Major risks when starting a startup

There are four major risks when starting a startup, entering a new market, or developing a new product:

  • technology risk — can you build it?
  • market risk — does anyone want to buy it?
  • distribution risk — how can you reach the people who want to buy it?
  • financial risk — do you have the money to do it?

The first two are addressed directly by YC’s famous "write code and talk to people": Write (prototype/MVP) code, talk to potential users, and achieve a virtuous loop of "build, launch, learn." At the earliest stages, the goal is not to build a smooth-running machine but to experiment and find out what works and what sells.

Financial risk is addressed by two popular modes: VC-funded (the vast majority of startups you hear about) and bootstrapped. In both cases, the amount of runway (time left until your funding runs out) is a good measurement of the risk. Simplified: If you’ve only got a few months left, your financial risk is high. If you’re in the black, your financial risk is low.

Distribution risk (or marketing risk) is sometimes overlooked due to the "build it and they will come" fallacy and sometimes confused with market risk (you think nobody wants your product when, in fact, nobody knows about it). In many areas, the market is super-saturated, and it’s very hard to stand out.

Of course, the risks are not independent. The financial risk depends on how much you spend, which depends on what you need to build and how you're marketing it. What you need to build depends on what the market wants, and so on.

Successfully getting your startup off the ground means identifying, reducing, and balancing these interdependent risks.

Technology Risk

Technical risk is usually low for technical founders, as they have a pretty good sense of what can be built, even if they're not sure about the timelines and details. For non-technical founders, the risk is twofold:

  • Can they find a strong technical team to build out their vision?
  • Are they over-promising and underestimating the technical challenges in building the project?

Wanting to stand out from the crowd, non-technical founders can set their goals high, overpromise, hype them up to the max, and as a result are virtually guaranteed to underdeliver and disappoint. Even if the actual product is solid, if it doesn't meet expectations, it will be viewed as a failure.

Strong in-house technical talent and the willingness to listen is a good way to mitigate this risk, as is having outside advisors who can provide a reality check.

A related risk for both technical and non-technical founders is the quality of the implementation. Technical founders often try to build the best product — in terms of tech, code, architecture, and so on — that they can. This takes up a lot of time, slows down the iteration cycle, and can lead to a product that's over-engineered and hard to change. On the other hand, non-technical founders often push in another direction, which can lead to unreliable, buggy, or slow products with too much technical debt, again slowing down the iteration cycle and making it hard to change.

The main challenges in addressing technical risks are:

  • Having a well-rounded team;
  • Understanding the technical challenges and requirements; and
  • Finding the right balance between speed of execution and codebase health.

Market Risk

It’s easy to build dream castles in the sky. Founders have a brilliant idea, brainstorm, flesh it out, and can't wait to unleash it on the world. Maybe they ask their friends, "This is a great idea, right? Right?" or use some MVP validation SaaS to get validated by random commentators. Then they spend 10 months building their beefed-up Minimum Viable Product (MVP).

Once it’s out, they’re shocked to find that nobody wants it. All their marketing efforts fizzle out as users check out the product but don’t stick. They stay at it for a few more months, trying to tweak it and build more features they think will attract users, but churn remains ultra-high, and the product gains no traction. A year later, they’re out of money, out of ideas, and out of the game.

This is invariably what happens if founders don’t talk to their (potential, future, current, or past) users early and often. Sometimes you can start even before spending time and money on the product: for example, with a launch page or a slide deck to show to people. The important thing is that it gets you actionable and real insights (see below).

The core iteration loop, taken directly from Lean Startup, is:

  • Build
  • Launch and get feedback
  • Learn and adapt

The faster you can get this loop running, the more metrics and feedback you’ll get, the faster you’ll learn, and the better your product will be.

It’s also important how you talk to them, as the feedback you get is only as good as the questions you ask. If you ask leading questions, you’ll get the answers you want to hear, not the answers you need to hear.

If you’re just starting and validating your startup idea, The Mom Test is a must-read. It’s poorly named (evoking every self-help-style book out there) but chock-full of specific, actionable advice on how to talk to potential customers and get real feedback.

If you’ve already launched, do your potential customers "get it"? It’s not a matter of luck or brute-force marketing. You need to be aware of how people perceive your product (who it’s for, what it does, etc.) and how to adjust so their perception matches your reality. Obviously Awesome covers this in great detail. While geared towards larger companies, the principles can be applied at any stage.

Distribution Risk

Distribution is getting your product in front of the people who want to buy it. At the earliest stages, founders seek out their first users through personal networks or by engaging on social media, forums, meetups, and other places where those users hang out.

It is a slow, non-scalable process and a huge time sink, but it’s the only way to get the feedback required to build a product people will actually use. At this stage, you’re not looking for growth — you’re looking for feedback.

As you learn more about your product and target customer and develop a product that people actually want to use, it’s time to get more strategic about distribution. For B2B startups, this means figuring out the kind of companies to target (size and industry), who the decision-maker is (they’re not always the same person), how to reach them (marketing channels), and how to convince them to buy (sales).

Some great resources at this stage are Traction and Lenny Rachitsky’s newsletter.

A common mistake here is to equate "marketing" with "advertising" and "sales" with "having a sales team." Advertising is just one of many marketing channels, and a poor one for early-stage startups. Likewise, sales at early-stage startups is the founder’s job (commonly called founder-led sales) — you can’t delegate that to a separate team.

A typical strategy for an app or SaaS product is to start with product-led growth (users find, try, and learn about your product themselves and buy it if it fits their needs), targeting individual users (bottom-up) at very small, small, or medium-sized businesses (SMBs). These users are usually early adopters and can buy your product without a lengthy sales process.

The opposite end of the spectrum is enterprise sale (top-down), where you target large companies and need a lengthy, high-touch sales process to close a deal. This is usually not optimal for startups as it's slower and more expensive, but for certain domains it's the only viable strategy.

Five Ways to Build a $100M Business has a great comparison of these strategies.

Financial Risk

Creating a product and starting a company takes time and money. A startup can be bootstrapped (funded by the founders) or VC-backed (funded by outside investors). Bootstrapped vs. VC-backed turns out to be a major decision that affects the company’s trajectory, culture, and goals:

  • Bootstrapped companies are usually more focused on profitability than size. They grow more slowly and place more emphasis on flexibility, work-life balance, and sustainability.
  • VC-backed companies are usually more focused on growth and market domination. They try to move as fast as possible and are willing to spend a lot of money to get there.

In both cases, an external (to the startup) source of money is required to fund the startup until it reaches "ramen profitability": the point where the startup is "in the black" (i.e., the revenue covers its expenses, including founder salaries). Until this point, the startup is burning money, and the amount of time it has left (money in the bank ÷ monthly burn rate) is called the runway.

The financial risk is that the money runs out before the startup reaches profitability. This can happen for several reasons:

  • The startup is spending too much money (burn rate is too high).
  • The startup is not growing fast enough (revenue is too low).
  • The startup is not able to raise more money (investors are not interested, or the founder’s savings are exhausted in the case of bootstrapping).

In general, the common advice is to keep the burn rate as low as possible without sacrificing growth. This includes keeping the team small. You want to optimize for a small, extremely productive team and hire carefully. This is hard to do for VC-backed companies, as they’re under pressure to grow fast. However, growing too fast in terms of headcount can easily slow down the company while making it more expensive to run, which can be fatal.