The Top 4 Startup Risks
Early-stage startups and founders face a particular set of risks as they try to grow and build companies built to last. There are four main areas of risk exposure: team, product, financial, and legal.
There are four main areas of risk exposure: team, product, financial, and legal.
In fact, according to CB Insights, when it comes to startup failure, 23% of startups fail because they didn’t have the right team, 18% for pricing and cost issues, 17% for products that weren’t user-friendly, and 8% because of legal issues. But how is your startup uniquely at risk, and what can you do to take a proactive approach to risk management while promoting trust in your company and brand?
While there are many unique challenges that startups face, startup success is often achieved by founders who plan for the worst case scenario, are transparent, do their financial and legal due diligence, and take decisive action to stay ahead of the curve.
As a recent TechCrunch article put it, “Let’s be honest: Most startups fail... That doesn’t mean no one should build a startup, or pursue their passions and dreams. When success happens, we like to talk about it, report on it and try to explain why it happens — because ultimately, more entrepreneurial success is good for all of us and helps to drive progress in our world.”
In this piece, we’ll look at the top four startup liabilities, and hear from experts in each area of risk management to find out: what can founders do to mitigate their risks and take their companies to the next level?
It starts with the right team
Moses Balian, SPHR, is a HR Consulting Manager at Justworks, the nation’s fastest-growing HR tech company providing access to corporate-level benefits, payroll, compliance and HR support to the small and mid-size business community. When describing the approach that founders should take when it comes to making their first hires and building out their teams, Balian says, “Early stage companies need to identify candidates with a penchant for learning. For example, candidates who went to liberal arts schools, where their education emphasized a global mindset and interdisciplinary thinking, have developed adaptability — which is more important than expertise and technical know-how.”
Balian goes on to explain that, when hiring for leadership positions, it’s essential that candidates demonstrate the fledgling company’s core values. Founders should set aside some time to decide what these values will be. For example, will you encourage a collaborative culture that celebrates teamwork over one that emphasizes and rewards individual accomplishment? Building a team that demonstrates a consistent set of values will preempt attrition down the road.
Balian says, “Look for listeners and thinkers who can blossom into doers. It’s easier to train a thinker to do than the other way around.”
“Look for listeners and thinkers who can blossom into doers. It’s easier to train a thinker to do than the other way around.”
After founders have made their first few hires, Balian recommends working with an HR consultant or HR professional to help draft up company-wide policies, codes of conduct and communication, ADA accommodations, and a general HR handbook to guide employees and managers alike on their behavior.
Balian also advocates for drafting a “crystal-clear anti-harassment policy and complaint procedure” so that employees know how to file a complaint, the company responds in a manner where team members feel heard, team leaders are trained on taking appropriate action, and startups can meet state and nationwide compliance standards. By taking these actions, startup founders set their teams up for success and safeguard their company against compliance risks.
Stand by your products, stand by your customers, and stand by your mistakes
Beyond mitigating your team risk, tech startups face numerous vulnerabilities when it comes to developing their product. Rajat Kongovi is the Chief Product Officer at Vouch insurance, business insurance for top startups, and he noted that as our workforce becomes more distributed, tech companies are facing more cyber security threats and attacks than ever before.
Kongovi says, “As your startup gains traction, a cyber security attack can not only harm your customers, but also wreck your brand and consumer confidence in your product.”
Additionally, if your product causes downtime or a financial loss for your customer, your company can be financially liable for any damages you may have caused. “When your business becomes a part of a critical workflow function of a customer, or critical revenue generator, someone's business depends on your business to function. There are real dollars at stake. If you can’t maintain your uptime, your customer is going to your competitor.”
To mitigate product risks and best communicate if there’s an issue with your product to your customers, Kongovi recommends building customer trust by owning your mistakes. He elaborates, “Law treats people kinder if they are forthcoming, and the market treats those players better too. How you communicate and how quickly and proactively you do it is important.”
“How you communicate and how quickly and proactively you do it is important.”
In terms of mitigating product risks, Kongovi says: “It comes down to three things: people, process, and systems. Hire people that do the right thing when no one is looking, and have processes and systems in place that alert the right people if an error is detected. Once your company is the right size, you can invest in a disaster recovery playbook should the worse case scenario occur.”
