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June 15, 2021 12 min read

A Guide to Startup Risks and How to Manage Them

startup risks cover

When anyone talks about startups, one of the first things that gets mentioned is the now-infamous failure rate that’s quoted in just about every tech blog and magazine; the ultimate startup statistic that 90% of them end up failing.

According to the data, 90% of startups fail in general, 75% of VC-funded startups fail, and only 50% of startups will make it past their fifth year of business.

And while these statistics might not be incredibly encouraging, the truth is that—even before the rise of startups—starting your own business has always been a difficult and risky endeavor. What leads so many people to try it is the unique and exhilarating feeling of being your own boss and creating something of your own from the ground up instead of working for someone else.

That’s why the number of new startups continues to grow year after year. Even in the pandemic-stricken year of 2020, venture capital firms gave more money to startups than ever before. Statistics like these prove that startups aren’t doomed to fail and that running one isn’t a reckless gamble. Just like any other business, the success of your startup can be determined by a string of calculated risks that you are going to have to take, most predominantly, in the early stages of your company’s growth.

To be fair, startup risks exist in every phase of growth. However, the early risks are often the ones that get talked about the most because they are the ones that can sink your startup before it even has a chance to take off.

Let’s take an in-depth look at some of the most major startup risks that young companies face and what entrepreneurs can do to try and avoid them or, at the very least, mitigate the damage they can potentially cause.

Unclear Product or Service Goals

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Having a great idea is one thing, but being able to explain exactly how this great idea can be turned into a viable product or service is much easier said than done. What is your product? What problem does it solve? How can you sell it to people? If you can’t give an in-depth answer to these questions to your friends over lunch, don’t expect to be able to sell the product to customers or your idea to investors.

This is the first and biggest risk you will encounter as an entrepreneur. The good news is that it’s a controllable and avoidable risk. What it requires is research. This initial research is incredibly important because if done correctly, it can neutralize a few of the earliest problems and risks that your startup can encounter, one of which is making sure that a market fit for your product or service exists.

Lack of Market Fit

As we’ve already mentioned, being able to establish clear goals for your product is enabled by performing proper market research in order to determine who your potential customers are and how and why they would want to buy what you are selling.

In order to avoid this risk crushing your dreams of entrepreneurship before they’ve even started, you are going to have to perform detailed research in order to confirm a number of things, including but not limited to the following:

  • The existence of market demand
  • A viable route to reach this market
  • How to build this route
  • How much it will cost
  • How much time it will take

According to a CBInsights survey, 42% of startups fail because there was no market need for their product or service. Not all ideas that look good on paper are actually good ideas in the real world. That’s why expansive market research must be performed by every would-be startup even before the company’s first employee is hired.

Another aspect of market fit that needs to be considered is your competition. Is the market already oversaturated? Is there an unexplored niche of the market that you can focus on?

No matter how good your idea is, if the market is already overcrowded and there are a few huge corporations that are dominating it, it’s going to be hard for you to break into the market and find your place within it.

Your best chance of succeeding in an overcrowded market is offering something that is truly completely different (and better) than what the big names are offering. If you believe that your idea is just that, keep it a secret until you’ve launched and patent all of your unique selling points so that the big-name competitors won’t be able to piggyback off your ideas as you put your plan into action.

Growing Too Quickly or Slowly

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Speedy growth is obviously what every startup (and investor) is looking to see, but growth can also be a risk if the timing isn’t right. A startup that grows too quickly could end up losing money due to staffing costs or a lack of market demand. At the same time, growing too slowly will allow your competitors to gain an advantage in momentum and it will also make you less attractive to venture capital firms.

The key to a healthy startup growth plan is heeding your metrics and following the data. Make realistic financial and growth predictions based on your early growth indicators and don’t set unrealistic goals, no matter how ambitious your startup is and how quickly you are growing.

Entrepreneurs will need to take risks if they want to see the kind of growth that VCs expect, but the chances taken still need to be calculated. Growing too quickly or slowly can cost you money, create conflicts within your team, and decrease the quality of the product or service that you’re offering.

