It’s no secret that most start-ups fail and become painful financial lessons.  I recently wrote about the themes of my past successful ventures (Got some start-up ideas in mind?).  On the opposite side of the equation, I’ve seen some common themes in start-up failures where I’ve had a front row seat as a witness.

Lots of people continue to pursue start-ups.  According to CNN Money, 340 of every 100,000 adults launch a business each month, creating 565,000 start-ups monthly.  Incidentally, immigrants (particularly Latinos) at 560/100,000 people, are almost twice as likely as Americans born in the US to launch their own business.  Learning Spanish is becoming increasingly important (Why we moved to Costa Rica for a year).

While the aggregate statistics are interesting, my perspective below is based on a much smaller world of friends and acquaintances that have started a business.  Typically, this involves making the jump from W2-earning corporate life and partnering with one or more people to pursue a start-up.  In no particular order, here are the most common drivers of failure I’ve observed:

• Legal steps, such as detailed operating agreements are overlooked or delayed.  When I hear someone tell me “it’s not a problem, we are good friends and we’ll get all the legal stuff done later on” or something of that nature, it feels like one of the few times in my life when I can really predict the future.  Spend the time and the money on professional advice, as it will protect the business and the friendship.

• The business is based on a personal passion with no real understanding of the economic engine or the practical implications of running the business.  Not to be confused with passion plus capability plus a good business model, which is a great combination.

• The focus is on a remote probability business (albeit with a potentially large payoff).  When the overwhelming majority of your success is out of your control that is a hard business.  When you are trying to create demand vs. fill demand that is a hard business.

• The cash flow is not managed or even worse, not really understood.  To say “cash is king” is a “master of the obvious” type statement, but it’s amazing how many people get into a business and don’t understand it, or for that matter, the differences between gross and net sales, gross and variable and net margins, etc.  If you (or your partners) don’t understand these concepts from some level of experiential knowledge, be careful throwing money into a start-up.

• The exit options (I.e., beyond annual salary and/or distributions, how do you monetize this thing at some point via a sale or public offering) are not considered at the outset or actively managed along the lifespan of the business.  When you are simply ready for a new challenge, or there is a business downturn or a bump elsewhere in your personal life, if you haven’t already determined how to exit, it won’t happen.  As coach John Wooden said, “When opportunity (or presumably tragedy) comes, it’s too late to prepare.”

What are the most common (and possibly avoidable) reasons for start-up failures you’ve observed first-hand or experienced first-hand? 

What might be just as sad as a start-up failure is a great start-up idea that simply dies a dream.  Most of the conversations I’ve had with friends and acquaintances regarding potential start-ups land in this scenario.  More thoughts on the reasons for this in a later entry.