Blog Article

Whether you’re a spectator, or actively involved in a startup, you have to know about Failure. What it means, why it happens, what happens before or after and if things work in your favour, how you can recoup. A common line we’ve read everywhere, including on Forbes.com – is that 90% of startups fail. This highly publicised line is not a stint, it holds with good reason. Networking with the right people, finding investors, startup fests, marketing campaigns and resources to run a startup are more easily available and possible now than they did a couple years ago. There’s no doubt that we see more startups and entrepreneurial ventures popping up now at a pace that we’ve never known before! When startups rise this quickly, they fall just as hard!

Since the year 2014, India has produced almost as many startups as the United States of America or the United Kingdom each year. Funding was at an all time high in 2015 with investors rushing in to get a little piece of the action with the fear of ‘missing out’. Though the Indian Government has taken several initiatives towards simplifying starting and conducting business in India, the country still lags behind on the ease of conducting business index. Though that is a separate debate entirely, it is in consequence to the startups failures in the past year as startups either consolidate or shut shop completely.

Most founders know that only one in around every 1000 startups becomes successful and even lesser becomes part of the prestigious unicorn club. While we see the number of startups getting funded drastically reducing, several investors have lost their money and new startups aren’t getting any funding.

Let’s further analyse in detail why startups Fail:

1. Not Legally Covering The Startup

Startups usually form when a bunch of peers, friends or colleagues get together to execute a business idea. Only a very few founders have a legal degree, practice law or are familiar with the laws in the startup and corporate world. Little do founders discuss the legal aspects of the business relationship they are entering into. Whether it is a founders agreement, hiring employees, a vendor agreement or getting intellectual property rights registered, a startup must use contracts to secure its position.

Hiring a lawyer or availing third party online services would be in the best interest of a startup to prevent against litigation and in case a legal situation does arise, legal counsel should be an entrepreneur’s first resort.

2. Not Registering In Accordance With The Provisions Of The Law

Sometimes, whether knowingly or unknowingly, companies get into a tangle with the administration or the law because of direct competition with state-owned subsidiaries, monopolising the market, not complying with the provisions of the Companies Act after registering or conducting an unlawful business activity. It is important to follow the laws of the country and the laws of the state as applicable. LegalDesk.com offers services for registering a start up along with providing insightful knowledge on the type of entity a startup should register as. ZipGo is an example of a company that got entangled with a state authority (BMTC), as well as examples of other smaller startups that collect payments but are not registered and hence such payments should not have been accepted in the first place.

3. Overvaluation Of A Startup

After a startup has formed and has a tested idea that’s proven successful, they usually need funding for operations, to scale, for hiring expertise, product development, design, etc. At this point, most startups think they have the potential to be the next unicorn. Absurd valuations always ensure that the company will not be able to live up to their reputation because in most cases, the startup’s don’t make the money back or they cannot raise more funding because the same equity cannot be valued lesser at a later stage. A valuation should be ‘reasonable’ and based on the cash flow, revenue, profits and overall business proposition of the startup. When investors invest millions on a company that will never make that same amount in revenue, they would lose out on the money invested and the startup might have to shut shop.

4. Over Or Under Funding

Funding is money invested by an investor for a share in the equity of a startup. There is no set valuation method for understanding the value of a startup. Different investors look at different things to estimate their value of a startup. Shark Tank is a good example of how investors value businesses fairly. The biggest mistake startups make is not whether to get funding or not, but how much equity to give up in exchange for how much funding that is required.

Overfunding is pumping unnecessary amounts of money into a startup that doesn’t require the money or the startup spends money invested inefficiently. The investor loses out on such a deal.

Underfunding is getting too little funding at the right valuation, too little money for too much equity or a startup missing out on the obvious need of cash inflow. Underfunding and overfunding can cause an otherwise moderately successful business to close down.

5. Not Having A Revenue Model

Though most startups start out without a revenue model, it is important to have one in sight for the foreseeable future.