Proactive planning and transparency with customers and governing entities can go a long way in terms of mitigating your product risks for your company.
Actively managing your startup’s finances helps you successfully manage your startup
Similarly, when it comes to preventing financial risk exposure, planning ahead is instrumental to startup success. Steven Lord leads Burkland's New York office and FinTech practice, and he says that while due diligence is important for startups, that doesn’t mean the same thing for every startup founder. “Due diligence is a loaded term. But from an operations perspective, doing your due diligence often comes down to having the right policies, procedures, and paperwork in place.”
Common issues and questions founders often ask Lord include: when do I need to file my biennial statement? When are taxes due? Are we set up to process employee payroll? What should I report to investors, and when?”
Lord says, “My advice is to get ahead of it: set it up early because it’s very expensive to do after the fact. By partnering with CFO and accounting services, founders can take care of all their financial basics like: who is going to do what, and when? All of these administrative tasks are often not top of mind, but you need to make sure all of these boxes have been checked so that you’re not facing costly litigation, fines, or back taxes in the future.”
“My advice is to get ahead of it: set it up early because it’s very expensive to do after the fact.”
In terms of helping startups manage their financial risks, Lord says that depending on a startup’s business model, where they’re located, and where their employees are distributed, each company may have a unique set of risks. With regards to limiting financial risk exposure and planning for years ahead, Lord explains, “Most CFOs are mapping out ‘what ifs,’ for example: what if covid has shifted the ground beneath us and consumption is different? How can your company pivot? We are saying to clients: if you want a plan to understand the next twelve months, you have to game-out several scenarios, and what are we going to do and how are we going to respond? Business planning is really important.”
“...you have to game-out several scenarios, and what are we going to do and how are we going to respond?”
A combination of instituting the right financial policies, procedures, and paperwork can prevent founders from facing financial risk exposure, and help startups be in the best position possible in regards to addressing the financial challenges in the years ahead.
A good contract can prevent good startups from going under
Beyond team, product, and financial risks, startup founders also face a high level of legal risk. Whether this comes down to protecting intellectual property or trade secrets, it’s helpful for startups to work with attorneys to create and review contracts to protect themselves in the future.
Joe Schmitt is an attorney at Nilan Johnson Lewis, a law firm that specializes in labor, employment, and business law. Schmitt says that one of the biggest threats to startups is theft of intellectual property (IP). “Issues regarding loss of IP can happen by data being taken or loss of key personnel. For example, without that startup having protections in place, they can't prevent that person from starting a competitive startup.”
“Issues regarding loss of IP can happen by data being taken or loss of key personnel.”
In the case of protecting intellectual property, Schmitt recommends having a robust effort to protect IP through agreements and virtual security. Another common legal pain point is around material contract problems. “Every startup has particular entities to contract with, from contractors to vendors. Oftentimes the startup doesn’t have the ability to end up in a contractual battle, as it is too costly or time intensive to fight. So from a contractual perspective, you need to implement and carefully review these documents and have an understanding of what they mean.”
To protect your startup, Schmitt recommends the following: “Non competition clauses are important to incorporate into key strategic partners and vendors, and you need to familiarize yourself with the laws regarding non competition clauses in each state, because state laws differ widely in this area. Founders need to make sure that in each agreement there is a provision that says who owns the IP and what can be done with it.”
“Non competition clauses are important to incorporate into key strategic partners and vendors...”
With the right protections, contracts, and agreements in place, startups can prevent the theft of IP or future disputes from occurring, and mitigate their legal risks.
As startups grow, so does their amount of risk exposure. However, hiring the best people for your startup, investing in proper planning and detailed documentation can help startup founders get ahead of the risk curve.
When founders do their due diligence and take a proactive approach to ensure that their business is compliant, they are simultaneously building trust in their employees and customers, and building a brand that is set up for success.
Interested in finding out more about the risk exposure your startup is facing? Take Vouch’s Risk Assessment Quiz to learn more about how you can manage your risks.
Burkland provides expert CFO services, accounting services, and tax services to startups across the United States. Reach out to us to learn more about how we can help your startup or portfolio company.