Why Start-ups Fail
Entrepreneurs usually put the blame on lack of capital. But more often, the problem is how they use the capital they have
You always hear that the vast majority of new businesses fail because they're undercapitalized. I don't buy that. It's true in maybe 50% of the cases -- no more. I'll give you an example from the software company I do business with in California. Two of its employees left to start a competing business. They contacted me because I was a potential customer and they wanted me to help finance them. They had a plan of sorts, built around signing up 60% to 70% of their old employer's customers in the first year. I wasn't interested, but I kept in touch. I think in the end they raised about $200,000.
So what was the first thing they did? They rented a beautiful office suite and filled it with lavish furnishings. Understand, at least 90% of their prospective customers were outside California, so they were never going to see the company's offices. Soon I received a brochure the new company had done up. It was elegant, and so was the stationery. When I called the guys up, I said, "That sure is beautiful stationery you have, great logo." They said, "Oh yes, our PR people did it for us." I laughed. Then I got an invitation to their grand opening, a really extravagant party. Of course, almost none of their customers could attend it.
A couple of months later, I was at an industry meeting, and I ran into the old employer. He was very upset with these guys. I said, "Don't worry, Tim. They're going to fail." He said, "How can you be so sure?" I said, "Trust me." They were out of business within a year. I called them up and asked what had happened. They said they were undercapitalized. Baloney. They'd raised $200,000 and thrown $120,000 out the window.
That's a very common story. People who fail on their first venture always say they were undercapitalized, and I suppose they're right in the sense that their capital ran out. But it's not because they didn't have enough capital to start out with. It's because they didn't use their capital wisely.
So why does that happen? Part of the problem, I believe, has to do with optimism. When people go into business for the first time, they have wonderful, wonderful dreams. They think they're going to be successful in the first year and make a ton of money. They're wildly optimistic, and at the same time they're scared to death. They're thinking, "Oh, God, I'm never going to make it." Meanwhile, they're projecting 10 times more sales than they can possibly do.
It's weird, but those two things -- fear and overoptimism -- almost always go together. I guess people use optimism to overcome their fear. They do everything they can to bolster their confidence. They believe that they'll improve their chances if they just act the part. So they rent a fancy office in the most expensive part of town. Or they join an exclusive country club. Or they invest in a computer system they won't need for two years -- if they're lucky. Or they do what I did -- drive around in a brand-new Mercedes. When I later read about Sam Walton and his beat-up old pickup truck, it dawned on me that the truly successful entrepreneurs don't need those symbols of success.
I eventually realized that you can always tell when people are going into business fresh, without a plan, without knowing what they need to do to survive. All you have to do is check out their offices. Are there drapes on their windows? Did they upgrade the carpeting? Are the walls painted or papered? Did they rent more space than they need? Is the reception area too big for a company whose customers rarely come in? Those are all potential signs of trouble. When you see them, watch out -- especially if people are asking you to give them credit.
Of course, if you happen to be one of those first-time entrepreneurs, I can only say this: Forget about image. Forget about making a splash. Forget about everything except getting your capital to last until you don't need it anymore. You don't have to give up your dreams. Dreams are important. Just wait until you can afford them.
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Norm Brodsky is a veteran entrepreneur whose six businesses include a former Inc. 100 company, a three-time Inc . 500 company, and a start-up that he hopes will become eligible for the list in 1996. His column, Street Smarts, will appear every other month. Readers are encouraged to send him questions care of Inc.
This column was coauthored by Bo Burlingham.
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