I’m getting worried about the effect the unicorn phenomenon in Silicon Valley is having on entrepreneurs around the country. I keep running into young people who have everything they need to launch a successful business but are blowing the opportunity by following the example of companies like Airbnb, Stripe, and Snapchat. They believe that, like those celebrated companies, they can build a business by coming up with a cool idea, raising a ton of money, and generating excitement through the media–all the while focusing only on increasing sales and acquiring users. As for profit, they figure they can worry about it later. How will they do it? “Volume.”
That works for a tiny percentage of startups, but it’s a recipe for failure for the vast majority of entrepreneurs who–no matter how cool their idea–will never have access to the amount of outside capital needed to keep a company going for years if it’s not earning a profit.
I’ll give you the example of a couple of bright and idealistic young people who came to see me a few months ago. Their company sold biodegradable household goods made from renewable materials.
These founders had a wonderful story to tell and had succeeded in raising several hundred thousand dollars, including a loan from the SBA and another from a major national retailer. They’d even turned down one loan of $250,000 because the would-be investor demanded a substantial ownership stake in exchange. They’d also been very successful at getting publicity. Subsequently, they sold 8 percent of the business for $500,000–putting its valuation at $6.25 million.
By the time they came to see me, however, they had already met with a bankruptcy attorney. In addition to having to pay back the loans they’d secured, they owed a lot of money to vendors, and the company simply wasn’t generating anywhere near enough cash to cover its bills, let alone settle its debts. It was dependent on continuing infusions of outside capital to keep going. The partners had identified some potential new investors and were optimistic about raising more money from angels, family, and friends. I asked why they would waste their time with the angels. No savvy investor, I assured them, would put money into their company after taking a look at its balance sheet, which showed massive current liabilities against a small fraction of that amount in current assets. As for family and friends, they were almost certain to lose whatever money they put in.
It was obvious to me what the partners had done wrong. They’d read too many glowing articles about startups with multibillion-dollar valuations. Following the example of those unicorns, they had failed to focus on what should be the first goal of almost every new business: getting as fast as possible to what I call viability–that is, the point at which a company can sustain itself on its own internally generated cash flow. Their company’s gross margins weren’t large enough. Competition set a limit on the prices they could charge, and their costs were higher than they should have been, partly because they were using outside vendors to handle their packing and shipping operations. The company is now out of business.
Understand, these are very smart and ambitious entrepreneurs. I have no doubt they will have a successful business eventually–though not this one, and perhaps not together. I just hope that they, and anyone reading this, will see their failure as an example of the dangers of believing the unicorn hype and applying what has worked for a small number of companies to your own.