Do You Recognize These 3 Early Warning Signs Of A Failing Startup?


Do You Recognize These 3 Early Warning Signs Of A Failing Startup?

Understanding common startup pitfalls is critical to preventing the all-too-often failure of would-be entrepreneurs.

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The statistics are harsh: 90% of startups fail. That failure often sideswipes business owners, but it doesn’t have to. There are early warning signs that predict startup failure. If any of the following indicators apply to your business, it’s time to step up your game before it’s too late.

1. Relying on paid ads as your primary marketing channel

Silicon Valley venture capitalist Andrew Chen says startups die when they become addicted to paid marketing, and explains how easy it is for startups to fool themselves on customer acquisition costs. Chen says as ad spend scales, it becomes harder to track CPA because scale effects work against you in paid marketing. Run an ad for too long and people get tired of seeing your ads. Your message gets old, and people become less responsive.

There is a ceiling you will hit with paid advertising. Chen advises taking some cues from a paid search experiment performed by DropBox. Instead of continuing with paid advertising that wasn’t working, they stopped and focused on the viral channels that now make up the main features of DropBox. Had they continued pursuing the best practices for paid ads, they wouldn’t be where they are today.

Instead of going all-in on paid marketing, find a way to innovate. Create other channels where possible, and invest the time to build a strong content and SEO strategy.

2. Don’t form an LLC just to get liability protection

Even after forming an LLC, courts can make your personal assets available to creditors if you’ve comingled personal funds with company funds, or you haven’t actually done any business. If you’re still trying to get your business going, it’s best to form a single-member LLC, also known as a disregarded entity LLC.

As a single-member LLC, the IRS will treat your business as a sole proprietorship for income tax purposes. There are several advantages to this approach. First, as a disregarded entity LLC, the IRS will combine your business and personal income/expenses; you won’t have to worry about filing separate taxes.

Also, as of 2018, the IRS provides a 20% deduction on pass-through income for single-member LLCs. This is a significant tax advantage over multi-member LLCs.

Form a single-member LLC until you’re ready to work hard to turn a profit. If you get sued and your LLC is just a shell, you could lose everything.

3. Making big backend promises to investors

If you’re still working out your business plan, you aren’t in a position to make financial promises just yet.

Making big promises without certainty can tank your profits. The film industry sets a perfect example of how easy it is to lose money by making big promises. In the film industry, actors and investors are often promised "points" for their contribution to a film rather than a set dollar amount. Usually, one point is equal to one percent. The question is, one percent of what figure?

This "backend point" scenario explains the dilemma perfectly. An actor is promised "10 points" for appearing in a film, but where those points come from isn’t defined. Does the actor get 10% of the gross, before distributors and investors are paid? Or does the actor get 10% after covering the film budget, domestic and foreign distribution, producer expenses, and other backend commitments?

In the film industry, the actor’s cut should come from the producer’s share of the investor/producer split because that ensures all other expenses have been paid. If left unclear, the actor might expect a larger cut. Or, if you didn’t clearly define where the points come from in their contract, you could be on the hook for paying that actor a large sum of money.

In any industry, it’s easy to promise investors a piece of the pie you don’t control. It’s crucial to be absolutely clear about what figure your backend payments will come from. It only takes one sour deal to taint your reputation.

Your startup doesn’t have to fail

The majority of startups fail due to the eagerness to be successful too soon. True success takes time. If you see your business exhibit any of the signs in this article, be willing to step in and investigate. Place a hold on your marketing efforts if they’re going nowhere, and don’t spend another dime on marketing until you bring in an expert to help.

Published on: Jun 6, 2019
The opinions expressed here by columnists are their own, not those of
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