Whether you plan on becoming the next Atlassian, or the next big thing in the share economy, many people, at some stage, will have their own new business dream.
And in 2017, the startup space to be in is tech. Hundreds upon hundreds of adventurous and enthusiastic minds are venturing into the tech space with dreams of being the next big thing. Indeed, in just the first half of 2017, 71 private investments and acquisitions in the tech space alone racked up $564.1 million worth of deals.
Among them, some seriously promising startups that raised anywhere in excess of $100million USD via several founding rounds, failed.
Throw the cryptocurrency phenomenon into the mix, along with the trend toward Initial Coin Offerings (ICOs) and anyone with the right offering can dream big.
Indeed, new business ventures are a cornerstone of a thriving and successful economy, and everyone is entitled to think big at least once in their lifetime – about how your new business idea is going to change your life and set you up for the future. But what stops many potentially life-changing business ideas before they’ve even seen the light of day is the reality that starting a business isn’t easy or free, and that there a long list of barriers that need to be overcome.
While that may sound like an obvious statement, with startup funding being the most obvious starting point for all new businesses – yet it’s the costs that many burgeoning business owners overlook that cause them problems.
In more than 20 years legal practice I’ve worked with hundreds of startups and have seen some common themes as to why they fail.
On the bright side, they can be avoided. It’s about being aware of some simple principles and preparing accordingly.
Far from this being a generous pouring of cold water on the brilliant ideas of Australian hopefuls, the intent is to help those hopefuls understand exactly what they’re in for, and how to properly prepare.
The top five hidden traps that can stop a startup in its tracks:
- Lack of commitment from founding partners
It’s hard to start a business on your own and you often need partners in crime so to speak to share the load. However, founders often drop off in the first 6 -12 months. They do so for many reasons but most commonly it’s due to finances (i.e. lack of salary or low salary) and lack of commitment (they didn’t think it was going to be this hard – it’s easier to get a job).
So, when founders leave, problems can arise in regard to their equity – do they get their money back? And at what value?
The answer is to ensure there is an agreement between founders, known as a “Founders Agreement” or alternatively a “Shareholders Agreement” which deals with the initial phase of the business, but also what happens when someone wants to leave. This is where an increasingly popular concept known as Founder Vesting becomes relevant.
- Overestimating sales
Most start-ups can predict their costs for their initial operational period. However, most terribly overestimate their potential income. This is usually due to poor marketing, poor ability to convert users into paying users, sales (that is – time between meeting a prospect, landing a sale, and revenue coming in – particularly with corporate clients) and sometimes, simply that founders don’t have the right skills to sell.
- Digging a deeper hole
Often an idea at concept stage is great, but as you get into it, challenges arise. For example, you quickly discover user uptake isn’t what you expected, or you didn’t anticipate the capital required to be successful.
The challenge at this stage is to know when to pivot to a new idea or when to shut down and cut your losses. However often, ego takes over. Founders don’t want to give up their dream and admit they made the wrong call. If they keep digging a deeper hole, often they and their investors will fall into it.
- Not understanding the regulatory space – and having no money to pay for it
This is quite pertinent for fintech startups. Many start-ups do not consider the legal, regulatory or compliance aspects of their businesses. Many also do not set aside adequate capital to pay for meeting their obligations.
I’ve seen startups shut down because they don’t have the ability to meet the requirements of an Australian Financial Services Licence or Australian Credit Licence (where either is needed). Sure, the ASIC sandbox may help, but this simply delays the inevitable compliance obligations.
- Not enough money
This is linked to the sales and capital planning issue. In summary, the start-up runs out of cash as it simply hasn’t gotten its financial projections right, nor has it been able to raise capital.
Alternatively (and quite often) the start-up attracts seed capital from what we call the three Fs (family, friends and fools), but the business requires significantly more capital to be successful and cannot raise subsequent rounds.
Founders are also often caught in the infinite loop of raising capital. Instead of raising capital and then working on the business, the Founders raise money via a drip feed. This means they spend their time constantly presenting to investors and chasing investors instead of working on their product.
In short, raising capital is hard. The ability to attract capital depends on a range of variables including:
- Connections of the founders or seed investors.
- The founders themselves – investors often invest in people and not businesses. Perhaps the investors do not believe the founders can deliver.
- Product type – what was sexy for investors yesterday, isn’t necessarily sexy today.
- Lack of worldwide focus.
- Poor user take-up of their product.
So, a concrete and realistic fundraising plan needs to be in place before a business should consider itself ready to launch.
The point is to seek the right advice and be sure you’re ready. Optimism and enthusiasm are great qualities to have, along with resilience, when trying to start a business. But they’re a lot more useful when you are fully prepared and ready to go.
Know your people, know your obligations and more importantly, know your product. A little bit can be made to go a very long way in this respect.
About the author
Darren Sommers is a Principal Solicitor at Melbourne’s KHQ Lawyers. He has more than 20 years’ experience providing general commercial legal advice and specialist technology law advice to clients in the IT industry and other technology industries.