Burnout

Early-stage startups are almost always very small, which means that they are usually made up of a small core of team members who all need to wear a number of different hats. Typically, Seed-stage startups are most prone to simply burning themselves out from being overworked and team members being overextended.

This is especially true for the founders, who are usually so deeply invested in the vision and mission of the startup that they feel as if everything will fall apart if they take even one day off to unwind. And even if they do take vacations, they hardly ever fully disconnect.

According to a survey performed by Xero, 85% of small business owners admitted that they worked while they were on vacation. Startup founders need to be incredibly mindful of not burning out in the early stages of growth and understanding that being able to disconnect and come back to work refreshed and with a new perspective can be infinitely more helpful than working themselves into the ground.

What can afford you the opportunity to take time off without worrying about your company collapsing in your absence is making sure that you are surrounding yourself with the right people.

Lack of Proper Mentorship

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Companies that are larger and have received several rounds of VC funding have access to plenty of mentors both on their boards and within their business ecosystem. But how can you find mentors as a young startup?

Networking is a good place to start. Not all entrepreneurs live in startup hubs and big cities like San Francisco or New York, making it harder for some to find people to talk to and experienced business people to get advice from when needed.

Obviously, if you do know people who have experience with building a successful startup, try to establish a relationship with them. Talk about your startup with mentors so that they understand your vision and ask for their advice whenever possible.

If you truly don’t know anyone, it can’t hurt to attend local Small Business Administration meetings and network with people there. You can even use websites like Linkedin to try to establish relationships with experienced business people and pick their brains whenever possible.

Not Having the Right Team in Place

Having a mentor or even a startup incubator that founders can use for advice is obviously a great way to prepare for the journey that lies ahead by bouncing ideas off experienced individuals and communities. However, putting together a great team is what’s going to determine the success of that journey.

Hiring people comes with its own set of challenges and risks. Disagreements over goals and visions, possible employee lawsuits against managers who aren’t conducting themselves properly, even the added salaries and distribution of equity can pose a new set of risks.

However, if you are able to put together a great core team, your chances of success immediately increase significantly. The best way to manage the risks of hiring is by having proper HR and screening processes installed that are going to ensure that you’re hiring the right people. Make sure that your team is made up of people with prior experience and success and that they check all of your boxes when it comes to the type of culture that you’re trying to establish at your startup.

In the early stages of your hiring process, it’s also important to choose team members with a diverse range of skills and people who are able to multitask and contribute in areas that might be a bit outside their fields of expertise.

Finances and Funding

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Whether you’re a tech startup or a small retail business or a restaurant, one of the biggest risks in the early stages of your company’s growth is cash flow. Many small businesses get their Seed funding from family, friends, and business loans and being bootstrapped doesn’t leave you a lot of room to maneuver financially. This means that you have to be very diligent and precise about how you’re spending the little money you have to work with as a young company.

The solution to this is having a very clear financial forecast and making sure that you’re budgeting effectively and making the best of what you have. If possible at this point, it would be great to be able to have an in-house accountant that will be able to take care of the bookkeeping for you in order to make sure that an experienced professional is keeping an eye on your finances while you are busy running the day-to-day operations of your business.

Most startups wrongfully assume that Series A funding can take care of all of their financial woes, but even VC-funded startups can run into the problem of not having enough capital.  Budgeting and careful financial planning in order to determine your runway before you might need to enter the process of pitching your startup to investors again to secure another round of funding to support your growth is absolutely essential.

Security Risks

Every modern business today faces a vast array of security risks, especially those related to cybersecurity and the damage that cybercrimes such as data breaches can do both in terms of your company’s finances and reputation. Whether you’re a law firm or a tech startup, the risks are practically identical in terms of securing your data properly.

Unfortunately, no amount of security measures can guarantee your protection and breaches and attacks will likely occur at some point. Cybercriminals gaining access to your company and customer data via social engineering schemes and malware attacks can cost your company incredible amounts of money; both in terms of what it costs to restore and secure your system after an attack and in terms of the potential lawsuits affected parties could file against your organization.