The main reason for not having a revenue model is because a product is still in testing, the company doesn’t know what or how to sell, the business might have pivoted, or enough money is invested for the business for the founders not to worry about having a revenue model. Well, the sooner you have a revenue model figured out, the less susceptible is you startup to fail. A revenue stream is what will keep the wheels of your business running once it progresses from being a startup to a company. So at some point, it is quintessential to understand and prioritize the revenue stream/s of a company.

6. Failure To Have A Clear Plan And Vision

Though it does not affect a business from a legal perspective, it is still important for the founders to have a clear plan and vision for the company. If the objective is to build and sell, cash out at a later stage, get acquired, in which direction to take the business, etc. the business should make these goals clear and work towards it without a conflict of interest. Silicon Valley has given us several examples of startups that fail because the founders lack a clear path. The plan and vision should be in the articles of association and memorandum of association. Anything a company does apart from what is stated in these documents will be considered void.

7. Over Expenditure On The Unnecessary

All startups get influenced by the way startups run abroad. The main objective is to attract the best talent by offering absurd packages and amenities in the office. This leads to expenditure on non-performing assets like sports rooms, play area, etc. Most startups are unable to pay for such services and end up with a much higher burn through rate when the startup spends unnecessarily leading to the startup to fail.

8. Bad Decision-Making

Most of us learn through mistakes so it isn’t a cardinal sin, though it could be seriously perilous to a startup. Sometimes, entrepreneurs leech onto the decisions after committing to something. Even if the decision turns out to be failing, it is important for an entrepreneur to pick up on the metrics that matter and make informed decisions. It’s better to admit a mistake and change a decision rather than to pursue a hopeless cause by sticking with a failing decision.

9. Breaking The Law

Some startups either knowingly or unknowingly may break the law. This could be accepting payments without registering a business, not obtaining the required documents, not paying taxes due, not adhering to the employment or the Companies Act and so on. It is important for an entrepreneur to seek legal advice and help from a legal professional while starting and conducting business. This would save a startup considerable time, effort and resources which are scarce in the startup world nowadays. Quite recently, several scams were unearthed in Mumbai by the CID. The consequences could be either a fine, jail time and/or both. The ever popular track ‘Breaking The Law’ by Judas Priest seems apt to describe this passage.

10. Investor’s Fear Of Missing Out

Everyone’s seen the meme ‘Take My Money’ from Futurama. The meme seems apt to describe what investors have done over the past couple of years with the startups in India. Investors with ample funding capacities didn’t want to miss out on the opportunity of turning a hefty profit by investing in a future unicorn startup. This led to investors pumping money into startups without conducting a feasibility study, a cash flow study, studying the business and the entrepreneurs to be invested in and so on. As a result of this, most startups don’t succeed anyway owing to other factors that might cause a business to fail irrespective of the additional funding pumped in.

11. Lack Of Experience

In the world of startups, every third person aspires to be an entrepreneur. Most entrepreneurs have an air of ‘I know it all’ and an arrogant attitude to pair that up with. Not only are these characteristics a turnoff but also lead to bad decision making. Young entrepreneurs tend to more often than not fall into this category. This affects all interactions a business may have with vendors, employees, investors, clients or even general users. Maybe there should be a course for entrepreneur etiquette for those that do require it.

To Conclude

With the information available out there, it should be easy to identify what problems a startup faces and fix those problems. Yet, we still see so many startups flounder and fail. It is either owing to the ignorance or lack of experience on part of the founder, and these issues can be rectified. Sometimes the product just doesn’t work, a competitor coming up with a better solution, bad business cycles or any other uncontrollable factor might also contribute to the failure of a startup. When that happens, there is little a founder can do to save the startup apart from evolving, branching out or cutting its losses. In order to help you start and run your startup successfully, the experts here at LegalDesk.com are at your service whether it’s a service relating to company registration, company incorporation, legal business documentation, or legal assistance, we are here for you.