s plan to overcome negative unit economics was to make it up on volume, as they grew faster and faster with additional investment.

Poppycock.

This reminds me of Paul McElroy in the old SNL skit, First Citywide Bank, who claims the bank makes it up on volume. Thus the old joke, “I lose money on every one I sell, but I make it up on volume.”

If your marginal profit per unit sold is negative, no amount of volume will help you be profitable. Taking investment to accelerate losses makes the situation worse.

Blitzscaling is taking in large amounts of venture capital for massive customer acquisition growth in a short period of time. Growing so fast, you can’t be ignored, and then basking in the glow of a sustainable, massively profitable business.

A Blitzscalable business must have positive unit economics so that scaling increases profits, over and above overhead expenses and marketing costs. In short, the net profit selling each unit accrues faster than your expenses. When this happens, your company becomes profitable and sustainable.

Over the past few years large amounts of venture capital have poured into negative unit economic businesses that tout “volume” as the solution to their woes. Unless those businesses have some monopolistic plan to dominate the industry and then jack up prices to alter the unit economics, they will fail.

Of course, they could be hiding a novel new technology that will disrupt industry cost structure to make the unit economics positive, but if they did, why aren’t they using that technology now?

For example, Uber analysts tout that the company may be profitable when driverless technology becomes broadly available. This begs the question why they’re just figuring that out now, after massive investment on a different thesis, but I digress.

Bottom line: when your unit economics are negative, the business is unsustainable and you are blitzfailing if you raise capital to dig your grave at an accelerated pace.

Instead, resourceful entrepreneurs should create disruptive innovation that dramatically lowers the cost to solve a customer’s problem or provide a new, novel service that generates massive consumer surplus that cannot be ignored.

If you choose the path of the resourceful entrepreneur, unit economics and the market will reward you handsomely.

Author’s Note: yes, I love old words like poppycock. So precise!