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Why Do Most SaaS Startups Fail?

Updated: Jan 24, 2023

why do most SaaS startups fail

The booming SaaS industry is predicted to increase by 21.2% over the next 4 years. With the barrier to entry at its lowest level and the allure of multi-million dollar acquisitions, SaaS seems like a goldmine for any go-getting entrepreneur with a bright idea.

Much like any other startup business however, the failure rate for SaaS startups is high. An estimated 92% of SaaS companies fail within 3 years despite growth and funding.

So why do most SaaS startups fail?

We take a look at some of the main reasons SaaS startups fail, and how you can avoid them in the early days of building a profitable business.

1. They Fail to Establish Product-Market Fit

SaaS Startups Fail When They Fail to Establish Product-Market Fit

If a startup is floundering, one simple question needs to be asked: Are they trying to fix a problem that doesn’t need solving?

A bad or non-existent product-market fit is one of the main reasons why most SaaS startups fail in their early days. Many founders keep their ideas close to their chest in case their groundbreaking idea is stolen, improved on, and launched before they’ve begun development. This is a risk with any business, but it’s important to start asking your potential customers if your idea is something that they would pay for and use in their day to day lives. A flashy interface with all the bells and whistles isn’t going to mean a thing if it’s not solving a fundamental need or problem.

Start small and take the time to do your groundwork. Ask everyone in your network, or anyone that could be a target customer if your product is something that interests them and would solve a real problem for them.

Is your product a must-have, maybe, or a flat out no? Identifying a real world need for your SaaS startup before you sink time and money into building it is crucial to avoid being another statistic in the startup graveyard.

Once product-market fit has been established, it’s important to develop a deep understanding of your customers so you can:

  1. Identify problems

  2. Improve your product

  3. Uncover customer pains to help match your product to their needs

  4. Generate new ideas

  5. Build lasting relationships

  6. Achieve sustainable growth

Keeping in touch with your customers through surveys, interviews, and phone calls can help you develop a product that’s constantly in touch with the market it serves and the problem it solves. Staying as agile as possible is a key factor in avoiding startup failure.

Without establishing product-market fit early, you risk becoming nothing more than another statistic, serving only to further establish this as one of the top reasons why most SaaS startups fail.

2. They Have Cash Flow Problems

SaaS Startups Fail When They Suffer from Cash flow Problems

To get your SaaS to the point of having a minimal viable product for launch, you’re going to need to sink in some cash upfront. For many companies, it’s tempting to let showmanship take over from getting the basics right. Big money is often spent on branding, fancy offices, and marketing before the product has found its feet. This can cause serious cash flow problems, and at an early stage it can spell disaster. Cash flow problems may be one of the main reasons why most SaaS startups fail, but it doesn’t have to be.

In the initial startup phase, money is better spent on development, road mapping, and design, with budget being allocated for marketing once a solid product-market fit has been established.

A good rule of thumb is to start marketing your product when it’s 90% complete. It’s difficult to successfully market a product that isn’t fully built and keeps shifting direction, features, and functionality. It’s also frustrating for customers who sign up to use a product that keeps changing on them. Money shouldn’t be directed into a marketing budget until you have a product that’s solid, compelling, and ready to wow the world.

In order to keep the cash coming in, founders often give away equity or risk everything with personal guarantees in an attempt to keep everything in motion. This can impact their business later on, or cause serious problems with their personal finances if their startup fails.

Savvy founders are increasingly looking towards revenue-based financing which has less risk attached, and typically a lower overall cost of acquiring capital when compared to traditional equity based financing. This method of financing is also perfect for the SaaS business model, as it takes monthly revenue into account.

For startups struggling with balancing new customer acquisition and churn, this can be a sensible option that helps give startups the cash flow they need for growth without the overbearing pressure of traditional finance solutions.

Whether you’re bootstrapped, financed, or funded, it’s essential to keep your financials under control. Having a clear understanding of all aspects of your revenue and expenses, key metrics, and how they impact your growth will set you on the right path to SaaS survival.

3. They Have More Churn Than Growth

SaaS Startups Fail When They Have More Churn Than Growth

Churn (and how to reduce it) is on the mind of every SaaS startup leader. It’s simple math that if your churn outstrips your customer acquisition you’re in big trouble.

The industry benchmark for average annual churn rate is around 5-7% (0.42-0.58% per month).

If your churn is significantly higher than that, you need to analyze your customer retention strategy and get an action plan together as soon as possible.

Again, keeping in touch with your customers is one of the keys to reducing your churn rate. By making sure they’re happy with your product and they continue to find value in your service, you can look forward to longer customer lifecycles and, in turn, more stable revenue.

4. They Suffer from Poor Management

SaaS Startups Fail When They Suffer from Poor Management

You’ve achieved product-market fit, so you’re going to be fine…right? While you might have nailed your product, it could be your team getting in the way of your success.

Knowing who to hire and when to hire them is a critical part of scaling your startup. The SaaS business model thrives on employees who understand the fast-paced dynamics of the industry and are excited to be part of building something from the ground up. One bad hire at an early stage can damage everything you’ve set out to achieve.

Getting your timing right with hiring is important so your cash flow isn’t tied up and you’re not reliant on raising huge amounts of capital to pay salaries. It’s important that you have a clear roadmap for hiring so you don’t get carried away trying to build a team if your startup isn’t ready for it.

Once you have a team, this can cause problems in itself. Weak sales teams can hinder acquisitions, while poor customer support can leave subscribers frustrated and ready to switch to the competition. Marketing strategists can miss the mark, sinking valuable budget dollars into tactics that have little return on investment. Any hires you make in the startup phase need to be evaluated in great detail to make sure you grow a team with the skills and passion to make your SaaS startup thrive.

While startup failures always point to a few main causes that can most likely be avoided, the temptation to excitedly throw everything you have at your SaaS product can be overwhelming. Resist the temptation to over-finance, sink additional money into your product without doing consumer research, or hire employees you may not actually need.

With patience, diligence, and a clear plan for scaling your business, you can avoid making the mistakes of the failed startups that have gone before you.

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