The best preemptive measures remain educating your staff about security risks and how to spot them while investing in your security infrastructure and team. If your budget doesn’t allow for hiring cybersecurity experts in-house, outsourcing these types of services is highly recommended.

Purchasing insurance is also highly recommended, especially a cyber liability policy. This policy will cover many of the often very steep costs that are associated with cyberattacks and security breaches including legal expenses, notification, public relations, forensic analysis, and more.

Companies that invest in cyber liability insurance are much more likely to survive the financial damage that a serious security breach can cause.

Unforeseen Events and Circumstances

Some of the most difficult risks young businesses face are, unfortunately, completely out of their control. Accidents such as electrical fires or extreme weather can strike at just about any time and cripple your business as a result.

Once again, the best way to protect your business from these risks is by transferring them to a third party via business insurance.

General liability insurance can offer you financial help if a third party is injured on your premises in a freak accident. Commercial property insurance will help you restore or replace property and equipment. A business interruption policy can help your business stay afloat by paying wages, lost revenue, and covering other important expenses if your business is forced to temporarily close down.

Insurers have recognized that these are core policies that provide protection from a number of common risks that businesses can’t really prepare themselves for, which is why most insurers enable businesses to purchase all three of these policies bundled as a Business Owners Policy (BOP), the cost of which depends on a variety of factors related to the size, location, and revenue of your business, among other things.

Legal Risks

Lawsuits against small businesses have been on the rise recently, especially against startups, where there is a lot of capital being invested. Legal risks are especially prominent because they are incredibly diverse.

Compliance challenges exist in any industry, with federal and state regulations always changing. Professional liability claims are also very commonly filed against lawyers, real estate agents, insurance brokers and agents, accountants, and any other providers of professional services.

Today, tech startups especially are prone to being sued if their customers or partners are not happy with the way their products work and professional liability claims against tech startups have been on the rise.

Here’s a rundown of some of the most common things for which startups (and businesses in general) are sued:

  • Employment-related claims: Employees can and will sue your business for a variety of reasons. The most common claims are related to discrimination (gender, religion, age, pregnancy, and more), harassment, wrongful termination, and failure to promote. The insurance policy that will cover costs related to these types of claims is called employment practices liability insurance.
  • Employee injuries: Most states require businesses to purchase workers compensation insurance, which covers costs related to injuries at the workplace, including medical bills, lost wages, rehabilitation, and more. Your chances of being sued by an employee for workplace injuries decrease significantly if you provide them with this type of coverage.
  • Breach of contract: Breach of contract and contract negligence claims are very common for businesses who enter into legal agreements with their partners or customers. Claims of this nature commonly stem from issues such as failing to deliver products or goods, delivering products or goods that don’t work as they should, or failing to make payments according to timelines stipulated in the contract.
  • Slip-and-fall accidents: If a third-party (customer or business associate) slips and falls on your business property and is injured, your business can (and probably will) get sued. While these types of injuries are less common in startups and other office-based businesses, accidents do happen.

Theft and Other Crimes

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According to the US Department of Commerce, businesses cumulatively lose $50 billion a year to employee theft. That doesn’t even take into account other types of crimes that can be committed by both employees and third parties that can cost your business huge sums of money.

All businesses that keep any money or securities on-site or provide access to these funds online in any way are at risk.

Once again, purchasing insurance is the best way to protect yourself, because no amount of security cameras, safeguards, and security protocols are going to keep these types of losses at bay. A commercial crime insurance policy will protect your startup from these types of issues and will reimburse you, as long as the crime is covered by your policy.

The cost of your crime policy will obviously depend on many factors, but most prominently, how much money, equipment, inventory, and property your startup has and the limits of your policy (up to what amount in losses the policy will cover).

If you’re a startup founder and would like assistance in protecting your business from as many of these omnipresent risks as possible by creating an startup insurance program that’s tailored specifically to your startup’s risk profile, feel free to reach out to one of our expert brokers at any time to discuss your options.

 

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